by James Freudigmann
Whether you’re considering buying an investment property, already own one, or have a large portfolio, one common theme is almost impossible to deny; property investment forms a big part of the Australian psyche.
But is property investment all it’s cracked up to be? What is all the hype about?
Whether you own property or not, there are two rules that should always form part of your investment decision-making. These are:
Rule Number 1 – Never invest to lose money! Regardless of how good the tax deductions are.
Rule Number 2 – Never invest with emotion!
I can hear plenty of you saying now: but I get great depreciation and negative gearing benefits. Absolutely, we’re not denying that these are some of the benefits of property investment, but this is not an investment fundamental. Negative gearing is still an expense because you only get back a percentage of the cost to hold the property. Unless the property is improving in value, all the depreciation and negative gearing benefits in the world are still not going to result in you making money.
Before we all go trawling through our past tax returns to work out how much our properties have cost us each year and whether we’re ahead, let’s consider the fundamentals of property investment and the real returns.
The fundamentals of property investment should include:
- To generate a positive return from your capital
- Invest for capital growth – proven, established, low-risk areas with strong historic capital growth
- Risk mitigation – Property should form a part of a balanced investment portfolio
As a Doctor, you will likely have access to special lending offers such as higher loan-to-value ratios without lender’s mortgage insurance (LMI) payable, making it easier to purchase an investment as you require less deposit.
The question is, does residential property provide the returns required to make it a quality investment despite this low deposit requirement?
Let’s consider an example with the following assumptions:
- Interest Rate 4% p.a.
- Deposit of 10% and purchase costs of 5% e.g. transfer/stamp duty (in this example, cash savings are used to fund this)
- Negative cashflow of approximately 1% p.a. after tax (reasonable in the current environment, but this will be dependent on the property type and market that you buy in)
- LMI not applicable
Firstly, let’s consider a very low growth market, for example the Brisbane unit market. This market has struggled for the past 5-6 years and has in our opinion, reached near the bottom of the cycle.
After tax, the investment provides a return of 6.67% on your initial investment of $75,000. When compared to current term deposit rates, it’s not a bad annual return for investing $75,000, even assuming capital growth of only 2%.
Secondly, let’s consider a house providing a modest capital growth of 4% p.a. with similar assumptions to the above example. The long term average growth rate (20 years) for the Brisbane market has been much stronger than this. However, for the purposes of this calculation, let’s assume the market growth is going to be somewhat subdued for the foreseeable future:
A 20% return per annum on my investment, after tax, is a sound outcome.
Finally, let’s consider if we purchased a “blue-chip” property in a strong capital growth area, assuming the historical returns that have been achieved over the past 20+ years:
The above figures are purely an illustration of the potential benefits of investing in property. A consideration has to be made whether this is the right investment for your personal circumstances, or whether investing in shares, your practice, a business, a term deposit or another type of investment is better for you. However, it is evident that a reasonable return can be achieved by investing in residential property with a reasonably low level of risk. But, is the risk low?
That all depends on what asset you buy, what market you buy in, and at what time in the property cycle you invest.
The risk of property investment is no different to any other asset class. The higher the risk, the higher the potential reward, but with high risk comes potentially large losses if you make the wrong decision. A perfect example of a higher risk investment is buying a property in a mining town.
The key to property investment is utilising a research-based approach, conducting thorough due diligence, investing with an element of caution taking into consideration historical data, and importantly, selecting the right market and cycle stage to invest.
To realise these returns from your property investments, you have to have a long-term investment mindset (7–10+ years). By doing this, it provides ample time to be able to experience a full property cycle, and allow the power of leverage and compound growth to work for you. The entry and exit costs into property are quite high (taking into account stamp duty, etc), therefore buying and selling in a short period of time can reduce the likelihood of you making a meaningful return from your investment.
Considering the potential returns that you can achieve in the examples above, investing in residential property can be very financially rewarding when executed correctly.
James Freudigmann is a co-founder of PMC Property Buyers which is a National property advisory and buyers agency business, and is a qualified property valuer and property investment advisor. You can view his bio at: https://www.pmcproperty.com.au/about/#team