There are many ways to make money and there are some people that would argue that real estate investing isn’t really that easy.
They complain that it takes time to develop the knowledge to understand the property market. It can take months to research areas and find the right investment property. Then when you’ve found it, you need to negotiate to get it at a favourable price. And that’s not all…
You will need to negotiate a loan and find a solicitor to settle the property. This part alone will take 30 to 60 days. Then, when you have settled the property, you still have to either find the time to manage it yourself, or else try to find a reliable property manager.
Is this all starting to sound too complicated?
You are not alone – that’s the very reason some people ignore property and choose to simply park their money in shares or managed funds.
But from personal experience I know so many people who have become financially independent by investing in real estate and I know how real estate has grown my own asset base and changed my lifestyle, that my response is that it’s well worth the effort.
Sure it takes time, but over the long term it pays off and as your skills and experience grows it gets easier as well. And, importantly, most investors find the process of building an investment property portfolio fun.
Two of the main elements of a good investment are:
1. High capital growth, which allows us to grow our net worth, and
2. Secure income, which increases over time (helping you pay the mortgage).
As such, residential property must be a key to your wealth-building program. Let’s look at the reasons to invest in property in more detail…
1. More Millionaires
If you look at the results others have achieved, you have to say that property makes pretty good investment sense. According to the BRW Rich 200 list, which is published each year, property has consistently been the major source of wealth for Australia’s multimillionaires. And it’s the same all over the world.
Those that haven’t made their money out of property generally invest their money in real estate.
Remember, there’s nothing wrong with seeing what successful people do and applying those principles to your own life. If the majority of extraordinarily wealthy people have used real estate profitably, it stands to reason that there’s money to be made in this sector.
2. Anyone Can Do It
Property investment is not just for the wealthy. It doesn’t really take large sums of money to get involved in real estate. This is because banks will lend up to 95% and sometimes even 100% against the security of residential property, which means that most Australians with a steady job and a little capital behind them can afford to buy investment properties.
It has been shown over and over again that careful and intelligent use of real estate can enable ordinary Australians, like you and me, to become property millionaires in about 10 years.
If you truly intend to become one of the wealthy people in the future, you should probably take a serious look at using property to your advantage.
It’s often said that residential real estate offers the security of “bricks and mortar”, but let’s take a closer look at why I believe it’s one of the safest and potentially most profitable investment markets in Australia.
You never hear of houses going broke do you? But lots of companies have gone broke. Even companies previously considered as blue chip companies have gone broke.
Yet even allowing for the ups and downs of real estate values that we hear about, the underlying trend of property prices in the major capital city residential markets has been steady growth.
You don’t have to believe me when I say that residential property is a secure investment. Just ask the banks.
Banks have always recognised property, and especially residential real estate, as an excellent security. The reason they’ll lend you up to 90% of the value of your property is that they know property values have never fallen over the long term. In fact the entire Australian Banking system is underpinned by the continual growth of residential property.
Another factor contributing to the security of the residential property market is its size. It has been estimated by Peter Waxman, from the Department of Land Economics at Sydney’s University of Technology, that the total value of all residential dwellings in Australia is about $2.5 trillion.
But the really special feature of the residential property market is that owner-occupiers, that is people owning or paying off their own homes, own about 70% of these properties. Investors own the other 30%.
Think about it….residential property is the only investment market not dominated by investors, and this effectively gives investors a built-in safety net. Even if all the investors were to leave the market at once, it would not totally collapse.
This 70% home ownership is a huge advantage for another reason- the majority of the market in which we invest does not act according to normal investment criteria or motivation. If times get tough the majority of homeowners don’t panic and rush to sell as can happen in other sectors such as the share market.
So while property prices do fluctuate over time, affected by supply and demand, the large homeowner market will always underpin property values.
Another factor that adds to the security of residential property as an investment is that you can insure it against most risks. You can insure the building against fire or damage and you can insure yourself against the tenant leaving and breaking a lease.
4. Income That Grows
The rental income you receive from your investment property allows you to borrow and get the benefit of leverage by helping you pay the interest on your mortgage. Over the years the rental income received from property investments has increased and this increase has outpaced inflation.
Will this continue in the future?
Well, statistics show that the level of home ownership is slowly decreasing in Australia. It is predicted that the percantage of tenants will slowly increae form 30% of Australia’s population to close to 40% of Australia’s population by 2011. There are a number of reasons for this but, in particular, as property prices keep rising, fewer people are able to afford their dream homes.
We know that the government is having difficulty providing public housing, which means there will be plenty of opportunities for landlords to make good money in residential property investment, particularly if you own a property that will be in demand by tenants of the future.
5. Consistent Capital Growth
Good capital city residential property has an unequaled track record of producing high and consistent capital growth. Over the past 45 years the value of the average property in Melbourne and Sydney has doubled in value every seven years or so.
However, in the short term the picture is much more uncertain and confused and at times capital growth stops and even reverses for a time, as we saw in the early 90s and in the slump of 2003- 2006.
In all Australian capital cities this growth has averaged just under 10%, compounding each year over the last 25 years. These are just averages. The better your property selection – where you buy, what you buy, how well you negotiate and how you finance your property investment – the better your returns could be.
By the way, that’s another great thing about property. You can outperform the average by researching areas of strong capital growth, by buying your properties below market value and then adding value, which increases your capital growth and rental return.
If a property increases in value by 10% per annum (averaged out over a number of years) then the value of that property doubles every seven years. Imagine you owned a property worth $500,000. In seven years time the same property would be worth $1 million and in 14 years it would be worth $2 million.
When you own a property worth $500,000 usually you have some equity or your deposit and you borrow the rest. Imagine you had 20% deposit and borrowed the balance ($400,000) from the bank.
After seven years you would still owe the bank $400,000 (assuming you had an interest-only loan) and your net worth would have increased from $100,000 to $600,000. That’s an increase in your net worth of six-fold even though the value of the property only doubled.
What would happen over the next seven years?
Your property would once again double in value to $2 million and your net worth would increase to $1.6 million dollars. Your initial $100,000 investment would have increased in value 16-fold while your property only increased in value four-fold.
This amazing increase in your net worth is due to the combined effects of compounding and leverage.
6. You Can Buy It With Someone Else’s Money
I will let you in on a little secret. The return you get on real estate if you pay for your purchase using all cash (without getting a loan) isn’t much higher than what you can achieve with other types of investments.
Of course, with real estate you usually don’t pay using raw cash; instead you use someone else’s money to buy your properties. That is, you put down a small deposit, often 20%, and the bank finances the rest. This is called leverage.
Archimedes said, “Give me a lever and I’ll move the earth.” As investors we don’t want to move the earth, we just want to buy as much of it as we can!
The ability to use leverage with real estate significantly increases the amount of profit you can make and, importantly, it allows you to purchase a significantly larger investment than you would normally be able to.
Because of its history of security, stable income and proven capital growth, residential real estate is regarded as a prime security or collateral for loans, which means that banks may lend you as high as 90% of the value of your property.
They won’t lend this proportion on other types of investments. If you buy shares in the banks themselves, the banks may only lend you 65% of the value of their own shares, and they only lend 70% or so of the value of commercial properties. This makes residential property an appealing vehicle for building wealth.
In the technical sense leveraging, or gearing as it is also known, means using a small effort to move a large object, like the gears on your bicycle where you have to pedal a small rotation to turn the large back wheel.
In the financial sense, leveraging is using a small amount of money to control a large asset. You do this by borrowing money and mortgaging your property, and using this borrowed money to invest in a larger asset.
The more highly you are geared, the more money you have borrowed, and the lower your invested capital in relation to your borrowings.
As you can see from the examples in the table above, the higher the degree of gearing, the more leverage you achieve and the more your returns are magnified. But be warned, gearing not only magnifies your profits, if the value of your investment falls, your losses are magnified as well.
7. You Are In Control
Property is a great investment because you make all the decisions and have direct control over the returns from your property.
If your property is not producing good returns, then you can add value through refurbishment or renovations or adding furniture to make it more desirable to tenants. In other words, you can directly influence your returns by taking an interest in your property and by understanding and then meeting the needs of prospective tenants.
8. Tax Benefits
These are so important that we have have a number of different articles on this in series, so we’ll skip over explaining them here.
9. You Can Add Value
There are hundreds of ways you can add vale to your property, which will increase your income and your property’s capital value. These include little things like giving it a coat of paint or removing the old carpet and polishing the floorboards underneath. Or you could do major renovations or development works.
10. You Don’t Need To Sell It
Unlike most other investments, when real estate goes up in value you don’t need to sell in order to capitalise on that increased value. You simply go back to your bank or mortgage broker and get your lender to increase your loan.
11. Most Forgiving
Even if you bought the worst house at the worst possible time, the chances are good that it would still go up in value over the next few years. History has proven that real estate is possibly the most forgiving investment asset over time. If you are prepared to hold property over a number of years, it’s bound to rise in value.
There’s really no other asset class quite like property!