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Recently I was looking at some properties available in large cities inner suburbs (in this case Sydney and Melbourne). What I found is that there are many small apartments available for rather affordable prices (200K-300K at the moment) while rental costs of similar apartments are quite high (350-400 per week). Simple calculation shows that if such property purchased with no mortgage, it is expected to give ~6%-8% in rental yields (excluding fees and maintenance).

As a skeptical person that sounds too good to be true and I looked for some info online. What I found are some articles like this one that discourage buying such properties and provide(among others) the following reasons:

  1. Choosing a property that the banks don’t like. Banks consider several investment property types as risky. These often include serviced apartments, student accommodation, defence housing, small apartments, commercial properties and properties in a business or mixed zoning or in country or outer coastal areas.
  2. Focusing on tax benefits or high yields and not on capital growth. Be wary of buying property that gives you good rental yields or good tax deductions or depreciation, but very limited prospects for creating wealth and equity. Capital growth should be the most important consideration as this equity will accelerate your wealth creation strategies and allow you to create equity and use this to build your portfolio further.

My questions are:

  1. I understand that if a bank doesn't "like" a certain property or area that basically means that less people will be able to buy it from me when I decide to sell it. What I don't understand is why would a bank have a problem with small apartments or students accommodation? As I see it, it's exactly the opposite. If there are universities and students around a specific area, it almost guarantees that the property is going to be in demand.

  2. Why focusing on high rental yields is bad? If such property is purchased with no mortgage and rented out straight away, that's profit. Even if the property price does not go up that's still better than holding money in a bank account.

P.S. Of course there are the risks of apartment not being rented out and other unexpected issues like maintenance etc...

  • why the downvote? – Eugene S Apr 5 '17 at 3:13
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    The "excluding fees and maintenance" bit is a problem. If it's an area with a high turnover of tenants, then there's a high risk that you'll get a bad tenant who trashes the place, refuses to leave until you get an eviction order, then disappears without paying the last few months' rent. – Simon B Jan 7 '18 at 22:53
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The banks see small apartments as a higher risk because usually very small apartments are harder to sell, especially during a falling market when there is an oversupply of these apartments. The price of small apartments will also fall a lot quicker in a falling market.

Regarding yield vs capital growth - the emphasis here is manly on high yielding properties in small country towns with small populations. How many properties can you buy with cash? Properties with good growth will enable you to build equity quicker and enable you to build a larger portfolio.

In my opinion you need a combination of good yield and reasonable growth, because without yield you cannot replace your earned income with passive income, but without growth you can't expand your portfolio. So a combination of good yield with reasonable growth will give the best outcome.

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    Just to add to this excellent answer, ignoring maintenance and tenant issues on apartments like these is utterly insane. Small, single occupancy residents are the absolute worst tenants available and can cause damages worth tens of thousands of dollars without even breaking sweat. This is also completely ignoring the huge agency costs (or full time marketing role your life has to become) to keep them filled with such high typical tenant turnover. – Philip Jan 8 '18 at 9:42

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