Investing in Property? Things you should keep in mind
20 Jun 2014
By Sally Huynh
Property may seem like a great investment opportunity, and for some it is. However, it is not the right choice for every investor.
Several common misconceptions exist about investment properties. Understanding the realities will help you make an informed decision before deciding whether or not to invest. Below are four key things to keep in mind:
1. Ownership and debt
Property investors often talk about the property they 'own.' However, a closer look often reveals that their property has large amounts of debt. So, the fact is until the debt is repaid the 'bank' holds title to the property not the investor. An investor's ability to rent or renovate their property can provide a false sense of ownership. The fact is, until the debt is repaid, it is the 'bank' that actually determines if title can be transferred, not the investor.
2. The real value of tax deductions
The ability to claim tax deductions for ongoing costs, including interest expenses, is a huge incentive for property investors. Yet many investors often mistakenly believe they can get dollar for dollar back for those expenses. That is not the case. Tax deductions mean certain expenses are offset against a person's taxable income. Effectively, an individual will receive an amount equivalent to his or her marginal tax rate. For instance, if your marginal tax rate is 35% for every $1 of cost, you would receive 35 cents back and the residual 65 cents are lost. It is this margin of loss that is frequently misunderstood.
3. A false sense of security
While most people are familiar with the investment risks involved in the share market, there is often a false sense of security when it comes to property. Despite the traditional belief in 'bricks and mortar being as safe as houses', the reality is that the value of property still rises and falls. Unlike shares, however, the day to day real value of property is not known. Without a real number to worry about, people can assume an 'out of sight, out of mind' attitude. However, we only need to look back in history to see that there were periods when property prices did decline significantly (see chart below). Furthermore, despite the common misperception that shares are riskier than property, shares and properties actually produce similar returns in the long run (see chart below).
Property often generates income weekly, which makes it appear 'safer'. In contrast, shares generally produce income half yearly. However, on average, residential properties currently only generate about 3% income a year once ongoing expenses such as rates, insurances, minor maintenance etc, are deducted. Australian shares, on the other hand, are typically generating about 6% a year (inclusive of franking credits).
4. Actual costs
Investors tend to remember the purchase and sale prices of a property quite well but forget the many other costs. Not figuring in stamp duty, agent fees, lost interest paid and additional capital outlaid for renovations and repairs can make gains appear higher than the reality.
Bringing it all together
It's important that, as an investor, you consider the above issues before purchasing an investment property. From a wealth creation perspective, property is only one of several asset classes available to build wealth. Each asset class has a role to play depending on what you wish to achieve. The common teaching 'don't put all your eggs in one basket' holds true, so before you commit all your wealth into property, seek to understand your investment choices to ensure you can achieve a successful investment experience.
To learn more about Sally, view her online profile.