Residential property investment
A GROWING number of Australians are investing in property, buoyed along by a market that is delivering good capital growth. But bricks and mortar also come with significant costs, and it's worth doing the sums to be sure you can handle the outgoings.
Housing finance figures for December 2009 show demand for investment loans rose for the second consecutive month. Many investors will be attracted to property by the steady price growth we're seeing in virtually every capital city
According to the Australian Bureau of Statistics, house prices nationally grew by an average of 13.6% last year. Melbourne values came up trumps, rising 19.7%, with Darwin (up 13.6%), Sydney (12.8%) and Canberra (12.4%) all enjoying strong price growth. Adelaide (5.1%) was the only city that failed to achieve double digit growth.
The capital gains seen in most of our cities last year is very appealing for would-be landlords. However one of the downsides of property is very high transaction costs.
Stamp duty, legal fees, loan application fees and pest/ building reports are all additional costs associated with property. Depending on the type of property and the price you pay, these buying costs can add an extra 5% onto the initial cost. That could mean outlaying an additional $25,000 on a property worth $500,000.
Later on, when you go to sell the property you'll be up for agent's commission (typically around 2.5% of the sale price), legal fees (to prepare the mortgage and exchange documents) and possibly early mortgage payout charges. If we assume these selling costs total 3% of a property's value, all up your investment needs to rise in value by at least 8% (5% plus 3%), plus inflation, just to break even over the period you have held the property.
That's why property is generally regarded as a long term investment. In addition to the vagaries of the market, it can take significant time just to recoup those hefty buying and selling costs.
The cash outflow doesn't stop with the purchase and sale of the investment. With an asset like shares, you hand over your money, then sit back and wait for the returns. Property is a bit different. You hand over the money...and then you hand some more...and then you hand over some more. Just like your own home, a property investment can be a constant source of expense.
At this point you may be thinking, "Yes, but I can claim plenty of these expenses against my tax". That's true. A wide range of ongoing costs associated with rental properties are tax deductible. But you have to be able to meet the cost before it can be claimed on tax.
That means being able to fund a new hot water heater when the tenant calls to say the old one has broken down. Or paying a plumber to make urgent repairs on a weekend, or meeting any number of expenses when they arise.
Don't get me wrong, I'm certainly not saying property is a poor investment. However, most landlords could be out of pocket for the first couple of years of the investment, so a very important question to consider is: what other source of income do you have to make up the shortfalls - and how secure is that source of income?
A good residential property investment provides long term capital growth and healthy rent returns, and if you are properly set up for it, I ordinarily recommend it. But if the upfront and ongoing expenses associated with property will put a strain on your personal cash flow you need to think very carefully about investing in bricks and mortar. It's a big financial commitment, and you have to be able to cope with, sometimes, big outgoings and occasionally, financial pain, along the way.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.