1.      How much do you want to borrow?

If you compare the total return (growth + yield) of residential properties against all other types of investment such as equities (shares), bonds, commercial properties, etc.  Over the last 25 years, shares and residential properties are very close and come out on top.

If you add how much risk you need to take in terms of volatility of their prices, residential properties would have outperformed shares by a long shot.  (In fact, you can calculate the impact of price volatility by a measurement called ‘risk adjusted return’, instead of just total return).

Instead of going into the complicated formula of ‘risk adjusted return’, I can give you a simpler demonstration of why low price volatility of an asset such as properties is actually very important to your wealth creation. 

When an asset has lower price volatility with steady growth, lenders are willing to lend you more money with less costs (lower interest rates).  This is the reason why residential properties have been the best vehicle to leverage safely, compared to other more volatile investments such as shares.

When you can leverage safely, you can use more of other people’s money to create your wealth instead of waiting to save up all the money required to buy the asset. 

Going back to your personal situation, if you are comfortable taking on more debt and want to go to a higher leverage to build a larger portfolio quicker, then the type of properties you need to buy need to fit into the lender’s preference: low volatility + steady growth.

There are many residential properties that don’t fit into this:

·          Some regional properties with very small population.  They might have high rental yield, but no steady growth of value, price can also be volatile due to the lack of demand from a small population.

·          Some rural properties with large acreage.  These properties may have very good growth in value, but very volatile in prices due to the difficulty for a quick sale when the lender needs their money back.

·          Many other specialized properties such as serviced apartments, holiday resorts, etc.  Many of these properties have a commercial arrangement that needs to be sold together with the property, which in turn reduces the appeal to general public and increases volatility on their sale price.

The properties that fit into the lender’s preference are usually the ones that can be put on the market with no strings attached, and within a very short period of time can be sold at or above the price of the lender’s original valuation.

So it is very important to understand that your desired leverage level can overwrite other conditions such as growth and yield.

2.      What is the minimum return on investment?

It is very common that property investors measure how much cash they put into an investment property against how much cash they get out eventually, we call it cash on cash return.  We all like higher cash on cash return all things being equal.

The problem is that things are not always equal.  Objectively, you can say that you can’t ask for higher return without considering accepting higher risk.  But this statement is not much use in practice because risk itself is very subjective to the individual.

What is considered risky to me may not be risky to Warren Buffet, what I consider too much to lose can be so small that he wouldn’t even notice that he has lost it.  On top of that, someone like Buffet could probably alter the property prices in a suburb with his personal influence to reduce the risk of his investment property. That option is not available to everyoneJ!

So again, the minimum return on investment is determined by your risk appetite and personal capacity, including skills, money and time you can bring to the game, this will dramatically alter the way you go about doing properties.

As a very rough guideline for return on investment in the current market, it can range around 8% to 30%.  While the low end is representing almost risk free type investments such as bank saving deposits and highly secured debts, and the high end is representing unsecured capital investment into higher risk business activities.

3.      How much of your own money are you happy to put in?

Many property investors started investing in properties with very little money, they were forced to be creative and leverage other people’s money.  What they usually do is to trade other people’s money with their own time and effort.

After a while, you may have accumulated a certain level of wealth and experience, and start to find yourself having less time and more money sitting around not being deployed to make more money for you. So you would probably start thinking about paying other people to do the work or putting a bit more of your own money in the deal to save some of your time and efforts.

There are also investors who are still doing a lot of the work themselves and trade their own time and effort with other people’s money after they have accumulated a lot of wealth.  There could be many reasons for this: some do it because that is what they love to do, others do it because they are happy to share profits with others as long as they can protect their capital.

If little of your own money down is very important to you, you may find yourself targeting property transactions that require a lot more creativity and effort, and your people skills will become more important.

4.      Are you prepared to work at it?

One of the main attractions of residential properties is that you can do something about it to increase its value such as renovation, subdivision and other forms of value added activities.  You can also work hard to get a bargain by good research and negotiation because you are always dealing with a subjective seller.

There are lots of ways to speed up wealth with properties, it all depends on whether you are prepared or able to work at it.

A large percentage of property investors can’t afford the time or haven’t got the know how to work their properties, they make their money elsewhere, property is simply a vehicle to store and grow the money they have made from other activities.

A very small percentage of property investors work very hard at their properties, some even go so far to quit their other jobs and businesses to concentrate on this.

Depending on who you are in this category, you will look at your properties quite differently according to your needs, and there is no need to stop doing what you’re good at and follow others.  The best person to emulate is always yourself.

5.      When, where, how and what to buy? 

These are the 4 standard questions most property investors would ask, but most of them ask as if the answers can be obtained objectively, and that is far from reality.

·          When to buy

People often try to get in at the bottom and sell at the top, but most of us can never get this timing right.  I think the best time to buy is whenever you are ready financially, it is more important that you are ready than other people are ready for you.

·          Where to buy

Many research institutions can list the top performing suburbs and streets for you, but eventually it all comes down to whether they fit your other requirements, or whether you are able to physically inspect lots of properties in those areas if you don’t live close by and unwilling to buy the site unseen.

·          How to buy

There are so many ways to buy a property, anything between do it yourself to completely hands free using professional help, again this is very much dependent on your experience and the time you have available for your investing.

·          What to buy

There are different types of properties and different price ranges, choosing what to buy is very subjective to the investor.  For example, the most expensive properties have outperformed the low end properties due to the fact that the rich become richer quicker.  Depending on the investor’s financial capacity, these properties may or may not be a viable option.

6.      What about tax benefit?

The amount of tax benefits you could get based on your personal situation can alter dramatically the type of properties you would buy.  For example, a very high income earner would get better depreciation and negative gearing benefit from a more recently built property, whereas a self employed business owner may not put as much weight on the negative gearing benefit from their properties.

This can further complicate the situation if there are other family members involved in the property when you consider the future capital gain tax distribution.

In summary

We can’t really gauge the true value of an investment property objectively.  The quality of an investment property can be measured by how well it meets the needs of the investor at a point in time; hence property performance is a subjective measurement to the investor, and it has very little meaning to other people.

If we go one step further, we can almost say that wealth creation itself is a self arriving journey, it has very little to do with external market conditions.

This article was written by Bill Zheng (founder and CEO) of Investors Direct™. Investors Direct is a specialist investment mortgage brokerage that provides financial solutions exclusively for investors. Our goal is to help every day Australian’s build sustainable wealth for their families through the educated use of residential mortgages. To subscribe to our FREE monthly e-newsletter visit www.investorsdirect.com.au

In this DVD you'll discover ...

• The steps you need to take to protect assets

• How to save capital gains tax and stamp duty.

• How different estate planning and asset protection strategies can save over $300,000 tax on a few rental properties over 20 years.

• How trusts can safe guard your assets from litigation.

• Why the rich rarely buy assets in their own name.

• How to pass your assets to your children effectively. 

• How 80% of people turn a tax deductible line of credit into a non deductible line of credit by parking their wages.

• Special benefits of the Property Investor Trust Deed.

Click here to order your copy today.