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More than 10% of households in Australia own an investment property – a far higher rate of ownership than the US, Canada or the UK. There are several key factors that make property a sound long-term investment, which are worth looking at:
• Strong demand
• Scarcity
• Ongoing rental income
• Long-term capital growth
• Tax-friendly returns
• Portfolio diversification
• Gearing
Strong demand
Australia’s population is growing every year. In 2005/2006, around 180,000 new migrants settled in Australia – that’s 72% more than in 1996/19972 . All these people need somewhere to live, and historically around one in three Australian households rent their home, providing strong demand for rental properties.
Robust population growth is also adding to the prosperity of our economy and business sector. This in turn is adding to demand for commercial property.
Scarcity
Despite a burgeoning population, our rate of new home construction is declining, with industry research pointing to a shortfall of around 20,000 new homes annually. Strong demand coupled with tight supply is pushing rents upwards, and it can also be a significant driver for long-term capital growth. For investors it means a better return on your investment.
Ongoing rental income
Most investment properties can expect to earn ongoing rental income. One of the pluses of rent is that it is usually a very stable source of income. Residential tenants typically sign up for leases lasting 6 - 12 months.
Commercial properties can provide even more stable rental income. Leases in this sector are typically for three to five year periods often with an option to renew.
Capital growth
In addition to regular rental income, property investors can expect to earn long-term capital growth on their investment.
Industry bodies produce regular updates of movements in property values however it’s worth remembering that property should always be regarded as a long-term investment – something you should be prepared to hold for at least five to seven years. This way your returns will be evened out across periods of market highs and lows.
Tax-friendly returns
One of the really appealing aspects of an investment property is that any profit – or capital gain – made when you sell the property may be concessionally taxed. Where you have held onto a property for greater than 12 months, only 50% of any profit on sale is taxed.
Portfolio diversification
One of the golden rules of investing is not to put all your eggs in one basket. Property returns tend to be far less volatile than those of, say, the sharemarket and an investment in property can add valuable diversification to your portfolio.
Gearing
The appeal of negative gearing
Negative gearing describes the situation where the costs of owning an investment exceed the returns it generates. The shortfall can be claimed as a tax deduction, which reduces the amount of tax you can expect to pay on other sources of income.
Positive gearing
An investment is said to be positively geared if the rental income it earns, exceeds the expenses associated with owning and managing the investment. One of the benefits of owning a positively geared property is that it provides an extra source of income – money that can be used to invest in additional assets!
All investments involve risks, and property is no different. We have listed some of the key drawbacks of investing in property – together with ways to overcome these risks.
High purchase costs
When it comes to purchasing property – whether as an owner occupier or as an investor – buyers face a range of up-front costs. We recommend that you build these costs into your investment budget. Some of the key expenses are listed below:
Stamp duty
Stamp duty is a state government charge payable both on the purchase price of a property, and in some states, on the value of the investment mortgage. The amount payable varies between locations and from state to state. Please note, the cost of stamp duty is added to the capital value of your property, so it will reduce the value of any capital gains tax you may pay on any profit made on the sale of the property.
Lenders Mortgage Insurance
If you borrow more than 80% of the value of a property, you will generally be asked to pay Lenders Mortgage Insurance (LMI). This involves paying a one-off premium, though this type of cover protects the lender (not you) in the event that you cannot keep up the loan repayments.
The LMI premium you can expect to pay will be based on the size of your mortgage and the purchase price. One of the best ways to reduce the cost of LMI is to have a larger deposit.
Miscellaneous costs
Purchasing a property involves other additional costs, which are listed below. One advantage of purchasing property as an investor is that many of these costs can be used to reduce the taxable income generated by the property. For example, borrowing costs can be written off (claimed as a tax deduction) over a period of five years. Other costs, like legal fees, are added to the cost of the property and used to reduce the tax you may pay on any capital gains.
• Borrowing costs
• Loan application fee
• Lender’s valuation fee
• Lender’s legal fees
• Pest and building inspections
• Legal fees (also known as ‘conveyancing’ fees)
Holding onto your investment for the long term is a useful way to ensure growth in the property’s value more than compensates for these costs.
Loss of rent through periods of vacancy
Manage this risk by thoroughly researching the market to determine that your property offers broad tenant appeal. Seeking the opinion of property experts will help ensure the rent you are asking is fair market value.
Exposure to rising interest rates
Always allow for the possibility of higher rates when determining how much you can comfortably pay for an investment property.
Exposure to property market downturns
All asset classes move in cycles, this is why property is generally recommended as a long term investment. By holding onto your asset for at least five years you should smooth out the effects of any property market highs and lows.
Encounters with ‘problem’ tenants
The vast majority of tenancies run smoothly, however you can reduce the odds of encountering a problem tenant by using a property manager who thoroughly screens prospective tenants and maintains a regular program of property inspections.
It’s also recommended that you think about taking out landlord insurance for cover against property damage or loss of rent through tenant disputes.
While it is important to be aware of these downsides, it is also worth pointing out that the vast majority of property investors enjoy strong returns, trouble-free tenants and a regular source of rental income.
About Intellichoice
Intellichoice are experienced mortgage brokers based in Brisbane, Australia, with an aim to help everyone achieve their financial dreams. Intellichoice can assist with home loans, business loans, construction loans, development finance, owner builder finance and investment properties in Australia.
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