How to invest in property without getting burnt

This is part two in SmartCompany’s five part Investing special report: The rules of investment. Written by SmartCompany and brought to you by Bendigo Bank.

If you want to invest in property, you’re in good company.

Of the 200 richest Australians in 2012, 55 made their fortune in real estate – by far the biggest single millionaire-factory in Australia.

And it’s not just the top end who are getting rich off land. The financial security of millions of middle-class Australians, perhaps yours among them, is maintained into retirement chiefly by the value of their homes.

Property is Australia’s largest asset class. But most Australians don’t use property for investment purposes. Which is exactly why you should, says Michal Yardney, a property strategist at Metropole.

“The beauty of property investment is that 70% of properties are owned by owner-occupiers,” he says. “That means it’s the only investment market not dominated by investors.

“That’s a built-in safety net. If everyone left the market at once, it wouldn’t totally collapse. It’s underwritten, in effect, by the occupiers. And they’re not motivated by money, but with the need to put a roof over their head.”

Unlike many asset classes, property is a long-term investment, held for a decade or more. This can be a boon to investors who don’t have a lot of time to devote to their portfolios, says Jo Chivers, the director of Property Bloom, a property developer specialising in NSW’s Hunter region. “We don’t recommend you go for quick gains. It’s too expensive anyway, what with stamp duty and legal fees.”

The problem, and the opportunity, in property investment is that it’s an imperfect market, Yardney explains. “The ASX is a perfect market. But property, well, you can buy below the true value, and sell above the true value. Or the opposite. So there’s real money to be made, if you do your research.”

Like everything though, it’s not a surefire way to make money.

“If you get it wrong, you leave the market,” Yardney says. “Most investors never get to their second or third property. One in five sell out in their first year, and half do so within their first five years. That’s why you need to get your first investment property right.”

Yardney says plenty of first-time investors get property-investing wrong because they make emotional decisions. “That might make some sense when buying your own home, but shouldn’t play a part in your investment decisions.”

Here are the things you need to consider when investing in property to make sure you don’t get burnt.

Funding hurdles: Why SME owners find it hard to buy their first investment property

The terms and interest rate paid on a property investment is a large factor in whether or not it ends up making you money.

However, many owners of small businesses find it difficult to secure the funding necessary to invest in property.

“When the global financial crisis came in, a lot of low-documentation loans went out of the market,” explains Chivers. “A lot of SMEs relied on low-doc loans. That’s because when you’ve got your own business, depending on how you do your books and how much you pay yourself, it could be difficult to get any other type of loan.”

The issue with SME owners, Chiver says, is that many don’t pay themselves enough, which makes taking out large loans difficult.

“That’s why it’s a good starting point to get finance approved. Go to a finance broker, show them your figures, and learn what amount you can expect to borrow. Once you’ve got an understanding of that, you can start researching where to buy.”

There is no national property market: Find which one you want to invest in

Asked whether property prices are likely to rise as quickly as they have in the past, Chivers disagrees with the premise of the question.

“There is no national property market,” she says. In the Hunter region, where she invests, there’s been slow, incremental growth in the last eight years. But not everywhere has been the same. “Some of the towns are reliant on coal mining,” she says, meaning their growth is affected by different factors to the more diverse towns in the region.

“It’s a matter of tracking the area. You can buy good data from lots of providers. You should track the quarterly median sale values, their growth, rental prices, as well as what’s happening in the area. It all depends on the economy of the location.”

Yardney prefers to invest in capital cities, even though the costs are higher.

“In the long-term, property values are driven by two things,” he says. “Population growth and the nation’s wealth.

“In the short term, there’s a whole lot of things, like interest rates, demand and supply, consumer sentiment, the availability of credit, and so on. But in the long term, it’s those two things.

“[Prime Minister] Julia Gillard came out the other day and said we’d have 40 million people living here by 2050. Most of those people are going to want to live in the capital cities.”

Do you want tax benefits or money to spend: Gearing explained

Property investment should be considered as part of your total financial position.

If you’re on a high income, investing in a brand-new property in a capital city means the rent won’t cover the ongoing repayments and rates. This is called negative gearing, and it can significantly reduce your tax liability.

“It can get complicated with small businesses, so you should have a chat with your accountant about the best structure to buy in,” Chivers says. “The accountant might recommend you set up a trust, for example.”

If, however, you’re looking for something to add to your cashflow (i.e. a positively geared property), you should look for investment properties in regional areas, where the yield is typically higher. “That can help you move forward onto another property pretty quickly,” Chivers says.

Starting out? Stick to residential

Commercial property investment is very much for sophisticated investors, Yardney says. It typically requires far more money to get started, and it needs higher overheads to maintain.

“It’s more useful for people when they get to the next stage and want to live off the cashflow of their asset base. For most investors though, they should be focused on building an asset base first.”

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