Many people swear by it as the best and safest form of investment while for others it’s too slow, requires too much money to get started, does not provide sufficient returns or it’s not liquid enough. There’s no doubt that some of Australia’s richest people have made most of their money in property. It’s also worth considering that whether you are a fan of property or not, it makes up a major part of our economy. Property is used as a measure of personal, corporate and national wealth and it is therefore worthy of careful evaluation. For most people, property is the cornerstone of their investment portfolio and often plays an important part in their wealth creation plan.
If you have not personally experienced major increases in property values, you probably know of people who have had major capital gains. Just think back to when your parents bought their first house. Has the value of their property increased in the meantime? Generally people tell me that they have experienced substantial capital growth, especially if they have owned the property for a long time.
Consequently, it’s tempting to think: - OK, that’s worked in the past, surely this will continue to work in the future. While it’s true that history often repeats itself, it’s not necessarily a good strategy to drive forwards while you are looking in the rear vision mirror!
For many people their family home is their greatest “investment”. Since they do not usually receive an income from their family home, the focus is on the amount of capital growth they have experienced. As a result we tend to evaluate property investments primarily on the possible capital gains to be achieved.
You should be aware however, that there are two very important issues that you need to evaluate whenever you consider property as an investment vehicle.
The first is cash flow or rental income and the second is capital gain. Let’s have a look at each one in more detail.
Cash flow keeps your bank manager happy now!
Many property investors have been induced into focusing on the potential capital gains to be achieved and often place less emphasis on the regular cash flow or rental yield achieved by their investment property. In most cases they have no system of comparing the returns achieved by one property in comparison to another. (I use what I call the RTP or Rent to Purchase Price Formula which I discuss in detail in the ‘
Super Secrets® to Wealth Do-it-Yourself Home Study Course.) Furthermore, they are often more interested in the amount of tax they may save rather than whether their investment is worthwhile or not.
Rental yields on residential properties may be as low as 3% and as high as 11%, depending upon the location of the property and the type of property. Just stop and think about it, - if you own a property that is returning you just 4% per year gross and you are paying around 7% interest on your loan, you are already losing money before you pay for property management, water and council rates, strata fees, insurance and repairs. This concept of losing money in order to take advantage of tax savings is called negative gearing.
What about negative gearing?
The whole principle of negative gearing means that you need to lose more money than you are making in order to claim this loss against your tax so that you can receive a refund. Do you know of any business that can consistently lose money and still stay in business in the long term? I don’t!
While we experienced high inflation such as during the 80’s, negative gearing worked quite well, however I have serious doubts whether this is a wise strategy to follow in times of low inflation and possibly even deflation. To protect yourself from serious losses, I suggest that the strategy for the 21st century should be to focus on cash flow and positive returns wherever possible.
What about capital gains?
Whereas the likely cash flow can be predicted with reasonable certainty, the potential capital gain is very uncertain. As such, I believe that the serious investor should consider the capital gain component to be speculative and a bonus if it happens rather than an integral component in the planning and consideration process when a residential real estate investment is considered.
Can You Really Make Money in Real Estate?
I believe that by following a prudent investment strategy, you can certainly make good money in residential real estate. In order to do so you’ll need to be very clear about your objectives and strategies. You can then utilise your property portfolio to leverage into other investments to spread your risk and increase your returns overall.
About Hans Jakobi
Hans Jakobi is an educator, author and investor. He is the author of six best-selling books including,
How To Be Rich & Happy On Your Income which is available at:
www.supersecrets.com and the presenter of the Super Secrets to Wealth® do-it-yourself real estate home study course. Join Hans Jakobi’s FREE Super Secrets® Online Newsletter
© 2002 Hans Jakobi. All rights reserved worldwide
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