Property industry professionals understand and accept that lenders are now under more scrutiny than ever before – with new lending legislation (Credit Code) introduced recently, not to mention the Global Financial Crisis (GFC).

However there is an irony here – especially when you consider this country’s desperate need for housing.  On the one hand it is absolutely essential that Australia continues to regulate its finance industry to ensure we never end up in a situation similar to America. On the other hand, the tighter the lending market becomes, the more desperate our housing shortage.

By way of example, according to a recent survey by the Master Builders Association of Victoria, there is an undersupply of 29,000 homes in Victoria with 5,000 too few homes being built each year. If this continues and you are interested in where Victoria will be in 10 years (the average time it takes for property to double in value), it’s a pretty simple equation: 29,000 + (5,000 x 10 years) = 79,000…that’s a 79,000 housing shortage in Victoria alone.

According to Executive Director of the MBA Victoria Brian Welch, the MBA survey clearly showed the impact of tighter lending practices.

An opportunity to profit

So the question is…how can property investors profit from the housing undersupply?

The answer to this question gets back to basic economics – when demand exceeds supply, prices increase.

The world’s greatest investor Warren Buffet advocates not following the crowd, ie doing the opposite to the majority. In terms of the property market, right now is a buyers market and smart investors are getting into the market, while not so smart investors (the majority) are sitting on their hands.

So cutting to the chase, now is the time to be buying property in Australia BUT with one very big caveat…do your research AND if you’re unsure as to what you’re doing, hire professionals to help.

Even those of us who do this for a living (as professional buyers agents), surround ourselves with a team of professionals including lawyers, accountants, building/pest inspectors, mortgage brokers, quantity surveyors, etc.

Let’s face it, buying real estate is the most significant purchase most Australians will ever make. If you make a mistake, the penalty is both very costly and long-term. So it pays to get it right!

If you would like to learn more about investing in Australia real estate, visit our website at:  www.ifyl.com.au where you can download your FREE Report…”The 7 Most Costly Mistakes Property Investors Make And How To Avoid Them”

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1. How could I profit from this investment?

2. How could I lose from this investment?

3. What is the worst case scenario?

4. What form of protection can I put in place?

5. Do I want someone else to take/share the risk?

6. How can I improve the profit potential?

7. What is the probability of loss versus the probability of profit?

8. Exit strategy – at what point will I cut my losses?

9. How will I collect the profit from this investment?

10. Does this investment fit into my plan?

11. Is this investment balancing my portfolio?

12. Will it enhance my life?

13. Compared to other opportunities, does this investment provide the best return for effort? 

This is by no means a comprehensive check list but is designed to cover most of the issues which arise in property investing.  For sure, each investment opportunity and each individual has their own unique circumstances but a check list offers first time investors an opportunity to consider issues which can make the difference between success and failure in property investing.  Property investing will not always deliver the anticipated profits, particularly if you’re new to it. 

New investors will look at the past performance of property and see the obvious attraction of buying.  It is too naïve to assume that you can put a small deposit down and simply reap the rewards of capital appreciation and a high yield over time.  There are periods of time when property prices languish and even decline. That should not deter us in moving forward. 

People’s circumstances can force them to divest of property – usually at the most inconvenient time.  What looked on paper as a good opportunity turns into a lemon and leaves you poorer for the experience.  Indeed in the early part of the last boom from 2000-2004, many investors buying at the (then) peak of the market lost their deposits.  This was particularly evidenced in some Melbourne high rise, off-the-plan investment ‘opportunities’. 

Investment is about managing the process of investing and ensuring that all the factors that can contribute to a loss or a risk investment are mitigated against and dealt with. 

Profit Management  

We buy into property in order to increase our wealth.  Wealth building comes from growing equity.  Equity growth comes from capital appreciation of the property and the capacity to leverage your equity into other property investments.  The actual process of generating wealth involves generating profits.  Property investing in this respect is no different to any other business activity.  Profit is the difference between the revenue and the cost of generating that revenue. 

Profit comes from:

• Cash flow
• Equity
• Lump sum cash

Cash flow arises when income exceeds your investment outgoings. 

Investing is a learning experience.  Each investment experience, whether researching or actually buying and owning the property teaches us valuable lessons which we can use to further our skills as investors and to enrich our lives. There is much to learn in property investing and like many other investment activities such as share investing and business building, each experience is folded into the next to make us better at what we do. 

Property investing can be a deeply satisfying experience.  There is great security in wealth building around bricks and mortar.  We intuitively trust property. . . we can see and touch it.  This is very different to shares where we have little control over the underlying performance of the business.  In property, we can influence our outcomes through careful research and buying well and adding value. 

These are powerful lessons for us and each lesson can be even more powerfully applied to future actions.  Profit can also be in the form of knowledge, experience, network contacts, and opportunity for further investments.  One of my very favourite quotes is: ‘knowledge pays the best rate of interest’.

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You could be forgiven for feeling that there is another boom around the corner. The turnaround in the housing market is truly remarkable. Sydney in the last 6 months has provided more growth than was achieved in the last 24 months. Melbourne continues to outpace all markets (except Darwin) on a 12 month basis. The latest data from the Real Estate Institute of Victoria (REIV) revealed Melbourne’s median house price rising by a stunning 13% to $441,875.

Population growth

Melbourne’s population surge is set to continue well into the next decade according to the ‘Victoria In Future Report’. Further, The Age reported recently that Melbourne will add 70,000 residents each year for the next five years making it the highest urban growth area in Australia.

The data commissioned by the Residential Development Council firmly supports the view that Melbourne will have a significant under-supply of homes by 2013.

Figures produced by Matusik Insights indicate that Melbourne will need 29,000 a year for the next five years a figure which suggest that alternative housing solutions will be required such as houses on smaller lots, townhouses, villas and apartments.

Melbourne Record Auction Clearance Rates:

The REIV Weekly Auction & Sales Results, Market Overview released on Sunday 30 November 2009 showed a total of 547 of the 642 auctions reported to the REIV sold, resulting in a clearance rate of 85 percent.

The report said that, unlike other weekends this year there were more auctions scheduled than the comparable weekends over the last three years.  The fact that the clearance rate remained above 80 per cent for the 16th weekend in a row removes any remaining questions about the strength of the market this year.

It was reported that REIV chief executive Enzo Raimond had said that the Melbourne property market had moved from “healthy” to “strong” on the back of low interest rates and first home buyer incentives.

Capital expenditure booms in Melbourne

Victoria is at the centre of an investment surge. Business investment surged over 2009, nearly all of it accounted for by an astonishing 20 per cent rise in Melbourne.

Private capital expenditure in Victoria is now at its highest on record, even after adjusting for inflation. The figures have supported the overall in the national accounts which were released early September which showed an above expected growth in the Australian economy with economists suggesting that investment was coming as the impact of the Government’s infrastructure stimulus package is only beginning to be felt.

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When is the right to time to invest? Where should I put my money? These are typical challenges facing the property investor or home buyer. Another property conundrum is the House vs. Apartment conundrum. Owning an apartment is usually an easier entry into property ownership than a house. The obligations of owning a property, that is, all the things that come with owning a house – repairing of gutters, painting and general maintenance of the property – are managed by an owner’s corporation in the case of an apartment.

Further, the rental yield is generally higher than a house in the same area due to the lower capital outlay. With affordability becoming the single most important driver in the residential property market, it is hardly surprising that twice as many people are buying apartments today as were buying 10 years ago. Moreover, the future is looking like more of the same: population increases in all Australia’s capital cities is surging, with Brisbane, Melbourne and Perth exhibiting very high growth and Sydney set to be a mega city in years to come.

All government planning authorities are running the ‘slide rule’ over available land resources and saying: “Let’s increase densification. The equation is simple: build more on less land. This leads to high rise – apartments as well as densification in the form of small lot sizes and strata development into duplexes, town houses and villas. With Australians’ propensity to live along a few kilometre strip of the coastline, this trend spreads to regional centres, well evidenced across Australia especially in South East Queensland, Northern Rivers NSW, and Central Coast NSW.

What goes up?

Property prices increase over time. But it is not the bricks and mortar that necessarily increases in value; it is land. Land is a scarce resource and therefore rises in value according to a corresponding rise in demand.

The value of a $500k house might be split between $200k for the land and $300k for the value of the building. Whereas in a $500k unit the land size is obviously smaller and so usually wouldn’t rise as much.

Logic then suggests to always buying a house. But this logic, due to the factors noted earlier is no longer always valid.

Data coming out of Brisbane’s inner suburbs, Melbourne suburbs less than 5km from central city and Sydney’s inner suburbs, show that apartment prices have equalled and in some cases exceeded house price gains over the past three years. The entry level factor for first home buyers is a factor: many buy an apartment as their first home, but there is a strong desire too to buy the ‘lifestyle”. Many people don’t want to live 30-km from city centre; they want to live in dense, crowded centres where their friends, the amenities, the lifestyle and the beaches are located.

Some of the more relevant issues when comparing houses and units include:

Houses

• Consistent growth and you own the land

• Control over the property but higher level of maintenance

• You have options – easier to ‘value add’ and modify use

• Lower rental yield

Apartments

• A trend toward strong growth in built up areas

• Meeting population trends to downsize

• Less control over the property but a lower level of maintenance

• Higher rental yield

• Body corporate fees

Given that the value of property is its land component, our philosophy has always been and remains primarily in favour of houses. There are however two emerging issues that require further consideration of unit investment: (i) population trends toward smaller family size and the increasing popularity of proximity to city centres AND (ii) units in small blocks (say up to 12 units), do offer significant capital growth opportunities. BUT the message is always the same . . . ‘Buyer Beware’

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Before I launch into a discussion about this extremely important topic, I issue one caveat:  almost everyone has an opinion and what follows is my opinion based on personal experiences – my own AND those of my clients. Ultimately you will need to make your own decision. You should seek the advice of your professional advisors prior to making your decision.

Notwithstanding this discussion is based around personal opinion, there is a good deal of anecdotal evidence to support my proposition.

OK, now that’s out of the way, let me answer the question: ‘should you consider fixing your mortgage interest rate or not?’

My definitive response to that question is NO!  Let me explain why.  I call this. . .

‘5 Reasons Not To Fix Interest Rates’ –

Reason #1: How do you know where the cycle is at?

Like most elements of the economic equation, interest rates run in cycles – they go up and they go down.  In fact when you graph interest rates over time, they appear like a ‘bell-shaped’ curve with ‘peaks’ and ‘troughs’.

If the standard variable interest rate is currently at (say) 5.6%, are rates at a peak, a trough OR somewhere in between?  In my experience, in order to get it right, you either (i) need to be brilliant (having completed your calculations, graphs, etc and come up with the right outcomes in terms of where the interest rate cycle is at) OR (ii) need to have ‘lady luck’ (in copious quantities) on your side.  Well let me tell you, neither occurs very often so probability is definitely on the lender’s side.

Reason #2: How do you know what’s likely to occur in the future?

If you are able to predict the future, please give me a call – I have a business proposition for you.

If you have had any experience investing in or trading the share market, commentators often talk about the difference between predicting the future and the probability of something occurring in the future.  It is impossible to predict the future . . . at best we can only attempt to calculate the likelihood (probability) that something will occur.  I don’t know about you BUT I have little confidence when attempting to ‘guesstimate’ where rates are likely to end up.  Anyway, generally speaking, fixed interest rates tend to factor in rate increases well in advance, so by the time you decide to fix, it’s probably too late anyway.

Reason #3: Do you really want your banker to control what you do?

Imagine you want to buy your first (or another) investment property and your existing lender (with whom you have a fixed interest rate loan), will not ‘come to the party’ with the necessary funds.  You decide to change lenders – to one that will lend you the money required.  You approach your current lender for a payout figure on your existing (fixed interest) loan and are informed that in addition to paying back the mortgage balance, you are up for break costs of an additional (say) $30,000 (I’ve used $30,000 only as an example based on recent anecdotal evidence – break costs will vary based on the circumstances of each individual loan BUT they usually are significant).

You now have a decision to make. . . break the loan and incur the significant costs OR not.  If you decide not to break the loan, there is a strong possibility you may not be able to buy that investment property.  In other words, your lender is in control.

Reason #4: How much will it cost you in ‘break costs’?

A common response to this question is. . . ‘BUT I wont need to get out of the mortgage contract and therefore I wont be affected’. I cannot calculate the number of folks who have said this to me only to find that some time during the fixed rate period, they either want to OR need to exit the fixed rate loan contract.

Most folks seem to think that circumstances will never change and that even if they would prefer to exit the contract, they will hang on to the end (and therefore not incur break costs).  What they fail to consider is that individual circumstances do change – could be employment, health, family or a variety of other reasons.  In other words, based on changing circumstances, you may not have a choice.

Reason #5: How much will it cost you in the mean time?

With most folks there is usually a ‘time-gap’ between the level variable rates are at AND when they make a decision to fix.  An example will help to demonstrate:

Imagine the standard variable mortgage interest rate is currently 5.6% while a comparable (in terms of features) 5 year fixed rate loan is 7.5%.  That means your variable interest rate will need to increase by almost 2.0% (7.5% – 5.6%) before you start gaining any benefit.  At this point you need to ask yourself two questions: (i) are interest rates likely to increase by 2.0%+ over the next 5 years? AND (ii) even if they do (increase by 2.0%+), when will they increase?  Normally rates increase gradually, so if you were to fix your rate at 7.5% right now, you will have to wait until variable rates increase by more than 2.0% before it stops costing you money.

Well there you have it.  In my opinion, no-one should ever fix interest rates because the balance of probabilities (the likelihood of guessing right) is definitely in the lender’s favour.  I don’t know about you BUT the one thing that really ‘urks’ me is lenders having more control over my investments than me.  After all, isn’t the purpose of education and experience to control your own destiny. . . no-one cares more about your money than you.

Want to learn more about Real Estate Buyers Agents and how to develop amazing property strategies?

Claim Garry’s popular Free Report: “The 7 Most Costly Mistakes That Property Investors Make And How To Avoid Them” identifying strategies you can implement immediately guaranteed to save you thousands, available at:

http://www.ifyl.com.au

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The truth is that positive cash flow property is a bit like the Tasmanian tiger: they exist but finding them is another question. You can find them but you’ll generally only find them in suburbs or towns which present the investor with changing questions: “Do I really want to invest here?”  We are not taking an overly negative view of such opportunities but do suggest investment on cash flow grounds need consideration of certain criteria:

1. A regional or rural town must have a population base of at least 2,000 dwellings
2. Real estate should indicate a future growth rate of better than five per cent, and
3. A property should show a gross rental yield of better than five per cent.

Tax matters

A high marginal rate tax payer derives significant benefit from receiving marginal tax cuts while (depending on the timing of any  sale), paying tax on only 50 per cent of the capital profits generated.

A low growth/high yield strategy is likely to suit those on lower incomes as the extra rent may allow them to fund an additional property. The lower income earner has fewer dollars available for funding their investments. Indeed some lower income earners who aspire to be property investors simply cannot afford to fund a negative cash flow.

Positive cash flow investing means that you have more money coming in from a rental property than is going out. It is the cash left over after allowing for cash costs of mortgage, insurance, interest, maintenance expenses, and supplemented by the non cash tax deductions (deprecation etc). If the operating expenses exceed annual income, the tax break becomes tax back in your pocket. When the after tax effects are added in to the investment equation and a positive result is achieved then you have positive cash flow from a property investment:

Positive cash flow investing remains vastly misunderstood by many investors.

Whether an investor finds a property that generates a positive cash flow depends on many things: rental income, the interest rate, allowable deductions, and your own marginal tax rate. As a simple rule of thumb threshold gross rental yield of around 8 per cent is needed to achieve positive cash flow, however (as mentioned above), this depends on the numbers involved with each specific property.

This should not be taken as a magic number, rather as just one of a number of selection criteria. The other issue is that of real long-term capital growth. This may mean eschewing fashionable urban areas in favour of drab, industrial suburbs or, as discussed earlier, regional or country towns.

A word of warning: if you are focusing on positive cash flow investments and considering investing in regional or country areas (for example), you MUST develop an intimate understand and knowledge of the issues involved and how best to proceed otherwise it could cost you BIG TIME.

Yield investors need to have their calculator ready to ‘do the numbers’. This involves making an estimate of the potential income (remembering to build in a vacancy factor of say, 2-4 weeks a year and the costs associated with advertising the vacancy), then adding up all the costs, including potential repairs. The remaining figure will be the amount of cash flow. Tax deductions in relation to depreciation on buildings, fixtures and certain contents will boost yields further as these are non-cash, tax deductible expenses in the year they are applied.

Risks

A regional or rural investor attracted by high rental yields must be concerned about the local economy. Investors feeling warm and fuzzy about high regional yields need look closely at the local economy.

Investors in regional towns are faced with higher risk than their city counterparts. In some towns you have to wonder whether there will be any population growth at all. If there isn’t going to be any real economic growth in a town then investors need to be compensated with a much higher rental yield.  Intending investors need to conduct a risk review that considers local economy risk as well as the more general risk of interest rate rises.

Leading into 2010 (and beyond), never has it been more important that investors understand what they are doing.  This market is not the time to be taking unneccessary risks.

Want to learn more about Real Estate Buyers Agents and how to develop amazing property strategies?

Claim Garry’s popular Free Report: ‘The 7 Most Costly Mistakes That Property Investors Make And How To Avoid Them’ identifying strategies you can implement immediately guaranteed to save you thousands, available at:

http://www.ifyl.com.au

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As we all know, Christmas, Easter, Summer, Spring, etc are cyclical…they come around once every year at the same time of the year. We are great believers in cycles: what goes around, comes around and history has a most unusual way of repeating itself: politics, wars, relationships etc. Even the weather can be talked about in a cyclical sense. How often have you heard someone say: “We are due…” when referring to a cyclone or a flood?  When looking to buy residential investment property, it’s worth considering these cycles.

The financial world is also cyclical. Take the Australian economy for instance. It goes through periods of booms (inflationary) and busts (recessionary). The Central Bank attempts to keep inflation low by raising interest rates. An increase in interest rates has a dampening effect on spending. Less spending causes less demand for goods. This means fewer jobs thus accelerating the decline in demand. If this lack of demand becomes too great, it will cause a recession (technically defined as two periods of negative growth). Recessions are also frowned upon by the Central Bank. Indeed, the Central Bank Charter actually places a recession as a major event to be avoided (if it can) at all costs.

So, what does the Central Bank do when a recession threatens? Decrease interest rates, of course. This will cause more money to be circulating throughout the economy thus stimulating demand, creating jobs, etc. The Central Bank has a very difficult job trying to create a balance between keeping inflation low and avoiding a recession. Sometimes they get it wrong. For some time now, we’ve been saying that the last three interest rate rises were poor decisions. We have been proven to be correct.

The demand for houses is also cyclical. When property is in high demand it is good for sellers (vendors) as they generally achieve higher prices for their properties. Other times it is good for buyers. When there are few buyers in the market place, it causes vendors to lower their expected return because of the lack of demand. Prices will level out.

The later is exactly what has been happening over the past 24 months or so. The world-wide financial crisis has made many investors ‘jittery’. There has been a lack of demand for property which has caused prices to level out. Many experts are suggesting interest rates have ‘bottomed-out’ and that they will begin to increase over the next twelve months as the Central Bank attempts to manage (what they suggest), will be a growing economy. The verdict for residential investment property . . . now is a great time to buy.

Listening to many financial ‘gurus’ the message is very clear: they are unsure what will happen to the stock market. This makes it a very unstable investment. Additionally you will not become wealthy by depositing your money with the bank – unless you wait 60 or so years. So what does that leave? Property of course!

In my over 20 years of experience in the property market, I have never witnessed conditions as good as they are right now for investing in real estate – interest rates are low (although they may increase), rents are increasing and there is a chronic shortfall in supply that is predicted to worsen. I am hearing from agents that their long-term investors are returning and looking for bargains which are there for the taking. It is my opinion that this demand will grow which will in turn cause prices to begin to rise. So, now is the time: remember, property is cyclical and in my opinion, now is the best part of the cycle to buy.

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