I come across a lot of clients wanting to buy an investment property. Here are a few things you should consider before taking the plunge.
You can ‘see and touch’ property – what about shares?
Yes, it is true you can see and touch an investment property. This is one of the main reasons people prefer investment property over shares. What if I said to you that you can see and touch your share portfolio?
When you buy shares in a company, you buy a part of that company. Consider Westfarmers shares.
Did you know that Westfarmers owns Coles Supermarkets? If you own shares in Westfarmers you own a small portion of Coles. I’m sure you would agree that you can ‘see and touch’ Coles supermarkets. Another example is Commonwealth Bank shares. If you stand in front of one of the Commonwealth Bank branches you can see the customers that walk in and out that branch. Every customer that walks in and out of a branch to transact with a bank teller is affecting your investment.
Property prices can be volatile.
An investment is only really worth what a buyer is prepared to pay. With shares we have the Australian Stock Exchange that tells us how much a buyer is prepared to pay (and therefore how much a share is ‘worth’).
Unfortunately, there is no “Exchange” for property. With property we need to rely on real estate agent valuations, market sentiment, recent auction results or even our own estimates. None of these methods are ‘real’. I can assure you, if we did rely on someone placing a real bid on our property, the price would move around quite a lot.
Whenever you buy an investment property you need to take into account the ongoing costs in maintaining that property. Ongoing costs include: rates, gardening and repairs & maintenance. These costs need to be paid by you. Other investments have little if any ongoing costs.
As a landlord you are at the mercy of your tenants. You only have to watch shows like A Current Affair or Today Tonight to see just how much damage and heartache a bad tenant can cause.
Ok, you’re probably saying to yourself that not all tenants are bad. Yes, there will be times when you are lucky enough to find a good tenant. Unfortunately, even good tenants can cause problems. The problem I’m referring to here is if they move out. You need to factor into your calculations that it may take time to find another suitable tenant. This may mean a reduction of cash flow from incoming rent.
Property is illiquid
Property can be illiquid. By illiquid I mean hard to sell. It is also illiquid because you can’t just sell part of a property. This illiquidity can cause problems if you need access to cash quickly (e.g. for an emergency). Shares, on the other hand, can be bought and sold instantly. The cash from share sales will be in your bank account within three days.
Direct property is a large investment. As a consequence, buying a property often results in your investment portfolio having a large allocation to a single asset. The performance of that one single property will have a huge bearing on the performance of your total investment portfolio. That is a big decision to make when you consider all of the other properties you have to choose from.
Yields (i.e. rent)
Australian property prices have had a fantastic run over the past 15 years. Unfortunately, rent has not kept pace with the increase in property values. As a result, it is not uncommon to see rental returns of between 2-4% on residential property. This is pretty low considering you can get a risk free return of 5-6% on a boring old term deposit.