What can make a property a lemon?

We hear this word often in the pejorative and the idea of it applying to a property can leave any investor or home owner feeling quite despondent.

There are many elements that can contribute to devaluing a property or creating stress for the owners, and depending on the owner’s risk appetite, cash flow, experience and time, some of these elements can be more troublesome than others. But it’s the impact of these negative attributes over time that can negatively impact the properties capital growth performance, desirability and rentability.

So how do we recognise some lemon attributes? what does it take to fix them, and how can we spot them? Some can be tackled, while others are here to stay. Some are invisible and require a careful contract review, while many are completely obvious to the eye.

The first relates to a lemon that has been modified or engineered without the correct permits or sign off. Once a property settles, any historical issues, non-permitted or illegal works and all liability for these works is transferred over to the new owner. Risks such as defects, poor workmanship, local council exposure and limited insurance cover could apply, so it’s important that buyers note any newish works to their legal representative before requesting the contract review. If the legal representative doesn’t know that modifications or extensions have been carried out, they won’t know to look for the appropriate permits and certificates in the contract.

Another relates to water ingress. This issue strikes often with apartment blocks and it’s imperative that buyers not only request a full contract review prior to signing or bidding, but they must read through the Owners Corporation AGM minutes carefully to see if any reports of water ingress are featuring. Water ingress can be caused by many things but a common cause is insufficient (or missing) waterproof membranes, poor tiling, bad drainage or roof leaks. In many cases, a thorough building and pest inspection can identify signs of water ingress.

A related issue is mould. From risking damp to poor ventilation, mould is a serious issue and sometimes a recurring one that is hard to remove. Tenants can demand their right to be accommodated elsewhere temporarily until mould is fixed in some cases too, which adds more expense to the issue if mould strikes. Again, a thorough building inspection can often identify a mould risk or mould issue.

One type of property investment that can come with a laundry list of issues is sometimes a high rise apartment. Lifts, pools, gymnasiums, concierge and other fancy trimmings such as window cleaning, (and anything else requiring high-rise scaffold) comes with a higher price tag than older style boutique apartment running costs. Sometimes owners underestimate the financial drain and stress associated with heightened management and maintenance costs.

A related issue relates to an investment that yields less than initially anticipated. Whether it be lower rents, higher running costs, vacancies or surprise special levies, an investor’s dream can quickly become their nightmare if the out of pocket costs associated with holding the property get too uncomfortable.

If the out of-pocket contribution exceeds the investor’s available cashflow surplus, they will have a problem.

And then there are issues with strata buildings; and in particular, cladding. If the building has been identified as one with flammable cladding, (or cladding requiring replacement), there may be an order on the property or it could be flagged for review. Pending how the order is handled and whether the Victorian Building Authority is financially covering some/all of the works, the property may have special levies raised for owners to contribute towards and it may be problematic to finance with lenders. While this particular issue has discouraged buyers in recent times, it’s not necessarily going to deem the property a lemon, but related issues and ongoing costs could do.

While on the topic of strata properties, off the plan is not enough to deem a property a lemon, but an off the plan purchase can often deliver some disappointments for purchasers, particularly high-rise. I penned eleven reasons why I avoid off the plan high-rise, but in short, the land to asset ratio negatively affects the performance of the property, and the abundance of similar units released at the same time can undermine the scarcity of the asset when trying to find a tenant.

One unfortunate element, (and one that is impossible to change) relates to a poor location. If the lemon is located where the majority of people prefer not to live it will underperform, and if an investment it may be difficult to rent for a reasonable rental figure. Negative location-based attributes can include main roads, remote locations with insufficient amenity, noisy neighbourhoods, unpleasant vistas and high-crime suburbs, (to name just a few).

While there are plenty of elements that can deem a property a lemon, this one is an invisible one that is usually spotted with a thorough contract review, or a chat to a town planner at local council. If the property has a different title type, or is in a restrictive zone, (such as commercial or industrial for example), it will be considered differently by the banks. Changing a title type is not impossible, but it requires subdivision and expense. However, changing a zone is not something that an owner can coordinate or pay for. It’s rare for zones to change and it’s entirely determined by urban planning decisions.

These properties can underperform when lenders don’t have a normal appetite for them.

In other words, if a bank rejects a property at an 80% LVR (loan to value ratio), plenty of potential buyers are then ineligible to finance the property. This reduces the number of buyers in the buyer pool and hence diminishes demand, (and growth).

Lemon properties are sometimes fixable and sometimes the opportunity can yield fantastic results. But for those who are less daring or have less resources to turn a lemon into lemonade, avoiding them in the first place is always a better approach.