Have you wondered, with so much in the media currently about record and increasing prices, low yields, worsening affordability, is it still worth buying an investment property?
My advice is “Do not buy an investment property. Rather, buy a property that makes a good investment and they are very different.”
Currently both Sydney and Melbourne markets are running hot. The rise in 2016 took many by surprise and economists are saying the key factor behind the strength has been the 2 interest rates cuts from the Reserve Bank. This double-digit growth in 2016 is expected to temper somewhat in 2017, but still remain strong. There is a difference in the rate of growth in houses and units and care needs to be taken in markets that have a looming oversupply of inner city apartments.
Having said this, is it still a good time to invest?
The answer is that once you understand the cyclic nature of property, current conditions make it much easier to invest as there are very definitive markers that help you identify where particular markets are at in their cycle, what markets are yet to perform, how yields are tracking and what market forces and dynamics exist to influence the markets going forward.
The principles for investing are completely different to buying your own home to live in. You need to understand the difference, particularly if you live in an area that is now priced out of reach for those looking to enter the market. An investment property you can drive past on your weekend, does not necessarily give you the best returns.
As I mentioned, all markets are cyclic, and each cycle generally takes about 10 years. The cycles are not always the same, yet trends remain similar. Some markets get very “hot” for a few years then perform little for more than double that time, and are flat for the remainder of that cycle. The message really is that property is best considered a long-term investment strategy. The high peaks, over time, help offset the longer periods of stagnation.
So how does this help you now?
In Australia, Sydney and Melbourne markets have experienced high growth for an extended period; longer than is usual for the ‘hot period” of a cycle. Affordability issues are very evident now so it is just a matter of time until the cooling of those markets occurs. The result of the growth has meant that the yields, (the rental returns in those markets) have fallen significantly. The rents have not risen along with the prices. In fact, yields and capital growth work counter cyclically. When rents are rising, growth is generally stagnant, and when house prices are rising rents generally remain static. Other factors such as supply and demand affected by population growth also affect the markets and the historically low interest rates have also had a significant impact on the requirements for landlords to raise rents.
However, when looking to buy, consider positioning yourself to enjoy the anticipated capital growth at the beginning of a cycle and start your investment at a solid yield, being closer to 4%-5% if possible. ( 5%, equates to a purchase price of say $500,000 receiving $500 per week rent. )
It is important to understand that high yielding properties generally do not deliver high capital growth. An example of classic high yielding properties would be those in mining towns. As the market responded to high demand that could not be quickly met, rents were at a premium. Prices and rents grew massively in a short period. Then the mining boom stopped, the homes were no longer required, so the rents and prices spiralled down and people were badly hurt financially. I do not consider this investing. The buying decision was not based on a solid, broad foundation, rather on a speculative gamble.
What steps can you take to make smart investments?
I always recommend starting by identifying and defining in detail the outcome you are looking to achieve. Make sure you have a realistic understanding of what you aim to gain from each property investment, and go from there. This includes the amount you anticipate you want, the time frame for the delivery and the form of that delivery. You also need a current understanding of your borrowing capacity. Criteria the banks are setting for people to borrow are changing regularly e.g. if someone received a pre-approval 3 months ago they may find that the terms are different now. Educate yourself and set realistic expectations.
Once you understand your goal, seek out markets that will deliver well throughout the time you’ve set to achieve this with an anticipated gain in the early years. Rather than investing in hot spots like Sydney or Melbourne at the top of their growth cycles, start in a market that’s likely to maintain or begin a growth cycle. If a location is already at the top of the growth cycle, what’s the point in investing in it at this time? Better to look at a market that hasn’t yet had the growth, and has a better yield. This will result in a sound foundation for growth to come. When you choose a solid yield, your out of pocket expenses will be more manageable if anything changes, e.g.interest rate rises, stagnant rents, both of which may well become a reality.
Lastly, and arguably most importantly, one of the best things you can invest in is sound advice. At the end of the day, you don’t know what you don’t know, and with property investment, mistakes can be very expensive.