Property is one of those things that you either like investing in or you don’t. Just like any other investment it can be a minefield of worry and if you get it wrong, it can really hurt. There are variables that can add additional stress, like finding (good) tenants, having to tend to repairs, ongoing rates and service charges, increasing loan interest rates and all the while hoping your asset will go up in value. It’s no wonder people either stop at one or invest in mutual funds instead!
Why I like Property
Personally I like property, none of those negatives worry me much because I automate as much of it as I can and get other people to worry about it for me. When I started out, I didn’t do this. I managed my first property by myself, found the tenants, collected the rent and looked after the repairs. Every dollar I saved helped me make up the difference between the rent and the loan, so I did everything I could. This worked for a few years, I hated it, but it was necessary. After a while I was able to increase the rent and the money that came out of my pocket was reduced. In fact rent went up so quickly that I couldn’t keep up! Pretty soon, the property started paying for itself.
Pretty good eh? Now I was making money. What I didn’t do at this point was pocket my earnings, instead I went and increased my expenses by hiring a property manager. Why? Because it bought me time! I no longer had to look after the property, someone else did it for me and because they knew what the rental income should be, they increased it further and ended up saving me money in the end. This initial hard work got me my first property, which has now begun to work hard for me. The value has increased, my loan to value ratio has gone down and I have a lovely thing called equity as a result. The next time I bought a property I was able to utilise the equity I had in the first property, which meant less money coming directly out of my pocket for the purchase. As far as I’m concerned, this is much better that having to save it all up again first. I also learnt from my first experience and got myself a property manager right away. For the price I pay, I feel it is well worth the added expense and the cost is tax deductible as well. So now I had two properties working hard for me and increasing in value, but the second still had a shortfall.
Making up the difference
This is called negative gearing by a lot of people and it is generally the part that stops most from investing further in property, or anything else for that matter, as they only have so much money they can contribute out of their own pocket. For this reason, some people are only interested in positive gearing (or finding property that pays for itself). I’m not really a fan of this strategy as I find that this type of investment is less likely to achieve good capital growth, so in the long term you don’t benefit as much. My whole philosophy with property is to buy, hold and never sell. A lot of people have trouble with that last part because they don’t want to keep paying the difference, but what most of these people don’t do is look for ways to help fund it.
As soon as I buy my new investment, I get a quantity surveyor to prepare a depreciation schedule of the house and contents so it can be written down each year and increase my claimable expenses. combined with the interest from the loan and additional cost for my property manager and other associated holding fees, I have a bunch of claimable costs that will help put money back in my pocket through my tax return. Unfortunately most people wait a whole year to get this money back in their pocket and have to pay it all by themselves in the meantime. This is very limiting and personally I don’t like waiting that long.
To get more money back in my pocket right away, I use a Tax Variation Form, which means that instead of waiting for a tax return at the end of the year, I get it added back to my pay throughout the year (Working through one of these things is pretty heavy going, so I would suggest you get your accountant to look at it instead). This extra money in my pay goes straight to my investment account via a direct debit each week, so I never have to worry about it. any remaining shortfall is vastly reduced, which means the actual holding cost is quite manageable. You might choose to pay for this out of your pocket, or like me, you might like to get the bank to do it for you.
This is something that may not appeal to some people, but it will make it possible for you to accumulate more property and ultimately have more assets working for you. If you do your homework to begin with and buy an asset that achieves good capital growth over the long term, then the risk is reduced to almost zero. So here’s what I do; I take a line of credit (which is my investment account) and use this to cover the remainder of the shortfall. What! More debt? Are you mad? Perhaps I am, but the amount is not big (lets say about $100 per week, or $5,200 per year for a 350K property). Yes, there is some interest to pay on this, so the final figure might be a bit more, but this is also claimable. To put your mind at ease, here is a very basic example:
Approximate holding cost on a $350K property after adding back claimable costs and utilising tax variation form = $100 per week or $5,200 p.a.
Approximate capital gain on a $350K property at 5% growth (very achievable) = $17,500 p.a.
Difference = $12,300 p.a. profit
And that is being conservative, the even better news is that this can increase as your rent goes up. Now imagine if you were doing this with more than one property…. yes, your holding costs go up, but your profits also increase further. After a few years, your investment has enough equity to consolidate your debt and the shortfall is gone because of the increase in rent. The rest is just profit!
If you are still shaking your head and don’t believe a thing I have said, go discuss it with your accountant – in fact even if you like what I have said, I recommend that you talk with your accountant. If you both end up shaking your heads, then I suggest you re-read the title of this post and find something else you would prefer to invest in instead 😉
Image by MattHurst