Maybe you’ve built up a bit of equity in your home, and you’re wondering how to make best use of it. Perhaps you are renting, love where you live, but want to get into the property market too. Or maybe you’ve heard from a friend or relative who invests in property, and are wondering about it for yourself.
Whatever your reasons, you are not alone. Plenty of us at some point start to think about the merits of owning a property and having other people help pay for it. In fact, according to the 2011 Census, a little over 1.7 million Aussies own at least one investment property.
Why property over other investment assets
What an excellent question, I hear you think! Many a debate is had between the merits of property and shares, or other tradable instruments as the vehicle of choice for wealth creation. It is not my intent to explore those fully here, but very broadly, here’s a few things to think about:
Firstly, the downside: As my share-investing friends regularly remind me, you can’t sell a bedroom. Property is ‘less liquid’ than other assets. As such, we need to view it as a longer term investment. By comparison, it is much easier and quicker to sell a portion of your share portfolio if needed. It is also much easier to diversify with shares. If we have $100k of cash or equity to invest, we will probably only purchase one property, but could invest in any number of different shares.
Thankfully, there is an upside. In fact, there’s a few. Property is tangible, and provides a readily understood, and needed purpose. You can drive past your rental house; you can add value to it directly by painting or renovating, for example. Most importantly, somebody can pay you to live in it! Whilst one can choose shares in companies that pay dividends as income, these are never guaranteed. Neither is rent, of course – vacancies do exist, but residential property has a broad appeal – everybody needs a roof over their heads, and property is the only investment asset class that provides this universal need.
Property is also treated favourably for investors by government policy. Anyone considering investing (in any asset class) would be wise to seek advice from their accountant, but in general terms, the taxman, as well as the tenant, can help the investor pay for property. Negative gearing, depreciation, and Capital Gains Tax concessions can all help to build your portfolio over time. Of course, there is always the risk that governments of either persuasion might change the rules. However, changes tend to be incremental and generally not retrospective – remember those 1.7 million Aussies who have rental property? Well, politicians would be well aware that they vote, too!
Perhaps the biggest advantage of property as an investment vehicle is that it is favoured by lenders. What other asset class will a bank lend you at least 80% of its value? Or up to 95% with Lender’s Mortgage Insurance! Banks are generally very comfortable with residential property as security for loans because of the proven, long-term viability of it as the preferred asset class. Of course, there are some limitations from time-to-time (mining towns, small inner city apartments as well-known examples), but overall, residential property security enables the cheapest and most readily-available funds that lenders have. So if our big banks see property so favourably, perhaps we can take some comfort in investing in it.
Property values increase over time. There are those, in recent years, who might suggest that is a bold statement. I say, take a longer view! I will leave you to do your own research on long term median house price vs share growth data, as this would be a very long blog! However, I’d encourage you to look at a 10 year plus timeframe, as this is really the minimum time we should be looking to hold property. If you happen to buy in a low and sell in a high part of the cycle, consider that a bonus, but if we hold property for at least a whole cycle, and have bought well in the first place, we would certainly hope to see some growth.
OK, so property is seems good. Why invest when I have a home?
Now of course, that is all well and good, but if you own a home, you’re building wealth, right?
Well, yes and no. Assuming we accept that property values increase over time, and you are steadily paying down the mortgage, the home you live in is definitely adding to your overall wealth. However, you have to live somewhere! If your needs change and you need to live in a different area, or bigger home, the new ideal home has almost certainly increased in value too.
For example:
John and Mary bought a $280,000 home in an outer suburb of Perth in 2010. They bought well in the early post GFC period, and had an initial mortgage loan of $260,000. At the time, their dream home, 10km closer to the city, was $420,000 and was just a bit out of reach. They diligently made loan payments, and in early 2017, the home was worth $450,000, and the loan $235,000. They had $215,000 equity, and were thrilled to see the original dream home back on the market, but now at $650,000! They would now need a loan of roughly double their current loan to afford the dream home.
Their friends Bob and Sally bought in identical market conditions, but purchased a home to live in, and a rental home, each for $280,000. Things were a bit tight at first, so they set the investment property loan as interest only, and only made the minimum payments on their home. Having the property tenanted, and using good tax advice, the investment property was almost cost-neutral. After a few years, rental income increased, so they started paying Principle and Interest payments.
By early 2017, just like John and Mary’s home, Bob and Sally’s home and rental, are each worth $450,000,. Their home loan is at $235,000, and the investment loan is at $245,000. So Bob and Sally have $420k in equity.
In the above, clearly Bob and Sally, our property investors, would be in a much easier position to afford their dream home. Of course, there’s stamp duty, CGT, agents fees and more, but the point is that they have more options than the non-investors in the same scenario.
This is why property investment works. Real, usable wealth is created not in the growing value of the home (unless you downsize of course), but in the growth of the additional property, or properties.
What’s your why?
For our fictitious friends above, it was buying a dream home. Yours might be to be able to afford nicer toys in a few years, or more travel. Maybe you haven’t built up much super, or don’t want to wait until 65 to access it. Perhaps you don’t want to choose between spending the kids’ inheritance and leaving them one! There are many reasons why the 1.7 million property investors have taken the plunge, but the most important reason is yours. If you have the why, I can show you the how J
Next blog, we’ll explore a little more detail about investing in property, and I’ll share some insights from my experience in buying, and selling, at all stages of the property cycle.
Brian Macauley – InReach Finance