Residential property has always been a popular investment option in Australia. It is an asset class that historically, over the long term, has produced satisfactory returns for a lot of investors. Arguably, it could be said that property has made more people wealthy than shares and it can significantly affect the wealth of the small investor as there is the potential for growth and even more beneficially for the investor, growth with the bank’s money.
Residential property has always been a popular investment option in Australia. It is an asset class that historically, over the long term, has produced satisfactory returns for a lot of investors. Arguably, it could be said that property has made more people wealthy than shares and it can significantly affect the wealth of the small investor as there is the potential for growth and even more beneficially for the investor, growth with the bank’s money.Let’s explore the world of property in more detail:
- Pros and Cons
- Personal Involvement
- Property Management
- Positive geared vs negative geared
- Criteria for a rental property
Pros & Cons
The first question you need to ask yourself is why do you want to invest in residential property as opposed to getting the apparent better returns in commercial property or shares.
Let’s look as some of the advantages and disadvantages of residential property investing.
Advantages
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Low volatility |
There is no daily fluctuation of price, making it easier for you to ‘stick with’ your investment plan. |
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Taxation |
There are considerable tax advantages for residential property. If you hold a property for more than 12 months then the 50% capital gain discount applies when you sell. If you live in your property then generally there is a full capital gains exemption. If you purchase an investment property, there may be tax advantages each year if the property in negatively geared. A note of caution though, never buy anything for the short term tax advantages. As a rule of thumb if you need the tax deduction to cover the shortfall then you probably can’t afford the investment. |
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Capital growth |
Because the bank provides most of the funds for a property purchase, there is considerable leverage and your capital growth returns can be considerable. |
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Long term |
Investing in property is a long term wealth creation strategy that can provide investors with consistent returns over the long term. |
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Demand |
In Australia there appears to be an ongoing housing shortage. National Housing supply council reports indicate that not enough homes are being built by the public and private sectors. This should mean that demand for rental properties should keep rents growing and house prices stable. After all, every one needs somewhere to live. |
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Mining |
High rental rates can be gained in some areas and as an additional benefit, mining companies often subsidise their employee’s rents which should translate to more stability in tenancy and rental return. |
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Rent increases |
Legislation protecting both the landlord and tenants means that rent increases can be negotiated and need to be reasonable. The Australian government social welfare policies means that residential property investors can still increase rents where they rent to low income earners because rental assistance through Centrelink is based on market rates. |
Disadvantages
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Valuation |
You don’t know the exact value of your property unless you want to raise more equity or sell it. |
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High capital costs |
Initial capital costs are much greater with property purchases. You need to have available the initial deposit amount for the first property which can be up to 20% of the capital cost. |
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Liquidity |
If funds are needs in the short term, property is not an asset that you can quickly liquidate or just sell a small portion. |
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Costs
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The costs to buy and sell are quite high for residential property. Stamp duty, mortgage registration and agents cost all need to be taken into account. |
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Locality risk |
Buying in the wrong location is a real risk for residential property. While other areas are steadily increasing, a wrong location can be stagnant affecting an investor’s return over the long term. |
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Interest rates
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Interest rates play a significant part of the costs of owning a property. When interest rates rise, investors need to be able to bear the brunt of the increased payments. |
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Negative gearing |
If a rental property is negatively geared, then the investor needs to find the difference each month between the income and the expenses. |
Personal involvement
One of the ways that small investors can make a difference when it comes to residential property investment is with their personal involvement and local knowledge.
Let’s look at a case study.
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Kathryn exercises in her local suburb and is constantly walking or riding around the local streets. She notices that the council has improved the playground facilities in the local park and a commercial property has been built nearby with a new 7/11 store and a coffee shop. She drives to work every day and sees the feeder road into her suburb being upgraded and a new supermarket and a new school being built in the next suburb. Kathryn knows that the ‘for sale’ ‘ signs on some properties in her suburb have been up for more than 3 months. She gets online and does some research and is able to negotiate a considerable reduction in the sellers asking price for a solid property in a good street. She has used her local knowledge to buy a good property at the ‘right’ price which will significantly increase her returns over the long term. |
Property management
Another way in which a smaller investor can make a difference is by taking on the management of a rental property themselves. This option is not for everyone but you may want to consider it for the following reasons:
Another way in which a smaller investor can make a difference is by taking on the management of a rental property themselves. This option is not for everyone but you may want to consider it for the following reasons:Property management costs can be between 7 – 9% so doing it yourself can save money. (don’t forget though that agents fees are generally tax deductible)
You can ensure that your property is maintained to the standard you want
Positive geared vs negative geared
There is a debate as to the benefits of negatively geared investment property compared to positively geared property. But first what do the terms mean
Negatively geared means that the expenses on the property, including interest payments, ongoing expenses and the intangible expenses such as depreciation are more than the rent received as income, resulting in a loss situation. Under current Australian taxation law, this loss can be offset against other income, which means that a negatively geared investment property is a legitimate way to minimise tax.
Positively geared property means the exactly the opposite, rental income more than covers all other expenses, resulting in extra income which needs to be included in your tax return with tax paid at your nominal tax rate.
Positively geared property means the exactly the opposite, rental income more than covers all other expenses, resulting in extra income which needs to be included in your tax return with tax paid at your nominal tax rate.Arguments against positive gearing are that to achieve a positively geared position from purchase an investor will likely have compromised on location so that the potential for future capital growth is limited when compared to a well located negatively geared property.
Capital growth does play a large factor in overall returns but there is no right or wrong approach and each investors’ situation will be different, and some investment decisions may also be based on future lifestyle choices. Remember too, that over time every property should become positively geared as rents increase.
Criteria for a Rental Property
There is no exact template that will fit all residential investment property purchases but there are a few guidelines that you may want to consider when you are looking to invest.
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Criteria |
Look for… |
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Location |
proximity to schools, transport, shopping centres and sports facilities. |
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Growth prospects |
potential for capital growth prospects. For example is the property located in close to the CBD, is the suburb undergoing a resurgence in popularity, are their future employment growth prospects. |
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Quality |
appropriateness of the building to the area, low maintenance, security. |
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Aspect and size |
appropriate land size to the area. Lifestyles are changing so having a minimum 800 square metre block is not the same issue as it once was and, while nice, is not a necessity. The right aspect on the block, not being close to a main road and other factors such as natural heating and cooling issues are more important considerations. |