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As I mentioned in my recent Aussie property market update, home prices in Sydney have risen over 70 percent in the last five years. The median home price to income ratio across the city is now about 12 to 1.

In other words, the typical house cost twelve times more than the average person earns in a year. For comparison, the historic norm across the United States is 2.6 to 1.

What a Bad Deal Looks Like

Believe it or not, investors are still buying properties at these prices in Sydney and renting them out. Most tenants are renting because they can’t afford to buy, so these investors are unable to get enough rent each year to cover even their interest payments. They buy these properties on the assumption that they will go up in value more than their cash flow losses by the time they’re ready to sell.

That’s a big assumption. I’m not so sure I would call that investing. It’s more like gambling.

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What a Good Deal Looks Like

In my day job, I mentor property investors. They pay me to help them make smart investing decisions. As someone who is not particularly bullish on Aussie real estate right now, how can I possibly encourage people to buy homes in Sydney today?

Believe it or not, there are still potentially profitable deals to be found in Sydney; ones that don’t assume future capital growth. The important thing is to find ways to make money on real estate that doesn’t involve simply buying, holding and hoping for the best.

a $400,000 Deal

One Sydney investor I’m mentoring sent me a deal today that stands to make him about $400,000 profit within the next 18 to 24 months.

Here’s a photo of the property:

How about that paint colour?

It’s not much to look at, but it is very close to the CBD (central business district) of Sydney, which makes it a highly sought after location.

It’s a three bedroom, one bathroom home on a 291 square metre block of land. For my American friends, that’s less than 1/10th of an acre. In other words, it's tiny.

Here’s the current site plan:

Somehow this property even has a backyard:

So what’s this little beauty going for?

My client just signed a contract to buy this property for $1.35 million.

He’s paying cash.

But he’s not putting a tenant in the property; at least not for long. As a developer, his plan is to knock this little house down and build two in its place. Believe it or not, another developer got approval from local council in the same area to build a duplex on 270 square metres.

These two-story units he builds will have three bedrooms each. The going price for new three bedroom units in the area is currently $1.45 million.

Here’s a basic run down of his development costs:

Item	Amount
purchase price	$1,350,000
stamp duty	$63,000
legal costs	$1,500
borrowing costs	$1,000
subdivision costs	$45,000
project management fee	$4,000
construction certificate	$20,000
build two units	$900,000
interest on build at 8%	$48,000
final survey	$2,500
TOTAL COSTS	$2,435,000

That means each new property owes him $1,217,500. Anything over that as a sales price is his profit. If he can get his $1.45 million sales price per unit upon completion, he’ll make a profit of around $400,000.

His primary assumption on this deal is that home prices will remain flat for at least the next few years. Unless something crazy happens overseas, he'll probably be right. The RBA still has a few interest rate cuts left in the bag for a rainy day.

Of course, there is a risk that home prices in Sydney retrace and come back down 10 or 20 percent, or more. Considering his timeline of 18 to 24 months, that’s a real possibility. If that happens, and he can’t sell these properties for a profit, his plan B is to live in one of the units and rent out the other one. He'll hold on until a brighter day.

Those are the types of deals that stack up in the Sydney market today.

What do you think? Would you have the risk tolerance for a deal like this?

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Jason Staggers