Why Chasing Capital Growth Means Planning to Fail

I wrote an article entitled “Is There Such Thing Called A-Grade Properties?“. Basically, the premise of the article was centred around comparing the capital growth of A-Grade properties (ie. the ones which people believe have huge capital growth, those ones close to CBD and water) vs B-Grade properties (ie. the opposite, basically). If you have not had a chance to read, I strongly suggest you do because what we found through our research, long term ie. 10-15 years+, the B-Grade properties still also increase by as much as the A-Grades.

What makes the huge difference however, is the holding cost. All of the A-Grade properties are obviously very expensive. Based on our data, in WA, they’re at least in the $800K+. In Sydney and Melbourne, they are easily in $1.5m+ range. Their rental yield is really-really small. We’re talking gross 3% and lower. I mean, put it this way. How much do you think you can afford renting a house in front of the ocean for? Would you be willing to pay $1000/week? $1000/week is a lot of money. That equates to $4000/month = $48,000/year just on rent alone!

And you have to fork this money out of your after-tax dollars. Well, if you earn so much money then it’s a different story. However, for the majority of the population, this doesn’t seem to be an affordable approach. The problem is, if you’re somehow the owner of that $2mil property, and you have 80% mortgage, and yet, you can’t earn that much rental income, straight away, you’re in the red. Your cashflow will always be negative, big time! All you need to do is to own 1-2 of this kind of properties and you’ll send yourself into mortgage stress.

This is why we never suggest this kind of approach in property investment. If you’re chasing for capital growth alone, you would always lose. It has been proven over and over again as being a very risky strategy. We call it, “The Evil of Investing”:

When price goes up, you don’t sell hoping it will go up even further. When it goes down, you still don’t sell hoping it might recover. In the end, you’ll lose it all.

It is harder for price to go up than to go down. For example:

If price goes down by $50,000 from a $500,000 property, it means 10% decrease. However, for a $450,000 property to go up by $50,000, it requires 11.1% increase.

Therefore, you would lose money faster than gaining it should price go down.

We know people who purchased a land for $2.2mil that became $11mil in 15 years time. The thing is, so did the B-Grade suburbs. If what you’re chasing is capital growth, then you need to be thinking long term. And when you look at long term, ALL suburbs grow at the same pace!

So, if from the beginning you’re already in it for the long haul, why would you ever buy expensive properties as an investment in the first place?

For us, our strategy is simple. Investment properties should not be more than $500,000, unless the rental yield can justify it. If the gross rental yield is less than 5%, we’re not even considering it. It’s that simple.

As of the writing of this article, interest rate is at the lowest in Australia. What happens to those owning $1mil+ investment properties when interest rate goes up? Like we said earlier, if you have paid off the chunk of the mortgage and you only have 50% LVR, then good on you. For the rest of the people who are not in that situation, they’re only in it for the stress!

With property price goes down all over the country, they can’t sell their properties nor getting a refinance. The only thing they can do at the moment is to hope that they have enough money power to hold onto their properties. Hopefully their job is secure which from what we’ve seen, in a downturn market, is not likely the case.

And, we also don’t know how long before price goes up to what it was before so that they can let the properties go. Furthermore, they also have to consider the holding cost during the period, that negative cashflow that needs to be factored in into the purchase price.

So, ladies and gentlemen….as much as we would like to support capital growth, this has now become a thing in the past for us. Number one rule is BUY RIGHT + CASHFLOW. Then, we can consider capital growth next.

Positive Cashflow is the only investing strategy we’ve seen so far that can ride through the storm.