“The trouble is, you think you have time” – Buddha.
Procrastination – property investment is not a ‘get rich quick scheme’. If that’s the kind of risk profile you have, then you are a speculator, not an investor. Time in the market is crucial to riding out any volatility in rent returns and values around the long term trend line. Many people take so long waiting to ‘jump on the train’ that they miss one after the other and are left back at the starting line for years. Remember the ‘miracle’ of compounding! Starting your investment journey as early as feasible allows you to reduce your risk, minimise outlays and maximise the potential returns.
Not seeking professional advice – in a highly specialised economy, it pays to leverage off the expertise of qualified, experienced professionals to support your investment decisions. This applies to seeking advice re finance structures (investment broker), legal entities, tax implications and ownership splits (accountant), estate planning and exit strategy (financial planner and accountant) and of course investment property choice, purchase and setup implementation with a property investment advisor.
Not having a plan – It’s said that ‘it’s a long time on the golf course if you don’t know where the 18th hole is’! It’s the same in life. Do you simply want to wait and see what happens or do you want to take charge and have an influence over the outcomes and options in your life and the lives of your family?
Investing allows you to identify that 18th hole and perhaps enjoy the 19th more!
Overcommitting – because property investment is a long term strategy, it’s necessary to make it sustainable for the long term. So the investor should not (and should not be encouraged to) overcommit. Your borrowing capacity may be large, but that doesn’t mean that you should spend to your limit. Borrowing capacity doesn’t necessarily equal your ‘comfort’ range. Ideally, the property should be able to tick away in the background without a significant imposition on your budget or lifestyle. Additionally, not using up all your borrowing capacity allows you to come back and buy again too – it means having more than ‘one pot on the boil’ at a time.
Lack of diversification – this applies to having a mix of asset classes and within the property class, mixing up the locations, types and price points. Allied to the last point about over-commitment, is the consideration of whether it’s wise to buy one expensive property if funds allow, or two lower-priced properties? Typically two lower-priced properties is a better idea because it spreads the location and type risk, and it also increases your liquidity. Property is a relatively illiquid asset – so if you need to access some funds or divest for some reason, you don’t have to exit the market altogether but can do so in part.
Assuming that nothing will ever change in the future – it’s vital to ‘stress test’ your choices. Once again, because a property is a long term investment, you need to understand that there are no guarantees in life. Interest rates can go up (or down), and rents are market-determined and therefore can vary from time time, additionally, government policy and regulation, in particular, tax incentives can change and personally, your circumstances are also subject to change and may have an impact on the sustainability of your investment position. Job security, relationship status and health may all throw ‘curve balls’ into the mix over the long haul. It is a reinforcement of the recommendation to invest sustainably and for the long term so that you ride out the ups and downs in the market and life.
“The only ones to get hurt on a roller coaster are the jumpers.” Paul Harvey
Inadequate insurance and risk mitigation strategies – keeping in mind that ‘profit is the return to risk’, the savvy investor acknowledges the risks and takes steps to address them as adequately as possible. It starts with using credible and qualified team members in the journey and seeking advice, asking questions, stress testing, making dispassionate decisions, and having adequate insurance in place ( building, landlord’s, contents, perhaps income and life) and not over-committing.
Making changes to finances midstream – Lender’s ‘goal posts’ shift all the time, and typically there are many hoops to be jumped through to be approved for a loan. Once a pre-approval is granted, it is recommended not to make any changes to your financial position, such as going out an buying a new car or changing jobs, until the loan is funded. (even formal approval may not be enough to allow changes to financial behaviours). Consistency is particularly crucial for settlements that are a long way off. There is no certainty that lending criteria will remain the same in 6 or 12 months. Once again, qualified, honest and compliant professionals in the property investment space will make you aware of this risk and help you to decide if it’s a suitable one for you to take.
Looking over the back fence – this one relates to the idea that you need to buy where you live and where you think you know. Australia is a vast country, and as we have discussed, there is no one property market, there are opportunities across states and regions, in inner, middle and outer ring suburbs in different types and style of houses. You are limiting your options and diversification by not considering the alternatives. It also pertains to the idea that if the property is close to where you live, you can look after it! That is the job of your property manager – engage professionals to do what is best done by them, keeping the emotion out of it. As your portfolio grows, there isn’t time to be doing your job and managing several properties. Property management fees are tax-deductible, a professional expense incurred in running your property investment business.
Unreasonable rent expectations – it’s a fact that rents are market-determined. There is no point leaving a property vacant in the hope of finding a tenant who will pay $520pw when the property manager is telling you that $500pw is the highest possible return at this point. Every week the property sits empty it costs you $500; if it is vacant for a month, then it has cost you $2000 or nearly $40pw. You are better off taking a tenant straight away, minimising vacancies and sacrificing the $20pw (or $1040pa) rather than $2000. Be pragmatic and don’t ‘shoot yourself in the foot’!
Recordkeeping – To make all the claims you possibly can and therefore minimise the bottom line, meticulous records must be maintained. Those who don’t have a system for recording all their property expenses will more than likely miss out on allowable deductions and cost themselves money! The ATO specifies that the property investor must keep proof of income and expenses and supply them on demand for the last five years. Typically investors use excel spreadsheets and shoeboxes of receipts and scramble at the end of the year to provide a record of the financial year to their accountant to decipher. Alternatively, ASPIRE clients have access to a Portfolio Manager to record, track and visually present their income, expenses and asset position at the click of a button.
Not understanding the purpose of bank valuations – Valuations are a measure of the bank’s appetite for risk, which varies over time. There is a difference between a bank valuation (done to protect the bank’s balance sheet) and market valuation. Bank valuations are inherently conservative and vary widely. It is wise to be prepared for some variation in the valuation from the contract price, anywhere between 5-7% is quite routine. Appraisals are very much an ‘inexact science’ at the best of times; they are heavily dependent on individual expertise and opinion. Forgoing an excellent opportunity that stacks up well in all other respects because of a low valuation may be shortsighted.
Thinking that the lender with the lowest interest rate is best – everyone wants the best deal possible, but the right choice is the lender who will do the deal for you! Some promise low rates but bring in valuations short of the package price, forcing you to contribute more. It’s their informal way of securing themselves. Insisting on saving .25% may save a few thousand over ten years but, if that lender is notorious for conservative valuations or restrictive criteria or is too slow and won’t allow the deal to ‘work’, as an investor you may potentially forgo capital gain for 10 years, which may result in a far higher opportunity cost. Be guided by your broker who knows who’s ‘doing the deals’
Not making all the claims you can – make sure you have an accountant who is up to date and thoroughly conversant with property investment tax legislation. Have a professional depreciation report prepared and claim these ‘non-cash’ deductions; they are significant in reducing your burden and are too often overlooked. Stay up to date with ATO rulings on allowable deductions.
Why the New Year is the ideal time to invest
Richard Crabb – MD ASPIRE Property Advisor Network | PIPA Board Member
There are a lot of promises we make ourselves at the start of each new year—things like spending more time with friends or getting our health and fitness plans back on track.
These are all perennial favourites, but another that seems to turn up every annum is the evergreen, “THIS is the year I’ll get my financial affairs in order.” And while all these good intentions are important, there’s no denying they become challenging as we settle back into our daily habits. It’s human nature to run to the routine.
We’ll find ourselves marching through the weeks to the beat of a familiar drum. Then, before you know it, Christmas decorations are appearing, and December is upon us once more. What happened to all those resolutions from January?
Well… this year is different because instead of dreaming about your ideal year, we’ve hit the turning of a decade which provides the perfect opportunity to ensure your future looks bright beyond the next 12 months.
In fact, 2020 is the ideal pivot point for motivating you into mapping out an amazing next 10 years in property investing.
The procrastination past
Perhaps, more than in any element of our lives, the unrealised idea of investing for our future is the most tragic missed opportunity.
The reason is the majority of successful investors gain their wealth by stealth. Incremental increases in value that don’t seem like much over short time frames – but add them together across multiple price cycles and you’ll see a monumental uptick in their financial position.
Property investment success works because the gains are consistent. This is why real estate outperforms most other investments vehicles over time.
The tragedy is that these slowly ratcheting capital increases don’t occur for most people because of one simple, but crucial, reason.
They fail to get started in the first place.
The key to success.
There are many reasons why people procrastinate themselves into an inadequate retirement.
For example, some read media reports like they’re gospel and become reactionary in their investment decisions. Anyone who had been scrutinising headlines over the past six months for Sydney would have been bracing themselves as we plummeted headlong toward the bottom of an almighty price crash.
These readers may have included potential investors who thought, ‘Now is not the time. Look at what’s happening!’
Of course, what a difference a few months can make.
As soon as interest rates fell once more and lenders loosened the reigns slightly, the market started to turn up again.
There are now plenty predicting the Sydney market has already bottomed and is due for double-digit price rises.
And those who failed to act a few months ago for fear of further value falls are now being left in the wake of tighter listing numbers and rising prices.
So, my first tip – stop reading daily property articles and believing the trend is set for decades to come.
You should be buying now to take advantage of the market in two price cycles time – or 10 to 20 years. You shouldn’t be thinking, ‘Will I live in regret in 12 months if I buy now?’. Instead think, ‘Will I live in regret in 10 years if don’t buy now?’… and the answer is, invariably, yes.
The next tip is to extend your expectations.
There are plenty of people in 2010 who thought about investing but held back because they couldn’t see a way to make gains in the first couple of years… so they waited.
Those same people will be here in 2020 having the same conversation with themselves. In the meantime, they missed some of the most impressive capital gain runs Australia has seen in its history.
Don’t be another stumbler – remember there’s plenty of wealth to made over a decade, but the key is to act, not wait.
The perfect is the enemy of the great
Another procrastination tool is the eternal hunt for the ‘perfect’ investment.
In truth, finding that unblemished gem is unlikely – and in the meantime, you’ll pass up a raft of opportunities that will pay very handsome dividends over the long-term.
Good property investments are out there and while they may not always be the most ideal home on the market, they will provide the type of returns that investors with staying power enjoy.
Don’t let the hunt for a flawless investment keep you out of the race so long that you gain nothing.
That applies to trying to pick the market cycle as well. In truth, there’s never going to be a ‘perfect time’ to invest because for those with a long-term plan, taking action is the only solution.
You simply can’t win this race if you don’t front up and start.
Advice pays dividends
The smartest way to reduce the risks and boost the benefits is to surround yourself with the right professionals and rely on their advice.
You don’t have to be paralysed by the research required to try and gain expertise in the field, because there are already experts out there that can work with you start the journey.
We are constantly presented with great investment opportunities and have the experience to steer our clients away from the duds.
So, here we sit at the start of another decade – did you hope to invest in the 2010s and now have non-buyer’s remorse?
If so, don’t go into the 2020s full of good intentions but without a plan for action. Take a moment this year, have a think about what you’d like to achieve and get moving.
Get your mindset right then talk to someone who can help map out a strategy, so you don’t live in regret come the end of 2029. Contact me an I will contact you with a professionally accredited property investment advisor that can assist you – 1300 710 933.
What’s the bottom line?
A very important step in choosing an investment property is to have the cash flow figures worked for you to make sure that the property suits your financial circumstances.
There are several professional programmes designed for this purpose, but with any computer-generated information, the output is only as good as the input.
A qualified and professional Property Advisor will provide the assumptions their model is based on and explain why these are important.
Based on these assumptions after rent and tax rebates and all associated costs, the property should return approximately + $35 per week to the investor.
This result assumes that the tax rebate of $4,420 is collected week by week after submitting a PAYG Withholding Variation. If it weren’t, then the investor would need to contribute approximately $50 per week.
Calculated by taking away the expenses ( interest cost and the rental expenses) from the income the property generates (rent) : $21,403 – $16,195 – $7,818 = – $2,610 / 52 = $50.19 per week:
Manipulating inputs such as anticipated rent, vacancy rates, inflation rates etc. will distort the truth and impact the bottom line result, making the costs appear better than they are or implying growth in capital value and rental income that cannot be guaranteed.
Be wary of rental guarantees – these sometimes provide a subsidised rent from the developer or the vendor at higher than market rates for a limited time. These can be very worthwhile and a great way to start with rental income right from the point of settlement, BUT if the cashflow is worked based on this ‘inflated’ rent, it will not give an accurate long term view of the holding costs. Sometimes they are used, and after the guaranteed period ends, the property owner receives a shock when suddenly they are asked to contribute more to the property than was projected at the point of purchase. Always ask your advisor to work the figures at verified market rates to see if you are still comfortable with the bottom line.
However, if the vendor is offering a rental guarantee that corresponds to current verified market rates or has identical properties in another development already achieving that rent, then the guarantee is a legitimate bonus.
A powerful way of looking at the affordability of a property investment purchase is to see who will pay to cover the holding costs of the property.
In this particular case, after rent and importantly, PAYG tax credits are collected, the property costs, on average, are serviced by both the tenant and the ATO:
The interest rate is the cost of credit.
Interest is the cost of credit.
There is no single interest rate.
Rates vary according to the availability of funds and the risk attached to lending for a particular purpose. There is a direct correlation between risk and the premium charged, as risk rises, so does the price of credit.
The investment loan mortgage rate is the one that is of consequence to investors and is relatively low because the asset securing the loan is a physical, ‘bricks and mortar’ asset.
Interest rates are cyclical, they go up, and they go down in line with the Reserve Bank’s responsibility to help manage inflation and unemployment. Interest rates are ‘tightened’ (upward pressure applied) to control inflationary spending, and eased to stimulate growth and employment.
Interest rate rises for the investor are not as ominous as the media would often have you believe. When rates increase, fewer people buy their own homes and more enter the rental market, putting upward pressure on rents. Higher rates mean more tax deductions. The net effect on the bottom line for an investor of a .25% increase or even a whole 1% increase is significantly reduced by the fact that part of every dollar in interest you pay may be returned to you by the ATO at your marginal rate.
“In addition to enterprise-wide stress tests, portfolio-level and risk-specific stress tests of residential mortgage lending portfolios are considered good practice.” Prudential Practice Guide: APG 223 Residential Mortgage Lending APRA 2019
Central to that stress testing obligation is lenders applying a ‘qualifying rate’. They work out if you can afford to borrow even if rates rise by around 2%. They don’t approve loans that are servicing on the current interest rate; they factor in the expectation that rates are cyclical. If you get approval, you are genuinely creditworthy! The idea is that even if rates rise, you can service the debt without undue pressure.
When considering finance options, the best lender is the one who will do the deal for you! Some promise low rates but if a conservative valuation falls short of the package price, forcing you to contribute more or to withdraw from the purchase, the ‘comparison rate’ is a price too high to pay.
It can be their informal way of securing themselves. Insisting on saving .25% on a $300,000 loan over 10 years = $7,500. But, if that lender’s criteria are so strict and they won’t allow the deal to ‘work’, as an investor you may potentially forgo capital gain for ten years, traditionally 7.2%pa or in this case $300,000 profit!
A variable interest rate fluctuates in line with the Reserve Bank’s Monetary Policy and more recently, the retail banking sector’s discretion!
A fixed-rate is set for a specific term of the loan. If borrowers can pick the bottom of the market, this can be a beneficial strategy. Keep in mind, though, if the bank’s fixed rates are falling, they are expecting them to go even lower in the future.
Even though the official cash rate may be as low as 0.1%, the price charged by lenders is higher because they add a margin on top – this is how they make a profit. So, housing mortgage rates may be 2.1-3.0% while the cash rate is as low as 0.1%.
Monetary Policy is RBA action to influence the availability and cost of credit by adjusting the cash rate. To be effective, banks need to pass on the reductions in rates to their customers. In recent times the banks have been accused of ‘hijacking monetary policy’ by either not passing on the rate cuts or by increasing their rates outside the policy cycle.
This why the Governor of the Reserve Bank has suggested that customers compare lenders and products, not be complacent and ‘shop around’!
Competition is a powerful motivator for lenders to keep and win new business.
Interest rates, what if……… Interest rates are defined as ‘the cost of credit’; in other words, it’s the price we pay for using other people’s money. Household debt in Australia is close to $2 trillion, around $200,000 per household. Some of us owe a lot less, and some of us owe a lot more! Finance is crucial to economic activity; for households, corporations and government. Few of us have all the money we need at our disposal to buy or build the big-ticket items like houses, factories or bridges and so we have to borrow and pay it back over time.
At a micro or household level, credit allows us to create wealth by purchasing assets that appreciate over time. It also allows us to buy assets that depreciate over time but enhance our standard of living, the cost we incur is the interest we pay.
For most people, the single largest purchase in their lives will be the family home, and so it’s not surprising that the lion’s share of private-sector debt is for housing and the rest is predominately credit card and vehicle debt. Housing debt includes owner-occupier liability and to a lesser degree housing investment debt.
Credit card debt is considered ‘consumption debt’ because we buy things with credit cards that get used up quickly or fall in value over time, typically it’s classified as ‘bad’ or unproductive debt.
As a nation, we are by and large committed and reliable repayers. Housing loans in default hover around the less than one per cent mark, and a significant proportion of borrowers are ahead in their payments. It seems a lot of us are not necessarily ‘great savers’, but we are ‘great payers’.
So how does all of this relate to an investment property purchase decision? Given that our lenders, with strict prudential supervision, are comfortable lending up to 100% of an investment property purchase is a strong endorsement of the safety in bricks and mortar as an investment. Borrowing to invest allows you to access the power of leverage and purchase assets much more significant than you would be able to if you had to fund it using your own money. The cost will be the interest you repay to the lender, but that cost like all associated with owning an income-producing (rent) asset is tax-deductible. The cost of borrowing is weighed against the opportunity cost of not investing now.
Time in the market is important when investing in property, so any recommendations need to be based on the idea of ‘sustainable investment’, can you afford to hold the property for the long term, allowing for reasonably predictable changes in circumstances over time and movements in interest rates? Why? Because interest rates will change over time as sure as night turns into day.
Monetary Policy is the Reserve Bank action designed to influence both the availability and cost of finance in the economy. Interest rates are pushed up to slow the economy and limit inflation, and they are eased to encourage spending and activity and therefore, employment. So, as economic circumstances change so will the prevailing cost of credit.
When calculating out of pocket costs for an investment purchase build in a buffer, ask to see the figures at an interest rate of 1-2% higher than currently on offer. Keep in mind though that given the RBA typically adjusts the dial by .25% at a time you have many adjustments before you reach the 2% mark.
The upside of a rate increase is that your tax deductions increase and more people may delay buying their own home and continue to rent and put upward pressure on rents.
Remember, ‘profit is the return to risk’ so you do have to take some risks if you are to build wealth for the future but make it a calculated risk.
There is no simple answer!
Smart property investment involves identifying assets that offer growth potential coupled with a sustainable level of rental return.
This combination is the basis for long term wealth building.
Australia is a vast country and opportunities exist in different states and different locations within those states. Even within the same suburbs, various types or styles of property present different opportunities.
The best place is the place that meets the investor’s specific situation and strategy.
One thing is for sure, the best place is not necessarily, the place you live in now! Many novice investors make the mistake of assuming that the ‘devil you know’ is the best way to go.
Looking over the back fence of an investment property is not only unnecessary but ill-advised. The investment property is an investment vehicle and should be chosen devoid of emotional attachment.
Concentrating on your work and income earning potential and leaving the management of your asset to a carefully chosen property management professional is the wiser approach. ( the benefit of specialisation is higher productivity)
This is particularly appropriate when you build a property portfolio. The logistics of managing multiple properties is beyond the scope of most people unless it becomes your full-time job!
Choosing a location to invest in ought to be a well-considered decision, based on your situation, budget, goals and time frames as well as an analysis of the demand side drivers and the supply side constraints prevailing in different places at different times.
The factors influencing demand and supply in any location are multi-layered and don’t always conform to textbook models.
Perfect competition requires perfect knowledge. To get the lowest price for bananas, you need to know who is selling them, where and at what cost at any time point in time.
Likewise, perfect knowledge and mobility in the housing market do not exist.
It is unrealistic to expect that the price of accommodation, either house prices or rents will be met with a ‘perfectly elastic’ responses on both sides of the equation.
For example, despite rising rents, families may not be easily mobile across locations in search of lower prices. Access to employment, transport options or the lack thereof, family ties and established links to schools, sporting and friendship groups make moving home tricky. It can also be prohibitively expensive.
Likewise, the timeframes involved in new supply limits the ability of the market mechanism to work as efficiently as it might otherwise.
It’s important to understand that Monetary Policy is a ‘blunt instrument’, that is, it affects all sectors of the economy generically and it’s not possible to selectively target just the ones you want to dial down or the ones you want to stimulate.
The effect of macro drivers for demand, such as interest rates is not location-specific. For example, the RBA was not able to increase interest rates in Sydney and Melbourne alone to slow house prices during the past expansion phase without collateral and unintended damage to other property markets. So, while record-low interest rates now are designed to provide a stimulus to the economy and to ‘soften the landing’ of slowing activity, they do so generically.
You can’t assume all markets will grow as a result of increased consumer optimism and confidence – it’s crucial to look at the specifics and to match a location to your particular needs before arriving at a decision.
Influences on the choice of location include:
The property cycle is divided into 4 phases
The property cycle is a recurring pattern of upturns and downturns in the market for housing influenced by economic, political, social and psychological factors.
Periods of growth are inevitably followed by periods of reduced growth and market ‘corrections’.
While property cycles can vary in length, pace and the height of the peaks and the depths of the troughs, they follow the same long term positive trajectory. Variations around the trend line are to be expected, but it is the overall direction of the trend that is important.
This is why a property is not considered a short term investment or a ‘get rich quick scheme.’
It is worthwhile noting too that while recovery periods typically match the length of time, it takes to go from peak to trough, it is not always the case.
Investors need to commit to sustainable levels of debt that will allow them to ride out the downturns.
Investment in real estate like any other asset class is subject to market sentiment and the performance and management of the economy as a whole. Returns may fluctuate depending on factors such as supply and demand for housing, population growth, interest rate changes by the RBA and government incentives and exogenous shocks to the economy.
Influences on the demand side include:
The business cycle – if the economy is growing, unemployment is low, and consumer confidence is high, as incomes rise more people buy their own homes and more people are in a position to invest. If the economy is slowing and unemployment or underemployment is growing, and consumers are pessimistic about the future they will hold off and wait for conditions to improve, leading to a decline in demand.
Government incentives through fiscal measures encourage owner-occupiers and investors via grants and stamp duty concessions, negative gearing allowances and capital gains tax discounts. Removal of the same inducements will have a reverse effect. Political uncertainty and imminent elections also inhibit consumer confidence.
The RBA’s manipulation of the cash rate influences the cost and availability of credit in the economy, and more people are likely to borrow and purchase property either for owner occupier or investment purposes when rates are eased and less so when the policy is tightened.
Prudential regulators such as the Australian Prudential Regulation Authority (APRA) can encourage or discourage borrowing by relaxing or toughening the guidelines for financial institution’s lending criteria.
Demographic trends such as population growth and the divorce rate will increase or decrease the demand for housing (and the type of housing)
Media coverage intensifies consumer perceptions and ‘fear of missing out’, and it can also drive ‘doom and gloom’. Consumer confidence and emotion govern many decisions.
Influences on the supply side include:
The availability and cost of development sites and materials: vendors will assess the profitability of entering the market as a supplier and calculate the risk and return potential. If they expect costs to increase, they will seek a higher margin as insurance against future erosion of profits.
Bureaucratic red tape and compliance costs influence the profitability of ventures, including the approval process and mandatory infrastructure co-contributions
The cost and availability of finance for developers. If credit is limited and difficult to obtain, a smaller number of projects will get off the ground, typically by more substantial, corporate developers.
Builder expectations, confidence and perceptions of buyer demand influence their willingness to take risks and enter the market.
The property cycle is divided into 4 phases: