• 04 Jun 2024
How to determine a property’s investment potential

Buying a property for investment purposes is a different prospect to purchasing the dream family home, and addressing key parameters will help ensure financial success.

Australian property investment has long been recognised as a lucrative venture.

The success of a property investment, however, largely hinges on how thoroughly you perform your due diligence and whether you understand what to look for when assessing a property’s investment potential.

There are a lot of factors that need to be determined to ascertain whether a property is going to lead to financial prosperity.

Here, we will break down how successful property investors look for potential.

Determine your real estate investment strategy

You need to put yourself first.

How can you find the right property, if you don’t really know what you are looking for?

The most important thing when buying an investment property and assessing whether it’s potential is to fully understand your strategy.

Start by thinking about what goals you want to achieve and what you want this property to do for you.

Having a clear mindset on what you are looking for is the key to finding investments that will help achieve those goals.

Define your objectives and whether you are looking for capital growth, cash flow, high rental yields, positive gearing, equity creation or a combination.

Your personal situation will influence this, in correlation with your level of risk tolerance. Strategy is based on how quickly you want to see gains, whether it’s short-term gains or long-term wealth creation.

If you carefully plan and align this strategy with financial goals and market conditions, you will reap better investment outcomes.

There’s more to choosing an investment location than it might seem

Look for areas with strong economic growth, robust infrastructure, and good transport links. Thorough research and strategic planning are essential for selecting the right investment location, but it’s not all about location.

When it comes down to looking at the specific property you want to buy, there are particular metrics that can help you evaluate a property’s potential.

Important metrics to consider when looking at a property’s potential include:

Past sales history

This metric helps you to understand how the property has appreciated over time.

Although future performance is not guaranteed, the sales history can give an indication of how the property might perform in the future, and the property’s growth potential. There are a few ways to find out the past sales history of a property, and subscriptions like RP Data and Pricefinder can assist.

Once you know what the property sold for five or ten years ago you can see what sort of potential you are looking at.

Also, if the property has been transacted multiple times in recent years this may be a red flag, because the property might have issues such as trouble getting development approvals, pest infestations, subfloor or under house/behind wall issues, or there might just too many small maintenance repairs that the cumulative cost becomes too excessive to repair everything.

Properties with a good track record would show the historical sales to double every 10-12 years.

If there is no past sales history available for a property, which is actually quite common if the property has had the same owner for a long period, then you can look at the locations sales history and metrics such as the average annual growth rate.

Days On Market (DOM)

The average days on market can indicate how popular an area is. Areas with a low DOM metric indicates higher demand, compared to areas with increasing or high DOM that indicate decreasing supply or overpriced properties.

This metric can help you identify locations that are strengthening so you can get into the market early.

Extremely low DOM means the market is quite hot and there is risk for buyers to get caught up in the rush and overcapitalise by paying too much.

Rental market

Investors look for areas that are in high demand which can be indicated by the rental market conditions. Areas showing low rental vacancy rates and a high proportion of owner-occupiers tend to offer stability and potential for capital appreciation.

It is important to know the percentage of the population living in that suburb who are renters in comparison to owner occupiers.

Gross rental yields graph

(Source: CoreLogic)

An area may receive good rental returns because it is a popular spot to rent, but if there is a low proportion of owner occupiers living in an area it might really hurt the future value and capital growth of your property when it comes time to sell, if no one actually wants to buy a property there.

An example of this is mining towns where there are a lot of ‘fly in-fly out’ workers who don’t actually want to live or buy a house there, but the companies they work for are paying top dollar to rent properties for their workers.

The rental return might be lucrative because the rental market is strong, but if you are unable to sell your property to anyone this will really damage your investment returns.

The ratio of owner occupiers to renters in an area can also be broken down to a more micro level to see the percentage or renters living in the same street, or even further down into the percentage within an apartment building.

Government-backed developments

To uncover the growth potential of a property, you can investigate what developments the government is funding in the suburb and surrounds.

Areas tend to go through strong gentrification and capital growth where the government invests into local amenities and parks, schools, and employment opportunities.

These areas with planned developments and infrastructure projects can offer substantial long-term growth potential.