Bricks and mortar investments are safe as houses, but what are the options for a long term property strategy?
Property investment is really a long term relationship. You need to choose your investment strategy wisely. 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.
Let's take a look at your options for long-term property investment.
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.’
‘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.
You can learn more in our detailed guide to buying property in a trust.