11 Jan 2017
local real estate
There are a number of ways you can make money in property. Unfortunately, there are equally as many ways to lose your cash. The key is to understand the different investment strategies before you dive in.
Choosing the right property strategy can be overwhelming, especially if you’re just starting out and talking to different experts.
For example, financial planners may suggest you buy new property to maximise depreciation. Developers may suggest off-the-plan properties, while your accountant may advise you to look at older properties.
The reality is, there isn’t just one way to get rich through property. But in general, there are three ways you can achieve financial freedom through property investing. These are:
- Capital growth strategy
- Cash-flow strategy
Capital growth strategy
A capital growth strategy, in a nutshell, is buying a property with the expectation that it will increase in value over a period of time.
It’s a strategy where you focus on getting maximum capital growth and making that as your priority.
“The capital growth strategy involves minimum effort after purchase,” explains Jeremy Sheppard, creator of DSRdata.com.au.
“The time-consuming part is the research. You want to find those markets that are ready to experience high growth right now and hopefully well into the future too.”
Your timeframe for holding any particular property can also impact what you are going to buy, so it’s important to be clear about your strategy first before looking for a deal.
A short to medium timeframe, for example, is one where your property grows in value over a 1-5 year period and then trading it back to the market or selling it to realise a cash profit.
For this strategy to work, you want to focus on an area where you can see a short-term major boost or buy in an area which is on the verge of an upturn to ride the impending growth.
A long-term buy and hold strategy means you are buying into an area where you can see the ongoing desirability of the area, where there will be continual demand and multiple reasons why the market has the potential to keep growing.
- It’s a passive investment. After doing the hard yards researching the right suburb and property, you can simply sit back and wait for your property to grow in value.
- Long term capital growth benefit. You reap the benefit of long-term growth in value which is key to financial freedom.
- You get the benefits of negative gearing. In general, capital growth strategy means buying in desirable areas with long-term growth prospect. As such, property prices tend to be higher compared to the rental income it derives, which produces a cash flow shortfall that you can then claim against your other income.
- Potential cash flow constraints. Because of its higher price tag, you’re likely to have to cover property-related costs such as mortgage repayments and maintenance issues out of your pocket.
- It’s difficult to time the market. Since you’re looking to maximise the capital growth of your property within the shortest possible time, you want to buy at the bottom and sell at the peak of the market. This isn’t always easy and could result in mis-timing your entry and exit.
- Lower borrowing capacity. As you spend more cash in supporting negatively geared property, you’d end up not being able to borrow further as you reach your maximum serviceability.
Who suits this strategy?
- If you have high income and looking for ways to maximise your tax benefits.
- If you have plenty of time to ride out at least one investment cycle (around 8 years).
- If you have the ability to support your investment out of pocket if it’s not earning enough rent to cover the holding expenses.
Cash flow strategy
As the name suggests, a cash-flow property investment strategy is where the priority is cash-flow.
This means there’s less focus on capital growth and other strategies such as renovation or development, although they’re also considered.
A cash-flow strategy can help those trying to supplement their income.
Typically, a cash-flow strategy is where the investment property earns more rental income than the cost of mortgage, property management, rates and other maintenance costs.
This strategy is generally favoured by many beginner investors, particularly those that are earning lower to average income.
- Higher borrowing capacity. Because the rental income covers most of your holding cost, you have greater disposable income that enables you to borrow more to invest.
- Extra cash flow. The extra cash flow can help you offset any shortfall you have if you’re holding a negatively geared property.
- Easier to ride out economic downturn. Having a property that’s self-supporting means you don’t have to sell it in a hurry if you lose your job.
- Generally, lower capital growth. Typically, higher yield, cash-flow properties are located in regional towns or in lower socio-economic areas where there’s higher demand from renters than buyers. As such, there tends to be lower capital growth.
- Slower to build equity. The lower capital growth rate means it’s also slower to build equity that you can then access to invest further.
- Low to no tax benefit. Because your investment property is generating income equal to or more than your expenses, your tax deduction is also lower. If your property is making more than it cost you to hold it, then you may even have to pay tax on it.
Who suits a cash-flow strategy?
- If you’re finding it difficult to get a mortgage due to tight cash flow.
- If you’re on an average to lower income investor.
- If you’re nearing retirement.
Renovation is a strategy where you actively seek out properties that you can improve to boost value or rent.
The key is picking the worst eyesore with the least cost to spruce up. The more you spend, the more likely you’ll “over-capitalise”.
- Potential to add value quickly even in a flat market. Because you’re forcing growth, you’re not relying on the organic growth of the market. This means you can boost your property’s value even in a stagnant market.
- Potential to make quick profit. If you time your renovation right, buy the right property and renovate well, you could potentially make big profits within a short period of time should you choose to sell.
- It’s easy to spend more than you plan to. Overspending on your renovation is very common especially if there are unforeseen issues that you haven’t factored in.
- There’s no guarantee that you make more money than you spend. While a lot of planning and buying well could help you mitigate this risk, the reality is that there’s no guarantee that your newly renovated home would be valued as you expected or want.
Who suits this strategy?
- If you’re an experienced investor looking to boost your home value quickly.
- If you’re looking to expand your portfolio quickly by accessing this newly-added equity.
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Credit Nila Sweeney