David French | 18/02/2009 3:39:52 PM

This article was originally published as ‘How not to become shark bait’ in The Morning Bulletin on 20th March 2003.

In the late 1990’s the dot.com boom was revving up. The stock exchange squark box relayed message after message of speculative mining companies changing their major activity to IT. Most of this was sheer opportunism on the part of the directors, who often having a large stake in the company, had been having a lean time with low gold prices. Like surfers waiting for Big Wednesday, they were hit by a tsunami of cash thrown by poorly informed investors. Many dot.coms are now worthless, or at least much diminished.

Then there was a minor boom in managed funds. For a period, everyone who walked into the office wanted a managed fund. It was clear that many investors did not know how a managed fund operates, or the risks involved. At the time of writing, the sharemarket is in a downturn and investors are concerned.

Ignore people who insist on the security of bricks and mortar. A particular house is not auctioned on each day, so unlike the sharemarket, it is impossible to value the asset on any particular day. An investment property normally involves a large amount of money so few people are willing to sell into a declining market. This cuts vendor supply and gives the appearance of the market falling by less than it actually does. Watch out if you find you need to sell the investment property in a hurry. Similarly, beware the big tax deduction pitch. Tax deductions for building allowances are an allowance for depreciation on the building structure. Eventually you will have to spend a significant sum to bring the property back to original condition (or take a price cut when you sell the property). Negative gearing only works if the property value increases by more than your after tax interest payments.

When choosing a property, talk to an agent whom you trust and who knows the characteristics of the region. Buy in a quality location, preferably with easy access to amenities and views. Do not expect a property 5km back from the beach in a gully to appreciate like a beachfront property. Keep in mind the building rights of neighbours and council development restrictions. Try to get something unique that others will pay a premium for later on.

Consider the rental market for the particular property. Market rent is closely related to value. Rent guarantees may simply reflect a strong market. Carefully consider what the state of the market will be when the guarantee runs out. Often you are just getting your own money back and a guarantee that expires at the same time as the construction workers leave town is not helpful.

Finally, the interest rate is as important as the cost of the house. Someone with a $100,000 loan taken over 25 years will pay $102,562 in interest if rates are 6.5 per cent, and $131,545 if interest rates are 8 per cent. Ignoring the time value of money, that’s the same as getting a $28,983 discount on the price of the house. When interest rates are low, spending more on a property will leave you no worse off. If it gets you an overall better property, then you could be ahead.

No-one is ever going to know everything about investment markets, but doing sound homework first will keep you from being bitten by the sharks.

The Investment Collective (AFSL 471728) is a non-aligned financial planning and investment firm specialising in providing tailored financial and investment advice for individuals and small business. Capricorn Investment Partners Limited's services include financial planning, share trading, portfolio management, insurance broking and self managed super fund administration. Additional information on services provided by The Investment Collective Limited can be found by following this link. Readers are reminded that this document has been prepared for general information purposes only, and any advice contained herein has been prepared without taking into account your financial objectives, situation or needs. Readers are advised to see their financial advisor prior to acting on any general advice.

More articles about property, investing.