Why Blue Chip Assets Aren't Always the Best Investment

For such a long time, some property investors have been spreading the line. It has to be blue chip, otherwise it's not a worthy investment. This claim is completely false. But not only that, I'm going to walk you through the issues that come from investing in blue chip assets and how the market around them might not be what you think it is. I'm Junge Ma, the lead research analyst at InvestorKit.

Now let's jump into it. So today we are talking about blue chip suburbs or blue chip locations. Instead of discussing it from a value growth perspective, because I've written a blog about it, I'll put the link in the show notes. If you're interested in it, just check it out. So today I'm actually discussing it from a portfolio building perspective.

I'm going through three potential shortcomings that come with investing in blue chip suburbs. The first shortcoming I'm going to talk about is potentially higher negative cash flow. Buying in a blue chip suburb, you will typically see higher rental days on market and lower rental yield. Both of them will hurt your cash flow. I'm not just making it up.

It's actually backed by data. Just go to any capital city or any big city with higher house prices, do a scatter chart between the median house prices of suburbs and their rental days on market. You will see that the higher median house price is, the longer the rental days on market will be. The same thing, if you overlap the median house prices with each suburb's rental yield, you will see a very clear negative correlation between the price level and the rental yield level. Now, to help you better understand how buying in a blue chip suburb would hurt your cash flow, let's do some calculation with an example.

As far as all the details and numbers are concerned, I'm going to put them on the screen. And just to keep it simple, I'm going to go through the numbers on a higher level. So if you're listening on iTunes or Spotify and want to see all the details, head to our YouTube channel to check the details out. Now let's get into the numbers. First, let's assume that our investors is a couple living in Sydney with no kids.

The total annual income of the household is $250,000. After tax, their monthly net income would be $15,700. And they rent an apartment in Sydney. Rent is $850 per week. And they live a moderate lifestyle, so their weekly living expense would be somewhere around $780.

And then they have no other debts or any credit cards. Now, they have two investment options in front of them. One is to buy one house in a blue chip suburb in Adelaide, Burnside. And the other, the house would be causing them $2 million. And the other option is to also spend $2 million, but to spread it into four properties across regional Australia in non-blue chip suburbs.

So for the house in Adelaide, their monthly repayment for a 80% LVR loan, interest only for now, would be $9,333. Their monthly rental income with a rental yield of around 2% in Burnside would be $3,324. And after deducting all the other outgoings, their net cash flow monthly would be negative $6,855. And now, in the second option, their monthly repayment would still be $9,333. And their monthly rental income, assuming 5% average rental yield, would be $8,666.

And then after deducting all the other outgoings, our net cash flow for this scenario would be negative $3,340. That is almost half of the scenario number one. So by going to non-blue chip suburbs with the same investment value and the same amount of loan, you are effectively saving $3,000 monthly. Then the second shortcoming I'm talking about is weaker borrowing capacity. Now let's go back to our Sydney couple investors.

Three options in front of them. Option one, to buy a $2 million house in a blue chip suburb, still Burnside. To buy this property, they have to maximize their borrowing capacity. With a rental yield of 2% and a weekly rental income of $775, their borrowing capacity for this house, for this purchase, would be only $1,319,000. And now, option two, if they would like to move away from the blue chip suburbs and to look at suburbs with more moderate houses and a healthier rental yield, for example, Meadowbrook in Brisbane or Basundin in Perth, their median prices are around $750,000 to $800,000.

And their rental yields are around 4. 3% each. To buy these type of houses, they can actually borrow up to $1,515,000, already higher than the first scenario. And with this borrowing capacity, they can actually afford two of these properties. And the third scenario, if they would like to look further away and get their investment properties in the regional areas with house prices around $500,000 and rental yield in the high fours or even above 5%, their borrowing capacity can be up to $1,580,000.

And with that borrowing capacity, they can easily afford three or even four properties in the regional area. In these three scenarios, I'm just talking about your borrowing capacity for the current purchase. In reality, if you are moving forward and try to buy more properties in the future, if you're holding properties in blue chip suburbs and receiving really low rental income, that will very likely impact your future borrowing capacity as well. And that will significantly slow down your portfolio building journey. And the third potential shortcoming is higher risks.

The first potential risk would be that you are putting too many eggs in one basket if you're just buying in blue chip suburbs. Back to our Sydney investor couple, if they're buying in Burnside, they are putting all their money, all their loan in one suburb. While if they choose to go regional and buy three or four properties across the nation, they are putting their money across different markets with different cycles. And obviously, their money would be safer in the latter scenario. And two, blue chip suburbs, their price trends tend to be more volatile than our ordinary suburbs.

Now I'm showing you a chart of two Sydney suburbs. One is Manly, a typical blue chip suburb, and the other is Bella Vista. 10 years ago, it wasn't a blue chip suburb, but now it is becoming a blue chip one. So if we look at the 10 years from 2004 to 2014, when Bella Vista was just an ordinary suburb, the house price trends there were much more smooth than Manly's. In Manly, the price trends were seeing lots of big ups and downs.

And in the decade from 2014 to 2024, as Bella Vista gentrifies and becomes a blue chip suburb, its price trend became more bumpy than before. So by buying in a blue chip suburb, your property value would be more subject to market fluctuation. So to summarize, blue chip suburbs are not your best option for portfolio building journey because of the higher negative cash flow, the weaker borrowing capacity, and the higher risks associated with it. But don't get me wrong, if you would like to buy an owner-occupying house and live in a blue chip suburb, just go for it. We are just talking about this from an investment point of view.

So that's it for today. I hope you have enjoyed it. If you have any comments, any thoughts, please leave it below. Arjun and I will do our best to reply to every one of them. I'm Joma, the lead research analyst here at InvestorKit.

Thank you for your time, and I'll see you next week.