Australians love for property investment cannot be disputed. A tax system that promotes investing in property coupled with the ‘quarter acre dream,’ has seen the Australian investment property market grow to $985bn1. This love of property investment can sometimes cloud personal judgement in what could be a good or bad investment decision. There are many advantages and disadvantages or property investment and investing in one type of investment is not for everyone. What would the MoneyGeek consider when weighing up a property investment?
Property Investment Advantages
No doubt one of the biggest advantages of property investment is the Australian tax system. An investment property can obtain a range of tax concessions including deduction of interest repayments and depreciation of fixtures and fittings. For a newer home, depreciation deductions can be large. The tax concessions available to property investment are relative to the investors income and the rent received, the higher the income, the larger the tax benefit for negatively geared properties.
Regular Cash Flow
Rent paid is another big advantage of property investment. Bad tenants aside, an investment property will return both by capital growth of the property and also the rent received each week. Rental Income will normally offset the loan repayments for negative geared investments or will provide an additional cash flow for a property that is positively geared. This cash flow is all but guaranteed for property investments with good long term tenants and low vacancy rates.
Some investors like to feel attached to their investments. For those who like to ‘see and feel’ their investment, being able to know the physical property is there gives comfort to some. Being comfortable with an investment is important!
Property Investment Disadvantages
Concentration of assets
Property is a big purchase, typically requiring hundreds of thousands of dollars. Concentrating what is typically the only investment that a person may have aside from superannuation into a single asset is a higher risk and a disadvantage. Give someone the same amount to invest in the share market and I’d be surprised if they invested the whole amount into a single company. Diversification is hard with property and typically your investment capital will be tied up in a single asset. If anything goes wrong with the property or the market moves negatively; your whole investment capital is at risk.
Management Costs / Involvement
Compared to other investment types, property is expensive to buy, sell and maintain. It is not unusual for purchase costs to hover around 5% and around 2% to sell. On top of this is property management costs, repairs and rental income lost through vacancies. All these costs offset the gross returns that the property investment will provide (considering buy / sell costs alone and ignoring tax and rent, that is potentially 2 years capital growth needed before breaking even!). On top of the cost is time needed to maintain the investment. You need to find a property agent, screen potential tenants, approve repairs, deal with body corporate and regularly deal with the accounting/tax of the property. You can outsource these functions, however again this comes at a cost which will offset what you potentially gain. Property investment is typically a more time intensive investment compared to other assets.
Any investment that involves borrowing means a higher risk, especially when it involves a single asset. During the ‘GFC’ many lost money on the share market from borrowing. Why didn’t property investors lose out as well? Well many did, it is simply less reported as values are determined privately between buyer and seller. If property was valued publicly on a daily basis like shares there may have been more nervous investment property owners and more nervous banks!
Gearing is risky, particularly with property where it is common for people to borrow up to 95% and use their own home as security. Gearing increases returns but also increases losses. Interest only loans are popular but this also highlights gearing risk. If after capital gains tax, you cannot sell your property for the principal balance of your loan that is left from the interest only loan; you are liable for the difference, this could be tens of thousands.
Many investors think that property never reduces in value – nothing could be further from the truth. Property has a similar risk/return profile to shares and the risk of losing money on property is similar to that of shares.
Much of the attraction of investment property is the’bricks and mortar’ element, but this is also the source of a major disadvantage. Property cannot be divided, it cannot easily be partially sold and is not overly liquid. What happens if you need capital? The entire property needs to be sold. What if it takes months to sell the property? Unlike shares or cash, where a portion can be sold immediately, you can’t sell a couple of bedrooms to unlock capital. Equally, property isn’t an asset that is designed to be sold quickly. Quick sales are normally done under true value.
Much attention is given to the initial tax deductions with property. Less consider the tax consequences of selling property, less again unfortunately seek tax advice and a proportion ‘forget’ to set aside money for the tax bill in July.
Many on higher incomes are attracted to the tax deductions available, but high incomes magnify the tax that you need to pay when you sell the property. Much like the house always wins at the casino, the tax man always gets his dollar! Capital Gains tax payable can exceed the deductions available – do your sums!
Like any investment, property has a place in an investment portfolio. Before buying an investment property, list the advantages and disadvantages and how they relate or could relate to your situation – be realistic. Also testing a potential investment property purchase against other investment alternatives can provide investment clarity. We all love property, but don’t let that love be blind when considering to invest!
Considering an Investment Property?
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Know any other advantages or disadvantages of property investment! Share your MoneyGeek tips in our comment section below!
About the Author – The Money Geek
The Money Geek is the head money blogger for MoneyGeek.com.au. With over 8 years experience in the finance industry, the Money Geek provides information over a range of topics to help families Australia-wide improve their financial literacy to become their own geeks and take control of their financial future!