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A tale of two investors

Wednesday, 4th Sep 2013

two investors

It’s not often in life you get such a stark demonstration of how different decisions can lead to vastly different outcomes. But this was definately one of those times, involving two property investors.

A client – let’s call him Andy – had entrusted Momentum Wealth to assist in the purchase of an investment property around two years ago. All up he paid $458,000 for the property, which was located in an established area of Perth. I was very pleased to discover that a bank had just recently ordered a valuation on this property and it came in at $585,000.

What made that moment particularly memorable, however, wasn’t learning about a client’s success but rather a sad email that I received. The email was from a financial advisor who was seeking some property-related advice regarding an investor – let’s call him Paul – who found himself in a rather difficult financial position.

Paul was sold an investment property by a well known ‘investment group’. The property, located in an outer-Brisbane suburb, was purchased sight unseen for $428,000 around the same time that Andy had purchased his property.

The shock came when I read the email further, which explained that based on recent sales evidence the property was now worth around $300,000. Paul was now in a difficult predicament, unsure whether to hang on to the property in the hope it will recover its value or cut his losses and sell.

While I hate to see anyone suffer such a loss (albeit on paper), it’s made worse when you think about the success Paul could of had if he had sought proper advice. In fact, if Paul had achieved similar returns to Andy, he would be somewhere in the region of $250,000 better off.

These companies typically operate with a very slick sales process with the ultimate goal of you buying a new property off the plan, sometimes in a distant location which you have been told is a “good investment”. The consultations and service is “free” as a hefty commission is loaded into the purchase price.

These companies spend a lot of time talking to builders and developers from around the country, trying to negotiate deals that involve high rates of commissions in exchange for providing an effective channel for flogging hard-to-sell property.

Investment groups only get paid when they sell you a property, so it’s not uncommon to experience high pressure sales tactics.

Many investors fall for this firstly because there is an assumption the purchase is free. Plus, it is very easy to get caught up in the excitement of buying a new property because it looks so good and offers benefits such as depreciation, low maintenance, and strong demand from tenants.

There are a few reasons why investments made through these companies often don’t live up to the promises that were made, particularly in terms of capital growth.

As with Paul’s case, not only did the property fail to increase in value but worryingly it is now worth around $130,000 less.

The poor capital growth performance of these investments is primarily due to the fact the properties are not what I would call ‘investment-grade’. They are in areas with massive supply potential, typically on the outskirts of major cities or in speculative locations.  Additionally, the properties, which are almost always new or off-the-plan, have a high proportion of their value in the building which depreciates over time, limiting the opportunity for growth.

Making the situation even worse, properties sold through investment groups typically have inflated prices to cover the commission that will be paid by the developer or builder.

Clearly, the cost of ‘free advice’ offered by investment groups can end up with a rather hefty price tag.  Consultants who represent these companies may say they are helping you but they are just helping themselves.

Any business of course needs to make money but there is a monumental difference between what an advisor does and what these investment groups do. A property investment advisor should offer simply that; advice on where and what to invest in and remain independent from any property sellers. There should be no financial incentive to push you towards one property over another, and a buyers agent or advisor that you engage ensures this by charging you a fee for service plus there is a legal obligation to act within the best interests of their clients.

The other major difference is to do with transparency. Although employing a buyer’s agent involves a fee for the service clients are completely aware of this fee when they engage the service . Plus, when you consider the scale of the returns that a great investment can generate, as it did with Andy, it certainly highlights the true value of employing a professional who is working within your interests and providing sound property advice.