What’s the all purpose of property investment???

[joo]

We have a dilemma that puts a question mark over the all purpose of property investment.

Let’s take an example of a unit, which provides a 10% gross yield, which is considered to be a good return. The example below proves that even in this good case it’s hard to get a positive cash flow.

The price of the unit is: 100,000

Income: 9,984 (weekly rental: 192)

Expenses:
Property management: 998
Vacancy (2 weeks): 384
Rates: 650
Insurance: 500
Maintenance: 500

Net income: 6952

This unit provides an excellent gross yield of 10% and a net yield (before interest paid for loan) of 6.9%.

We would like to put 5% of down payment which is $5,000.

We would like to get a reasonable (yearly) positive cash flow of $1000.

That leaves us with $ 5952 (6952-1000) for interest payment.

The current interest rate is approx. 7.7% per annum. A quick calculation will bring us to the amount that we have to borrow, which is $77,298. (For that amount we will pay an interest of $5952).

The conclusion: the deposit needed for this house will be $22,702 (100,000 – 77,29.

The cash on cash return will be in this case 4.4% (1000/22,702) x100) .We are excluding tax benefits and growth as they supposed to be the “cream” and not the real purpose of property investment.

If we deposit $22,702 in a saving account, we are going to get more than 4.4% return on investment. Furthermore, a large deposit like that will mean that we will be able to buy only a very small number of properties, which is not the real target of us.

We thought about a solution that will enable us to keep the positive cash flow and only pay 5% down payment. We will take a revolving loan for part of the money and immediately deposit that money in the revolving account, so we will not need to pay interest for that loan. We will take some of the money out of the revolving account for buying the next property. But meanwhile we will not pay an interest for that loan.

For example: a loan of $77,298 (Interest only) and $17,702 in revolving loan (that will leave us with $5000 down payment). We can immediately deposit $17,702 in the revolving account, thus not paying an interest for that loan. However, we will need that money in the future for buying the second rental property - so what have we done here?

To summarize, we don’t understand what is the all purpose of property investment if even in an excellent property we cannot get a return which is higher than bank interest.

You might say that we should put more than 5% down payment, but than our property portfolio will be very small and it will not allow us to retire in a few (or more than few) years.

You might also say that we should add value to the property and increase its value. However we are talking about one unit out of four in an excellent condition, and we can’t add any value to it. You might say that we should buy a neglected house and than add value to it. However, we are working full time and we don’t invest in our home-town, thus it will be almost impossible to manage such a project, not to mention the high hourly rates of the trade persons.

What is the solution?

[Julian]

A good post - well thought out. But it could be flawed. You found a property investment that does not work for you and say, Why bother with property investment, when the real question might be, Why bother with this property investment? or How can I make this property investment work?

If property, as an investment vehicle, is working for lots of people what could you do that they are doing? Can you get the rent up for relatively little cost? Can you find a way to manage it yourself, or get lower management fees, perhaps by partly managing it yourself? Can you find a different investment property that has better numbers? Is now the right time to be buying on 5% deposit? Can you get cheaper finance, say from family? Can you do some quick cash deals to build up the deposits? Can you change your jobs to be closer to your rental property? Can you buy a rental property closer to where you live so that you can manage it? Is commercial property worth looking at?

On the other hand, the present time might not be the ideal time for you to enter the property market, and then the question might be, What is the best and most secure way to grow my savings so that I am in a better position when I do enter the market, should I chose to at a later date?

Julian

[Josko]

A good post - well thought out. But it could be flawed. You found a property investment that does not work for you and say, Why bother with property investment, when the real question might be, Why bother with this property investment? or How can I make this property investment work?

A little easy on this one aren’t you Julian , most certainly a flawed synopsis.

To summarize, we don’t understand what is the all purpose of property investment if even in an excellent property we cannot get a return which is higher than bank interest.

Property investment historically is proven to be an excellent long term investment and the returns far out perform bank returns even if you take compounding interest into consideration.

For the long term shares would also be a more prudent investment strategy, than bank returns.

So the solution is learning more, ask more questions, develop a strategy, develop a set of investment rules, keep hunting for that investment that fits and do it.

[Glenn]

Oh you young people are always in a hurry.
Things like this have been said for thousands of years.

You after all have the greatest chance of gaining from capital gains because you can expect to live longer.

This investing game is like working for the Government. Well what it used to be like when I worked for them. Slow and boring.
For years and years the low-grade workers slave away and get an occasional promotion. It is only in the final years of the 40 put in that many people get some good promotion, just at the time the kids have left home and the poor sods do not need the money.

The first property you buy generally takes ages to be any good to you.
This is why many pundits suggest buying higher risk / higher rate of return properties at the beginning. The trouble with this sort of property is they are the ones with all the trouble / work and many people cannot be bothered after a few disasters and sell out.
One approach is to consider an investment property as a savings scheme.
So yes if one has a revolving credit facility over part of the property you can continue saving (from your full time job) into this mortgage. Once you have enough money in it (credit available) then you can buy your second property.
Property investing is really not much different from starting up a small business. Very few small business investors will be able to take very much (if even wages) out of that business in the early days.
With residential property the best profits come from the capital gains.
You do not need to sell to use these capital gains just refinance so you can borrow more to buy another property.
As well as capital gains (we have seen plenty in the last couple of years) you may also reap rent increases. Because your mortgage does not get any bigger you should at long last start gaining on the principle repayments.
So yes it can seem slow and not very rewarding for a long time.
We have just been through a short rapid increase of capital values.
Many pundits pontificate on how to do well and sell their books, courses, and seminars telling you how to do it. Really though most investors out there reaped the benefit of the capital gains without any input or clever calculations of their own. It just happens. You do not need to be clever to benefit just patient.
The next few years might not be so wonderful. But if you can keep the cash flow going supplementing it with extra cash you will come right in time.
If you try and run before you learn to crawl, like buying heaps of property in a short time with 100% finance then you just might take a fall when the market is going the wrong, or no way, at all.

[Julian]

Ivy,

Property investment historically is proven to be an excellent long term investment and the returns far out perform bank returns even if you take compounding interest into consideration.

Before you dismiss bank returns too quickly remember there are two ways to get bank returns - one is to loan your money to a bank and cop the interest and not much else, and the other is to buy shares in the bank.

If you had employed the latter strategy you might have surprised yourself in just how well banks can perform.

Julian.

[David-Suzuki]

You buy, and in the future interest rates rise. Your investment becomes not so good. Others wake up that they are in the same boat. They sell. But there are not as many buyers. So prices drop. If they drop more than 5 percent, you are too highly geared and make a capital loss. Read the fine print of your mortgage document to see if the bank could make a margin call on you for more equity (money) if prices drop 10 percent. You are wondering whether it is worth buying now, but unless rents rise, it could look even worse in the future. Your tenant moves out and you have nothing but overheads and no income. Property prices go down in value. You must sell, and at a loss - fire sale price of 80 percent of what you paid for the property plus agent fees and lawyers. This is your worst case.

I am just one small voice in a large market, but I personally believe apartments are a bad investment. Study the performance of apartments in other markets such as Sydney and Melbourne.

But, Glenn is right. All property tends to go up in value over the long term.
They say land appreciates, buildings depreciate. How much land comes with your apartment?

Perhaps you would be better off studying the performance of family homes on freehold titles. By improving a property you can effectively hedge against a market downturn by adding value to the property and adding income by increased rents and rental appeal. Houses can generally be improved more easily than apartments, which are often bought over-capitalised.

David Suzuki

[JohnL]

Another way to at least ensure some protection against a downturn is to buy at a discounted price from a motivated vendor (yes, easier said than done at the moment but still possible). If you wait until the heat is out of the market, you could well pick up one at 80% of a registered valuation.

A do-up is another way of achieving this.

This not only gives you a better cash flow return, it allows you to refinance to reduce the amount of money you have in so that you can look at buying the next property.

It gives you a head start in the capital gain game, which is more speculative.

John

[joo]

Thank you all for your replies

Thank you all for your replies

[Glenn]

Goodness David.
You are so right it is all a terrible risk.
Better not get out of bed. Why a brick might fall out of the door of a passing plane and kill you.

why is it that people regard university degrees that take 4 years to complete more highly than those 3 week courses completed at night school.
It is because more effort is required for the longer ones and only the best people can be expected to pass the hard courses involving more work.

It is the same with investing. Often the flash in the pan properties can reward you but really the best ones usually are the ones other people also strive to own. If they strive to own them the tenants will also strive to rent them and you will almost always have a steady if not spectacular rental stream from them.
Normally the cheap nasties will increase in value when the market is on the move but they are the first to drop in value when things are going backwards.

Glenn

[David-Suzuki]

Some people here are very angry, others are more softly spoken and try to help the innocent with knowledge and study.

[MarkS]

Hi joo

You do make some good points.
Glenn has stated that capital gains make up a lot of your profit in the long run (speculation but pretty safe speculation) and David has stated that if the property market goes flat or even slumps (again speculation but historically a good guess) you could be in a poor position depending upon how your IP is set up re cashflow.
You know that both the above points are potential risks/gains (i.e. capital gains don't happen/ do happen and market slumps/ doesn't slump) You have to assess those risks (and all the others) and then plan your game to mitigate them.
One good rule I use (I think it came from Donald Trump or some one with less hair) "Plan for the downside and the upside will look after itself", another good one that goes hand in hand with this is John Burley's "Make your profit when you buy" and of course Kerian Trass's "Property investing is a marathon not a sprint" puts all of these in perspective.
In summary "This is your game and you set the rules" but along the way make sure you have fun. This is one of my guidelines when investing and for life in general really.
All the best.

[fudosan]

Warren Buffett said in a recent Fortune interview that "You're neither right nor wrong because others agree with you. You're right because your facts and reasoning are right." He is a big fan of "margin of safety."

[David-Suzuki]

To clarify, while Glenn is right in general, Joo's question was in relation to an Auckland apartment. I believe that in a downturn, capital losses are more likely with apartments than properties with a higher land content.

I also believe that properties with the potential to improve contain a built in buffer to any downturn, as do cashflow positive properties. In my opinion the property offered by Joo for discussion is riskier than other potential purchases, because it has neither of these built in buffers.

Any studies you may undertake into the performance of apartments in other markets over the last 15 years will no doubt lead you to the same conclusion, particularly when you take rising interest rates, strata fees being outside your control, and over-supply into account.