What’s the right property for this stage of the property cycle?

As Australia’s real estate markets move into the next phase of the property cycle strategic investors are asking themselves: “What’s the right type of investment for the new financial era?”

After a number of years of exceptional house price appreciation, it looks like we’re in for a period of lower house price growth across the country, underpinned by expectations of lower economic growth, lower inflation, lower interest rates and slower income growth.

So back to the original question – what’s going to be the best investment in the years ahead?

One thing is certain: there is no such thing as a perfect investment.

If somebody tells you they have found “the perfect investment” be very sceptical and ask lots of questions, because chances are they’re trying to sell you something you just shouldn’t buy.

The things I look for in an investment are:

• strong, stable rates of capital appreciation;
• steady cashflow;
• liquidity (the ability to take my money out by either selling or borrowing against my investment);
• easy management;
• a hedge against inflation; and
• good tax benefits.

Examining the major categories of investments, you’ll recognise that not many fit the bill when it comes to all of these criteria.

To grow your wealth in the current uncertain economic environment you’re going to have to invest in assets that are both powerful and stable.

By powerful, I mean that they must have the ability to appreciate in value at wealth producing rates of growth. This usually comes from the ability to borrow and leverage against them.

By stability, I mean your investment should grow in value steadily and surely without major fluctuations in value.

Many investments are powerful and many are stable, but only a few are both. Prime residential real estate is one of the investment vehicles that has both power and stability in spades.

Now that doesn’t mean it’s perfect, because property is not as liquid as many other investment classes. It can take months to get cash out of your portfolio if you sell a property. Or you may be able to get funds a little quicker by refinancing against the increased value of your properties, but even this takes time to organise.

While some might see this relative lack of liquidity as an issue, I would argue that it is one of the virtues of property as an investment vehicle.

Why?

Because the only way for an investment to achieve liquidity is to relinquish some of its stability. If it is liquid (easily sold, like shares) it is more likely to have wide, and more volatile, fluctuations in value.

Let’s examine this concept a little more closely by looking at the stock market.

The stock market is another potentially powerful investment vehicle because you can borrow against the shares you own. But in order to achieve the liquidity the stock market provides, you give up some stability.

Share prices are volatile, fluctuating up and down and then down and up again. Sure you can get your money out quickly, but you also run a bigger risk of making a loss.

What about putting money into a savings account? While this type of investment is both very liquid and pretty stable, it won’t give you a wealth producing rate of return.

If I had the choice, and I do, I’ll take stability (lack of big swings in price) over liquidity every time.

Over the last decade we’ve been troubled by a number of world economic crises, experienced both high and low interest rates, had a mining boom and then a bust, and we’ve been governed by five prime ministers. During those last 10 years the properties in my real estate portfolio have more than doubled in value but have been relatively illiquid – it would have taken time to sell up.

However, over the same period, the value of many shares that were very liquid decreased in value by 30% or more. I will stick with property any day.

When-to vs how-to investments

Now I know that many advisers recommend ‘when-to’ investments, which means you have to know when to buy and when to sell.

The problem is that timing is crucial with these investments: if you buy low and sell high, you do well. However, if you get your timing wrong, your money can be wiped out. Shares, commodities and futures tend to be ‘when-to’ investments. And so is chasing the next property “hot spot”.

I’d rather put my money into a ‘how-to’ investment such as established capital city real estate, which increases steadily in value and doesn’t have the wild variations in price, yet is still powerful enough to generate wealth producing rates of return through the benefits of leverage.

While timing is still important in ‘how-to’ investments, it’s nowhere near as important as how you buy them and how you add value.

‘How-to’ investments are rarely liquid, but produce real wealth. Most ‘when-to’ investment vehicles produce only a handful of large winners but there tends to be many losers.

On the other hand, investing in well-located capital city residential real estate produces many wealthy people (both home owners and investors) and only a handful of losers

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.