Looking for an investment property? Take the focus off the rental return and start looking at the capital growth. Here’s why…

When it comes to investing in property, I am a firm believer in QUALITY, not quantity. I really don’t see the point in building a portfolio of properties that deliver high rents yet fail to grow in value. (I will put in a caveat, however: there is only one exception to this rule*, and you will have to read to the end to find out what that is…) And even though I am a passionate property investor myself, it must be said that tenants can bring headaches, so owning a few really good properties is always easier to manage than a lot of ordinary ones.

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Here are eight really good reasons why capital growth is so important:

  1. The high cost of acquisition.

Unfortunately, the deposit is not the only money you have to come up with when buying your first property. There are other costs that need to be covered (stamp duty, legals, searches, inspections, bank fees, etc) and these add up to approximately 5% of the purchase price. Which means an extra $25K on an $500K purchase, or $40K if you are spending $800K. You really want your investment to cover these costs as soon as possible!

  1. The large amount of capital tied up in each investment.

Most people only have capacity to invest in one property at a time. You can’t chop and change once you commit to a property. Your ability to buy another is contingent on you saving up another deposit (and having the cashflow, but that’s a whole other topic) or having enough equity to borrow against. And capital growth is the way you build equity.

  1. The large amount of debt involved.

How do you feel about carrying debt? Some people can’t sleep at night for fear of a market crash or interest rate rises. The only good reason to take on debt with property is for leverage (not for negative gearing!!) – this means that your intention is to magnify your gains. But in order for this to work, you need to have gains!! We see too many people who have their borrowing capacity tied up in a low growth asset and this is incredibly limiting when it comes to financing other, better performing property.

  1. The lack of liquidity.

What this means is that property can be difficult to sell quickly (and it costs a lot to sell). But if you do need to sell, those properties with good capital growth prospects are a hell of a lot easier to sell than the rest. Also, you can’t sell part of a property to free up some cash, like you can with shares.

  1. High divestment costs.

I have noted above the costs of buying, and you also need to consider the costs of selling. Agent fees, advertising, legals, etc add up to approximately 3% of the sale price. That translates to $15K on an $500K sale, or $30K if your property sells for a cool million.

  1. The huge amount of interest paid over the life of a loan.

Consider this: if you borrow $840K over 30 yrs at 4% and pay interest only, you’ll pay a whopping $1,008,000 in interest & still have to pay back the original $840K at the end of the term! Interest rates are low at the moment, so the total interest you pay will no doubt end up being much higher.

Here is a couple of examples of how much interest you could be paying:

If you borrow money over 30 years and pay principal + interest at a rate of 4%pa, you will pay an additional 72% in interest. OR if you pay interest only, you can 120% interest to the total cost of your money. To put that into context, if you borrow $500K, you’ll pay between $360K and $600K in interest.

Increase the interest rate to 6%pa and you will pay the bank an additional 116% if you pay principal & interest OR a massive 180% if you pay interest only. On a $500K loan, this translates to a final interest bill of between $580K and $900K!!

You want to make sure that your property grows enough in value to cover this cost as well as all the others – and then still return a profit!

  1. You need to preserve your capital.

Once you have saved a deposit, you don’t want to blow it. What many Aussies fail to appreciate is that it is possible to lose money in property, so buying with capital growth in mind is essential in order to protect your hard earned savings.

  1. Once you have equity you have choices.

If you buy a property that doesn’t grow in value you have to hope that the rent continues to cover the costs of ownership. But if you buy one that goes up in value, you have a number of options that increase over time. You could use the equity to buy another property and maybe refinance in order to free up cashflow for other investments. You could renovate to add value. You might choose to sell it at the point of retirement in order to pay down debt. Or, if you started early enough and structured things well, you could simply live off the income!

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I don’t want to scare anybody off property investment! But I do want to stress that successful investors consider risk very carefully. There are ways to minimise risk and focus on the locations and property types that maximise capital growth.

Download our free eBook on how to choose a low risk investment property

*The exception to the rule is if you are at the retirement stage of life and buying property purely to generate an income.

 

Published:  19 January 2017

 

DISCLAIMER

Good Deeds buyers tips are intended to be of a general nature. Please contact us for advice that is specific to your individual circumstances. You may also need to get advice from other professionals such as an accountant, mortgage broker, financial planner or solicitor.

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