Property prices are on the rise yet again but there appears to be plenty of scope for growth. As a result, more Australia residents than ever before are considering property investment as a means of generating income. Owning your current residence really doesn’t count since the whole idea behind property investment is to have an asset that can be sold swiftly plus you are also looking to generate a regular income stream.
After spending several years on the sidelines due to the market crash, property investment funds are once again seen as a potentially lucrative purchase. Towards the end of 2018, property was #3 on the ‘most popular fund sector’ list with balanced portfolios and Australian equities ahead of it. Property fund investment has been growing steadily since the beginning of 2018 and in this article; we will look at the options at your disposal as well as giving you some helpful tips and advice.
Direct Property Investment
This essentially means you are investing in bricks and mortar so you are purchasing a building. If you own your own home, you are already involved in the direct property investment market but it also means your assets are tied up. There are also two main forms of direct property investment: Buy-To-Let and Property Development.
Buy-To-Let
This is arguably the most straightforward way to dip your toe into the property investment market as it involves purchasing a property with a view to renting it out to tenants. As a landlord, you have certain responsibilities which you can view at theLandlord Law Blog website. You either use your own cash or else you purchase a buy-to-let mortgage after paying a deposit. There are a number of advantages to be gained from this form of property investment:
- With property prices rising, you arguably have a more solid investment in your portfolio than stocks and shares.
- The rent received from tenants can go towards the mortgage repayments.
- Once the mortgage is paid off, you can sell for a profit or continue to earn money through rental.
Of course, there are also downsides:
- If you can’t find tenants, no money is coming in and you still have to make repayments.
- If the housing market goes through another bad spell, your property could be worth less than what you paid for it.
- You have to cover the costs of purchasing the property which includes solicitor’s fees, stamp duty, survey fees and running & maintenance costs.
- You will also need to purchase buildings & contents insurance and landlord insurance to protect your investment.
- The consumer protection that applies to many other investments does not apply to buy-to-let arrangements.
As long as you understand the risks and don’t mind having your money potentially tied up for a long time, buy-to-let could be a great property investment choice.
Property Development
This is a step up the ladder and is property investment on a much wider scale than buy-to-let. It is a multifaceted business that involves renovating and re-leasing buildings to purchasing land where new developments can be built. While it is different from construction, many property developers also build though it is more common to purchase the land, finance the deal and allow high quality construction companies to build under a fixed cost. Below, we provide you with some useful property development tips.
- Choosing the Right Property: It isn’t easy to distinguish between money pits and properties that can be improved to turn a profit. For example, you may enjoy the challenge of renovating a home but it may only be worthwhile if you intend to live there. If you wish to be a successful property developer, you need to finish the project, find a buyer and move on. Therefore, your role is to view properties through the eyes of a buyer which means looking at the space, location and style of each property. You also need to calculate the cost of the project, the length of time it takes and whether or not the property is worth working on.
- What to look For: The normal transport rules apply which include good access to amenities and transport links. The more contacts you have in the real estate and surveyor industry the better as they can tell you whether a property is a good development opportunity or if it is better suited to a buy-to-let investor. If the property is in an expensive neighbourhood, improving and extending it could be extremely lucrative.
- What to Avoid: You need to be aware of the ‘maximum’ possible sale price which also dictates the most you can spend developing the property. Again, having the assistance of a good surveyor or architect will prove invaluable. Unless you are very experienced in the property development field, it is best to steer clear of homes with serious structural problems. Experts know the best properties are ones where others fail to see the potential; if you have the ability to change layouts and add space, you could profit where others see only loss.
Indirect Property Investment
This involves investing in property funds on the stock exchange. If the fund performs well, you will receive dividends or rental income depending on the kind of fund you choose. Below, we look at the three main indirect property investment types.
Real Estate Investment Trusts (REITs)
You invest in a real estate company that is on the stock exchange. This company owns and manages the property on your behalf. This form of property fund could include residential and commercial property and you invest by purchasing shares in the REIT. There are actually two completely separate REIT elements because of tax considerations: ring-fenced property letting where corporation tax is not paid and non-ring-fenced business such as property management services where corporation tax is paid.
If the REIT performs well, all shareholders receive a cut of the profits. A normal REIT may provide a better level of profit because of the corporate tax exemption and you can include these shares in a tax-free ISA. However, there are risks involved in this form of investment and the value of your shares could go down as well as up. As REITs are not supervised by the Financial Conduct Authority (FCA), you can’t make a complaint nor are you protected by the Financial Services Compensation Scheme (FSCS).
Property Company Shares
This is similar to REITs insofar as you purchase shares in a property management company that is on the stock exchange. One of the key differences is that these particular organisations either choose not to become REITs or else they are too small. You purchase shares in the company and benefit from rising share prices.
As many of these companies invest in specialist property types, you will have access to markets that may otherwise be inaccessible. You can also place these shares in an ISA up to the yearly limit. Like with REITs, there is no FCA supervision and no FSCS protection.
Land Banking Schemes
This involves purchasing a plot of land in an area where no permission has been given for development. The sellers claim that the land will skyrocket in value once planning permission is given but there is a chance that you will be purchasing protected land which will never be built on. These are high risk schemes and in many cases, are outright scams.
Land banking schemes are not regulated by the FCA, you don’t have FSCS protection and you may well become a victim of fraud. You could speak to the local council and find out if the land is likely to be released but we can’t recommend this kind of property investment. It is entirely possible that the land you purchase is polluted or is protected due to its beauty.
Direct or Indirect Property Investment?
If you choose a buy-to-let arrangement, you will need to work with tenants or else hire a property management company on your behalf. With property funds, you have a fund manager who deals with everything so you just invest and relax. Property development is arguably the most stressful of all since there is so much to be done including managing projects and even taking part in renovations yourself.
High Returns
Direct property investment allows you to purchase a property without needing 100% of the funds. All you need to do is pay a deposit to get a mortgage and the property can be yours. If the property value rises, you can receive an immense return on investment because you benefit from the total increase despite only paying a fraction of the price.
For example, you could purchase a $250,000 property with a $25,000 (10% deposit) initial investment or else you could use the money to pay for shares. If your shares increase in value by 20%, you receive $5,000. If you own the property and it goes up by 20%, you make $50,000 in profit which gives you a 200% ROI compared to the 20% gained by the shares. Of course, this is a very simple example and doesn’t take into account fees and risk. Always look at property investment as a mid to long-term investment; 7 years is the minimum recommended investment term.
Risks
If you get a mortgage to purchase a property, you will be placing yourself in substantial debt. Depending on the kind of mortgage you have chosen and the length of the term, your repayments could vary depending on interest rates. If these rates escalate and you have a buy-to-let property, you may find the rent payments are not enough to cover the mortgage repayments. If your property lies empty, you have no income and the repayments become more difficult.
In the field of property development, so much can go wrong. For example, renovation may take longer than expected or go over budget. If you complete the project but no one is interested in buying the property, financing the mortgage will eat into your profits. As there is the possibility of the property staying on the market for quite some time, panic may set in. Even when you find a buyer, the process takes up to 3 months in Australia. Therefore, property is not a liquid asset whereas shares are. With shares, you make the purchase with your own cash and can sell whenever you wish.
Property Investment Tips
Research the Market
Don’t assume that the property market will maintain its upward trajectory indefinitely. While the signs are extremely encouraging, you can’t invest in property with the blind hope of achieving profit. It is necessary to identify areas with a high capital growth potential. Large new-build developments are a poor investment since they are comprised of similar units which guarantee too much competition. The Telegraph outlined 10 of the best property investment locations in Australia but bear in mind the property market changes so rapidly that nothing is guaranteed.
Know Thy Tenant
This is a buy-to-let tip though it could be used in the world of property development. Whether you want to rent your property or sell it, you need to know what prospective tenants want. For example, there are property companies that specialise in 1-2 bedroom flats for rent on the grounds that 3+ bedroom flats are unlikely to see an increase in rent. With property development, you need to have a clear idea of who you want to purchase the building so you can clearly plan and budget for the project.
Knowing the going rental rate is essential since tenants will almost certainly be aware and will not tolerate a rip-off landlord. Budgeting for extra high rents is a recipe for disaster since it will ruin all calculations. Rents can also be used to calculate the value of the property. Using a 4% gross yield, a flat with a weekly rent of around $400 should not cost more than $520,000.
Understand Costs & Yields
Stamp duty can place a real dent in your profit margin so be sure to factor it in along with legal, surveyor and other fees. You may also need to furnish the property to attract tenants and a good guide for furnished flats is to set aside 7% of the purchase price to bring in furniture and appliances.
If you take out a mortgage, you have to understand the rental returns. It is likely that running costs such as letting fees, maintenance and service charges will reduce the overall rent received by as much as 30%. This could reduce your yield to 3-4% which is a wafer thin profit since the best mortgage rates on the market are around the 3.5% mark. The bigger the deposit you pay for your mortgage, the higher your margin will be.
Conclusion
Getting involved in the property investment market is a dream come true for many Australian residents but it is a potentially stressful choice fraught with danger. If you purchase shares, their value could drop with the market thus leaving you out of pocket. Direct property investment is even riskier since you will be taking out a mortgage in most instances. If you don’t occupy the building, it will be tough to repay the loan. Property development is a hands-on form of investment and involves renovation, selling buildings and also looking for suitable land.
On the plus side, the possible rewards are staggering. If the property market rises, your shares could make you a substantial profit. Likewise, buy-to-let investors are likely to have a greater demand for their property which means they can charge a high rent and also know it is possible to sell for a profit. Property development is the most lucrative investment of all and has made many millionaires. If you want to join the ranks of those who profited from property, be prepared to work hard but be aware that there is money to be made.
