One of the greatest fears that most property investors have is that they will buy a property that will be a complete lemon, and in doing so they’ll become financially ruined. When I meet investors for the first time, it’s most likely that they will state this fear as being the number one reason they’ve not invested. It’s such a big barrier for many that they won’t invest at all, for fear that everything they have worked so hard to achieve up until this point will be forever lost on the dud property investment.
I’m not going to say that you’ll never buy a dud investment – it can definitely occur even when you have used your best endeavours to research well. Unexpected events can occur, planned infrastructure may become unviable, large employers can close down – there’s a host of unforeseen circumstances that could leave you holding a lemon. The point is, if you’ve purchased a property that isn’t performing, you need to address it and take action. It’s no use allowing it to just sit in your portfolio. If it’s truly a bad property, it will only get worse, and every day you hold it will only lead to a compounding of the loss.
First, though, you need to know if you truly do have a lemon. Some sure fire signs are:
- You have high and consistent vacancy.
- You have a constant flow of really bad tenants who keep damaging the property and diminishing your asset.
- The property now has a value that is less than you paid for it, which is still going backwards AND a very low cash flow, or
- It is situated in an ugly duckling suburb that didn’t get better – much of the planned future improvements failed to occur.
What is notably excluded from the list above are properties that aren’t growing and those with low or negative cash flow. Lack of growth and negative cash flow only become an issue if they in some way prevent you from adding to your portfolio. It’s perfectly acceptable to have in your portfolio a property or two that’s not performing at the present time, as long as they still show characteristics that point to economic vibrancy. If this is your property, you should go back to it again. If the answers are still positive, it could be just your timing that’s out, and the property should come good.
On the other hand, if you think you may have a lemon, here’s what to do:
- Assess the true financial impact of that property upon you today
If the property is creating a lot of real, personal financial hardship, and you are prevented from enjoying your life now because your money is being poured into this non-performing asset, or if the existence of that property in your portfolio limits your capacity to borrow again to buy something else in an area with a better prognosis, you must sell. Don’t hang on to it hoping for that elusive capital gain, or because you believe that you have to try to recoup your losses. Although property markets do go in cycles, these cycles are measured and expressed as an average only. This means that within these cycles, a property in any one area can still stay in a trough indefinitely and behave very differently to the average.
You will most likely make a loss, but you will be able to carry forward this loss indefinitely to offset any future capital gains, and selling now will halt further loss.
- Consider keeping it a while longer
If the reason you consider it to be a lemon is because it is suffering from value losses, but its cash flow is still positive or at a minimal negative amount, you may want to keep it for a while longer. You should only do this if owning it does not mean you cannot qualify for further lending to buy more property, and so you are not able to build your portfolio further while-ever you own it.
Be aware that many properties that seem to be losing value are doing so because too much was paid for them in the first place. Make sure that’s not your situation. Did you pay market value, or, if you bought from a developer, might there have been commissions that boosted the purchase price over market value? Before selling due to a loss in value, examine the economic landscape – you don’t want to sell out of a property that subsequently performs well unless there is no other choice.
- Sell now and get straight back into the market
If you’re experiencing a crippling negative cash flow, and the area shows distinct signs that growth is light-years away, you may be best to sell now and get straight back into the market with a property purchased in an area with greater economic potential, and better rental yields.
Likewise, if you have a property that attracts unsavoury tenants and your landlord’s insurance policy has reached its maximum allowable claims, this may again be a good reason to sell and cut your losses. Where one property takes up the bulk of your time and energies, it may be better out of your portfolio.
Remember that while ‘buy and hold’ is a sound strategy, it doesn’t also mean you hang on till the death knell on a property that you made a mistake buying. Learn how to see the writing on the wall, and exit from bad investments before they get the chance to get worse.