When is an investment property a bad-performer?

During the week I had the task of reviewing an investor’s portfolio. She had secured her properties without my help, but had a sizeable portfolio with mixed styles, locations and even had an interstate investment in the list.

It’s important to note her work-timeline.

She had held these properties for over a decade; one for over twenty years, and had embarked on a consistent acquisition plan every couple of years to amass the portfolio that I had on a spreadsheet, sitting on my desk.

She wanted to be in a position to retire in about five years’ time.

Cashflow was critical.

The first few were great performers in my view. They had delivered the important four attributes well;

1. Healthy capital growth,
2. Rental return in line with the expected gross rental yield for the area and dwelling type,
3. Continuous rental occupancy with quality tenants,
4. Reasonable maintenance expenditure demands.

The fourth was a little more interesting because the landlord had opted to lease out the one-bedroom unit on an AirBnB platform with a third party service provider. There is nothing wrong with this approach, provided the following five issues do not strike;

• Owners Corporation restricting AirBnB or creating issues for the owner,
• Insurance cover being in question due to the nature of, and arrangement for the short-term rental,
• Cost of set up, furnishing, cleaning and provisions eclipsing the benefit of the short-term rental income,
• Tenants causing headaches for the owner (complaints, bad reviews, damage, etc)
• Occupancy rate being unreliable or insufficient for owner’s cashflow.

There are a lot of possible issues here, and it is for these reasons that we tend to avoid short-term rental suggestions for mainstream properties.

When I quizzed the landlord, she agreed that the occupancy rate she’d been quoted by the third party was in fact quite higher than actual. When we calculated her costs and income, her profit was break-even when contrasted against the going rate for a standard residential 12 month lease rental income.

This arrangement had cost her in furnishings, appliances, more risk and more headache.

All this aside though, the property was fine. It was well-located and despite being at the tougher end of the banks’ tolerable-internal-floor-size spectrum, this property was a good little performer.

The metrics started to bother me when I considered her later acquisitions, and I had to ask myself the question;

Are these properties worth keeping?

We run a business that is broadly based on helping clients with a Buy and Hold strategy. We aim for A-grade assets, are always mindful of cashflow implications and we pride ourselves on identifying characteristics that will preclude a property from being an ideal fit for our clients’ individual portfolios.

The idea of canning a property, only to write off the stamp duty, suffer losses (if the performance has been that dire), and attract marketing and sales costs is a last resort.

But when should the Buy and Hold strategy be upturned?

How badly does a property have to perform to be written off?

If a property has experienced enticing capital growth but is demonstrating a sluggish rental return, it could be forgiven (pending the owner’s cashflow circumstances).

And likewise, if a property is smashing out a positive rental return after costs, it is by definition a cashflow-positive asset.

I’ve met plenty of owners who have listed a good investment for an immediate sale after some heady expenses or troublesome tenant tales too.

None of these reasons in isolation are necessarily good reasons to sell.

But when a property is delivering bad news on multiple fronts, (or worse still, all of these fronts); and particularly if the chances of positive change are not apparent on the horizon, it might just be time to throw in that towel.

A good reason for an investor to sell can be when it is obvious that their money, (after purchase and selling costs are taken into account) could be working considerably better for them if it was put into an alternative property.

Property is a reasonably forgiving asset; even a B-grade property can perform. But when the longer-term growth has been limited, zero, or (gulp) negative, and the cashflow is also negative, I have to ask a basic question.

Is it time to let it go? This property is costing money to hold, and it’s not delivering any benefit in return.

It is important to recognise the attributes that can lead a property to under-perform too. Visible things such as an unsafe area, an unattractive address or a poor orientation are some examples. But invisible things such as bank policy limitations, challenging title types: (for example, Company Share or Stratum which banks hate), challenging zone types, covenants, easements or compulsory acquisition orders (to name a few) can doom a property from the start if they cannot be removed.

Investors should be patient and remind themselves that property investment will always present challenges here and there, but when the property is underperforming longer-term, costing an unfair amount of shortfall, throwing up significantly expensive maintenance issues, and causing a tenant headache beyond a Panadol-fix, it might be time to ask the hard question.

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