By Rich Harvey, CEO & Founder, propertybuyer.com.au
One thing I’ve noticed about the property sector is the number of people who claim to have an insider understanding about investing.
There are many Australians who (mostly because they’ve bought a property at some point) believe they have a comprehensive understanding of how to make money via real estate. It’s a “BBQ stopper” topic where everyone has an opinion.
But understanding the detail around investment is a little more challenging. You need to have been involved in multiple property deals over a long period of time to truly comprehend the full benefits and risks.
So, what can Australian property investment achieve, and why is it a superior asset class?
The basics of property return
There are two components of financial gain from a property investment.
The first is the rental return. This is simply the rent you collect from leasing out your investment.
Rental return is described as the property’s “yield” and is expressed as a percentage. The yield is simply the annual income collected in rent divided by the valuation or purchase price of the property. If you are looking to buy an investment property for $750,000 that collects $500 per week in rent (or $26,000 per year), it’s annual rental yield is 3.5%.
The second component is capital gain, and this is the one widely recognised as the strongest wealth building element.
Capital gain refers to how much your investment moves in value over a given period. So, if your $750,000 purchase was valued at $795,000 one year later, that reflects an increase of $45,000 which equates to a 6.0% capital gain.
That means for our hypothetical property above, you’ve made 3.5% yield plus 6.0% capital gain, which is a total annual return of 9.5% on your invested money.
Not a bad outcome… but wait, there’s more!
Property investment boosters
Property remains a superior investment vehicle because it can utilise several characteristics that boost its returns.
Leverage
Even with rising interest rates, the ability to invest borrowed funds to elevate your returns remains attractive with property because you can borrow at a much higher LVR (loan-to-value ratio) as compared to something like shares.
Drawing on our example above, say you could borrow at an LVR of 95% for our $750,000 hypothetical property.
That means you will be borrowing $712,500 from the financier at an interest rate of approximately 4.0%. Based on these parameters (assuming an interest-only loan) you will be paying $28,500 a year in interest.
But here’s the cool thing – that borrowed $712,500 is earning you 9.5% in total returns, or a whopping $67,688 per year. Even after paying interest to the bank, you’re ahead by $31,188 per year.
Smart investors know leveraging funds for investing wisely is key to accelerating wealth – and property is the only vehicle that allows you to borrow at such high LVRs.
Compounding
Another magic property investment component is the compounding of a property’s value.
Compounding describes the way investors don’t simply earn capital gains on their initial investment. In fact, they earn capital gains on top of their capital gains each and every year, which accelerates their property’s value exponentially.
In the example above, say your $750,000 investment increases in value at an average of 6% per year for 10 years. This doesn’t mean you just make 6% of $750,000 ($45,000) each year for 10 years which would be a grand total of $450,000. No, it’s actually far better.
After one year the property will be worth $795,000. But in year two, a 6% gain on $795,000 equates to a value of $842,700. Move to year three and it’ll be a rise to $893,262.
In fact, if we extrapolate this out to the 10-year mark, our $750,000 property will be worth $1,343,135 – that’s a capital gain of $593,135 which equals an astonishing 79% increase in value.
Other value adds
Of course, there are more immediate ways to improve your returns through strategies such as renovation. Property affords the opportunity to carry out upgrades. It could be as simple as a repaint and new floor coverings. More adventurous landlords might even look at adding extra rooms or improving the car accommodation.
So long as you’re thoughtful about the works and avoid overcapitalisation (i.e. spending more on an improvement than it adds in value), then a renovated property should result in increased rent and market value.
For even more entrepreneurial types, you might be able to complete a redevelopment of your asset. Perhaps it has potential for a small subdivision, or the construction of a duplex unit. While this will require more capital outlay, the result may well be a substantial increase in rental income and market value. Guidance from an experienced advisor will be crucial for making this strategy work.
As you can see, property delivers opportunities for smart investors to boost their returns, and with the right advice most of the upside can be achieved with minimal risks.
If you’re interested in understanding where the best investment prospects are in the current market, be sure to contact us at Propertybuyer. We can discuss your individual needs and circumstances, and help you unearth an ideal investment prospect.
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