"I am a 30-year-old childcare worker, earning $50k per year. I would like to invest, have always thought about property, but not sure if that will be the best strategy"
- Hannah in Canberra, ACT
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Your question suggests that you have at least some understanding about investing, but is absent information about yourself, your personal/ family situation, your current net worth (and how that is calculated), your surplus cash flow, or your preference for investment in property in a particular location that would all be helpful in considering the appropriate response. A basic question back to you is whether you are considering property as a wealth accumulation asset, or more as a future residential security: the following response presupposes that your interest is in a wealth accumulation strategy.
Whilst there is much to consider – and the detail below will give you some idea of the risks and costs associated with a property portfolio – your apparent gut feel that ‘..this (may not) be the best strategy.’, should probably be interpreted by you as a good reason to hold off until you can take personal professional advice on the matter. Even if you are not likely to start your property portfolio in the near-term, seeking detailed advice early will help you to come to grips with the challenges you will confront – and make the journey easier to undertake should you stay committed to it.
The following comments are made to give you some general understanding of matters to consider in undertaking a wealth accumulation process through investments, particularly focusing on property. Not all of these issues will accrue to every investment asset, but all need to be considered to the extent that they are relevant to the investor, and to the asset class. Other issues will also arise depending on where you intend to invest in property, and again, timely advice before you are too committed to the process or indeed, any particular property, will serve you well.
Selection and acquisition:
Property has long been a darling for Australian investors: it is usually residential property that people prefer, but small industrial/ commercial units where longer-term tenancies may be available are also reasonably popular. To acquire an investment property, there is a range of costs that need to be considered beyond the anticipated purchase price – and these can add several percentage points to the contract price of a property: they include research (mainly a time issue), search and inspection costs, legal costs and State-imposed Stamp Duty. These acquisition costs are often best-funded from available capital rather than as borrowed funds.
Funding and debt servicing:
Funding the acquisition of an investment property is subject to financial conditions at the relevant time: borrowers have different experiences in this regard, especially first-time borrowers. A reputable finance/ mortgage broker may be required to help in this regard, especially if you don’t have a sound relationship with your Bank. Information such as your credit history, your income certainty (both from your own employment/ business; and from the investment property itself), the amount of capital you have to contribute to the purchase (remembering to hold back a reserve to deal with unexpected setbacks), will all be taken into account to satisfy the lender that you will be able to service the loan over the long-term.
One of the issues that will be considered by a lender is the insurance protection you hold – with the two key areas being income protection (income replacement in the event of disability by illness or accident for instance); and capital protection (lump sum payments in the event of your death or permanent disability). Such insurances come at a cost and if they are not already part of your cost structure, you should allow for them when considering your ability to service any borrowings to acquire your property investment.
Property -v- shares (equities):
Whilst long-term financial performance of investment properties in Australia is very similar to that experienced by equities investors (investors in share markets), there are some differences between the two asset classes that need to be considered: these include –
Can the investment property be fully tenanted – and can the tenant always pay the rent; what return on the investment can be assured, allowing for all costs such as tenant acquisition cost, property insurances, rates, body corporate, repairs, maintenance and replacements, agent fees, land tax and interest cost on any borrowing;
Equity investors have the luxury of a well-communicated dividend policy and regulated transparency as to corporate actions that might impact their investment.
Maintenance costs for a property can be ‘lumpy’ and unexpected at times and whilst insurance may cover repair or replacement of some of the items, longer-term wear and tear, termite damage and structural ‘failings’ can amount to significant cost, interruption to rental income and potentially impact the resale value of the property;
The equities investor is not involved in funding such matters, although they are reflected in the amount of the dividends paid to them.
Investment properties require some level of management and in many instances, owners engage property managers to attend to the engagement/ removal of tenants; deal with tenant concerns, complaints and requests; engage the repair and maintenance sub-contractors; collect rent; undertake regular property inspections; attend renewal of leases (and ensuring lease terms are complied with); and other actions on their behalf – others do these things themselves;
Equities investors don’t have this level of management engagement, but they do need to watch for public announcements about activity that may have an adverse effect on the value of their shares (and on the dividend they expect to receive).
Liquidity (how quickly the investment asset can be converted to cash):
Even in a favourable market, property will take time to prepare for sale, list for sale, negotiate sale contract terms, undergo inspections, await finance approval – and ultimately, settlement. From the first decision that a sale needs to be affected, to the point of actually having the funds in your account it is likely that sixty (60) days would be a short process – and that could extend to several months;
For the equities investor, the current market value of the shares held is transparent and well-publicized – and from time of deciding to sell, listing and awaiting the T+3 settlement, their cash will likely be in their account within a week.
Ownership of a property ties you into the full ownership and responsibility for it – and when it comes time to raise capital from it, you have two possibilities, either borrow funds against your equity in the property (i.e., the difference between what the property is worth and how much you are in debt against it), or you can sell it (noting the Liquidity issue above);
The equities holder, on the other hand, can sell small parcels of shares (albeit subject to some trading limits in this regard), or they can sell shares in selected companies from their portfolio to raise the capital required.
This is a very complex area for the property owner, requiring records to be kept in some detail to ensure that deductible costs (and non-cash offsets) can be substantiated – and at the end of the ownership, any capital gains tax properly determined;
For the equities holder, dividend statements published by the companies in which they are invested not only provide a simple record, they also include the tax offset for imputation credits. Records still need to be retained to facilitate calculation of any capital gains tax payable in the event of partial, or total sale.
(Negative Gearing is something that attracts some people to property investing, but there are two key issues to consider here: the potential for government to change the deductibility of investment property costs in excess of the income for the relevant year; and the need for the net cost of the interest and expenses on the property to be recouped on sale to make the investment break-even, or hopefully, profitable.)
While the Adviser Ratings Website facilitates the question and answer functionality, all such communications are between users and authorised financial advisers, of which Adviser Ratings has no affiliation. Adviser Ratings is not the advice provider and does not provide financial product advice and only provides information that is general in nature.