Property Buyer's Equation

Learn how to pick a property investment winner!

by Paul Maraia

 

 

If you’re looking to invest in property you’re probably asking yourself the same types of questions we all do. Should I buy close to the city or further out? A two bedroom unit or 4 bedroom house? Should I buy new or old? And which choices are going to net the greatest financial result?

The concept of buying property seems fairly straightforward. You set a budget and then begin searching for the best value property you can find. But is it really that simple? The complexity begins when you have to make choices around which property attributes to favour at the sacrifice of others. Do you buy the large property 15kms from the CBD or a smaller property only 5kms out? Both properties are the same price however which one will deliver the better long term investment result?

To help guide you through these buying decisions we’ve created a framework known as the Property Buyer’s Equation. On one side of the equation lives price, whilst on the other side lives the three main property attributes that determine the quality of an investment, they are Dwelling, Location and Land Content.

The buyer’s equation is expressed as:

PRICE = DWELLING + LOCATION + LAND CONTENT

 

As with all equations they must remain balanced on both sides. For the majority of property investors the capability to borrow funds is finite limiting the maximum purchase price. With a consistent price the decision to favour either the dwelling, location or land content will have an opposing effect on one or both of the other attributes. This change and effect relationship between these factors is expressed as a change in the buyer’s equation.     

To get a good understanding of how the equation works let’s first take a look at the property attributes.

Dwelling attributes include the type (unit, house, townhouse etc.), configuration (number of bedrooms, bathrooms etc.), age, size and quality of the physical dwelling. Dwelling does not relate to the land in anyway, just the structure that is built on the land. Intuitively dwellings that are larger, newer and of higher quality are more expensive to build, incur a higher price and have a higher rental appeal. Like most physical assets a dwelling has a finite life span before it needs to be replaced. For this reason a dwelling is considered a depreciable asset as it loses value over time.

Location refers to the geographical attributes of the property. Typically land that is closer to the CBD is more expensive as the closer the proximity the more densely populated it becomes. With high density comes higher demand for the limited supply of land which puts upwards pressure on prices. Comparatively land that is a further distance from the CBD is less scare and reflected in a lower value. In addition to the property’s proximity to the CBD, location also encompasses the property’s adjacency to other factors such as main roads, power lines, commercial buildings, transport hubs and social amenities which can influence a property’s overall value and appeal. Decisions around location also incorporate the micro and macro-economic factors that will influence the performance of your investment.  If you’re wondering whether your investment will be a winner it’s worth bearing in mind that 80% of investment success is born from selecting the right location.

Land Content refers to the value of the land as a proportion of the overall value of the property. For example an inner city property worth $800,000 with land value of $600,000 has 75% land content. In contrast a new build in the outer suburbs worth $500,000 with land value of $200,000 has 40% land content. It’s important to remember that units and apartments also have land content. Consider a block of 10 units built on land worth $2,000,000. Each unit is attributed with 1/10 or $200,000 in land value. When considering the long term growth potential of your next investment its worth remembering that land appreciates in value whilst the dwelling depreciates.  

Let’s explore the relationship between these property attributes to understand how it effects your buying decisions.

 

Scenario 1:    PRICE = DWELLING (favour) + LOCATION (compromise) + LAND CONTENT (compromise)

In this scenario an investor favours the dwelling over the other 2 property attributes. Assuming a moderate purchase price the investor would likely have to compromise on location by expanding their search area further from the CBD, reducing land value to cater for a more expensive dwelling. This decision would typically result in a larger average land size but lower land content. Alternatively the investor may decide not to compromise on location and instead choose a much smaller parcel of land closer to the city resulting in lower land content. Given that land appreciates in value and the dwelling depreciates, thought needs to be given to heavily weighting your investment decision in favour of the dwelling.

 

Scenario 2:    PRICE = DWELLING (compromise) + LOCATION (favour) + LAND CONTENT (may favour or compromise )

In this scenario an investor favours the location over the other 2 attributes. Assuming a consistent purchase price the closer the proximity to the CBD a compromise in the dwelling attributes is typically realised. An investor weighted towards this strategy is making decisions like whether a high quality unit close to the CBD is a better investment than a small, low quality house in a similar location. A unit may carry a higher yield but is likely to have higher holding costs (such as body corporate fees), experience a lower rate of growth and have a lower land content. A smaller house close to the CBD may have stronger land content however the rental appeal and maintenance of an old house can make this type of an investment more of a challenge.  

 

Scenario 3:    PRICE = DWELLING (compromise) + LOCATION (favour or compromise) + LAND CONTENT (favour)

In this scenario an investor favours a high land content over the other 2 attributes. For a given purchase price, as land content increases generally the dwelling quality takes a tumble regardless of where the property is located. The challenge with this strategy is rental appeal. Finding tenants for less desirable properties often results in lower yields and higher maintenance costs. This investment strategy however is common amongst investors who are keen to renovate in order to improve the quality of their asset.

Finding the correct balance between these three property attributes is a critical part of your property acquisition strategy. Planning your property investment journey and understanding which properties will compliment your portfolio, is fundamental to building future wealth and passive income through property investment.

If you have any questions regarding your property investment strategy or would like advice on growing your property portfolio send us a message or join the conversation in our Facebook community Property Investing Chat Group

 

Happy Investing!

 

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Information contained in this article is of a general nature only and does not take into account the individual circumstances, objectives, financial situation or needs of any individual person. This information does not constitute financial, legal or investment advice or recommendations (expressed or implied) and should not be used as an invitation to take up any investments or investment services. No investment decision or activity should be undertaken on the basis of this information without first seeking qualified professional advice. Zuu Property Pty Ltd, its employees or contractors do not represent or guarantee that the information is accurate or free from errors or omissions and therefore provide no warranties or guarantees. Zuu Property Pty Ltd accepts no liability or responsibility for any reliance on investment decisions, claiming the use or guidance of this publication or information contained within it. Copyright Zuu Property Pty Ltd 2018