PROPERTY OWNERSHIP SHOULD NOT BE YOUR GOAL


PROPERTY OWNERSHIP SHOULD NOT BE YOUR GOAL

Published on May 22, 2015

Property ownership should not be your goal

We live in residential property, either as tenants or homeowners, and in all but some cases it’s pretty fair to say that the key goal is homeownership.

Buying your first home is a very special time in one’s life, however, making that very last payment to the bank knowing the home is now 100% yours, is  even more special.

I love residential property investments because...

I love residential property investment because I have that added security that my asset is in a class dominated by homeowners, and no matter what goes on in the economy, people always need a roof over their heads. I cannot think of any other asset to invest into that falls into that category, rather investors dominate all other asset classes – even holiday lets and commercial property.

While the knowledge that I am investing in well researched (permanently let, median priced) residential property is a real positive, on the flip side, it means that unlike any other asset class, the attitudes and processes people apply to investing in residential property are more often than not skewed by human emotion and subjectivity.

Investing in windmills

So for the sake of getting a message across objectively I am going to liken residential investment property to windmills, given nobody would become emotionally attached to a windmill.

Imagine if you will, that instead of building an investment portfolio of four properties, you’re going to build one with four windmills.

Why would anybody want a windmill, you may ask?

Obviously not to live in, not to look at, not for anything really, except to generate power to perhaps power your own home and then sell back to the grid.

So, if my goal is the output of the windmill, then it really doesn’t matter who owns it, does it? It only matters who controls it and who has the rights to the energy that the windmill produces.

With this analogy in mind, and forgetting your emotional attachment to property (because you live in one and want to own it, or you want another one), think of your investment property as something that will deliver an outcome – and an outcome that you own because you had control over the asset.

When a strong wind blows, it will turn my one windmill or my four windmills (or however many I have been able to gain control over), and produce energy. Four windmills means that after that strong wind, I will have four times the energy to sell to the grid compared with  someone who only has one windmill. The wind may be free, but it’s only those with windmills who will reap the benefits.

Therefore, why would my goal be windmill ownership if the cost of ownership prevented me from controlling multiple windmills?

And so it is with residential property investment; most of us have a limited borrowing capacity and limited cash flow from which to support a family, pay our bills and live a comfortable life. What we can set aside for our investments is not open ended, so by using as little of our own cash reserves as possible, and by leveraging off other people’s money as much as we can, we will control more properties than would have otherwise been possible. Holding, or controlling, more property means more reward on the other side of the ‘property market wind’.

Property market winds

When I speak of the property market wind, I refer to those seasons where price growth is consistent and sustained. These times tend to visit markets around once every decade or so. Right now, for example, Sydney is at the back end of what has been a sustained period of strong capital gain, while Brisbane is only in the ‘recovery’ phase (post GFC) and in the early stages of its next upswing.

The investor who used smaller deposits (even paying mortgage insurance) in order to hold (control) more Sydney property, will undoubtedly have more equity or wealth, than those investors who pumped all their available cash reserves into paying down the debt on a single investment property, with the goal of owning it outright.

Dirty four letter word

I know that debt is a dirty four letter word to many people, but it is important to understand the different types of debt, By all means get rid of your horrible debt as quickly as you can (consumer debt used to buy things that depreciate in value and offer no tax deductibility). Then there’s tolerable debt; debt that does not attract a tax deduction, but is used to buy appreciating assets, such as the family home. Finally, the debt that astute investors use to aid their wealth creation plans, I refer to as productive debt. This is the debt which works for you. It attracts a tax deduction and is used to buy things that go up in value. Productive debt is what we use to buy our windmills, I mean investment properties.

Given productive debt is tax deductible, it makes fiscal sense to first pay down your  non-deductible debt. Of course, once you are at the stage where you cease accumulating more investment properties and you have cleared your non-deductible (horrible then tolerable) debt, by all means shift your focus towards paying down your productive debt. This can be done in different ways, and my suggestion would be to choose the option that leaves you in control of those funds, so that should you need to draw on them for any unforseen reason, you can do so without having to ask your lender’s permission.

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Partnering with you for your investment success.

Nick Lockhart.

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