So you’re looking at purchasing an investment property. This might be your first or you may already have a couple under your belt. But there are a few things you should be covering off well before you start house hunting.
Many investors buy into a lot of the hype around negative gearing and get emotional about the purchase and end up with a property that doesn’t help them move towards their goals. Remember this is a big commitment, we are talking about hundreds of thousands to millions of dollars so a little strategic planning upfront can easily reap you benefits along the way.
The first is why property and why now? Why not buy a sports car or trade the share market or contribute to super? There is always a reason behind why you want to buy a property and why you want to action that now. You want to start with the end in mind. What job am I buying this property to do? The job might be to help you retire at 55 or reduce risk by diversifying your portfolio.
By getting clear on what you are trying to achieve this acts as part of your decision making process. A qualified financial advisor can help you decide and plan out what different types of investment fit your profile.
Warren Buffet, the godfather of investing, famously claims his rules of investing are:
Rule No.1: Never lose money.
Rule No.2: Never forget rule No.1.
I’ll quickly loop back to my above comment about negative gearing before some readers blow their top. If this term is new to you, what this means is the cost of owning the property (council rates, agent fees, body corporate etc.) including depreciation and interest, will be more than the rent you receive. So essentially you are making a loss. For tax purposes in certain circumstances you can use this loss to reduce your taxable income and potentially receive a refund at tax time.
What really needs to be identified here through some financial modelling work is what is the true cash cost of owning this property. If it is negative then there may be an opportunity to refund a portion of it through the tax system but you want to ensure the capital growth of the property is exceeding the cash cost. Otherwise you’ve got a property not increasing in value that’s costing more to hold than the rent you receive.
Also keep in mind interest rates. At the moment rates are historically low, which is good if you want to enter the market or expand your portfolio but what if rates go up say 2% over the next year, would you be able to service this? These scenarios need to be factored into your financial modelling so you’ve got your bases covered and not over-extended in the event of something like an interest rate hike.
Now let’s get strategic, when looking at your financial models, do they align with your goals you identified in the first step? So is the forecasted return going to move you towards the destination you’d like to get to? This applies to a future property purchase and also your current portfolio. If the answer is no, then you need to make a decision and this is where I find many investors fall down, they are not quick to execute.
By reviewing your current portfolio, this would include the returns and growth you’ve received from purchase to today, what it looks like now and what is forecast going forth, do the numbers still stack up or is there a bad apple in there that needs to be dealt with?
Undertaking a development or improvement type project is at the top of property strategies and is where many investors make the most gains. This might be as simple as identifying an undervalued property that with an injection of cash to give it a face lift will result in substantial growth in valuation and rental returns. Now you’re starting to think like a business person but like a savvy business owner you’d want to crunch your numbers and do your thorough due diligence.
Mazie Poole from The Wealth Division, a specialist in sub divisions and development opportunities for herself personally and also investors, says she focuses on the buy and hold strategy.
“The longer you hold the property the more you reap the benefits of capital growth. As property cycles are not normally regular, it is important you ride the peaks and the troughs.
Cashflow or neutral properties allows you to hold many properties long term without sucking cash out of your everyday income. However some people earn very high incomes and negative gearing may work better for them. Not one strategy works for everyone and as circumstances change in your financial life, your portfolio too may need to change. It may mean buying more, reducing your portfolio or working what you already have a little harder.
Strategy is a personal plan and no one can tell you what you should or shouldn’t be doing, but the numbers will. Once you know your numbers, you find a property to suit this strategy.
Personally, I have decided that I am happy to pay tax and have a cashflow positive property portfolio. Paying tax is not an issue if your making the money, strategize with your accountant and minimise your tax without turning yourself inside out to save a cent. This for my husband has occurred as my husband who is 9 years older than me edges closer to retirement age.
A simple strategy of making money on the property within the first 6 months as well as turning your property into cashflow positive is to split the block, sell the block or build a property and rent it out. Who would like to make $100k every year by using this simple strategy?
If your not able to split your block, maybe you can add value to your property and certainly increase your rent by adding a second dwelling to your current site? Some states allow for generous size 2 bedroom dwellings to be built, others for a 60sqm, 1 bedroom dwelling. If this turns your property into cashflow positive then the only reason you would sell is if the property is in a low growth area with no infrastructure planned for the next 10 years.
I have a friend who only buys property in the most expensive, best located suburbs in Sydney, Melbourne and Brisbane. His strategy has allowed him to achieve very good capital growth, utilising negative gearing which is important for his high income and holding long term. This strategy has increased the value of his portfolio significantly in the last 10 years.
If you prefer to put your money into a development and receive a return on your investment or profit share then these options are also available to you. Earning 12% p.a. without taking any of the risk, time and effort of developing works for many people. It certainly beats the rates the banks are offering at the moment.
A mentor of mine once said “ Have you even wondered why the likes of Stockland, Peet etc never bother putting an extra bedroom or painting a room pink ? Its because they are making so much more money out of land subdivision than anything else. They understand that the money is in the land.”
A simple example:
You own a café. You buy a slab of carrot cake for $25. You cut that cake into 25 slices and they each sell for $5. That equals $125. There’s overheads which increases the cake cost to $75. The total profit on the cake is $50. This same philosophy applies to land.
You buy a piece of land, obtain Development Approval, Operational works, install your services (power, sewerage, water, access) for each block, obtain titles and sell each block. The profit is the balance after you have purchased the land, added the costs to establish the services and your sales price.
Whilst this sounds simple for every 100 opportunities I look at, 98 go in the bin. As this sounds simple, on average the larger the development the more work is required to make it work. The best place to start is for a simple 1 block into 2 or 3. Once you have completed several of these you may want to increase your subdivision options and turn 1 into 20. Sometimes a simple boundary realignment may be all that is required.
The wonderful things with property is that anything is possible. The most important part is to surround yourself with experts and pay well for their work and advice. They will help you understand what’s required and therefore limit your risk. Once you understand more about developing then you have the opportunity to shop around for cheaper options as you know exactly what you require.”
Also don’t forget the fundamentals such as expert tax advice and how to best structure the purchasing name or entity. These should be a no-brainer. If you are spending hundreds to millions of dollars on a property, it can really hurt if you get it wrong.