Hai guyz! How y’all doing?
Unfortunately, it’s a bit wet and miserable at the moment in Old Sydney Town – so what better than to snuggle up to your lover, switch on the mood lighting and play some soft tunes as you… read through the latest from your favourite personal finance blogger!
Today, I’m going to continue the real estate series – it’s where the bulk majority of my net worth sits (read about in my numbers revealed) and an asset class which I am continuing to learn, develop and grow.
Following on from the last post (here), where we discussed the team to build around you – this post is on the strategy to create and execute.
I found this the hard way when I made my very first investment – it was more of a “spray and pray (buy and hope)” than a clinical execution.
Luckily, time in the market helped me out here and it’s gone up a fair bit since.
However here’s 3 quick thoughts on what I wish I’d known had I the chance to go again.
In investing, the top-down approach is where you take the macro view and filter down into the micro, from a bird’s eye view all the way down into the microscopic.
In property investing, this involves analyzing on a national level, down to state, to city, into the suburb, the street and finally the property.
What are you looking out for?
What DON’T you look out for you mean? Because there’s so MANY factors to consider.
Luckily, it all revolves around supply vs demand (remember this post?)
Here, check it out boys and girls:
- The economics of the nation, the state and the city.
- A healthy economy has more population growth (more people want a piece of the “lucky country”).
- More people means more infrastructure – new roads, bridges, schools, hospitals etc. to cater for this increase in demand.
- Who’s going to build this new infrastructure? That’s right, we need to hire more people, more jobs are created.
- More jobs, more income.
- Income growth translates into more discretionary spending – people can afford to spend, spend, spend.
- More spending, more price growth (including house prices).
Cash-flow or Capital Growth:
Here in Australia, there is a generational debate regarding which type of real estate is better – the one which yields a higher income (from rent) but typically has lower capital growth OR the inverse, a higher capital growth but lower income.
For example: would you have a 7% p.a. yielding cash flow property at 3% p.a. growth or a 3% p.a. yielding capital growth property at 7% p.a. growth?
The argument for cash flow is that it helps you with your mortgage repayments, you are able to borrow more from the banks (rental income is used in servicing) and that you should continue to grow your portfolio easier.
For capital growth, the argument is that growth is what makes you truly wealthy (compounding returns), that capital growth properties are in better locations, that the rent will increase over time.
Income allows you to stay in the game and growth allows you to exit the game. Get that personal formula right – happy days.
Positive or Negative Gearing:
This leads to the another controversial issue regarding positive or negative gearing.
Again, quite unique to Australia – our tax system allows investors to either increase or decrease their taxable income based on the income generated from their investments.
Here, let me explain.
Let’s say you have a property worth $500,000 and it generates a 4% p.a. yield (rent).
So basically $500,000 x 4% = $20,000 p.a. income.
But wait, there are expenses we have to pay – mortgage interest, fees, maintenance, costs associated with investing, all up, let’s say that it costs you $30,000 p.a.
So that means you are running a $10,000 loss p.a.
You earn $70,000 from your day job – that $10,000 loss can be offset against your $70,000 wage and hence you are paying tax on $60,000 instead of $70,000.
Why would anyone run an investment at a loss?
Aha, this is because they’re banking on the investment growth to be greater than $10,000. If it is – then they’ve made money on paper.
Conversely, positive gearing is when the income generated is higher than the expenses. So in our example, let’s say the costs associated with investing totals $10,000 p.a. instead of $30,000 p.a.
So $20,000 p.a. income less the $10,000 p.a. equates to a $10,000 gain.
That $10,000 gain is added onto your $70,000 p.a. wage – you end up having to pay tax on $80,000 instead.
Who likes to pay extra tax?
But many people positively gear because well, who doesn’t like more money in your pocket? Also, the banks factor this in when they are calculating whether to lend you more money – so a higher income obviously helps.
This is how many people in previous years were able to build enormous real estate portfolios in Australia.
Find a high cash-flow yielding property to positive gear – approach the bank lender for more money to buy more positively geared property… rinse and repeat.
Unfortunately, in 2018 – building portfolios like this is nowhere near as easy to do, more regulation, more oversight, more government debate means more scrutiny is placed on Australian banks and lenders like never before.
That’s why property investment is really a game of finance more than a game of real estate. You really have to pick and choose.
Mind you though – whether you are negatively gearing or positively gearing, it’s only a point in time.
For a negatively geared property might have rent increases so that the income generated turns it into a positively geared property down the track.
A positively geared property can suddenly have no tenants for an extended period of time thus making it negatively geared.
That’s 3 quick thoughts on what I wish I had known – at the end of the day though I try and remember that real estate, like shares, bonds, heck even like crypto-currency – it’s just a vehicle for financial independence.
Everyone’s situation is so different, there really is no right or wrong way to go about it – as long as you’re comfortable with the risks and effort involved, why not get stuck in!
What do you think? Did you enjoy this post? Please help me out if you enjoyed this and click on the little “follow” button at the bottom right and be a follower. This way, you’ll never miss my words of awesomeness!
P.S. As always, the posts are opinions and thoughts of yours truly only – you should really obtain professional advice regarding which strategy works best for you. Remember that every person’s circumstances is unique so seek specialised advice!