24 Jan The 8 Best Property Investment Strategies in Australia
Buying a property is not an investment strategy.
Building a property investment portfolio involves much more than picking the property type and your price bracket.
You need a goal in mind and a plan for achieving it.
And not only that… it’s essential!
After all, planning is bringing your future into the present so that you can do something about it now.
That means that creating a property investment strategy needs to be the first essential step when you set out on your property investment journey.
Launching yourself into property investment without a strategy in place, without knowing the stakes, or without understanding the pros and cons can be a recipe for financial disaster.
However, choosing exactly what strategy works for you can be a daunting task.
In my experience, winning strategies lend themselves more to the tortoise pace of slow and steady.
To help, I’ll share my list of the 8 most popular property investment strategies in Australia and how they work.
But first, there’s an important point I’d like to make…
Are you aware that you can profit from real estate in one of five ways?
And if you get the combination right you’ll make money from bricks and mortar.
They are:
- Capital growth – To build yourself a sound asset base, your properties will need to appreciate in value at wealth-building rates.
- Cash flow – In other words, your rent.
- Tax benefits – While you should never invest solely for this reason; a good tax strategy can help you manage your cash flow, decrease your tax obligations and increase your bottom line.
- Accelerated growth – Getting your hands a little dirty (metaphorically speaking) by purchasing a property that needs a bit of cosmetic TLC through renovations or a major facelift through property development is a great way to manufacture capital growth.
- Inflation – Property investors have learned it’s too hard to make money using your own money. Instead, they have learned to use other people’s money to leverage and gear.
1. Positive Gearing Property Investment Strategy
Positive gearing is a type of gearing-related strategy. This is when the income from a rental property covers the expenses incurred in holding the property and delivers some extra cash flow.
In other words, you are making a profit from your investment property, and you have the added benefit of the option of using some surplus income to reduce the size of your loan or maybe for your living expenses.
Of course, I can understand why many beginning investors look for cash flow-positive property deals.
They’re looking for cash flow to give them choices, but they need to build an asset base first before they can move to positive gearing or positive cash flow investments.
Down the track, they may achieve this by lowering their loan-to-value ratios, through commercial properties, or perhaps by buying shares.
The three stages of building wealth through property are:
- Accumulation phase: This is the stage where you build a portfolio of high-growth “investment grade” properties, usually over a 10 – 15 year period.
- Consolidation phase: The consolidation phase involves slowly reducing the debt on your properties, which conversely increases their cash flow when you need it the most.
- Lifestyle phase: This phase is all about enjoying your life and living off the cash machine you have produced in the first 3 phases.
Our plan is not to beat the short-term averages, but to build a substantial asset base in the long term, which means we steer clear of “get-rich-quick schemes”.
In today’s higher interest-rate environment, it would be very difficult to get any positive cash flow from properties unless you have a very low loan to value ratio.
The other big problem with many cash flow positive properties is that, in general, cash flow-positive properties are in cheaper areas, lower socio-economic areas, or regional locations.
Not only do these locations offer lower capital growth, but they also offer the prospect of lower rental growth.
2. Negative Gearing Property Investment Strategy
This is the second type of gearing-related property investment strategy.
This is where, unlike positive gearing, the rental income doesn’t cover outgoings and expenses, including your mortgage meaning there is a cash flow loss.
Put simply, gearing means that you have borrowed money to buy your investment property.
A property investment strategy using negative gearing usually involves buying a property in a high capital growth suburb, but where the net rental return is lower than the cost of holding the property.
Running at a loss is not ideal, but in terms of Australian tax law, it’s not actually all that bad.
That’s because the Australian Tax Office (ATO) allows property investors to deduct any losses they make on their investment property from their ordinary taxable income.
Investors who purchase properties for long-term capital growth don’t usually expect to make their money on the rent.
They recognise that residential real estate is a high-growth, relatively low-yield investment, so they will generally use the negative gearing strategy in conjunction with the ‘buy and hold’ property investment strategy.
They understand that while rental income will keep them in the game, it’s really capital growth that will get them out of the rat race.
The pros of using this type of property investment strategy are that if you know what you’re doing, you can legitimately claim a tax deduction and use your tax to help cover the expenses of holding the property investment.
But the downside is that the investor has to cover the shortfall to keep holding the property.
That’s why this strategy tends to work best for higher-income earners in the top tax brackets.
But many ordinary mum and dad investors buy negatively geared properties using the strategy of having a financial buffer in place to buy them a couple of years of time using their cash flow buffers.
In other words, they do not borrow up to their full financial capacity to purchase their property and leave funds in a financial buffer, such as in your offset account, to buy themselves a couple of years’ negative cash flow.
In other words, these smart investors are not only buying themselves property, but buying themselves time.
If you are on a low income, the tax effectiveness is significantly reduced, as you would be on the lower end of the tax brackets.
For example, the interest you are paying on your mortgage and all other associated costs with the property, equal more than the income or rent you earn from that property.
As a result, you are making a financial loss.
3. Using Equity to Buy an Investment Property
This property investment strategy involves using the equity from your home (or other investment properties) to help buy your next investment property.
So while you may have thought of your home as a never-ending series of monthly loan repayments, with every payment you make you are building up your equity and over the last couple of years, with the market pushing property values, your home equity is likely to have grown considerably.
There is a difference between the equity in your home and your usable or borrowable equity though, which means the first step when using this property investment strategy is to calculate your usable equity and then work out how much you can borrow with that equity.
By using the equity in your existing property to purchase a new investment property, you can avoid the deposit-saving process (and even avoid selling your home).
I’ve heard some refer to this as “leapfrogging.”
Essentially, you’re using your equity as a deposit.
The first step for buying a property with equity, or even building on your property investment portfolio, is to approach your mortgage broker or lender to request a valuation to assess your property’s fair and current market value.
If you’ve lived in your home for a while you probably have considerable equity in it.
This will then help you determine your usable equity as we discussed above.
The loan product you choose and the amount of equity you are looking to access may result in various fees and costs, such as Lenders’ Mortgage Insurance or if you decide to switch to another lender, there may be costs such as fees associated with breaking from a fixed rate product, a new loan application fee or government fees.
4. Buy and Hold Property Investment Strategy
The buy-and-hold property investment strategy is the easiest and lowest-risk form of real estate investment and history shows it’s a great strategy.
Buy the asset, never sell it, and draw on the equity it creates over the years to buy another property.
The idea is simple because you’re basically just holding onto your property and relying on compound growth to do the work for you.
The key trick is to select what we call an ‘investment grade’ property in a good suburb primed for capital growth and hold onto it for long enough.
The area and property type should also be in strong demand and where development is restricted.
Finding the right investment strategy is harder than it sounds, but at Metropole, we have a wealth of experience behind us to help you make the best investment decisions.
Now just to make things clear…
5. Renovate and Hold Property Investment Strategy
While renovations can be an effective way to boost equity and add value to your property by “manufacturing” capital growth, it’s not the right property investment strategy for everyone.
That’s because it’s very easy to overrun your budget – after all, every renovation project is liable to encounter some sort of additional, unexpected cost at some point.
Then there are the surprise costs – once you begin renovating, you may unearth “hidden” work that requires an investment, but that doesn’t add any value.
It’s also difficult to get an accurate estimate of the work’s cost, particularly because costs fluctuate depending on the area, materials, tradespeople used, and the age of the property.
And the rising costs of materials and construction in the current market mean that resources are both scarce… and expensive.
It’s not all bad news though.
The benefit of renovating and holding an investment property is that you can increase the rental income and the value of the property at the same time.
It can also increase tax depreciation allowances.
6. House Flipping Property Investment Strategy
The other renovation alternative that some speculators use is to house flip.
This is buying a property, renovating it, and then selling it for profit within a short timeframe.
Proponents of this strategy, and those who sell courses teaching how to do this, will tell you that the key to flipping houses successfully is knowing the types of improvement you should make to the property to maximise your bottom line.
They suggest that you should at least double your renovation outlay, aiming for about $2 for every $1 spent on cosmetic improvements.
In order to achieve such lofty profits, you are usually taught to undertake a heap of due diligence by researching:
- Local property values and the growth history of the actual building are to be improved.
- Ceiling prices – what is the highest property price achieved in the area?
- Costs and potential profit margins – is there any profit left in it after all expenses? This is the (sometimes literally) million-dollar question.
- The market itself – you need to become a local real estate expert understanding your target market, who is your potential buyer, what they expect, and what they’re prepared to pay.
- The target property – “house flippers” tend to go for properties being sold by highly motivated vendors. The theory is to buy at the lowest possible price – clearly something very difficult to do in today’s seller’s market.
While this strategy might make a few experienced property investors money, in my opinion, it’s the wrong strategy to adopt for two reasons:
- To improve a property’s value by $2 for every $1 you spend on it you need to do much more than the simple cosmetic renovations – the type which is in the scope of most D.I.Y’ers. It generally involves structural renovations that cost significantly more, take more time, require permits and involve a different level of expertise.
- And even if you can undertake this type of work… Most of your profits will be eaten up in costs.
For the occasional flipper that makes a profit, it’s likely that they have fortuitously caught the right stage of the property cycle and values have moved in their favour.
In other words, they got a “free kick.”
The problem is that most experts, let alone beginning property investors, have real trouble pinpointing where we are in the cycle until it’s already moved on to the next phase.
That’s because budgets and time frames are at serious risk of a blowout should you purchase a property that, at first glance, looks like it’s in need of a few cosmetic enhancements, but actually turns out to be a structural money pit.
7. Subdivision Property Investment Strategy
This strategy involves buying one piece of land and splitting it to create two individual parcels of land on separate titles.
You can then do one of the following:
- Sell off each subdivided part of the land
- Keep one piece of the land and sell the other
- Keep both and use one plot to generate income and the other as your primary residence.
Not only will you have various options when it comes to deciding how to use the plots, but the value of the land will also generally increase once it has been subdivided.
The downside is that subdivision is a longer-term strategy because of the amount of time needed to complete.
And the risk is that in the meantime, a change in the market may mean it is difficult to sell one, or both, pieces of land.
Similar to property renovation investment strategies, there is potential to maximise the return on your investment, but there are also quite a few risks.
This is a significantly lower-risk strategy and it is not solely about chasing profits or income.
It is more about building longer-term wealth.
As I said above, there are downsides to this investment strategy, but by having a team around you that is known, proven, and trusted, you can lower the risks substantially, while maximising your return.
It becomes less about maximising profits and more about finding the right state, suburb, and street for longer-term capital growth.
8. Real Estate Investment Trusts (REITs)
A REIT is an alternative to all the property investment strategies above for investors who want portfolio exposure to real estate without a traditional real estate transaction.
A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on major exchanges, like any other stock.
The benefit of investing in a REIT is that it is essentially a dividend-paying stock – that means that a portion of the company’s earnings is distributed to investors on a regular basis.
Not only are they cash-producing, but they’re also a long-term investment.
The cons are, you’re not investing in the traditional physical real estate market and the value of your shares in the trust fluctuates in line with the general ups and downs of the property market.
What is the Best Strategy to Choose?
The best property investment strategy depends on your situation, finances, and your goal.
There is a “no one size fits all” strategy when it comes to property investment and what strategies to use.
The key to picking the right property investment strategy for you is making sure it lines up with your current financial needs as well as your future financial goals.
Having a written Strategic Property Plan means that you won’t worry too much about market timing.
When you have a Strategic Property Plan you’re more likely to achieve the financial freedom you desire because it will help you:
- Define your financial goals;
- See whether your goals are realistic, especially for your timeline;
- Measure your progress towards your goals – whether your property portfolio is working for you, or if you’re working for it;
- Find ways to maximise your wealth creation through property;
- Identify risks you hadn’t thought of.
Our investment team is ready to help you accomplish your financial goals and needs. Feel free to send us an email at info@centrawealth.com.au or give us a call at 08 82314709.
Article courtesy of Michael Yardney’s Property Update.
