Australian Tax Office (ATO) data shows that only 9% per cent of investors own three or more properties.
So, if property was such a good investment, why do many stop at one?
Unfortunately, most people simply buy the wrong property, buy emotively, sell quickly and never buy again, or stubbornly hold onto it hoping things will change.
Investors who do it right normally succeed and succeed extremely well.
Therefore to become a successful property investor clearly requires a different approach. Like baking a soufflé, successful property investing requires these important elements – a well- proven recipe, good ingredients and technique.
I’ve followed a well-proven recipe for years, which I refer to as the ‘10 commandments’. These are 10 investment principles that can be applied to any asset class, but I’ll focus on how each of them is specifically relevant for property and property investors.
1. MONEY THAT YOU INVEST MUST CARRY MINIMUM RISK – SO DO YOUR HOMEWORK
Risk can be mitigated in many ways. The principle tool of the investor should be education and knowledge. Property investing must be looked at and operated as a business.
Successful property investors know all too well that shortcuts or lack of research are sure to cause financial distress.
Anyone spending $500,000 on a café would look at their expertise, best finance, structure, competition and cash flows as well as their exit strategy, i.e. a thorough due diligence.
Property investors should also do their due diligence, just as if they were buying an actual business.
2. YOU MUST ACHIEVE THE BEST POSSIBLE RETURNS RATHER THAN THE RETURN ON TOTAL ASSET VALUE
Maximise your returns by investing the minimal amount.
Even on an 80 per cent lend, a property that doubles in 10 years will see your cash investment (i.e. the 20 per cent deposit and costs) yielding you more 50 per cent return per annum.
3. INFLATION AND RETURN AT LEAST SEVEN PER CENT ANNUALLY OVER 10 YEARS
Who wants to invest in an average asset?
Average means a mixture of bad returns, mediocre returns and high returns, so target the high capital growth areas and property types.
“Compound interest is the eighth wonder of the world.
He who understands it, earns it… he who doesn’t… pays it,” according to Albert Einstein.
Investors should be looking at maximising growth, which is then compounded year-to-year.
4. YOU MUST INVEST USING THE RIGHT STRUCTURE: ‘OWN NOTHING, BUT CONTROL EVERYTHING’
A particular risk area that many investors fall into is failing to identify the correct name to purchase the property in before they sign the contract.
If an investment property is in a structure that doesn’t give adequate asset protection or ability to significantly improve returns, then you could risk losing everything you own as a result of a frivolous lawsuit, or risk diminishing the profit potential by paying too much tax.
Issues such as land tax, income tax, capital gains tax, asset protection and estate planning need to be considered before finalising the structure to buy in.
For example, buying investment properties in your personal name (or in your spouse’s name) doesn’t offer any asset protection, so if you’re personally sued by say an injured tenant and the investment property is in an individual name, you could potentially lose that asset.
Some investors buy properties in a company, believing it will offer them asset protection.
This is a dangerous fallacy.
The individual is usually the shareholder so they could lose the shares in a successful lawsuit and therefore lose the assets.
Furthermore, a company doesn’t receive the 50 per cent general capital gains tax discount and is also very inflexible on distribution recipients (current shareholders).
Successful investors however use trusts to protect and control their assets, as the individual doesn’t own the asset, rather it’s owned by the trust and controlled by the individual. Therefore, if the individual is sued they have no assets to lose.
Not all trusts are created equal, so it’s imperative to talk to a specialist property tax accountant about how you can structure your investment
5. YOU MUST INVEST WHERE TAX BENEFITS ARE PLENTIFUL
Residential property provides negative gearing benefits and deductible borrowing costs.
However, negative gearing should always be seen as a short-term cost for a long-term benefit.
Also, when doing renovations, remember to obtain a scrapping schedule, which will identify the value of any outstanding depreciation on what is being thrown out and allows for an immediate tax deduction.
6. YOU MUST INVEST IN ASSETS THAT CAN BE INSURED AND PROTECTED
Landlord insurance should be taken out so that in the event of a tenant destroying the property, a refurbishment is available without costs to the owner, as well as some insurance in case a tenant stops paying rent.
Income protection and mortgage insurance can also be taken out individually and especially in the early years where there may be little equity for adequate life cover – this can assist with leaving your family an income as opposed to a debt.
Periodic contact with your mortgage broker should also be maintained to always have your line of credits or equity balance maximized to allow you to quickly take advantage of any opportunities.
Constant market research on price can also assist to ensure the property is adequately insured as under insurance can cost you dearly.
7. THAT’S SPECIFIC AND ALL ENCOMPASSING
Pay attention to all the cash flow streams i.e. purchase price, rental and capital growth.
To begin with, look at rental yields as a quick guide to cash flows.
This can be calculated by dividing the annual rent by the purchase price i.e. $20,000 annual rent
Care is needed to differentiate between gross yield and net yield, which is after deducting property expenses excluding interest.
As a purchase guide also look at purchase price based on square metres.
While this is only a guide it’s a useful tool when comparing properties.
As banks don’t tend to call in loans or request additional funds to be paid into loan accounts if repayments are up-to-date, this helps in times of property value declines.
Use the upcycles to maximise borrowings to then draw down in down cycles or when opportunities arise.
Stick to what you know best and invest in the property types that can maximise your returns.
That means in some areas apartments are favoured while in others maybe townhouses are, and if you enjoy the thrill of cosmetic renovations and or improvements, then target properties that fall into these categories.
8. YOU MUST INVEST IN ASSETS THAT REQUIRE MINIMAL INPUT
While property shouldn’t be a set-and-forget asset we’re normally busy or purchasing interstate and so minimal involvement is valued.
A good property manager can save you more than they cost and are a good intermediary when negotiating rental increases and up-to-date information in the rental market.
They can also be particularly helpful in the event of needing to terminate a lease agreement.
9. YOU NEED TO INVEST IN ASSETS, WHICH REQUIRE LITTLE MONEY WHILE MAXIMISING GROWTH
Some residential properties allow for extended settlements thereby increasing your returns prior to purchase and with early access approval can allow for renovations prior to taking the property over.
Off the plan means buy now, pay later and potentially growth with no mortgage.
However, care is required with off the plan to ensure you’re not paying the developer’s profits in the future today and that you’re able to complete settlement, as the bank’s final approval won’t be known until completion.
If values fall or banks change lending policies you could be caught short and unable to complete.
10. Residential property is the only asset class that allows this in the form of renovations and refurbishments.
Even minor cosmetic changes (repainting) can greatly increase value.
Residential property is also not subject to unscrupulous management, which can destroy all value and can give passive income without the need to continuously replace your asset