Property Investing For Dummies (Australian Edition)
Thinking of investing in residential or commercial real estate, but not sure where to start? As everyone knows, talking about where the property market is headed (Up? Down? Sideways?) is a sure-fire dinner party topic of conversation. But getting a start in the investment property market isn’t a game (although it can be fun!), so check out these key principles of investment success. This Cheat Sheet is well-worth rereading often, to keep your property plan on track.
Principles for Real Estate Investment Success in Australia
Everyone wants to give you advice on when, and how, to invest in property. But often that advice is misguided when you take the market and economic factors into account. Here are some timeless pieces of advice for both beginner and experienced property investors
Real estate is a proven wealth-building vehicle. Investing in rental properties can generate positive income and significant tax benefits, as well as build equity from appreciation over the years.
Although many people can succeed in investing in real estate, rental property investing isn’t for everyone. Take account of your investment preferences and personality before buying property. Real estate is a hands-on investment and can be time consuming. Do you have time to devote to your investment? Are you comfortable troubleshooting problems or hiring a property manager?
Make sure you’re financially fit before investing in rental properties. Particularly with highly geared property, you will need excess monthly savings to cover initial negative income, often for several years. Having a monthly budget is important. Most successful property investors build their investment portfolio through having saved money first and then gradually buying properties over the years.
Don’t underestimate the importance of establishing good credit. The best returns on real estate rely upon the use of credit to obtain the leverage of using OPM (other people’s money).
Your home is not an investment property. Your home is an investment (of sorts), but Australian tax law makes it considerably different from ‘investment property’. But, if you’re the DIY type, or a good project manager, you can make plenty of money in real estate from renovating your own home and selling it free of capital gains tax.
Focus on residential properties in the beginning. Residential property is an attractive investment and is easier to understand, purchase and manage than most other types of property. If you’re a homeowner, you already have experience locating, purchasing and maintaining residential property. But don’t forget this important point: You’re not buying the property to live in yourself.
Among residential property options, top recommendations are stand-alone houses. The maxim that ‘land appreciates, buildings depreciate’ means that the properties with the highest land content are most likely to appreciate the most over the longer term.
Have your real estate team in place before you begin your serious property searching. You’ll need a solicitor, mortgage broker, accountant, depreciation specialist and a financial adviser. They’re your team. You’ll rely on them for help.
Be wary of property spruikers promising real estate riches in no time. Too many people have been too greedy over the years trying to ‘get rich quickly’ with property. Property investment requires a ‘get-rich-right’ mentality.
Nail down the best financing terms and keep your banker on his toes. The bigger the deposit you can offer (say, more than 20 per cent), the more access you’ll get to the best financing deal for your first property. But if you’ve got plenty of equity in your own home, you’ve also got the asset that banks prefer in order to lend you money on reasonable terms. Leverage can boost your rates of return. But too much leverage can be dangerous if the rental market turns and your debt expenses are high. Regularly search the market to make sure your financing is at competitive rates.
Use the powers of leveraging and compounding to build your property portfolio. Property portfolios are built through a snowballing effect. Buying your first home or your first investment property can be difficult. But the powers of compounding and leverage will make subsequent purchases easier. It may take five years to acquire your first two or three properties but, in the second five years, you can probably double the number of properties you buy.
‘Location, location, value’. This adage clearly emphasises location, but also the importance of finding good value. Owning real estate in up-and-coming areas with new development or renovated properties enhances your chances of finding and keeping good tenants and leads to greater returns. Another great opportunity comes from properties in great locations that haven’t been well maintained. Look for aesthetic issues that can be cheaply addressed.
Don’t make real estate investments too close to home. Buying property in the same, or next, suburb as your home is a dangerous philosophy. Diversification is important within any investment portfolio and having both your home and an investment property (unless it’s one of many investment properties) in the same suburb or town leaves you doubly vulnerable to a downturn in that area.
Any decision about where to invest starts with an evaluation of the region’s economic trends. If the area isn’t economically sound, then the likelihood of making successful real estate investments is diminished.
You’re purchasing a future income stream when you buy a property. The key is identifying which properties sellers have underpriced.
The buy-and-flip real estate investment strategy can work, but it also has a downside. Buying and flipping (or buying and quickly reselling property) can be a way to make quick money in real estate if you time your investments correctly in a rapidly rising real estate market. However, flipping can cause your profits to be fully taxed — that is, without the advantage of the 50 per cent capital gains discount. The costs of buying (stamp duty) and selling (agent and advertising fees) also makes profiting here difficult.
Give yourself some ownership options. If you’re building a portfolio and buying with your partner, consider how you structure the ownership of the property to leave yourself some options to minimise tax when it comes time to sell.
Think about gearing in terms of what you want out of your investment. Everyone’s heard of negative gearing, but negative gearing means ‘losing’ money on an annual basis, which can make sense for some investors, especially those on high incomes. If you’re not on a high income, neutrally geared or positively geared property may better provide you with what you want from property.
The best laid plans can be destroyed by one catastrophic event. Don’t believe you can get away without proper insurance. And insurance isn’t just home and contents and landlord’s insurance. A proper property plan includes personal risk insurance, so you can keep your property investment plans afloat even if disaster strikes.
Property in Self-Managed Super Funds
Self-managed super funds (SMSFs) entered an exciting new era from late 2007 with the ability to buy geared property. The Global Financial Crisis meant a slow start, but now opportunities abound for a SMSF to purchase property, with similar benefits to property purchased outside of super. However, it’s a complex area of the law:
Superannuation is a low-tax, even no-tax, environment. Complying super funds pay tax at a maximum rate of 15 per cent. But when in pension phase, they pay no tax. Compare this to Australia’s top marginal tax rate being 46.5 per cent and you’ll see why property in super is an exciting prospect.
Direct property is only available through SMSFs. You can’t hold a rental property through a regular super fund. But there are around 500,000 SMSFs in existence, at the time of writing, and it’s only those vehicles that can directly hold residential (or commercial) property. Do you have the time or willingness to learn how to run a SMSF? It comes with considerable responsibilities, but the financial rewards can be even bigger and better than investment properties bought in your own name.
Make your SMSF the landlord of your business premises. Many businesses are run from a property that is owned by the business, or the business’s owners. But there can be great reasons for your SMSF to own your business premises: It is an asset where ownership can potentially be transferred into your SMSF.
The size of your SMSF matters. To invest in property through a SMSF, you have two options. You either need the cash to buy the property outright. Or your SMSF needs to borrow. But even if you’re borrowing from a bank, your SMSF still needs to have at least about 30 per cent of the property’s value, plus enough left over for a lender to be comfortable that you can foot future bills and interest.
Complex structures are involved, so make sure you get it right. The laws allowing lending in SMSFs are particularly strict. And the consequences of getting them wrong are potentially costly and disastrous. There are legal structures (trusts) that need to sit inside the SMSF to hold a geared asset. And, importantly, your SMSF trust deed itself needs to allow for borrowing, which not all trust deeds do.
SMSFs have a large and growing panel of lenders who are prepared to lend in this space. Because of the GFC, banks were initially slow on the uptake of providing compliant loans. But that has changed and most major lenders are offering financing for SMSF property loans now. But beware: They can have some funny individual policies.
You can be the lender to your own SMSF. If you have plenty of equity, it is possible for you — as trustee/s of the fund — to be the lender/s to the super fund. The source of your funds might be savings, or money you have borrowed elsewhere.
SMSF borrowing arrangements are complex and professionals are mandatory. It is not the same as buying an investment property in your own name. And it’s highly unlikely that you will have the skills to do it on your own. Get help from trusted independent professionals. The penalties are too severe to bear contemplating.