Property investment has been a hot topic in the past decades. Why? Because it has generated a lot of wealth. When it comes to property investment, things can get quite complicated for beginners. In this article, I’ll discuss some of the fundamental concepts of property investment. So, if you’re looking to start investing in property, read on…
Is investment property a good idea?
An investment property can be a good investment if you have the right investment strategy and buy the right property at the right location, at the right time. Needless to say, property investment has been very popular amongst Australians. In the section below, I’ll illustrate some of the reasons why property has been so popular.
Property is a real asset
Unlike shares and bonds, which usually are just in the form of papers and figures, property is real. You can see it, touch it and feel it. You can live in it, and you can rent it out. This gives people greater peace of mind.
Property can help you generate income. When you rent it out, you can collect rental payments on a regular basis as income in your cash flow. Having income flowing into your pockets without having to go to work, isn’t that nice?
Property can also generate wealth when it increases in value. It’s what we’ve been seeing in the past decades – average house prices going up. When you sell your property at a higher price than what you had paid, you’ll make money and this is known as capital growth.
Low interest rates
Interest rates relate to the cost of borrowing from the banks – in order words, how much we need to repay to the bank on top of what we’ve borrowed. We’ve been living in a low interest rate environment for years. This has somewhat drove property prices upward. Property is expensive. Therefore, most people who buy properties will need to borrow and involve the banks. As borrowing costs are lower, people will be more willing to buy and can buy more. Low interest rates will also mean money sitting in the bank will not earn as much.
Inflation refers to the rise in the prices of goods and services over time. When prices of goods and services rise, you need to pay more money for them. If your money is not earning for you, it’ll lose value. Therefore, inflation makes money depreciate. Just imagine how much a box of eggs used to cost in 1970 and how much it costs today. As property can generate income and provide capital growth over the long run, it can be a good investment for some investors who want to counter the effects of inflation.
Property can minimise your tax through negative gearing. Negative gearing occurs when the costs of owning the investment property exceed the income it generates. It’s been attractive for high income earners as they can reduce their tax and enjoy capital growth at the same time. In Australia, income tax is payable on a percentage of income earned. High income earners have a higher tax rate (percentage). When they pay more money for tax, they can also claim back more money (compared to lower income earners) from tax deductions as the deductions will reduce their taxable income.
Property in Australia has experienced a relatively stable growth in the past decades. Take a look at the graph below showing the median house and unit values from 1993 to 2018.
Although there’ve been some periods of decline, values have gone up over the long term.
There are risks in property investment
“With great risk comes great reward.”– Thomas Jefferson (3rd US President)
When it comes to investing, property is not the only option. There’re also other options like:
- Managed funds
- Fixed interest bonds
- Term deposits
- Savings accounts
Out of the four investment examples listed above, savings accounts and term deposits are generally considered the safest in terms of risks, but the returns may not be as great compared to the others – particularly in a low interest rate environment.
Just like shares and managed funds, property is capable of generating high growth. When there’s growth, there’re risks – the greater the growth, the higher the risks. Despite having a good growth history, property prices can go down. We’ve seen it before. This was also evident in countries like Japan, Hong Kong and United States. Price fluctuation is just one of the risks of property investment. There’re many more, and I’ll discuss them in our next article. As an investor, you need to establish a good understanding of what you’re investing in. You need to understand the risks to decide whether the investment is right for you.
The different types of property and property investment strategies
When it comes to property investment, there’re different types:
- Freestanding house
Commercial and Industrial
As a beginner, it’s best to focus on residential properties as they’re easier to understand, purchase and manage compared to the other types. There’re also different types of property investment strategies. Some of them are:
Buy and flip
This is buying a property at a low price compared to the market and then selling it at a higher price over a short period of time.
This may involve buying an old property, renovating it and then selling it at a profitable price.
Buy and hold
This is buying a property and then holding it for a longer period of time to achieve a higher capital growth.
This may involve buying a property, renting it out to generate rental income and then selling it once a desirable capital growth is reached.
Buy and build
This is buying a land to build a property or properties and then selling.
This may involve buying a land with subdivision potential. It may also involve construction and development. This investment strategy is usually more complex. It requires a lot more research, money and knowledge around Government requirements. Therefore, it’s usually more suitable for experienced investors.
This involves buying a property that has potential with friends and family and then selling it when the right time comes.
Many people don’t have enough money to enter the property market. Generally speaking, to enter the property market, you’ll need a deposit – around 5% to 20% of the purchase price. This strategy will allow money from different people to be combined together so that there’s enough to fund the property purchase. This strategy, however, is generally only suitable for those who share the same investment goals and have a good bond and trust between each other. Otherwise, it’s possible that arguments and disagreements may arise down the track.
There are ongoing costs when owning an investment property
An important point to note is that property investment does indeed incur ongoing costs, and these ongoing costs are quite high compared to other types of investments. Whether or not your property is making money, the ongoing costs still need to be paid. These are some of them:
- Land tax
- Council rates
- Water rates
- Strata rates
- Loan repayments
- Bank fees
- Unexpected costs like repairs and vacancies
So, it’s important that you’re able to budget for these ongoing costs over the long-term before committing to property investment.
When it comes to property investment, find what’s suitable for you
The most important thing in property investment is that you need to plan and research. Property investment is not a one-size-fits-all type of investment. Different people have different investment goals and appetite. Your friend’s investment property may not be something that’s right for you. You need to plan and research in order to find what’s suitable for you in terms of the type of property, its location, the investment strategy, your intended investment timeframe, the budget required, the risks involved and your level of commitment.
In summary, an investment property can offer a range of benefits:
- It’s a real asset
- It can generate income
- It can generate capital growth
- Low interest rates can benefit property ownership
- It offers tax benefits (negative gearing)
- Property has a relatively stable growth history in Australia
However, there are risks in property investment. It’s important to understand the risks in property investment to decide whether property investment is suitable for you. Property investment also incurs much higher ongoing costs compared to other investments like shares and managed funds. In addition, property investment is not a one-size-fits-all type of investment. There’re different types of properties to invest in, and there’re different types of investment strategies. The key is that you need to find what’s suitable for you according to your circumstances.
In our next article, I’ll show you the risks and tips in property investment that’ll help make you become a wiser property investor.