Nothing beats location: four investment property rules to live by
There are a myriad investment vehicles out there hoping to attract your hard-earned dollars with the promise of future wealth, so why should property be top of your list?
In my experience, real estate is streets ahead (excuse the pun) in three key areas: predictable performance, leverage and control.
In my mid-teens, I distinctly remember one outcome of my parents' divorce was that mum paid out dad, as part of the settlement, so she could keep the family home.
My folks bought that house in Sydney's western suburbs in the early 1980s for $35,000.
The market hadn't seemed to show a hell of a lot of growth, even after my mum became the sole owner. We even went through the staggeringly high interest rates of up to 17.5% in 1987 and 1988, which caused many property owners no end of heartache and some even to lose their homes.
Then, as if all of a sudden, it was 1993 and a revaluation of the home revealed its worth was $200,000. Nowadays that home would be worth closer to $850,000.
It struck me, even back then, that it took little effort to achieve that big result in capital growth. I thought, "Geez, that's a lot of money - that's crazy how much that property has gone up. You bought it for that and it's now worth this!"
This was the first time I took note of the consistent performance of property values. I've since spent a fair bit of time studying shares versus property. Did you know the Australian Securities Exchange (ASX) index in December 2018 was still 13% below its peak in 2007?
This looks very disappointing when you compare it with a carefully selected property, which would have doubled in value over the same period. With the right strategy in place, real estate doesn't have to be a burden on your cash flow either.
If your risk profile is on the low side, riding the waves of share price peaks and troughs is more a horror than a thrill. For long-game investors, property has shown a steady and consistent value growth cycle that's hard to beat.
One of the secrets to building long-term wealth in any investment type is compounding interest. Combine that with the ability to leverage (borrow against) your holding, and you can watch your personal balance sheet skyrocket.
When I first considered the value gain on my mum's house, I was too young to understand leveraging and compounding growth, so I decided to learn more about it.
It didn't take long to grasp that if you've got equity in a property, it can be leveraged - and, if you can afford the repayments, why not recycle that money?
For me, that was a "light-bulb moment". While my career as an investor and adviser had not yet begun - in fact, it was still some years away - the seed had been sown. I had realised there was a way to own property and build a portfolio without having to put down a hell of a lot of cash up front.
You could extract equity from an asset and then recycle that equity into other holdings that could grow in parallel and thus create a diverse, successful investment portfolio.
The final attraction of property, for an investor like me, is control. Mum's home was our solid foundation.
As long as she could manage the repayments on the home loan and the costs of necessary maintenance, she would not only provide a roof over our family's head, she'd also have a secure asset for her future.
You can invest in property, you can invest in shares and you can invest in businesses. There are upsides to each of these choices, but in the end with your properties you're the one in charge. You have a tangible asset that is always going be a saleable asset.
Compare that with a business investment, where bad decisions - irrespective of whether made by a CEO or non-CEO - could cause that business to sink rather than surf. They could potentially affect your stake in the business and you would have limited to no control over that.
One of the great things about the real estate investing community is it's a broad church.
The investor enclave comprises a diverse cross-section of people - from first-time millennial purchasers, to middle-aged mums and dads, to those contemplating their imminent retirement and everyone else along this spectrum.
Investors have a variety of risk tolerances too.
While some may be happy to snap up whatever is on offer, paddling fast and hoping they're perfectly positioned, others will be more clinical in their research and decision-making, allowing waves of opportunity to pass them by while they keep a keen eye on the conditions with a plan to jump on the ride of their lives.
Whether you're an early or late investor, have a high or low risk tolerance or are looking for blue-chip or more affordable locations, there are four fundamental philosophies that I think you should understand to elevate your chances of building a cracking property portfolio:
Timing is everything
There are two great regrets I commonly hear from seasoned property investors:
- I started too late.
- I sold too soon.
The former can be remedied by looking at my steps for learning how to adopt the winning investor mindset. The latter is often a result of not accepting that property is a long-term investment. Long-term investors sit at the pointy end of the plane.
Most investors looking for solid gains across their portfolio's lifetime need to be in it for the long haul.
Buying quality property, with the right ingredients, means sometimes you can ride a rising market wave and profit quickly - just ask Sydney property owners who bought in 2011.
However, if you look back over the 15-year period in the run-up to 2011, you'll find growth in Sydney property values lagged other capital cities for most of a decade before it had its boom run.
Big money comes from patience; you need to allow compound growth to do its thing over the long term (more about compound growth later).
Be prepared to resist the temptation of making a fast buck and selling too soon.
Nothing beats location
You can't out-train a bad diet, and you can't sweeten a property lemon. It's fine to have the big home with the tasty finishes, but if it's positioned on a main road in an isolated suburb where's there's an oversupply problem then your chances of realising a great return are limited.
Location is the key to success because it's in "limited supply" and can't be changed regardless of how much money, time and effort you have at your disposal.
Make sure you research your locations well, looking at region, suburb, street and individual property to ensure you maximise your chances.
The nation is your market
Real estate in Australia has evolved at a rapid pace over the past decade. Ask your elders (for millennials, this means anyone over the age of 40) about where they were most likely to invest two decades ago.
The vast majority - if not all - would say the suburb they lived in or, if not their home suburb, certainly somewhere within their home city.
Today it has never been easier to be a borderless investor, capable of seeking out markets anywhere across our broad, brown land. There is a wealth of information readily available online and a growing number of professionals capable of helping you study and acquire an investment property in a multitude of areas.
Don't limit your thinking to tracking those five suburbs you know and love, where you used to ride your bike and play street cricket. Broaden your horizons and take advantage of all the real estate that's on offer.
Free your mind - the rest will follow
I understand the concepts of gut instinct and emotional connection. They can be important tools when you need to react quickly to the question of "Should I stay or should I go?" To be a successful investor, however, the numbers must make sense first.
As a fundamental, I implore you to run through the figures carefully before making decisions that will affect your financial security.
Start with your home budget and make sure you won't go broke - or, at least, have a buffer - if you must take on a higher level of risk. Check your loan commitments and ability to deal with a mortgage.
Check and recheck the figures on properties you are interested in investing in, too. Don't just take an agent's word for it. Do your own research into rental income and comparable property values. Do they all make sense?
Get the numbers right so you can rely on your heart and gut without fear when opportunity presents itself.
Your personal or home budget should take pride of place among your fiscal considerations. A property investor's home budget should be a frank and fearless dissection of what it takes to run a household and not go broke.
There are plenty of budgeting tools available online to use to work out your world of dollars and where they're spent. Your talented mortgage broker will also help guide you through the personal budget process as part of your loan application.
A personal budget initially helps you track and report how each dollar of your income moves through your household. The great thing about budgets is that for many of us they become ingrained and automatic over time.
I find, for example, that I no longer need to track my budget with surgical precision. How and where I spend my money to fulfill my family's wishes is now second nature.
I've become holistically better at money management through achieving a necessary income, keeping an eye on my goals, regularly rechecking my personal barometer and making informed choices about where my dollars are used.
I think budgets help households prioritise money, and the flow-on is you gain an almost automatic ability to assess your spending habits each time you reach for your wallet.
While initially you might find yourself saying, "According to my Excel spreadsheet I can only afford takeaway dinner twice this month. What a drag!", what eventually happens is you automatically prioritise the importance of what you're doing.
You'll choose to have a takeaway dinner only once this month because your personal barometer already decided taking the family to see a live performance of The 43-Storey Treehouse was a better use of your cash.
The nice thing is, when you get to grips with budgeting, you stop denying you and yours the important things in life and begin enjoying how you use your money, all the while watching your personal wealth increase through investing.
It's a pretty nice way to live.
I always advise investors of the importance of developing the right mindset and setting goals to determine where the finishing line is. But typically, what is the process for defining a path once you understand where you want to end up?
Like any journey, knowing your destination is only part of the process, because the next step is formulating a plan to get there.
Let's say - for argument's sake - to achieve your dreams you have to create $100,000 a year in passive income. What do you need to think about in order to forge your path? Start by taking stock of where you are now:
- What am I earning now?
- What is my total savings position?
- What are my present commitments (eg, rent and/or mortgage repayments)?
- What expenses do I need to live, work and play?
- What's my superannuation position?
- How many years do I have until retirement?
By looking at your take-off point and compounding potential returns over the years you have until retirement, you have a better chance of determining where the likely shortfall is and how best to fill that gap.
If you've got your own home, how long is it going to take you to pay off that on your current income at your existing mortgage level? By calculating how long this will take, and allowing for your total savings and equity position, you can start to understand what sort of wealth you will need to build over the next few years to help you achieve your goal.
If you buy a $500,000 property now, based on, say, a 6% annual capital growth rate compounded over 13 years, it would be worth $1,006,098 in the future. At a net (after costs) yield of 2.5%, that reflects an annual income of $25,152 to you.
Consider how close this will get you to acquiring that $100,000 a year passive income. Based on these numbers, that investment is going to get you a quarter of the way there. So, theoretically, you need four of those assets in your portfolio and to be mortgage-free too, of course.
You need to factor in all the variables. Figure out where you are now financially, how much you have in super, and how much it is going to take to pay off your home or pay rent (if that's what you choose to do). And then, from a property perspective, how many investments are you going to need to buy, what will their value be and what sort of rental return can you expect?
If you have a joint mortgage, you're going to have to discuss with the other mortgagor/s how you'll eventually pay down the mortgage or mortgages. Would you sell down the assets at a defined time and pay down the debt?
Finally, there are important decisions to make around ownership structures, pay-down methods, sell-down methods, the ramifications for capital gains tax and all the other aspects that come with property investing.
As you can see, setting out an investing strategy is both complex and highly individualised, but the three essential elements remain the same:
- Where do I start?
- Where do I want to finish?
- How will I get there?
It needs to be a really calculated, step-by-step process and requires you to be frank and open, laying all your cards on the table.