Property investing is a popular topic of conversation at barbecues and dinner parties around the country. Despite turbulence in property markets around Australia in recent years, property investing remains a popular choice for Australians as they look to build wealth for the future. There still seems to be an insatiable appetite for new content about property, as evidenced by the seemingly never ending procession of reality TV shows which cover renovating, flipping and all manner of the property buying process.
But, it’s worth asking ourselves, despite the amount of newspaper articles dedicated to exploring the idea of property investing, and the myriad TV shows showing how ‘easy’ it can all be, does the average investor really know what they’re getting into when they sign the deeds for their investment property? In my experience, from speaking to hundreds of investors and would be property investors, very few of them actually take the time to sit back and contemplate why they are actually investing, or to make a plan of how they are going to manage their purchase going forward.
Property investment in Australia seems almost to be a rite of passage for a lot of people, something that people just end up falling into. Core Logic estimated there were around 2.03 million property investors in Australia in 2016, which is quite a large number for a country of its size. Given the widespread acceptance of investing in real estate as a mainstream option, it’s little wonder that many would be investors fail to plan ahead and to actually map out why it is that they are buying a property. Many seem to somehow fall into property ownership, without giving consideration to things such as cash-flow, ownership structure or exit plans.
So, what are the key questions you should ask before considering buying your first investment property, or adding to your portfolio. The main ones I like to run through with clients are as follows:
What am I looking to achieve through property investing?
When working with clients, I like to work backwards from a future required income goal, and then understand what type and how many properties it will take to achieve this. Everyone is different, and the target income can vary greatly, as can the time frame that people allow themselves to attain that goal. One thing is for certain however, setting an income goal will help you understand why it is you are investing, and can help you stay on track. Compare this strategy, where every property has a part to play in a portfolio, to the usual approach where investors suddenly decide they’d like to invest, approach a bank to get a pre-approval, and then jump onto one of the property portals to see what they can afford.
What’s the long-term plan for this property?
Once we’ve established the overall portfolio goal, it’s time to drill down to better understand what each property purchase looks like. The type of property purchased at any particular time will be dictated by things such as available purchasing power, cash-flow requirements and the growth profile needed for that property to perform as it needs to, to help the portfolio hit its overall income goals in the future.
Do I have an exit plan, should things go wrong?
It’s crucial that we first look at how we can ‘get out’ of an investment down the track, should we need to. The upfront costs of purchasing real estate in Australia are quite large, and a common rule of thumb is to use a rough estimate of allowing around 8-10% of the purchase price of the property to cover costs associated with buying and selling the asset. This covers things like stamp duty, legals and selling costs. Obviously each property is different, but you get the idea-property has significant entry and exit costs. So, it’s often not ideal to exit an investment in the first few years. However, sometimes plans change, and a property that you earmarked as a long-term hold might need to be sold at short notice.
If we take this into account in the beginning we’re going to be more prepared for this outcome, should it occur. This means we really need to make sure we’re purchasing a property that will be in high demand, now and into the future. In essence, we’re looking for market liquidity and buying the right type of property for the area. Whilst owning a beachfront house in a quaint little town a few hours from a major city might sound great, it’s unlikely that you’ll be able to find a willing and able buyer at short notice, should you need to sell. Further, even if you can find that buyer, it’s likely that you wouldn’t be in a strong bargaining position and hence wouldn’t achieve the selling price you’d perhaps hoped for. Therefore, whenever we’re looking at purchasing a property, we really need to make sure we’re buying in areas that will have a strong resale potential in the future. This means thinking about things such as local employment options, transport infrastructure, not buying too much above the areas’s median price and making sure we buy the right property type for the area.
Another thing to think about at this stage is how we finance this property, now and into the future. Given property, on the surface, isn’t as liquid as other assets such as shares, it’s important that we create a finance strategy around each property we buy. Taking advantage of things such as offset accounts or perhaps looking to set-up a line of credit against a property can enhance the liquidity of the actual property, and help ride out any storms in the future. Having options to help smooth out cash-flows and assist in holding onto a property, should circumstances change, is far better than being forced into a fire sale.
How much negative cash-flow can I withstand for this property?
For now, let’s park the debate of cash-flow investing vs capital growth investing. We’ll re-visit that in a future blog. Suffice to say though, if you are investing in an asset that will be negatively geared, it’s important to understand how much negative cash-flow your weekly budget can withstand. I’ve met with countless potential clients who were super keen to get started, but had a very bare bones budget to get them into their first asset. The real risk was they were only ever one maintenance request away from running into cash-flow issues, as they didn’t have sufficient cash buffers built up. Generally speaking, residential investment properties should see their cash-flow profile improve over time, and a property that started out as negatively geared can switch to positive cash-flow over time. However, it takes time and it isn’t guaranteed. It’s critical to understand how much you expect the property to cost you each week, and also put aside a buffer for unforeseen issues such as unplanned maintenance and extended vacancies.
What structure will I use to own the property?
As we’ll discover in future blogs, having access to a good, property focused, accountant is really important, especially when you’re first starting out. I recommend clients speak to their accountant well ahead of each potential property purchase, to understand the best structure to hold the property in. There are pro’s and con’s for each, but it’s important to spend some time (and normally some money) to work through the options. The reason I’ve listed this last is that, in order to properly brief your accountant, you’ll need to know the purpose of the property, the planned holding period and also get an idea of estimated cash-flows of the property. This will allow you, and the accountant, to take a long-term view and really plan ahead. Getting the ownership structure wrong in the beginning can cost tens of thousands, or more, to unwind in the future. So it’s important that this is a major consideration for each and every purchase.
So, in summary, property investing is a well understood vehicle for everyday Australians to help build wealth for their future. It’s important, however, to take some time to understand why you’re looking to invest in real estate, and get a few ducks lined up in advance. This shouldn’t take a huge amount of time, and you’ll be very glad you did.
Please note: the above information and analysis does not constitute financial advice in any way, and it should not be relied upon. It’s important that you seek guidance from licensed professionals, who can provide advice based on your individual needs. No investment decision or activity should be undertaken on the basis of this information without first seeking qualified and professional advice.
