There are many strategies available for investors. Some strategies can be considered opportunities and produce good cash flow or capital growth; others can be considered a waste of time and detrimental to an investor’s property objectives.

Student accommodation and serviced apartments are considered by many to be a waste of time. investors may be lured in by low entry prices, higher yields and rental guarantees, but there are several reasons why you should think twice.

Consideration 1: Banks will generally not lend more than 60 per cent debt against the value of either type of property. The underlying reason is it is considered one of the most risky residential investment property decisions that an investor can make and lenders do not wish to expose themselves to such risk.

Consideration 2: As lenders will consider only 60 per cent loan to value ratio (LVR), generally an investor must contribute 40 per cent plus costs to the deal. This is a waste of equity/cash as these monies could have been contributed to other investment properties with more capital growth potential, with possible lending to 95 per cent LVR.

For example, (excluding costs and loan mortgage insurance): a $400,000 serviced apartment with a 60 per cent LVR means the investor would have to contribute $180,000 to the deal. Consider a normal residential investment property type assuming a 95 per cent LVR, the borrower would only need to contribute $20,000 toward the $400,000 purchase. The $160,000 difference is a huge amount.

Consideration 3: When the investor wishes to sell the property, there may not have been much capital growth, which is bad enough, but the resale market is considerably smaller than the normal property market.

There would be far fewer buyers mad enough to put in 40 per cent themselves; they would also find it difficult to obtain finance, as the original investor would have found as well, and very few lenders will lend on such a security as already mentioned.

So the seller would not be in a position to demand what they want, and it would most likely, potentially always, be a buyers’ market, meaning sellers would not be in a strong position to negotiate.

Few investors want to plough in 30-40 per cent of their own money, and many won’t have that much money anyway. So don’t think about it in terms of whether you can afford to do it – think of it in terms of how many others can financially or will want to financially do it. The answer is not very many.

Serviced Apartments

The prospect of capital growth potential is connected to the rental increase of the property, which is limited with serviced apartments. Let me explain why. While some serviced apartment contracts have built-in rental increases over a given period of time, the rental increase directly affects the capital growth. The increase is, effectively, the capital gain.

Be aware that the value may not increase at the same rate, in the same time, as a normal apartment. The added risks with serviced apartments, over and above normal apartments, are: the quality of the management service provider, the use of the dwelling, whether it can be owner-occupied, and the exit strategy. These are very onerous, limiting, controlling and expensive (yet more reasons why lenders don’t like them).

Investors, depending on the type of serviced apartment provider, may be required to spend thousands every few years for the refurbishment of furniture and appliances. What a burden!

Serviced apartments can be good cash flow vehicles, on the surface, but after management and body corporate fees and forced upgrades, the true value of the higher cash flow can be very quickly eroded.

It is always recommended that investors undertake normal research and due diligence as to where they are and how many there are in the location. Their proximity to amenities must be considered.

Sometimes the management contract reverts to the owner, after five to 10 years, which can eliminate the enforced requirement to refurbish (after this period). But, on the other hand, you then have to spend time and effort finding someone to manage the property on your behalf. This may prove difficult if the dwelling is in a building with other dwellings that still function as serviced apartments.

The fact the dwelling itself may have reverted to a normal apartment may not reduce the difficulty in obtaining finance, as it may be in a building which still has other serviced apartments. This is a deterrent for lenders.

Student Accommodation

Student accommodation can be a good income-earner, but these are often very small inside (usually under 50 square metres), which limits the appeal in the aftermarket and can make it difficult to find a lender, as I explained earlier.

Student accommodation may have less onerous contracts, depending where the accommodation is. Some investors turn a house into room-by-room leases, but structurally the dwelling is still a suburban house. This can be a time-consuming responsibility and may not appeal to most property investors.

This is, however, better than a designated student accommodation scenario as it allows the flexibility to borrow normal debt levels.

Furthermore, specific student accommodation purpose securities are not unique.

They are often the same as all the others in the building. Often, there is a large supply of these and strong competition to rent them out, forcing the investor to lower the rent to attract a tenant. The same rule applies when selling. These may always be a monkey on the back of the investor – a perennial hindrance to obtaining a loan, renting it out, and selling it.

In summary, it’s difficult to recommend pursuing an investment in either a serviced apartment or student accommodation. They both provide good cash flow, but investors are likely to encounter resistance in obtaining finance, plenty of fees, a weak aftermarket and a need for continuing investment.

Posted by Andrew Crossley – Australian Financial Review on 23rd October, 2014