Investing in Property – What Is the Best Way to Buy Rental Property?
Investing in Property
What is the best way to buy 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, right? 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 just 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. Growing up 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 buy a newly complete one bedroom unit back in the early 2000s. It was just something I’d always wanted to “have.”
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 the advice of my wife 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 counselled me to consider this as an option. My “adviser” had discouraged me on the basis that I would be putting all me 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 on the basis of 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 pool and gym equipment. The rent never paid for the outgoings and I lived in hope that the price would go up so I could make a “paper” profit at least!
Now some time later I did end up selling the unit for around $300k, so it was far from a complete disaster. In the end I was very glad 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 city, walk to tram, bus and train and there was no high-rise in the vicinity. The area couldn’t be quickly re-developed and units added. In short, the amenity was desirable and there was not going to be any new properties added in the foreseeable future. This meant there was a cap on supply.
In the city here is not a cap on supply. 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 then 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 neighbours 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 cashflow or for 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 other area of income. I don’t disagree with the concept, we ought to be able to weigh our profits against our losses and pay tax on the net result. BUT, if all we own are “investments” that are make 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 deciding to invest of 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 do an audit of 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, your family situation, the personalities of you or your partner and your goals in life.
If our main goal in life was 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 of 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 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 make a decision 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.
Your relationship with a property needn’t be a marriage for life. There’s no compulsion to “stay together” till death do you part!.
What about Cashflow positive real estate?
I love cashflow positive property and investment strategies. So Yes, I look to see where the cash if flowing and see how I can get if flowing towards me.
Think! Are you buying for lifestyle or for investment? What return are you hoping to achieve? Only when you can answer these questions honestly are you ready to take action!
Until Next time,