Property in Australia has always been a key wealth builder for Australian families and has proven to be a relatively safe investment as long as it is in the right area, has the right infrastructure around it, is professionally managed and you know in advance of the associated costs to hold it.
Property markets move in cycles, reflecting the underlying strength of the economy, political factors, demographic trends and market sentiment. That’s why its very important to have a formula that works.
Professional property investors understand that what they are really buying is time, and therefore investment property should only be considered where the investment time frame is 10-15 years or more.
This is reflected in the table below, whereby between 10 to 15 years of ownership, over 48% of investors doubled their money and after 15 years or more a staggering 95% of investors doubled their money
Location, location, location
What makes a great investment property?
Some say its proximity to shopping centres, public transport, something with views, something in a city, a house, an apartment. What about a suburb’s past or predicted capital growth performance? What about new infrastructure in emerging suburbs?
A good location can be defined in many ways and will vary depending on whom you ask. Whilst all of these attributes are important, the main focus should be in understanding how to manage the cost of holding your property over the medium to long term.
Over longer time periods, property prices and rental demand are mainly determined by fundamentals such as jobs and infrastructure. When it comes to investing, one of your greatest allies is time. It has a moderating effect on property investing risk, and the longer you hold an investment, the more likely you are to enjoy capital growth. It’s important to get the formula right to buy enough time!
WHAT ARE THE ‘OUT OF POCKET’ COSTS?
The core concept behind property as an investment is that it should grow in value over time.
History shows us that you need to be able to hold onto your property over the medium to long term (10-15 years) to see the best results. That’s why its important to conduct a cash flow analysis to discover the true holding costs after any rental and tax benefits are taken into account. This will tell you how much you, or your SMSF, may need to contribute towards the property (along with the rental income) to meet the loan repayments, council rates and other property costs. We like to work on a ‘cost per week’.
There’s little point in looking at a property that will cost you $200 per week if you can only afford to invest $100 a week.
Whilst this seems like common sense, it means that sometimes you may need to select the next best location, or next best property from your list in order to keep in line with your budget or you risk over committing and having to sell your investment property before you achieve the growth you want.
Here’s an simple example of property cash flow13 based on a couple earning $100,000 and $45,000 per year. You’ll see that the tax structure and type of property can vary the cost per week substantially so its important to get it right.
12 – Source- CoreLogic RP Data’s Pain & Gain report for the September quarter 2014.
13- Figures above are based upon an $100,000 and $45,000 ownership split as shown, 4.75% interest only rate (6.25% for SMSF), council ($1,800), strata ($4,000 on units only), water ($350) and estimated depreciation benefits (2019 built 200sqm house – $12,000, or 2016 built 200sqm house – $4,500) or unit (55sqm unit – $5,200) and repairs of $2,000 per year for the second hand homes. SMSF structure figures are based on SMSF balance of $200,000, SMSF income of $13,875 Super Guarantee Contributions (9.5% of $145,000 member income). Tax saving is year one. Excludes any structure establishment costs but includes annual costs of $4,520. Seek advice before using your Super. Pictures are for illustration only. Source – Prowealth Property Investment Calculator.
STRATEGIES TO CAPITALISE ON YOUR INVESTMENT PROPERTY OVER TIME VALUE
In the beginning
Often when first purchasing the property there will be little to no equity available and sometimes might even be negative if you borrowed extra for costs like stamp duty and legal costs. As time goes on the property should experience some capital growth. At the same time, the debt level often remains the same as when you started as most investment loans are interest only. The difference between the value and the debt is called equity which can now be used to help achieve your goals.
Draw on equity strategy
Involves borrowing on the available equity by establishing a line of credit. Pro’s – You don’t need to sell the property to access the money (tax free) and whilst the debt will increase, so will the value over time. Con’s – You need to have significant growth and a number of properties if you intend to do it multiple times or take enough money to live on.
Buy and sell strategy
Perhaps the simplest, it involves selling the property once you believe there has been substantial growth. Pro’s – You can use the money to pay off debt like home loans and credit cards. Con’s – You will likely pay capital gains tax and agent costs which could eat into the profit and you will no longer have the asset which could have grown in value further.
Potential SMSF property accumulation strategy
If using an SMSF to purchase property you could direct your employer or salary sacrifice contributions into the loan to repay it faster. Pro’s – A debt free property in Super could create more tax free income in retirement. Con’s – You can’t access the equity personally nor recoup or redraw your contributions once paid into the loan. Seek advice before engaging in a property via Super Strategy.
Potential SMSF property retirement strategy
You may choose to sell the SMSF property in retirement and access the equity or profit tax free. As you are now fully retired you can use the cash to fund lifestyle or pay off other debts and enjoy your retirement. Seek advice before making a decison with your super.