8 Reasons to Choose Real Estate Investment to Create Wealth
Housing is Australia's single biggest asset class.
According to recent taxation statistics, there are now more than two million Australians who own at least one investment property, with a combined value of more than $6 trillion.
This article covers eight of the main benefits of investing in real estate and some suggested next steps and further reading if you are interested in growing your own portfolio.
The Difference Between Real Estate Investing and Property Investing
It’s important to understand the difference between real estate and property.
What is Real Estate?
Real estate, which is land, is what we invest in. Real estate is what appreciates (goes up in value)
Property, on the other hand, refers to the structure that is built on the land.
Property is what produces cash flow back to the investor to make holding the land possible.
Investing in real estate / land alone is called land banking.
Land banking can be very profitable in the long run but, because it does not produce cash flow, it is a strategy that’s limited to a few.
Now that we have differentiated between the two terms, here are eight benefits of real estate investment.
What is Leverage?
Leverage is an investment strategy of using borrowed money to increase the potential return of an investment.
To demonstrate how powerful leverage can be in when investing in real estate, here's a scenario for you.
What value of shares can you own with $50,000 in cash? The answer is usually $50,000.
What value of real estate can you purchase with $50,000 in cash? You could buy a $50,000 property (if one existed).
However, you could also invest in a $500,000 property using a 10 percent cash deposit (excluding purchase costs), or alternatively use existing equity in your home as a source of deposit.
When you invest in the share market it is generally more difficult to leverage your investment, and many that have tried lost the lot because of events like the GFC.
However, when you select real estate investment as your wealth creation vehicle, you are investing in a tangible and secure asset.
It’s a fact that banks and other lending institutions will generally lend up to 90% of the value of a residential property, because, over the long term, they know the value of Australian residential property has increased.
Australian Median House and Unit Prices: 1993 - 2018
Using leverage to grow your wealth through real estate investment is a powerful tool and being highly leveraged can greatly magnify your profits, but also, if the value of your investments falls, can magnify your losses as well.
It’s important to strike the right balance between being fearful and doing too little vs. being reckless and abandoning caution altogether.
2. Real Estate Can Provide an Additional Income Stream
When you have a property on your real estate investment, it provides you with cash flow.
Your rental yield is the percentage yield from rental income and can be calculated as either gross or net.
What is a Positive Cash Flow Investment?
Positive cash flow investments is an investment which earns more than it costs to own.
For example, if your investment property brings in $40,000 per year in rental income and tax deductions, with yearly expenses - maintenance costs, and loan repayments of $30,000, your positive cash flow would be $10,000 a year.
Certain types of real estate investments, for example dual income properties, can provide high rental yields and provide investors with an additional source of income.
These properties are often positively geared, meaning the rental income alone, before adding in any tax savings, exceeds the costs associated with owning the real estate investment.
3. Tax Benefits
Investing in real estate comes with considerable tax benefits including negative gearing and depreciation.
What is Negative Gearing?
Negative gearing occurs when all the costs associated with holding your real estate investment are more than the income you receive from it.
Any net loss you incur from holding your investments can be offset against your other taxable income. This means that potentially, the amount of tax you pay is reduced.
Depreciation is a tax deduction that is available to property investors.
It allows you to claim a tax deduction for the wear and tear over time on new investment property.
Depreciation on second hand property is now limited to the physical structure, but not to all that goes in it.
Should there be a change of government at the 2019 Federal election, that too will be removed on second hand policy, and likely retrospectively back to when the announcement was first made by Labor in Opposition.
There are two types of allowances available:
- Plant and Equipment, which refers to items within the building, like ovens, air conditioners, carpets, blinds door handles and wiring etc. (no longer on second hand property).
- Building Allowance, which refers to the construction costs of the building itself, such as concrete and brickwork (soon to be disallowed on second hand property, should Labor win the 2019 federal election).
4. Real Estate Investment Can Help You Pay off Your Home Loan Faster
Your minimum monthly home loan repayments for a principal and interest loan is worked out on how much you will need to pay off the entire loan over the loan term, plus the interest that will accrue.
Most home loans are over a term of 25 years.
If you 'park' the rental income from your real estate investment(s) in an offset account against your home loan you will reduce your interest bill and pay off your home loan earlier, and rid yourself of tolerable debt.
This can potentially save you many thousands of dollars in interest repayments (subject to you continuing to make repayments at the same rate as you would have if you hadn't offset your investment loan).
Two strategies that could help you achieve the goal of paying off your home loan sooner:
- Investing in positive cash flow property and parking all the rental income into your offset home loan account to reduce the interest and accelerate the mortgage pay down.
When your lender draws out the interest payment (and you pay other costs, such as rates etc.) your offset account will still have a surplus in it.
- Investing in well located property with good capital growth potential. You then sell these properties after they have appreciated in value, using the profit to pay down your home loan.
This sounds good, maybe, but capital gains tax eats into your profits; unless the property was bought and sold inside a self managed superannuation fund (SMSF), where capital gain tax is not applicable to those at least 60 years old and retired.
For more information on this and see if you qualify, contact the MRD Finance Team for a free finance check-up.
5. Capital Appreciation
This table shows the Australian capital city average percentage growth for houses, from 1970 to 2018.
It shows the considerable growth experienced across all these cities and the long term benefits real estate investment has delivered.
These percentages are averages and in the short term growth can stall or even go backwards in certain areas, due to the cyclical nature of property.
Real estate investing, however, presents you with the opportunity to outperform these averages, by carefully choosing what and where you buy and how you finance your investment property in terms of the loan and structure you choose.
You also have the potential to add value and manufacture your own equity through improvements or renovations, if you are able to time the market correctly and avoid over-capitalising.
After leverage, time in the market is your greatest wealth building tool. Procrastinating for one year at the start + time = a SIGNIFICANTLY bigger cost than one year at the back end.
Read about the hidden cost of procrastination.
6. Use Market Cycles to Your Advantage
Real estate is a cyclical investment.
A property cycle is a sequence of events reflected in demographic and economic factors, which affect supply and demand for property and subsequently influence the property market.
Timing the real estate market is not an exact science, and within Australia different states and even suburbs will be at different phases of their cycle.
However there are several key indicators you can use to determine where a particular market is within its cycle, including:
- Supply and demand
- Interest rates
- Employment trends
- Infrastructure and population growth
- Historical capital growth trends
7. You Can Choose Your Own Strategy
There are different property investing strategies you can select from, depending on your current situation, experience, level of comfort with risk and long term investing goals.
For example, are you looking to renovate and potentially make a quick profit, do you want to generate cash flow to supplement your income or are you investing for the long term to grow your wealth and create a better retirement?
Each of these strategies has pros and cons for you to consider and you can learn more about each of them in our recent webcast.
The Cash Flow Strategy
A cash flow strategy is a simple one to execute, in theory.
It involves investing in properties with a high rental yield potential so you generate income that is greater than the total expenses of holding the property.
The Renovation Strategy
The renovation strategy involves buying property under fair market value and making cosmetic and / or structural improvements to manufacture capital growth and increase your rental yields.
The risk here, for those wanting to 'get in and out' quickly is that the have to time the market accurately, or risk losing on the whole exercise.
The Capital Growth Strategy
The term capital growth strategy refers to the creation of an investment portfolio that will maximise value in the long term.
This involves choosing well-located real estate investments likely to have strong demand and out-perform the averages.
Whichever strategy or strategies you choose, your next step would be to select the right opportunity for you.
In short purchase the right opportunity, in the right location, at the right price.
It is difficult to generalise, but some key fundamentals to consider would include an investment where:
- It's a freestanding block of land
- Ideally in, or with close access to, a capital city (where the more diverse and better paid job markets are)
- Land supply is limited
- People want to live (increased demand)
- There is access to abundant employment opportunities
- There is good infrastructure and a range of services
- There is an abundance of lifestyle choices
- There is a diversity of industry
- It is located within walking distance to transport, shops and amenities
- There is a planned growth strategy for the area
8. Wealth Creation
Strategically selected and located real estate investments can be powerful vehicles to help you generate long term and sustainable wealth.
It is critical that you run your investment strategy like a business, making rational, educated decisions and plan for the long term.
By engaging the help of a professional (even champion athletes at the top of their games engage coaches) and diligently sticking to a predetermined plan, you can certainly achieve great success.
James is Marketing Manager at MRD. He has been investing in property for the last 11 years, and owns properties in Burleigh and Palm Beach on the Gold Coast. He loves family, surfing, gardening and swimming.