Possibly every first-time property investor has asked me this question.
Understandably, if you’re making the call to buy an investment property, you’re comfortable with exceedingly large amounts of debt and taking a risk, for the promise of return down the line.
If you’ve read the article on the MRTMAD method and tomorrow’s you, then you’ll be comfortable with the fact that in order to accomplish something financially, there are often several opposing paradigms. We’ve observed in our business with our clients (with 1-3 rental properties), that success with property investment often occurs in environments that conflict with the traditional view on what makes a good property investment.
The traditional view of what makes a good investment property is this:
1 – Purchase cashflow positive properties.
It’s entirely appropriate to own cashflow properties (where the rental income more than covers the interest and other holding costs). It makes sense when you’re in need of income (like in retirement) and growing your base of wealth is no longer the objective. There is, however, a negative correlation in most cases, between cashflow positive properties, and prospects of strong capital gains.
2 – Purchase in up and coming areas.
This fits very nicely with the natural human tendencies to ‘get a bargain’. In most cases, people who are in a position to purchase in an up and coming area, already own a property in an ‘already and established’ area. Getting a bargain leads to taking a risk here – buying in an area which has not yet experienced good growth, means there’s a likelihood the gains in value may not occur.
3 – Purchase using a financial paradigm.
Makes sense not to get emotionally involved as you’re not going to be living in it right? Well, what if something doesn’t work out according to the plan (no significant capital gains, change in your personal circumstances etc). Using a financial paradigm usually also involves tax considerations…which can change.
The Blue Chip Method (BCM)- an alternative strategy.
1 – Buy in the same area that you live in.
IF you own a home in a good area (and most BCM property investors do), then buy your first rental property in your own area, or one just like it. If you can’t purchase in your own area, pick another good area – Chances are, you’ll end up attracting tenants who are just like you too – perfect!.
2 – Purchase blue-chip properties.
Properties that are ‘blue chip’, are known to weather market downturns, which helps to contribute to their long record of stable and reliable growth. Buy something that’s already proven instead of taking a risk on properties that ‘may be the next best area’.
3 – Capital gains when you’re young, cash flow when you’re old.
A block of three flats in Te Kuiti could be a great place to park $750k – the rental income as a percentage of the money invested would be relatively high and could fund your retirement quite nicely. If you’re trying to grow your wee bit of wealth, however, purchase properties that are voted most likely to succeed, in value.
4 – Have multiple purposes.
Buying a rental property for the sole purpose of getting passive positive income is a trap. It’s a trap because if it fails on that basis, you’ve just taken that risk for no return at all. When shopping for a rental property think: Could I live in this property if I had to? Could one of my kids live in the property whilst studying or could they purchase this property as their first home? Could this be a property that we live in when the family home is eventually sold?
If you’re young (like less than 50 young), chances are you have a personal income stream that will take you around 15 years down the road. It’s not long, but it’s actually long enough to still build some wealth through property. Purchasing rental properties that are cashflow positive in most cases equates to properties that don’t grow in value as much.
Cashflow positive properties are great in retirement, but they make very poor building blocks, as often it takes twice as long for them to grow in value. Most property investors who’ve done well, have started off with properties that have grown well in value relatively quickly, which they then leveraged off of to purchase further properties.
The BCM method is perfect for the mum and dad homeowner, who are looking to purchase perhaps 1-3 rental properties. They have good disposable income and are keen to ensure their existing base of wealth is amplified over the period of time they have good personal income. At the time of retirement, the option exists to sell one or two to their kids, sell one in the open market to repay debt, or sell the whole lot and cruise around the world!
