Should I invest in property?

Australian’s have a love affair with property and it’s unlikely to end anytime soon.

We all know people that love to spruik property.

“I bought this place for only $10,000 back in the 60s”

“This place has doubled in value”

“All the richest people made their money in property”

“Everyone needs a roof over their head”

“Property only goes up in value”

Not all of these statements are correct and believing they are can lead to serious problems. Like any asset class, property carries its inherent advantages and disadvantages. As an investment class, property is similar to cash - it’s easy to understand and it’s not overly volatile.

It’s easy enough to estimate the rental income and expenses, and most people are relatively comfortable that a well located property will increase in value over the long-term. I’m one of those people as well.

Historically, property also has the advantage of strong capital growth over the long-term. This has no doubt helped make property investing one of the most favoured investment classes.

People also tend to like the feeling of buying bricks and mortar. It’s something physical, they can visit the property and see for themselves what they have invested in. Compared with property, shares are certainly more ethereal.

With property, there’s a feeling that if something goes wrong, you could always move into your property as a back up plan.

Apart from property being easily understood, another thing I like about property is that you are in control of your asset. For the average investor, it’s not possible to call up Telstra and ask them to make some changes to their business model to improve returns. But as a landlord, you can install a new kitchen or upgrade facilities and achieve higher rent.

It’s not just Australian’s that love property - banks love lending against property purchases and the Australian government has a long history of blessing property investments with concessional tax treatment.

But perhaps the biggest advantage of property is the ability to leverage your funds. This is where property significantly differs from shares, as many investors are not comfortable leveraging shares.

Say there is an investor that has $100,000 to invest.

They could buy $100,000 of shares, or put a 20% deposit on a $500,000 house. To make it easy for me, let’s ignore stamp duty in this example.

The share investor now controls $100,000 worth of shares.

Alternatively, the property investor now controls a $500,000 asset.

If the value of each asset increases by 10%, the returns look something like this:

• Property investor: $50,000 capital growth

• Share investor: $10,000 capital growth

In addition, the share investor is likely receiving a 4% dividend yield, for $4,000 per year, while the property investor may be receiving a 3% net yield for $15,000.

This, combined with concessional tax treatment available from negative gearing, makes property a very popular investment vehicle.

A love affair gone wrong?

When you combine concessional tax treatment, easy access to debt, and a love affair with property, you end up with some of the most expensive housing in the world. And in this regard, Australia bats above its average.

While I think everyone should have the goal of owning their own home, as an investment option, property is not without its flaws. It’s far from the perfect investment it’s made out to be, but you can make it work with the right strategies in place.

One thing I know for sure though is that a lot of people that hold property for the long-term, end up being frustrated by the low rental yield and are always worried that some unexpected expense is going to pop up and wipe out their profit for the year.

For most people, it’s not possible to retire off rental yields, as the rental yields from residential property are so low. At the least, most people would need to own multiple properties to achieve a rental return that covers their living expenses, which is becoming harder and harder as property prices increase across Australia.

In a hot market, it’s easy to say that property is one of the best investments going around. But boom times are often followed by many years of stagnant growth. As property becomes more expensive during the current boom, it is easy to have a negative outlook for this market. After all, when people are rushing in to buy this asset class, prices increase, therefore decreasing rental yields and the prospect for future capital growth, especially when placed against the backdrop of increasing interest rates.

Unfortunately, human nature plays a part in promoting property as the rags to riches asset class it is made out to be. I genuinely believe that people blatantly overstate the return they receive from property. It’s easy to look up the historical sale price for a home, and see it doubled in value over 10 years. But people forget the stamp duty paid to acquire the building, the real estate agent fees to sell it, the renovations undertaken and all the interest they paid over the ownership period.

There’s always the feeling that everyone needs to have an investment property. That you’d be crazy not to. This is certainly not true and I have seen many people lose money thinking they had to have a negatively geared investment property because it was good for their taxes. This is one of those mindsets that needs to change. Property does not always go up in value.

An objective look at property as an investment:

When you take a step back and look at property objectively as an investment vehicle, it looks something like this:

Advantages:

• Easy to understand

• Owner is in control of their asset

• Ability to leverage

• Tax concessions for negative gearing and building depreciation

• Well located properties have achieved consistent capital growth over the long-term

However, property comes with the following disadvantages:

• Low rental yields are typical for residential property

• Expensive to buy and sell

• Expensive upkeep as the building is subject to wear and tear

• Property can be illiquid compared with other investments (hard to sell quickly)

• Australian property prices are over-priced compared with other Western countries, potentially limiting future capital growth and making servicing loans with low rental yields a challenge

Now don’t get me wrong, there are thousands of ways to make money in property. But my goal is to provide my unbiased professional opinion, based on what I have seen so far throughout my career and my own personal experience.

If you feel that the ability to buy multiple properties is out of your reach, don’t despair. There are plenty of ways to build wealth outside of property. Property remains, just one of the ways to build wealth over the long-term.

One thing I genuinely believe is that everyone should own their home before they retire. It provides the cornerstone of financial security. But when it comes to investing, I’m certainly not suggesting that everyone should run out and buy as many investment properties as they can.