Are student rentals a dangerous investment?

Do you believe student rentals are a no-go zone? Not always!

One of my clients recently drew my attention to a property listing and I have to admit, it delivered such strong returns they seemed almost too good to be true.

That’s because, as it turned out, they were!

The property in question was a three-bedroom apartment in a student accommodation complex on the Gold Coast. It was on the market for $220,000 and was achieving a weekly rental return of $515 per week.

It doesn’t take a maths genius to figure out that those returns are extraordinary. In fact, it equates to a yield of more than 12 per cent, which is attractive in anyone’s language.

It’s these types of sky-high rental returns that can make student rentals seem like a tempting investment proposition. But they very, very rarely constitute a wise investment, for a number of reasons, including:

They are very restrictive

You are very limited in terms of what you can do to the property because all of the apartments in the complex are generally required to be a similar size, style and quality for consistency purposes. Your property goes into a rental ‘pool’ and a management company places student tenants on your behalf. So, for instance, if you suddenly convert the garage into another living space, but they’ve rented the property to a tenant with a car who requires safe and secure parking, this could create headaches.

They cost a lot to own

You have to factor in higher-than-average property management fees, on top of body corporate fees and council rates; combined, these three expenses can easily chew through $200 per week, or $10,000 annually. In this example above, this brings the rental income down to $315, which cuts down the profit potential substantially. You’ll also pay a higher rate for your landlord's insurance, due to the riskier nature of renting by the room (particularly to young students).

They appeal to a narrow set of buyers

The only buyers who can purchase this property are investors. Owner-occupiers – which comprise a fairly huge segment of the market – are locked out, which minimises your pool of buyers if and when you decide to sell.

They attract limited capital growth

As a result of the above limiting factors, combined with the high turnover of tenants/residents (which fast-tracks wear and tear), these types of properties generally attract sluggish capital growth, if any at all.

Lenders are not fond of student accommodation

Mortgage insurers do not insure student accommodation, so it hard to get a loan above 80 per cent. In fact, some lenders restrict lending to student accommodation to less than 70 per cent, which is an indication of the resale value of such an asset.

For the above reasons and more, I usually always caution my clients against investing in a student rental – unless you invest in a student rental in a smarter way.

This is what I chose to do when I was looking for a property to invest in near the University of Queensland in Brisbane. I had no exposure to the student market and wanted my next property to be in this area, but I certainly wasn’t looking for purpose-built ‘student accommodation’ because this is difficult to finance and hard to sell.

I identified a three-bedroom townhouse for sale in St Lucia, in a small, gated compound of eight units. The townhouse was only one year old and the tenant was a local coffee shop owner.

It was listed for sale at $420,000 and was returning just $370 per week in rent. However, I discovered the seller had personal issues and needed to offload the property, quick smart. I told him that with a rent of $370 per week, I wouldn’t be prepared to pay more than $370,000, which would give me a reasonable but not excessive yield of 5.2 per cent.

He eventually agreed and wanted me to take over the lease too, which I accepted. Soon after I acquired the property, the tenant asked if he could vacate early and I negotiated an exit with him. Having thoroughly researched the market, I was more than ready for him to move out – it was actually costing me money having him stay put!

You see, I knew that foreign students were prepared to pay as much as $180 per week for a room in a well presented, modern home such as this. So I gave the unit to a managing agent who specialised in finding accommodation for foreign students, and the rent immediately jumped to $550 a week.

This gave me a good-quality property situated in a great suburb, with strong resale potential because it appealed to a broad market, but which could also comfortably accommodate three people and rent easily to students. This was a brilliant outcome – but the story doesn’t end there.

As an added bonus, the market was rising at the time of purchase and as a result, within two years I was able to refinance the loan based on a valuation of $485,000 to extract equity to invest in my next property. The rent is now $640 per week and I smile every time I see my monthly rental statement.

It just goes to show how the market can work in your favour if you do extensive due diligence and select a property outside of a traditional student rental complex.

And this is also why I now say that while student rentals are usually a no-go zone, there is occasionally an exception to the rule!