Reinvesting.

Rentvesting is an accelerating trend in Australia that I have employed in my own investment strategy.

If you want to have a prosecco-swilling, latte-sipping lifestyle while securing your future by building a property portfolio, rentvesting is key to help ensure you still have free cashflow to enjoy those activities.

Below, an article I wrote a few years back on a private blog before the trend had even got a name and some helpful example numbers that explain what I mean…

 

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Much has been made of late of affordability of real estate in Australia and in particular capital city markets, and how it is affecting first home buyers (FHBs), who have fallen to just 14.7% of the total number of market purchasers in July 2013, while the non-first home buyers (upgraders) and investors are performing strongly in a rising market. The below graph shows the difference in finance approvals per month between upgraders, investors, and FHBs.

I can’t tell from experience as I’m just too young, but we are frequently told by the media that housing affordability levels are at historically low levels, while at the same time this is contrasted with commentary about many people being unable to afford their first home. I am certain that the recent market recovery in Sydney which is behind a 12% growth spurt in the recent year would be disheartening for many FHBs. The initial savings required to purchase one’s first property are substantial and right now it might feel that the bar just keeps being raised beyond reach. I can tell from experience it took me 5+ years to save for my first property which I settled on in January 2013. I think the reality is, saving for this investment will never be easy, even if something (policy) changes to improve housing affordability, which could be the subject of another article.

However, I wonder what percentage of the investor purchases in recent times are in fact first time property buyers, who have elected to buy into the market as an investor, without having bought a home? In other words, these first time buyers rent out their own place of residence or continue to live with their parents. I don’t believe the ABS (or other body) releases this kind of data. My suspicion is it would be a reasonable component of the investor buying market!

The reason for my hypothesis is because this is exactly what I have done! I rent in an inner city apartment but have purchased an investment property in the inner west of Sydney, which is a less expensive entry point into the real estate market than the inner city. I choose to live in the city for lifestyle reasons but I actually believe I am saving money by doing this. Let me explain.

Conditions are currently such that rental yields are high (5+% in many cases) while interest rates are trending down to 5% p.a. across the board. Coupled with the tax deductibility of expenses in a rental property as well as the ability to negatively gear a property investment against personal income, it becomes a very attractive proposition. Now I realise this gets a bit technical, but below is a comparison of the net cashflows of a purchase of $450,000 with a 10% deposit, between a homeowner and an investor who must rent his/her place of residence.

	Home owner (and occupying)	Investment
Purchase Price	$450,000	$450,000
Deposit %	10%	10%
Equity	$45,000	$45,000
Loan size	$405,000	$405,000
Interest rate (interest only)	5%	5%
Interest per annum	$20,250	$20,250
Gross rental yield	0%	4.5%
Rent income per annum	$0	$20,250
Rent income per week	$0	$388
Other costs (assume 25%)	$5,063	$5,063
Gross cash flow	-$25,313	-$5,063
Marginal tax rate		38.5%
Negative gearing benefit		$1,949
Net cash on property flow after tax	-$25,313	-$3,113
Rent (place of residence) $pw	$0	$420
Rent (place of residence) $pa	$0	$21,900
Net cash flow per annum	-$25,313	-$25,013
Net cash flow per week	-$485	-$480

What I have tried to show is that the investor can actually afford to fund a higher rent for his/her place of residence than exists on the investment property itself. In the above example, $420 per week rent costs on the place of residence with a $388 per week rental income on the investment, is equivalent to the home owner living in that same property, from an ongoing cashflow perspective.

My assumptions are quite conservative as I have only used a rental yield of 4.5% (Sydney is typically 5%+), and I have assumed no depreciation benefits which would improve the investor’s position further, as would an upswing in mortgage interest rates. I did assume the income used for negative gearing would attract a marginal tax rate of 38.5% but this does not change the conclusions of the analysis significantly if it is varied.

Why would I want to live in my first property? I can enjoy my active lifestyle as a 20 something while I am young and still build my property portfolio (sometimes I think moving out of home from my parents was a mistake because I would have so much more property already!)

Of course you may say that this analysis ignores stamp duty exemptions available to FHBs on off-the-plan property and that the investor will have to deal with capital gains tax upon sale of the property. I also should comment that the investor will only be better off overall if they have bought a quality property with good prospects for capital growth! Otherwise funding negative gearing is still a loss, regardless of the tax benefits.

What do you think? Have young people got it tough or am I onto something here?

What having a buyer’s agent is like

For today’s time poor professional, a buyer’s agent is your friend. If you’re just getting started in property investment, they are your friend.

I bought my first properties with a buyer’s agent in Sydney. I had no experience buying property; I just knew I wanted in. Some of the questions that were in mind were: What are important features to look for in an investment grade property? How to wrangle with agents? What about the sale process and going to auction? What is a fair market price for property? As I was going to spend $80K on a deposit and take on significant debt, I didn’t want to do it without serious advice. I didn’t want to skip too many Saturday morning brunches instead of going to months of open houses. I didn’t want to get stuck with analysis paralysis.

I met with a couple of different agencies before settling on one I was comfortable with. The first agency I met with had off-the-plan stock to push. I nearly agreed as it seemed easy and attractive, especially as there were no “fees”, but my mentor convinced me otherwise. The second agency’s method was buying established stock in inner city areas. They helped me devise a strategy to grow a property portfolio. I was convinced to engage them as they had no vested interest in a particular property. I signed a binding agreement that they would search for an investment property for me, which would continue until I closed on a property in NSW. During the process I never felt pressured to purchase a property my agent put forward; I didn’t get the sense they were trying to rush me so they could book their commission and move onto the next client.

I went out on several Saturdays with my agent, going through properties she had pre-qualified as interesting. I could see how she interacted with the selling agents – they all knew each other – that she was on the ground every day and had an excellent understanding of the market. After leaving a property, we would have a robust discussion about what we liked and didn’t like about the property, and my agent’s strategies for dealing with the selling agent, specifically what she said and didn’t say, what she picked up from the agent and what he said.

One thing that a buyer’s agent can do is open up new opportunities you didn’t know existed. During a sunny Saturday morning roving, one of her contacts called and invited us to a deceased estate property that had passed in at auction, and as a result it was affordable within my budget. I missed out on the property because another agent outbid me (he wanted to buy for himself!), but I never would have been aware of this opportunity had I been searching on my own.

It will add to the initial cost of purchasing a property. You can expect to pay 2-3% of the purchase price of your property to a buyer’s agent. That said, I know I paid fair market value, or perhaps even a bit below when I eventually bought, because the seller was moving to a retirement home and needed a quick sale. I was able to act quickly with a strong offer with my agent’s advice that was accepted. After all the time I had spent with my agent, I was comfortable it was a good price and the flat made a good investment to hold onto for the long term as well.

You can be as hands off as you like if you’re too busy – you could live in a different state, in fact. There is no need to get as involved as I did; I just valued the investment in my own knowledge. Expect a good agent to make you feel special by calling you regularly to discuss new and interesting properties they’ve found and plans for the weekend.

Capital Growth comes from buying in the Capitals

At this stage in my investment life, I am focused on acquiring capital city properties that are within 10 kilometres of the CBD. These are relatively expensive, but they are quality ‘blue chip’. Also I’m really only referring to Sydney and Melbourne. I am confident that in this zone, property values will go up relentlessly over the next few decades due to several compelling supply/demand drivers:

1. Sydney and Melbourne are the only cities in Australia that have a ‘world city’ status about them, which means robust population growth for decades to come. They are already attracting a strong level of Chinese investment which will continue as that country becomes richer. In this regard, we are following the lead of New York and London – so get in there first.
2. Sydney and Melbourne have diversified service-based economies. This means they are exposed to many industries that will prevent high overall unemployment which ensures there will be a ready supply of people who are able to afford to rent or buy your property. Other capital cities and regional towns tend to be one-horse towns – if a local industry shuts, people will leave and your rent and capital value will drop. There is a reason that regional towns typically have low capital values and relatively high rental yields – but you won’t get rich on a property that’s cash flow positive from day one.
3. Supply of housing is not keeping up with population growth. More specifically, the supply of properties that people actually want to live in is not keeping pace. Forget the ‘Australian Dream’ of owning a quarter acre block out in the ‘burbs – it’s just not going to be as relevant in future. People are going to want to live close to where they work and play – they don’t want to live their lives sitting in congestion. This means smaller, townhouse and apartment living in that 10km radius of the CBD.¹
4. Sydney in particular is land-locked geographically with beaches on the east coast, the Blue Mountains to the west, Hawkesbury to the north, the Shire(?) to the south. This means that the available land to build new housing estates is basically all used up, so we have to go upward. NIMBYism (Not In My Backyard) is thriving which dampens the speed higher density development, either by local action (see North Shore community opposition to increasing density along the North Shore rail line), or by high fees (bribes?) lobbied on developers by local and state councils.
5. There is a lot of infrastructure being built at the moment in our capitals, but this is going to have localised effects on property values – look to the Eastern Suburbs, along the light rail line, or the Hills District (North West Rail Link). As it will be easier to get in and out of these places people are going to be more attracted to living there = more demand.²

At an early stage of my career, I’m in an asset accumulation stage, so it makes sense to buy quality properties that have prospects of long-term capital growth.

My salary is likely to go up in the future, so that I know that I’m able to service the cash flow loss on these properties temporarily until they rise in value and rent over time, until I’ve built up enough equity to acquire another capital growth property. Then wait patiently again for the values to come up and repeat.

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1. And by apartment living, I don’t mean the monster off-the-plan developments that get built in the centre of the CBD. At the moment, lifestyle options for Gen Y professionals are better slightly out of the CBD, and families don’t want to live in them either.
2. Interestingly, I feel that infrastructure is being invested in already expensive and rich areas that already have good access to the CBD.

Investment Rules: Do Not Buy Off-The-Plan

I understand the attraction of an off-the-plan property investment. I nearly dropped a $50,000 deposit on a huge development close to Brisbane CBD back when I was getting started with property investment in 2011. I was lured by the attractive bonuses such as:

1. Cash back on settlement;
2. A free furniture suite;
3. Rental guarantees for the first year;
4. High levels of depreciation deductions; and,
5. Government stamp duty concessions that were available for new build properties.

However, I’m really glad I didn’t sign. A close mentor of mine asked some sensible questions which made me back out of the deal and rethink my strategies.

Reason #1: Future price growth is built into the purchase price

The developer and marketers of these projects have to make a margin somehow, and this is one of the techniques they use. Don’t assume that the value of the property will increase as they say it will in future – it will be affected by overall macro and micro economic effects. Do your research. You could be overpaying such that you won’t get the benefits of any capital growth for up to a decade. Where do you think the rental guarantee is coming from? You’ve already paid for it.

Reason #2: Off-the-plan properties typically take much longer than they forecast (it could be years!)

That delay is extra opportunity cost for your deposit money which could have been invested in an established property the same day you signed that contract with the developer. For the property I was looking at, I was originally told completion would be in 2012 but it didn’t finally complete, three years later, in 2015. Meanwhile, I managed to buy two established properties in Sydney over the same period, because my first property started working for me as soon as I settled on it in January 2013.

In fact, watch for the sunset clauses in contracts. In several cases where projects have been delayed past the sunset date, the developers revalued the properties at a higher price and required all the depositors to stump up the extra cash!

Reason #3: Build defects

With off-the-plan developments, strata is often mired with building defect issues for years after the completion of the property. If these only start to appear after the developer has checked out, it could run into the millions of dollars for the strata to fix. In the case of large blocks with many investor owners, it could then also take a long time to reach a resolution on course of action, while your apartment with a leaky roof loses its tenant.

Reason #4: There is no guarantee the final product will look the same as the glossy brochure.

Sometimes, in order to improve their project margins, developers will choose cheaper fittings and fixtures in the final product. Developers generally have the right to make minor changes to the size and design of the apartment without breaching the contract.

Reason #5: Fire sales on completion

I once heard recently that 70% of off-the-plan properties get valued below purchase price by the bank at settlement. In this case, you have to stump up additional deposit money, or you’re toast (you could be sued by the developer). In particularly bad cases, this causes a series of fire sales in the building, all at the same time. As everything in the building is similar, that makes it a commodity and decreases the market price for units in the building. Assuming you managed to scrape through settlement, this could be devastating to your future capital growth plans.

Reason #6: Lower owner-occupier appeal

Often, these developments are large towers close to or in the city which do not have broad market appeal for owner occupiers, as they tend to be smaller square footage and do not have the same access to lifestyle options such as cafes and restaurants. You want owner-occupier demand, such as rich families, to push the price of your property up in future. Unfortunately with the cost of development these days and rampant NIMBYism in the middle suburbs, high rise stock in the city seems to be the only type of real off-the-plan apartment developments going. Odds are the block will end up full tenants who will never purchase a property in the block. Don’t be surprised if the rent you get doesn’t meet what the developer suggested you could get either; high supply of similar units coming on the market at the same time will not guarantee an optimum revenue!

Conclusion…

Don’t do it. Just don’t. Unless you have money to burn and it’s the dream property for you to live in. If you’re just getting started on the path to financial independence through property, buying it will be a handbrake at best (and hitting it in the reverse at worst), preventing you from getting to your next property sooner.

I would only recommend off-the-plan to the seasoned investor who is familiar with the risks and to pick a smaller development, where there is still some scarcity value about the property which minimises downside risk considerably, while retaining the attractive depreciation deductions.

Discipline

The first key to financial independence:

Have the discipline to continually invest in yourself. Keep learning about investment classes that interest you: property, shares, businesses (equity or starting your own). The idea being that you want to de-risk any investment you make by being knowledgeable about it so that you stand the best chance of a decent return on your money! There is plenty of good information available on the Internet these days or pick up an ebooks so it need not cost you much. Take some time each day to read into an area of interest. Subscribe to blogs and after a couple of weeks you will be surprised by how much you can learn! Property Update is a great primer for Australian real estate as it covers many different aspects of property investment and articles are written by many different authors.

Have the discipline not to spend every pay packet every month. Do what ever you have to to make sure you are putting away at least 10% every month. If you are the type to impulsively spend from payday until you’re “broke” for the rest of the month, set up an automatic transfer to take 10% or more out of your account and put it somewhere safe where it can accumulate. Alternatively, invest it directly into some stable, low fee growth assets such as an index fund. There are many new user friendly services that can help with this, such as Stockspot (AU), Nutmeg (UK) or Wealthfront (US)*. Stay away from the fat cat managed funds as they don’t outperform the market on average and will charge high fees for doing so.

Have the discipline to pay off your debts and stop buying the new shiny thing. Related to the above but if you have a credit card debt this is the first thing to get under control as you are never going to get a rate of return higher than the interest rate on your credit card! And when you are tempted to buy the new MacThing, really ask yourself if you need it – or are you just coming up with reasons to justify the purchase? Trying wait at least two weeks and see if you still want it so much.

Have the discipline to stop drinking every night and invest in your health. Not saying that you can’t have any fun but be aware of how much you drink and consider cutting down – it will also save you $£€, you will sleep better, and you won’t spend every day in a fog. This will make you more effective at your job so you will be able to earn that raise, that promotion in the future. Or if you hate your job, you’ll be able to focus that energy into investing or a new job or a new business idea!

I still consider myself very early on my financial independence journey but these are the things I remind myself every day.

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*I’m not affiliated nor do I invest in any of these, but I would be tipping money in if I had spare capital!

How to deal with Housing Affordability as a young Australian today.

Judith Yates has written probably the most balanced article I have read on the issue of housing affordability in Australia today.

Short term cyclical factors are not enough to explain declining rates of home ownership amongst younger households. Underlying structural factors and changing institutional arrangements have been critical.

These include:

• our system of housing finance that makes it relatively easier for better-off households to accumulate housing assets through debt finance;
• our income taxation system that provides these households with an incentive to treat property as a means of accumulating wealth ahead of its more essential role as providing shelter; and
• our system of property rights that ensures those who do own land are able to act as rent-seekers by expropriating for their own the increase in land values not of their own making.

The way I see it, the tax treatment of property in Australia is unlikely to change dramatically soon (too many are already invested highly in property). Further the inner metro areas of Sydney and Melbourne will continue to experience high capital growth rates due to forecast population growth. This growth will be escalated by insufficient supply of well-located property, or property well-serviced by public infrastructure.

Judith puts it better:

In other words, increasing land values in urban locations are an inevitable outcome of the combined impact of:

• the pressure of income and population growth;
• structural change which results in increasing urbanisation and concentration of (knowledge-based) employment in its central locations
• a failure to invest in rapid-transit transport infrastructure that facilitates cost-effective access to employment and essential services.

Therefore I believe the best thing a young person in Australia trying to get onto the property ladder today can do is to buy small, affordable investment quality properties in the inner rings of Sydney or Melbourne which will allow them to ride the waves of capital growth in these area as they come in decades to come. This will allow those investors to build up a growing asset base over time which will eventually enable them to buy where they really want to live. (This is my strategy.)

If you can’t beat them, join them.

An alternative to the real estate advertising duopoly

Via StartUp Daily:

Yesterday, Metcalfe announced that he had officially launched another big data play: a new real estate platform under his existing NationMaster brand that was designed to make it easier for people to make more informed decisions when it comes to property.

The platform has been designed to ‘invert’ the classic property portal model and focus solely on the buyer. Dominant players in the market like Domain and RealEstate.com.au should be worried about what Metcalfe has created here because it eats into their current business model where their customers, namely real estate agencies, are able to collect lead generation data through “free” property reports on their sites.

“Our customer is the customer. We are the automated buyers’ agent,” says Metcalfe. “Everything we do is to improve the experience of property buyers. So they can skip inspections that don’t suit them and get their Saturdays back.”

realestate.com.au and domain.com.au have terrible user experiences that are funded by users’ private information and advertising. Uncertain if NationMaster plans to have property ‘ads’, but at the moment the free information available on a location is more impressive than what is offered by the established players. Looking forward to seeing how this evolves, and I hope to test it out with my future property investment decision-making.

Related: the NSW Government’s recent pledge to make all of its property sales data public is going to be very exciting for the property investment and create opportunity for some innovative startup ideas.

raison d’être

I’m a late twenty-something living and working in Australia.

I have cultivated an interest in finding my own financial independence, particularly through property. I’ve got a couple runs on the board and I think I’m more forward thinking than the average punter my age. I stay up to date on what is going on economically in Australia and have my views. I have a strong desire to express my opinions and help others find their own financial independence.

I will be writing for me, in that this blog will contain articles and links to things that I personally find interesting and helpful – I hope you find them helpful as well. I’ve also got interests in entrepreneurialism, productivity, technology and health, which may pepper the blog from time-to-time.