5 reasons why investing in property is a great idea
Last week we discussed ways of getting into the property investment market with no up front, out-of-pocket expenses. We had a super positive response from our readers, but some still needed some convincing. Sure we proved how easy it is to invest, but what makes real estate a better investment than say, shares or sticking the money in savings account?
Here we break down what we consider the Top 5 reasons to invest in real estate:
1. It’s safe
The Australia Securities Exchanges recently released its 2016 Long-term Investing Report, which identifies residential property investment as the highest performing long-term investment of the past decade.
Average returns on investment property over the past decade reached 8% per annum. On a $400k property that’s a return of $320k over those ten years. The investment assets most able to compete with residential investment were global bonds (hedged) at 7.3% and Australian bonds and global shares (hedged), both at 6.2%.
The above statistics may come as a surprise—after all, haven’t we all heard stories about the $1 share that became worth more than $100? But for every one of these stories there are a dozen failed companies and investments that have gone worse than nowhere.
In addition to out-performing shares long-term, part of what makes investment property a safer bet is that bricks and mortar don’t disappear.
Share values can plummet and become worthless in a day and you’re left with nothing—or worse, you’re left in debt.
Cash returns, such as term deposits, are often seen as the safest of investments as the Australian government will always bail out the big banks in a time of financial crisis however:
• The 10 year investment report saw a return of only 3.1% per annum.
• You need the cash upfront to invest.
• You only see a return on your cash (as opposed to getting a return on the bank’s money).
2. You can borrow money to invest
With a term deposit you can only see a return on the cash you have upfront to invest. You’d never borrow money to invest in a term deposit because the interest rate on the loan would cost more than the interest you’d make.
When investing in real estate, most people take out a loan, which means they’re reaping returns on the bank’s dime. Let’s get super conservative here and look at just the appreciation aspect of your investment property returns (so taking tax benefits, rental income etc. out of the equation). In Canberra according to recent Corelogic data you’re looking at an average of 3.7% per annum in appreciation alone.
We’ll use Stacey from last week as an example. She didn’t have any cash savings, but she had $145k of equity in her home. She used that to borrow 100% + costs of a $240,900 investment property that is cash flow positive (it will pay for her movie tickets each week). If the property increases in value by the average 3.7% her net worth will increase by $8,913 in that first year without her having to stump up any funds, because she’s using $145k in collateral to get a return on $240,900 worth of property.
Even if she had $145k in cash savings and had put that into the highest paying term deposit (a Bank of Queensland term deposit paying 3.25% p.a. with 4 year term) her investment will have increased by only $4712 in the first year.
Now Stacey could have borrowed money to invest in the share market, using the equity in her home. This is called a margin loan. Given the considerable risks involved with shares, banks won’t loan 100% of the value of the investment as they do with investment property. At most they’d loan Stacey 70%, and then only if her financial circumstances indicated that she’d be able to top up the investment with more money if the share price fell.
The danger with a margin loan is banks have a set value-to-loan percentage (LVR) that they’re comfortable with based on a range of factors including your financial circumstances. If share prices fall, and your investment value drops below the LVR, your broker may call you asking you for more cash to shore up your investment. This is a margin call, and if it happens your options are:
• Find extra cash to pay the lender.
• Sell part of your investment at the low rate to raise cash.
• Give the lender additional security (e.g. security over other shares).
You could potentially end up owing more than your investment is worth. These dreaded margin calls abounded during the financial crisis, yet it is practically unheard of for a bank to ring and ask you to put more money into your mortgage. As long as you’re still meeting the repayments, they’ll leave you alone.
The Australian Securities and Investments Commission recommends margin loans only to “dedicated investors who actively monitor and manage their investments. Many people have suffered financial ruin when margin loans have gone sour. If you don’t fully understand how margin loans work and the risks involved, don’t take out a margin loan.”
So essentially, unless you’re willing to take the risk with a margin loan and have the means to become a dedicated investor, investing in the share market is only really possible with the upfront cash you have on hand.
Part of what makes the real estate market less volatile and less risky than the share market is the fact that investors only make up a minority of the market, with homeowners making up the vast majority. This means there is a constant level of activity in the market providing a buffer from financial ups and downs.
3. It’s easy
Firstly, banks like backing property as evidenced by the fact that you can borrow 100% of the home price plus costs. While lending criteria have tightened over the past 12 months, as long as you’re earning a full time income and have equity in your home, you can invest in property with no out of pocket expense. (see our article on how here)
It’s also easy to get started. Most people begin just by purchasing a home to live in as the process of investing in houses is simple to learn. Buy, rent out, watch your asset grow. Admittedly there’s a bit to get your head around in regards to tax benefits, depreciation etc., but nothing your mortgage broker can’t teach you in a couple of hours.
Unless you relinquish control of your shares to a broker, playing the stock market on your own means learning a whole lot of terminology, getting a handle on the system, researching brokers and fund managers and then doing a whole lot of reading to get a gauge on the different companies out there. The work doesn’t stop with the purchase though, it requires paying attention to what companies are doing see signs of company health. It’s important that you’re regularly reading financial market papers to know when to buy/sell. On the bright side, there are stock market virtual reality games out there to help you get a handle on it all.
4. There are tax benefits
Strong housing investment is good for the country. It means more housing supply, lower rents, less dependency on government housing and a strong construction industry. The Australian government encourages housing investment through a number of tax benefits.
Firstly, you can claim expenses related to your property as tax deductions, lowering your taxable income. This means you offset, or partially offset, any shortfall between your investment rental income and your expenses. In some scenarios this results in a cash flow positive investment. One of the deductions you can claim is depreciation. The newer the property the higher the depreciation, which means purchasing a brand new property can result in a windfall come tax return time.
Secondly there is Capital Gains Tax. Unlike stock market shares, you never pay tax on income earned when you sell your primary residence. If you sell an investment property that you’ve owned for more than 12 months you only pay tax on 50% of the profit.
As an example, Jane’s sole income is property investment (most investors are everyday Australians with other jobs, but it’s a Monday morning and there’s a limit to the amount of math we want to do). After all her deductions including depreciation, last financial year she made $120,000 profit selling investment properties she had owned since 2012. She only pays tax on 50% of that, bringing her taxable income to $60,000.
• Her tax bill: $12,247 (including the Medicare levy)
• Her total income: $107,753
John’s sole income is the money he makes playing the stock market (not the VR games, the real deal). He also makes $120,000 profit, but has to pay tax on the whole lot.
• His tax bill: $34,747 (including the Medicare levy)
• His total income: $85,253
Gina made $120,000 profit from her 3.25% term deposit in the same financial year, but that’s because she has 3.7 billion dollars in the bank.
5. It’s subsidised by others.
You’re already using the bank’s money to increase your net worth. The ATO is adding a share as well. In addition to that there is the rental income you earn, which offsets your expenses. Effectively these three entities are chipping in for your capital gain.
If you’re looking to use some of the equity you have to invest, and think property is right for you, the first step is to get in touch with a mortgage broker, who can go through your personal circumstances and help you finance an investment loan. They’ll also help you through the entire buying and investing process. The best bit? Clarity Financial Group will do this for free.