Bricks and mortar investments are safe as houses, but what are the options for a long term property strategy?
Times are tough nowadays. Europe is in bad shape and the US is doing all it can to rein in an unprecedented budget deficit. Economic uncertainty is a sign of the times. Although Australia has been one of the countries that has been doing better than most, people are still not sure on where their money should go to get the best long term return. And the age old adage, ‘safe as houses’ has never rung so true.
According to property consultant and head of MAP Real Estate, Michael Furlong, one of the best long term investing strategies is the one that involves buying property and holding it until the investment properly matures. That is, buying property and holding it for seven to ten years.
‘People believe that you can just buy a property and sit on it for two years, make some money and get out. They’re totally not understanding what the strategy of property is. The strategy of property is long term – a minimum of seven years,’ Michael says.
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Choose the right long term property strategy
Property is a long term relationship. Choose your investment strategy wisely. Common long term investment strategies include:
Buy and hold for capital growth
This is one of the most common strategies and probably the simplest and most secure ones. It consists of buying a property, holding onto it and hopefully reaping the benefits of capital growth. Capital Growth is the term for an increase in the price of an asset over time. The value of the property increases in line with market prices. For example, what you paid $500,000 for 10 years ago is now worth $600,000 today. The property has grown in value by $100,000. Essentially capital growth can be achieved through buying and holding an asset as property prices have traditionally grown from year to year. Many investors rely on capital growth as a certainty in life; however, the topic of Australian housing prices over the next decade is contentious issue. Furlong says the forecast is for the property market to pick up in 2013 and 2014, so riding out the storm is his recommended strategy.
How much your property is expected to appreciate in value is subject to a number of factors including location, property type, time frame and at what stage the property cycle is currently in.
Residential property group, ‘Which Property’ crunched the numbers and gave the following scenarios to demonstrate capital growth and rental returns for residential dwellings throughout Australia.
The last 6 years, rental returns
‘Over the last 6 years, rental returns have been stronger than capital growth in all Australian capital cities, according to RP Data. Between 2005-2011, rental growth has increased by 46.8% on average across all Australian capital cities. If a property was rented for $300/per week in 2005, the market rate would now be an additional $140.40/week approximately, which is $7,300.80 a year additional cash flow for investors.’
The last 5 years, capital growth
‘Home values across Australia’s capital cities over the last 5 years to August 2012 increased at an average annual rate of only 2.4% per annum. Based on this data, a property purchased for $300,000 in 2005, would now be valued at $360,000. This growth rate has been greatly subdued since the Global Financial Crisis (GFC), which was sitting at 8.4% pre-GFC (August 2002-August 2007). As such, investors have become more reliant on strong rental yields rather than capital growth.
Generally, the balance tips between capital growth and rental yields. Renters turn to purchasing when rents go up and residents turn to renting when capital growth moves upward. This is a standard trend that is typical across the property markets long-term cycles.’
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‘This strategy allows investors to reduce taxable income, while building wealth through potential capital growth’, says Which Property. ‘ In simple terms, if an investor makes a loss on a property investment, they can claim the tax reduction against their income which is known as a tax offset. This allows investors to lower their tax bracket, meaning they can pay less tax.’
Which Property says that, ‘negative gearing is a strategy that can be effective according to an investor’s goals’. ‘This is a strategy that is used mainly by high-income earners who are looking for smart ways to grow their property portfolio whilst the tax departments assists with an investment property’s holding costs. This strategy does require a cash outlay from the investor, however with careful property selection the rental returns will increase over time and the property will shift from negatively geared to neutral and then to positively geared. Over the long-term, gradual rental increases and reduced tax payments, should enable the investor to recover any initial losses from the negative gearing phase.’
‘Furthermore, when the property is sold, the capital growth should more than make up for any losses and this is how wealth is built over the long-term.’
This strategy is often used by investors who like to mix up different kinds of assets. This approach allows investors to buy an interest in a professionally managed portfolio, just as you would buy a share in a company, which has all sorts of types of property. The money you originally invest stays with the trust until the trust ends and the properties are sold, the proceeds are distributed among the trust’s stakeholders in addition to any gains if the properties were sold for a capital gain.
The past ten years have been shaky for the listed property trust sector. The GFC exposed issues around gearing and diversification, diminishing returns over what is historically a well performing asset class. For instance, according to the Vanguard 2012 Index Chart, Australian Listed Property Trusts were among the best performing asset classes between the period of 2002 - 2012 before factoring in fees and charges. It also demonstrates the impact of the GFC on the A-REIT sector. In 2008 and 2009 A-REITs were the worst performing asset class including Australian and international shares, bonds, cash and international property trusts. Financial year total returns (%) for the sector were -36.3% in 2008 and -42.3% in 2009. In 2010, the sector showed signs of resurgence with a 20.4% average return for investors before fees and charges.
There are a number of other strategies investors can use, like renovating for a profit; however, these strategies are both long term and short term.
Is property the right investment type for you?
Which Property also answers some common questions people have before deciding on a property investment strategy.
How does a person know if long term investment property is right for them?
‘We only recommend long-term investment in property as this will reap the greatest return. With this strategy in mind, it is integral to select a location that will always be highly demanded and close to core infrastructure such as public transport, schools and shops. This strategy minimises any risk by ensuring that your property will always be highly demanded, whether it be by tenants for renting or investors/owner-occupiers when it comes to selling. Holding a property for the long-term will also mitigate the initial setup fees as well, which may include Stamp Duty and loan setup costs. This will maximise an investors returns across the long-term.’
What factors do you need to consider when getting into property investing?
‘There are a myriad of factors to consider, however the single most important though, is to determine your long-term goals. What do you hope to achieve through property investment?
Once you have determined this, look for a suitable property that fits your strategy. This is often the most challenging part though. Trying to understand the market and demographics can be confusing and overwhelming. To maximise your investment returns, we recommend to our clients incorporating key criteria which include location, design, build quality, tenantability and return on investment. This is why it is absolutely vital to use property experts when reviewing your options.’
What will make you create wealth or lose money when you invest in a long term property investment?
‘This comes down to understanding key fundamentals and underlying demographics which affect market movements. We are seeing a growing trend towards medium density living, particularly as the population seeks to live closer to amenities. The key with property investment is to minimise any foreseeable risk and maximise investment returns. Wealth can be built through property investment over the long-term if the location and property selection itself meet key market needs. Purchasing in an area with a growing population, employment nodes, key supporting infrastructure and well-designed, functional properties will ensure success.’
Which strategy do you recommend?
‘We recommend purchasing brand-new properties close to core infrastructure, and holding for the long-term to reap maximum returns. Purchasing brand-new properties is one way of maximising your returns, given depreciation is higher on newer properties. Remember, the location, property type and design, and holding period will be integral to an investor’s success.’
'Don’t look at property as shares'- Michael Furlong, Property Consultant and head of MAP Real Estate
Insecurity is one factor that may lead you the wrong way. When times are tough in the property market, the worst thing you can do is sell your investment property. Michael says the talk on the street is that people are frozen in their decision-making in the current state of the economy.
‘Whether it’s clients or socially or other industry professionals, the feedback we are getting from those who would ordinarily be buying is that with so much uncertainty people are not making any decisions – there’s almost a state of paralysis, people aren’t doing anything,’ he says.
Michael says property has always been a long-term investment, and that people need to have a realistic approach to what 'long-term' actually means.
‘Some people have the philosophy of approaching property market in the same way as they approached the share market - where you can buy and sell, play the market, and try to make a profit. But you shouldn’t be looking at property that way,’ Michael says.
Is it time to sell?
Michael Furlong’s five main points
Michael gives the following points to consider before selling an investment property:
- ‘If you’re in a position where cash flow is tight and you don’t think you can hold the property the first thing you should do is talk to an adviser – a tax planner, an accountant or last option a mortgage broker. So rather than sell the property and lose your asset, incur a tax implication (pay capital gains or have a capital loss) and lose the capacity to earn income out of the growth over a long period of time, the first thing you should be doing is look at all your other options.’
- ‘Maybe you can chat to the bank and refinance, get a different loan, if there’s equity in the property maybe you can capitalise for the next two years.’
- ’Borrowing against the equity will increase the size of your loan but that extra cash will help tide you over for a couple of years until the property market recovers. 'It will assist you in the short term with your cash flow,' he says.
- ’Many people are becoming disheartened by the flat market but that doesn't mean it’s smart to sell your asset. 'If your investment property is not growing, join the club. No property is growing at the moment: collectively we’re in a flat spot. But if you go and sell, you’re going to miss out on the recovery.’
- ‘If an owner still decides to sell after all our recommendations not to, we’re suggesting they do a refresh of the property. New carpet, a fresh coat of paint, new blinds and hire staging furniture. If you’ve got a house then you would need to spend time and money on getting the garden well presented. 'Poor properties are sitting on the market for a long time - for months. Good properties will still sell.’