28 Mar Perfecting the ‘dud property’ detector – Michael Yardney
As with any investment, real estate has its good, bad and average performing assets and if you’re not careful, you could easily end up with a property investment lemon. Today Michael Yardney gives us the key questions to ask to detect a ‘dud’ and what to do about it.
Kevin: If you’re a regular listener to the show, you’ll know that we talk all the time about having a strategy. But when can the strategy go wrong? Sometimes it does, sometimes you end up with a property in your portfolio that you don’t want to hold onto any longer. So how do you find out when you’ve got a dud, and then what do you do about it? When to sell, and when to hold a property? That’s the question I’m going to pose this week of Michael Yardney from Metropole Property Strategists.
Michael: Good morning, Kevin.
Kevin: No doubt you’ve come across this in your own portfolio.
Michael: I’ve come across it in my own portfolio, and definitely with lots of our clients, Kevin. It is a difficult question because there is so much time, effort, and money involved in buying, and emotion as well, that sometimes it’s hard to look at it subjectively. It’s something one has to do, though.
Kevin: Yes, indeed. What are some of the questions that you ask yourself or you get your clients to ask themselves to determine whether or not it’s a dud and what they should do about it?
Michael: A good question you should ask yourself is: is my property performing like I expected it to? Because that goes back to what you said in the beginning; you actually have to have a strategy, you have to have some expectations.
The next question I’d ask is: is the property outperforming the market? Maybe it’s just a lull in the market. In certain markets – in Western Australia, in Perth, for example – you probably wouldn’t have performed well because the general market is not doing well. But it doesn’t necessarily mean you have to sell up. So, how is it performing compared to the rest of the market?
The third question I’d ask myself is: if this property was on the market today, would I buy it again? I like asking: knowing what I know now, would I buy that same property?
I’d also then look at: is there anything I can do to improve my property’s return, maybe to make it more attractive?
And the last question I’d ask is: is this property likely to outperform in the long term? In other words, is there an opportunity cost in holding this property compared to something else? These questions are going to make sure that you own the right property, Kevin.
Kevin: Looking at those last couple of questions, I want to look in detail at probably three, four, and five, but four and five, even if you do do something to improve it, number five – which is “Is it going to outperform the market?” – that’s probably the ultimate question, isn’t it?
Michael: It is. In general, the performance of your property is going to be 80% related to its location and maybe 20% or so to the property itself. If you bought in the wrong location, in one of those isn’t going to do well in the long term – in other words, not in a capital city or not in the right locations in a capital city – it’s just going to be too hard in the long term, no matter how much you tart it up, pretty it up, what value you add, because that’ll give you a one-off improvement, but “Is it going to do well in the long term?” is a question I ask myself.
Kevin: I said at the outset that we all make mistakes. In your experience, Michael, what are the things that make a property underperform?
Michael: There are a couple of things. First of all, there’s timing – buying at the wrong time in the cycle or just holding it at the wrong time in the cycle. We know that every ten years or so – not that the cycle is exactly ten years – there are going to be three or four years when the market is flat, there will be a year or two when all properties drop a little bit in value, and then there will be a period of time when things go really well. So, is it the time in the cycle? If that’s the case, don’t worry, because if you have an investment-grade property, it’ll do okay.
Maybe it has underperformed because you paid too much, and that may mean you’re likely to have a few years of no capital growth. But again, if it’s the right location and the right property, it’s a one-off cost but you have yourself a good property.
As I said right at the beginning, the location is the most important. Some suburbs will underperform and others will do better – and they’re the ones you should be owning.
And then is it the property itself? Have you just chosen the wrong sort of property? Maybe one that doesn’t fit the location or one that just doesn’t have the attributes that make it investment-grade, Kevin.
Kevin: We said in the outset about having a plan, a strategy. That’s so important. But another big mistake is if you have a plan and you find there’s something not quite right, not taking any action, not doing anything about it.
Michael: What I commonly hear people say is “It’s not costing me anything; the cash flow is covering the mortgage.” And while it may not be costing you in cash flow, if you didn’t own a good property in the last couple of years, you’ve missed out on some of the best markets we’ve ever experienced in Melbourne or Sydney, so there’s a huge opportunity cost.
I explain it this way to clients. I say, “Do you own a business?” – because remember, property investment is like a business – and many of them do. I say, “Well, imagine if you did, and imagine if you had an employee and they came late to work, they played on Twitter and Facebook all day, and they went to lunch and came back and didn’t see the customers or the clients, what would you do?” They’d say, “We’d sack them.” And I’d say, “You probably have to do a performance review first because that’s what industrial relations requires.”
And this is what we’re doing with your portfolio, your property business. We’re doing a performance review. And if you can’t improve its performance, then what I would do is I would sack them. And you know, sometimes you have to pay a redundancy package.
And then the clients get it, Kevin. Because I say, “You pay a redundancy package, get rid of your bad employee, so that in the future you have a better employee who’s going to work even harder for you and make more money.” Then the penny drops.
Kevin: That’s a great point, and a great way to describe it too.
So we’ve made the decision, we’re going to sell this lemon, this dud property. But what if it’s the wrong time to sell?
Michael: Again, it’s all related to opportunity costs. That’s why I was saying that there’s a redundancy package in some ways. Yes, there will be some losses that you crystalize, some selling costs or some opportunity costs, but if you have a dud property and it’s not a good time today, when the market improves, in general what will happen is the investment-grade properties, the better properties will outperform your dud property, and the gap will only widen. So it never seems to get much better.
It’s a difficult decision to make. Sometimes you just have to bite the bullet and move on, Kevin.
Kevin: Yes. Great comment, Michael. Thank you so much for your time. Michael Yardney from Metropole Property Strategists.
Thanks for your time, Michael.
Michael: My pleasure, Kevin.