It’s no secret that Aussies love investing in property. I mean – negative gearing has to be the best tax break going around, right? And honestly, what else would you talk to your friends about around the barbecue if not the cheeky tax refund you get each year (because some accounting magic has ensured your investment property is costing you more on paper than it’s making in rent)?
For generations, investing in property has been the ‘in thing’ here in Australia. Our grandparents did it. Our parents did it. And now it’s the turn of us Millennials.
But is property investing all it’s really cracked up to be? And is it right for you?
As always, we recommend running any investment decisions past your financial advisor. But if you’re wanting to do some research first, here are some benefits and pitfalls to weigh up.
Five reasons why property is attractive to investors
1. Ease of borrowing
Borrowing to invest in property is far easier than other asset classes. For a typical investor with $100,000, it’s far easier for them to purchase a property for $500,000 than it is for that same investor to purchase $500,000 worth of shares at an 80% LVR (Loan to Value Ratio).
While banks can review the LVR or call in a loan on a property, in our experience they rarely do so (unlike margin calls – which investors in direct shares through margin loans are familiar with).
2. Tax benefits
A property is negatively geared when the costs of owning it – interest on the loan, bank charges, maintenance, repairs and depreciation – exceed the income it produces.
Negative gearing is a tax break that allows you to offset any net rental loss incurred during a financial year against all your other income. This offset reduces your taxable income and thus the amount of tax you need to pay.
Even when a property is positively geared (the rental return is more than loan repayments and expenses), you are still able to claim some of the property expenses as a tax deduction.
3. Set and forget
Once a property is purchased, the property manager deals with it, the rent comes in, the mortgage payments go out and slowly, month by month, after 30 years the property is yours outright. You could almost consider property investing a form of forced savings. For this reason, it’s quite attractive for time-poor individuals who want to make sure they are building their wealth, but in a ‘set and forget’ kind of way.
You can drive past a house. You can make it into a project. You can see the rental return every month in your bank account. People draw a sense of comfort from the tangibility and visibility of property over other forms of investing like having units in an index fund.
5. Government assistance
First home buyers have access to various stamp duty concessions on a state-by-state basis and access to the First Home Super Saver Scheme (FHSS) which makes it attractive to enter the property market, even if you only live in it for a period before spinning the property into an investment property.
So – those are the things that make property attractive to investors. But investors do often overlook the pitfalls of property. And it’s not until they’ve committed to the plan that they realise it might not have been the best long-term plan for their personal circumstances.
Three potential pitfalls of property investing
Unlike shares, you can’t sell a quarter of a property if you need the funds.
There are also the trading costs to consider:
- Stamp duty on the way in (which is about $18,000 on a $500,000 property)
- Selling costs of about 2.5% or $12,500 on the way out.
It also can take months or years to sell a property once you list it on the market plus the time for settlement and finance approval from a buyer.
A property that sits untenanted for four weeks of the year can take months to recoup. Consider these numbers.
Let’s say you purchased a house at the median house price of $530,000. If you put down a 20% deposit and borrow the rest, this means a loan of $424,000 which equate to repayments of around $925 per fortnight or $24,050 a year (assuming a 30-year P & I loan with 3.92% interest). You then have other costs like:
- Council rates $1,500
- Water rates $1,500
- Insurances $1,000
Which gives total costs of $28,050 per year or $539 per week.
At $600 per week, this property is making just $60 per week in net income. Every week the property is untenanted, the investor loses $539 of cash and needs 9 weeks of rental income just to catch back up to their position. At 6 weeks without a tenant, it would take more than 12 months for the investor to recoup their cash.
This isn’t allowing for property management fees, repairs, maintenance or depreciation of the property. Meaning you’d really hope the capital growth was strong to make up for the low yield.
3. Unrealistic expectations
We’ve all seen them – articles about the person in their late twenties who bought their first property in their teens and now they have seven properties and can retire and live off the rental income. But when you dig deeper into the article and find out how this person got into the market in the first place, you’ll often find they’ve benefited from something like:
- A lucky break with that first property investment
- Access to the ‘bank of mum and dad’ when it came to buying their first property
- Living at home rent-free for a long time and able to pour all their savings into their property portfolio.
The point here is that it’s easy to be seduced by articles that sell the dream of building a property portfolio that yields a living income. The reality is that the situations and outcomes described in those articles are hard to replicate and repeat.
The bottom line
As with any investment, an investment in property needs to consider:
- Your current and future lifestyle goals
- Your cash flow and other investments
- Your financial buffers
Once purchased, properties should then be reviewed annually to check they are still a worthwhile component of your wealth creation activities.
Evaluating investment classes like property and shares is something you should review with your financial advisor on a regular basis.
This is general advice and does not consider your particular circumstances. You should seek advice from HPH Solutions who can consider if the general advice is right for you.