Investing in Property
What is the best way to buy a rental property? The question you need to ask yourself is – Am I buying this property as an investment? Now, this sounds like a pretty stupid question. But in reality, many people (myself included) have made a purchase decision on the basis that they love the “property,” not the “investment.”
What do I mean? Well, you have to stop and ask yourself, do I really love investing in property, or do I love to own property. Many have purchased an “investment property” on the basis that they “liked” it rather than because they had calculated it would provide a great return.
When investing in property, you should always run your numbers through a property investment calculator before deciding whether to even look at a property, let alone buy it!
My first CBD apartment – aka “Investing in Property for Fools!”
I’d always wanted to own a piece of the CBD. As a kid, I loved visiting the “city” to look at the skyscrapers and imagined coming here for work like my Dad did each morning. Sure, I was investing in property. I was investing my emotional security in a property location! So you can see quite clearly that it was an emotional rather than a hard-headed decision to repurchase a newly complete one-bedroom unit in the early 2000s. It was just something I’d always wanted to “have.”
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I remember driving around the inner city with a well-known property spruiker looking at projects he was involved with. Of course, his level of involvement was as a master salesman. A unit became available for approximately $230k. As a young couple, my wife and I discussed the pros and cons, and I decided against my wife’s advice that this might not be such a great idea.
At the same time, another unit had become available in the inner city block of apartments that I was currently living in. It was available at a similar price. My wife counseled me to consider this as an option. My “adviser” had discouraged me on the basis that I would be putting all my eggs in one basket. There was some truth to this advice, so I followed my “dream” of an apartment in the “city.”
When I went to the office to sign the papers, I remember being advised that the original unit was no longer available, but a different one on a higher floor was, at a higher price! I said OK, No problem, like we Aussies tend to do. Then I was presented with the option to purchase a “furniture package” for an extra $20k. This would “guarantee” a rental return of 8% to me for the first 2 years of my investment. I hadn’t previously considered this, but of course, I said “Yes” and was told what a wise choice I had made. (Of course, this made me feel good about myself!)
The truth was I bought the unit not based on its potential financial return but its immediate emotional return. I never did end up living in it or even spending a single night there, although I’d often wander past and gaze up at my balcony and wonder how “cool” it would be to live here.
In fact, the property was a complete drain on my bank balance due to the high costs associated with the common areas, including the pool and gym equipment. The rent never paid for the outgoings, and I lived in the hope that the price would go up so I could make a “paper” profit at least!
Now sometime later, I did end up selling the unit for around $300k, so it was far from a complete disaster. In the end, I was happy to sell and call it even. In reality, the cost to me was an opportunity cost. What else could I have been doing with my money?
I looked recently for sales data on the city block in question and found a similar unit sold for $355k, approx—10 years after my initial purchase. Currently, in the inner city block I was living at, prices are over $650k. Remember that 10 years ago, these properties were selling for approximately the same price. If I had listened more to my wife and less to my own emotion, I might have ended up $300k better off!
What did I learn? I learned that whilst it’s great to listen to “advice,” be aware that sometimes advice might be just a little biased! I’ve learned to trust my own instincts more and weigh advice against what I already know to be true and reasonable. The reason I liked the apartment in my own block was that it was located well. It was quiet, had views, was close to a city, walk to tram, bus, and train, and there was no high-rise in the vicinity. This meant there was a supply cap. The area couldn’t be quickly re-developed, and units added. In short, the amenity was desirable, and there were not going to be any new properties added in the foreseeable future.
In the city, there is not a supply cap. There are numerous developments under construction at any given time. I’d be more than happy to live in many of them. But I wouldn’t buy them as an investment! Unless they were in a landmark building of some sort, there is no scarcity value in them. They can be replaced easily.
If one of your neighbors wants to sell and needs to move quickly, guess what. They set the price for your unit. You have virtually no control over the market. No matter what you do to your own living space, the whole value of the block will be determined by factors outside your control.
Investing in Property for cash flow or growth?
Let’s be honest. Most of us are investing in property because we think that prices are very likely to go up! On the other hand, we all know about “negative gearing.” In essence, it means we can write of our “losses” on our investment against another area of income. I agree with the concept; we ought to weigh our profits against our losses and pay tax on the net result. BUT, if all we own are “investments” that are making a “loss” and we’re offsetting that against a “gain” from our job, that’s not really smart investing, is it?
Sometimes a property might be increasing in value at a greater rate than we could expect to make as a cash income from our investment. This is not always the case, as you can see from my experience in the Melbourne CBD. But at what point does this cease to be a valid reason for investing even “keep” and existing investment? Steve McKnight from PropertyInvesting.com once said something very illuminating at an event I attended. Basically, he said we ought to audit our property portfolio every year and re-assess whether we ought to hold or sell each property!
Seriously. I never thought I was going to sell anything – Ever!
Early on in my property journey, I’d decided I was going to “Accumulate” property. Buy and never sell! That was my motto. Once I’d paid down the loan, I would be sitting on a nest egg and having rent more than cover my outgoings.
But consider this! Real-world example –
My unit in inner Melbourne right now would be worth about $650k, and yet it might command a weekly rental of around $480. That’s about $25k rental annually.
The yield is, therefore, 25k/650k annually, or 3.8% of the value.
Setting aside things like mortgage repayments, there are still fixed costs on any property – In my case, they include for the last financial year:
- Council Rates $820
- Water $945
- Insurance $302
- Owners Corporation $1660
- Agent fees $1815
- Repairs $890
- Total fixed expenses for the year $6430
- This reduced the total income to ($25000-$6430)=$18570
Now my actual annual return is 18.5k/650k = 2.9%
Of course, costs like Agent fees and Owners Corporation are not always applicable, but they serve to show that in the real world, the actual return can be a lot less than a simple headline figure.
If I include my interest costs (which still exist), I must deduct another ($150000*6%)=$9000 from my income.
- This reduced the total Real income to ($18570-9000)=$9570
- Now my actual annual return on the asset value is 9.5k/650k =1.5%
- Should I Sell this property?
There is no right or wrong answer. Sometimes I say yes, and my wife says NO! Sometimes I say No, and my wife says NO! Do you see a pattern here? There is no right answer because everyone has different needs, has different skills, and is coming from a different base, and most importantly – We all want different things! It depends on your circumstances, family situation, personality or partner, and goals in life.
If our main goal in life were to increase our cash on cash return or all our assets, then it would be a no-brainer to sell up and invest elsewhere (assuming I could expect a greater return than 1.5%!) Having said all that, I still love property, and I love investing in property.
It’s quite possible to love the idea of property without loving investing in property. In fact, most property that you’ll “love” will probably be pretty darn useless as an investment. Don’t be confused.
Would I choose to invest $650k of my actual cash in this investment right now if it were available for sale? Probably not! – So why am I still keeping it? I love it and plan to live in it.
This is a question only YOU need to ask yourself and answer on a case by case basis. I’ve looked long and hard at my own situation and decided to keep it for now based on family reasons, NOT investing reasons.
Review every property every year
For every investment I currently hold, I review the property and decide based on the real numbers, not a fantasy of what I’d like to see happen.
That’s why I decided to sell my apartment in the Melbourne CBD. It was “Costing” my money to hold and NOT growing in value anything like I’d hoped it would. So I cut it off. It was why I needed to sell my first home out in the “burbs”. It was why I made a similar hard decision to sell a property in inner-city KEW that was returning a reasonable cash return and well located but had ZERO capital growth over ten years. It was one of the reasons I sold a great apartment in Sydney’s North. I had improved it and added value. It was time to take my money off the table.