Investment properties 101

Crown Money, where we show you how to pay your home loan off in up to half the time of a normal bank loan. Welcome to the Crown Money Podcast. My name is Jessie Edge, money expert here at Crown Money, and I'm joined by CEO and Money Master Scott Parry.

Howdly doodle. Good neighbor.

So today I just want to have a chat about something that, you know, everybody's heard of in Australia. It's, you know, one of the big things that we as Australian are told that we should do, and that is to buy investment properties. So we just want to talk about investment properties in general, some of the different concepts that people should understand and what's involved. So what I want to start with a big question. What are the different ways you can earn money from investment properties?

So with a property, you're obviously wanting to look at either capital growth or cash flow. It's very rare that you get both. It's, you're not going to get a positive cash flow property with rates so low. It's actually quite reasonable right now, but rates aren't going to stay this low forever. The average interest rate in Australia over the whole history of interest rates is about 6.5%. Today they're very, very low. And so that positive cash flow is very realistic, but it's not going to be forever. So you're looking to buy a property that's going to give you A cash flow or B, capital growth. And so they're two very different things. And when you've got your investment strategy, you have to look at what are you aiming to achieve. When you're looking at buying an investment property, you can do the buy, hold strategy. And what we're going to do is we're going to tell you over the last 16 years and assessing over 6,234 families and their investment property options, what they've done, their strategies, what we've learned to do, but more importantly, what we've learned not to do. And that's what we want to teach you here today. So let's look at a buy and hold strategy. I'm an investor, I buy a home, it's established and I put it on interest only. I put my tenant in and I sell and forget. With that buy and hold strategy, you're hoping for capital growth. And so with that, over the long term, no doubt it will grow, but it's something where it could go down before it goes up, it could go sideways. You could be buying a property which doesn't grow for seven years and then all of a sudden it gets some growth over two or three years, which is normally the case. Properties, you really only grow for about two or three years out of the 10. The rest of the sort of seven or so years, they're going sideways or maybe even a little bit down. So buy and hold that strategy. It's okay for your first one, but once you start getting more than one property, you really want to start to get a bit more advanced. The next sort of strategy to make some money of an investment property is to buy a fixer upper or buy something where you can add value to it. So this is where you buy a house where you could potentially do a renovation to it. The key areas to renovate on a property to make sure you actually utilize. For every dollar you spend, you get $2 back in value. The kitchens, the bathrooms, landscaping and painting. Those are the four areas you should focus on. Anywhere else where you're spending money, you're probably not going to get the value back. And what's the point in putting money into a property if you're not going to get the value back? So that's the Renault, the fixed wrapper, where you're buying something which just needs a little bit of tlc. I mean, some clients have bought a property, done a TLC and then sold it later that year and made 50 to $100,000 just because it looks visually a lot more appealing than what it was when they first bought it. So not a bad strategy there. A lot better than to buy and hold because you're adding value to it and you're actually controlling that equity.

You have control over it. You're not waiting for something to happen in the market.

Exactly. The next one is really where you want to manufacture equity. Okay, so when we talk about manufacturing equity, that's buying something on a lot bigger block of land, which you can potentially subdivide in the future. What a subdivision is, is where you apply to the council to actually basically split the block in two or three, however many DEP on the size of the block. So prime example of this is I bought a block in Adelaide for $350,000. It was a corner block, was on about 800 square meters and it had an old place on it. I knocked over that old place, got a subdivision approval from the council to put three basic units, townhouses on there. And so I actually got three blocks from that one purchase and it cost about 20 to 30,000, depending on the council, to get that subdivision. So that piece of paper, I've now got three blocks I could sell three blocks separately, I decided to build three units on there. Each unit cost me 200,000, so it cost me 600,000 for the construction, 350 for the original land. So it owed me about 950. At the end of that, my whole portfolio was voted at 1.5 million. So it cost me 950, had a $1.5 million valuation. So we've made about $500,000 just because we added value and manufactured equity. So now I could sell one of those off, pay off some of the debt on the other two units. I could sell them all off, I could keep them all rented out. I've got so many choice and so many options there. So that's manufacturing equity. That's really where you want to get to, especially if you've already got one investment property. That's probably your next step that really revolves around the strategy of buy as much land as you possibly can. It's the only part of the property that goes up. The building goes down in value. It's called depreciation. The land, the dirt, is what goes up in value. So we've seen clients who bought apartments and we've seen clients who bought houses with pieces of land or decent sort of 4, 6, 800 square meters. And those 10 years later, the clients who have actually bought the apartments are still spinning the wheels and probably maybe had 10 to 20, 30 grand months, very small capital growth that probably they bought for 450 might be worth 480. And they've also had a lot of body corporate costs, strata costs coming out of their cash flow. Whereas the clients who bought houses with on a piece of land could be a townhouse even. But obviously the more land, the better. They've really had some huge capital growth because they've got land which goes up in value. Apartment, you've got 60 square meters of land. A house on a piece of land could have 600 square meters of land. So buy as much land as you possibly can, hopefully with subdividable opportunity in the future, whether you do the subdivision or not, you can actually just go to the council, pay the 20 to 30 grand for the subdivision, and then just sell that off to someone else to do the development. Absolutely.

And that's very much an option because a lot of people can't be bothered going through the process of getting the subdivision or don't even know that it's an option and you're presenting it to people and say, ego ready to go.

Or they might not have the income to be able to service a $600,000 construction. So yeah, I mean you can just create equity manufactured by getting or adding value to that piece of land there. So that's how we look at ways to earn money from property. Obviously just renting it out to well and good being. We got some clients to do share houses where they rent out rooms that boost the cash flow. So it's even more positive cash flow. Let's talk about positive cash flow versus.

Negative negative gearing versus positive gearing. So explain that us.

Okay. The easiest way to explain this and so many people get caught up with the negative gearing. Oh, it's reducing my tax.

Yes.

When anything reduces your tax, it means you're losing money. And then the government feels sorry for you because you're losing money. So they give you maybe 30 cents back of that dollar you lost. So let's put it into $1. $1 positively geared property. I'm making a dollar in income. I'm getting taxed on that 30 cents, but I've still got 70 cents. I'm up 70 cents.

Yes.

I'm being paid to own that property. That's the name of the game. Negatively geared is I'm losing a dollar because my rent doesn't cover my mortgage. And then the government feels sorry for me, so they give me a 30 cent break tax and as a result I'm still down 70 cents. Which those two properties do you want to own? The one that's paying you 70 cents to own it. Yeah. You're paying tax. Who cares? You're making money. Or the property where you're losing money but getting 30 cents back in tax. I think everyone gets so focused on a tax break when at the end of the day you'd only buy a certain amount of negatively deed properties before.

The bank says, yeah, because you're holding, it's costing you money to hold that property.

You can't borrow anymore. You're ceiling. Whereas you can continue to buy positive cash flow, properties and events can continue to lend to you. And that means your borrowing capacity doesn't get maxed out as quickly.

Absolutely. So how do you find a property that's positively geared?

So you want to look at the numbers. And this is all numbers. Don't get caught up in what the color of the carpets are, the curtains or anything like that. So what you want to do is look at obviously the rates being so low. It means it's a lot easier these days than what it was when it was. Rates were back at 6 or 7%. So you want to look at a property where the cost of property, let's call it $400,000 times the interest rate, let's call it 3%. You look at that figure, that's what's costing you to hold the property. Then you want to add another $2,000 to that figure to take into account ins and rates and bits and pieces. And so that's the cost per year. And then you want to look at the actual rental income that's going to be coming through and make sure the rental income is higher than that figure. So if we want to do the numbers here, 400,000 we can run. And if that $400,000 at 3% is going to cost us per year, $12,000 plus 2,000, so it's 14 grand is a holding cost of a $400,000 property. We need to make sure we're getting more than 14,000 do per year in rent, which is around about $270 a week. So as long as that probably is renting for more than $270 per week, which it really probably should. I mean, 400 grand house I'd say would be renting for 350 is a ballpark figure. So it means it's positive cash flow. It's paying me to own it, which is great. All well and good when rates are low, but as rates increase, that may not be as positive anymore. And so when you're looking at buying off the plan, it's very dangerous because.

Well, let's take a step back. What is off the plan versus say a house and land package?

Yeah. So off the plan is where a developer will sell you a unit or an apartment which they're developing in a complex of apartments and they'll say, hey, we haven't built it yet, but these are the plans. Do you want to put down a deposit and then buy this when it finishes?

And they usually take you to a very pretty little display suite and you get to see some of the fittings and blah, blah, blah. But you've never actually seen the inside of one of these apartments until they're built.

Yeah, they don't exist. Yes. You're literally buying off a glossy brochure. And I've always found that the glossier the brochure, the worst deal. So yeah, off the plan I just find that that's got a lot of risk because if the property price moves down whilst and after you've signed for that price because that the developers forecasting what the thing's going to be worth when it's built, they haven't Forecast and.

They'Re always quite optimistic.

They are relatively optimistic at the best of times. So from that off the plan, there's a lot of risk that when you actually do sell on a place in two years time, it's actually going to be worth less than what you paid for it. But the banks don't care what you pay for it, they'll just actually lend against what the value of at the current time.

Yeah, so we've seen so many where they've gone down and it's really scary because the client then has to come up with extra cash and try and find a way to complete this purchase.

Or lose their deposit. And if they lose their deposit, then they get sued for the difference if the developer can't sell it for that same price they paid for.

And what is the deposit usually for?

Another 10% minimum. So 50 grand plus being sued for the difference. So that could be another 10, 20, 50, 100 grand as well.

And again, generally they're apartments. Like we said, that's not where you're going to get the best value for your property.

And you've got 50 square meters of land.

A lot of people don't realize it's the 50 square meter rule. So when we're applying for finance for a client, if you've got less than 50 square meters in your apartment, it's actually really difficult to get a bank to lend to you. They just say no, we're not going to do that. Or we might do a maximum of 60% LVR, which is loan to value ratio. So we're only going to let you borrow 60% of the value of this apartment. So you've got to think about these things. Really just ask yourself, is this good value? And a really great question that I always ask myself when I'm looking at property is would I be willing to live here? Is this somewhere where I would like to live? And so you've got to think about space, location, how it feels, how close it is to transport schools, the city water, those sort of things. And if you wouldn't be willing to live in it, how can you expect other people to want to live in it as well? So something to think about, definitely that's.

Such a great strategy is buy what you would like because guess what, other people like it too. Don't buy investment grade stock, which is these boxy little apartments which you never live in. Like it's so tight, it's claustrophobic, it's like a jail cell. So don't expect other people to want to Buy that off you when you want to sell it one day.

And another thing to think about with apartments as well is you are competing against a lot of other apartments in the exact same location. So the likelihood of you getting a tenant that stays in there long term is actually reduced slightly as compared to buying a house or something like that. So it's also about the competition in that particular area for rentals.

The competition is one thing. What really not many people take into account is the actual recent market sale. So let's say you've got an apartment complex with 100 apartments in there. And then a husband and wife get divorced and they just want to flip this investment property which they bought and they don't care what they get for it. They just want to pay the loan out. And so let's say they bought it for $400,000, but they owed $320,000 on it and they don't care. They say let's just sell it for 320 just to get rid of it. We want to get divorced as quickly as possible. Make a clean break. Now guess what? Your apartment which is next door to theirs is worth $320,000.

Yep.

So you've just dropped 20% because old mate next door has had a quick fire sale. Absolutely exceptionally dangerous. So that basically what we're saying is don't buy a partners off the plan.

The other thing that they don't talk about as well is that people that are selling you these properties, they build their commission into the purchase price. So they get paid a lot of money for you to buy this property off them. And they're paying and you are paying a premium because of it.

Yeah, the valuations on those very rarely stack up to what you pay for them. That's because the developers have put commissions on top of them. So I.

So you're always, you're already on the back foot in terms of the value of the property.

You're underwater from day one. So no off the plan apartments.

If I were you, if this was me, I wouldn't do off the plan, which we wouldn't.

We've seen over 6,000 families and if I position and like those ones who have bought off the plan, never.

Yeah, it's never been a success. And so onto house and land packages.

Yeah, so house and land packages. So how this works is especially if they're in new estates. And so what happens is a new estate which has basically been created out of a farm or a paddock. And so these new estates you want to get in on the first stage, because what happens and here they, how they manufacture the growth of these estates is you buy a plot of land which you're going to build a construction of a house on. And that plot of in the first stage is let's say 400 square meters. They're not very big these days. Then in the second stage they sell it for the same price with smaller pieces of land, maybe 380 square meters. Or they increase the value of that 400 square meter block in the second stage. So they manufacture the growth of those stages later, the stages, more expensive small plots of land. And as a result, if you've got in on a stage one versus a stage three or stage four of a development for a house land package, you're going to come out in front. If you are going to do the house land packages, definitely get into a stage one. However, this is about demand and supply. This is all it comes back down to. I know we've heard about that, but I want to explain it to you. So prices will increase whenever demand at strip supply. Think about this. You're buying a house and land package that was previously a paddock. That usually means you're on a rural sort of urban fringe of the city. And it's certainly not in a city. And as a result that there's usually more land around you.

Absolutely.

And when they release more land, there's more supply, not as much demand. Prices can't grow when there is not more demand than supply. Vice versa, if you're buying anywhere near the water, very limited supply, massive demand, prices continue to grow.

And that's something to think about. Off the plan is, I mean, sorry, house and land packages are generally in an area where, you know, it's not going to see that long term growth, continual growth that you might get something that's closer to the city or closer to the water or something along those lines. So some people might use it as a tool just to get into the property market because the prices in general are quite a lot lower. But you need to think about it and really consider whether it's a good long term play.

And would you live there? Like would you drive an hour into the city each day to work? You got to put that test to it. Would I live here? Yes or no. And if I wouldn't then why should I buy an investment property there?

So I mean I can definitely speak from personal experience here. I bought a houseland package down the coast in wa. Great area, up and coming kind of location, you know, school on the, on the development Side I brought in one of the first stages and I was like, man, this is great. It's gonna be gung ho in. I think I held it for 12 years. I saw zero property growth. It did not go up in value.

At all because there was so much.

Supply around, so much supply, so much competition and people, why would they buy my property where they could buy a block just down the road and build the house that they want for pretty much the same price? What I did have going for me though is because I'd held it for so long and rates were so low, it was positively geared. So I was being paid to hold that property. I had tenants that were in there for the entire time. I was very lucky with that. They had stayed there the whole time. They'd taken care of the place as if it was their own. So I was very, very lucky in that sense. But long term, do I wish that I had maybe put my money into something else? Absolutely. And what it comes down to, and every decision I make from now on will be I need to buy a property in a location that I would want to live in and a property that I would be happy to live in. And again, try to manufacture equity wherever I could through property development.

Exactly. Now let's talk about what affects property prices. We talked about the demand supply. And whenever there's large supply, no demand on those sort of outer areas of the city versus the coastal areas of the city, you're not going to get the capital growth that you're sort of hoping for. When it comes to employment rates, this is super important. So I've always something that's been quite.

A big topic lately with in the.

Just recent year, as goes jobs, so goes real estate prices. What that really means is as unemployment increases, property prices decrease.

Okay, so why?

Because if we scale this back, if we have a person who's lost their job, they normally don't have the ability to pay their mortgage. And so they go into arrears and then from there they'll usually try and sell their property because they can't afford the mortgage. They don't know how long they're going to be if they don't have a buffer, especially, and so put the house up for sale. Or more importantly, they've got an investment property.

Yes, the investment property that they'll put up for sale.

And so you've got people with investment properties and the first thing they do when they lose their job is sell the investment property, try and reduce and.

They'Re happy to take a loss.

Yeah, they Just want to reduce outgoings. And so what happens with people as the unemployment grows? We've got more and more property coming onto the market, let's call that supply. And less and less people being able to borrow because they don't have work. And so then banks start getting a little bit nervous. They start tightening their credit policies, what people's income can borrow that is reduced. They start to look at how much rental income they take when they assess loans. All these other factors take into account because the banks can see. One thing I've learned in 16 years is the banks are three steps ahead of everyone. Whatever the banks are doing, take notice of that because they can see what's happening on the horizon. These guys are the smartest guys in the room. They're making $2.7 million an hour, not accidentally 45 grand a minute. So these banks tighten up, people can't borrow as much, and all of a sudden things start to head downwards. I mean, they reduce their loan to value ratio. So with the coronavirus, huge unemployment as a result of that, property prices dropping, some banks are saying up to 30%, other saying 10%, bottom line is going down, as goes jobs, so goes real estate prices. And so as a result of that, you've got extra supply, no demand, because no one's buying, because things in the economy are a little bit uncertain. We heard some data coming out of those house land packages. All these first home buyers looking to buy house and land packages. So many of them employed in the hospitality industry, restaurant industry. And. And as a result of that, the coronavirus hit, 60% of them pulled out of their contracts. So they said, yeah, I'll buy a house of land, here's my deposit, 60% of them. Basically, I'm out, I can't do this, keep the deposit. So that's again, that whole supply coming onto the market. And more Airbnbs came onto the rental market. I think 20 or 30% increase in number of rental properties. And so huge amount of supply rents go down as well.

I think it's important for people to remember though, that if nothing has changed in your own personal financial situation, you need to be able to ride these waves out. And your property is only worth what it's worth the day that you sell it. So you are only going to make a loss if you sell it when the property prices are down. But if you can hang onto it and you ride out that storm, it will go back up again.

Exactly. That is the most important component of what we've just discussed here. It's Irrelevant what a property price is doing. Except on the one day that you sell, it probably is going to go up. Irrelevant probably is going to go down. Irrelevant that day you sell. That's important.

If people got their property valued every single day, I swear to God they would die of stress. It can fluctuate so much and there are so many things that can impact it. So you need to sit there and go, this is long term. Property is generally long term and you need to go, I need to ride out the waves and just not worry about it if it's happened to be dipping.

Yeah. One bit of advice I give to a lot of clients is think of every investment pro like a super fund and buy it and don't worry about it until you turn 60, 65 years of age. And then you look at it just like you don't look at your super fund every single day or every single month and the super is going to go up soon, is going to go down. So look at each of your investment pros as a superannuation fund. Buy, hold, whatever, renovate, manufacture equity, but don't worry about that property until you turn 60, 65. I can assure you it's either A going to be debt free and B, hopefully spinning out 4, 5, $600 a week in passive income which goes on top of your super fund.

Well, so I've got a question for you then. If somebody's holding a property, it's negatively geared, it's not going up in value. At what point do you say hang on a second, should I be putting my money into something else? Another property, another investment, something like that?

If that's an apartment, I'd say definitely sell the apartment and put your money into something else.

Yeah, but if it's land, you've got the potential long, long term that it will go up.

But would you live in it?

Yeah, great question.

Would you live in it? And knowing that property and that price right now, would you buy it again for the price it is today? And if you wouldn't buy it again, then maybe it is time to sell something to consider.

I think the other thing that we probably all heard as well is that Property doubles every 10 years. Exactly.

That is total bullshit. That is what property spruce investment property sellers try and tell us to try. It makes the sale very easy. You buy a 400 grand 10 years time, bingo bango. That is not true. I just said that probably only goes up two or three years out of 10. So how can it double if it's only going up two or three years out of 10. So that is a fable that does not come true. And in the 16 years that we have been doing this every single day of our lives, we have seen that it doesn't come true. You get some areas which it may be true and then for now it'll pull back.

And some periods of time, some 10 years, property definitely has doubled, like we've seen that so much. But then you have financial crisis, the gf, you have coronavirus, you have all these external factors that you can't account for that are going to affect property.

Prices got to take into account as well. So for a property price to double, that means people have got to borrow double the amount. Their incomes don't double every 10 years. And so if your income's not doubling every 10 years, you can't borrow double. And that is the key factor, is that you can only borrow what your income can service. And the banks, at this point in time, we're not going to let you borrow double in 10 years time on the same or relatively similar income. So property does not value every 10.

Years, double every 10 years.

Yeah, it's going to have two or three years of growth over the 10 year period. It's going to have some sideways years, it's also going to have some down years. But if you can get a positive cash flow property, which is paying you to own it, where you can manufacture some equity on a big subdividable block.

In an area where you want to.

Live, tick, tick, tick, boom.

It.