Welcome back Property Investor,
Now we know where to buy, the question is, “what to buy?” Our answer to that is generally this: “brand new, residential property in the middle of the market”.
Let me explain why.
First of all, if you’re in residential property you can achieve a higher lending ratio, thus buying more properties with the cash or equity you have. For example, if you want to buy a shop, you’d be lucky to get a 70% loan for it as it is a commercial venture, and you’ll also pay a higher commercial interest rate.
With commercial properties, you are restricted to borrowing less and you pay more for it! Whilst with residential you can often borrow up to 90% depending on where you are buying and the lender’s criteria, and get a lower interest rate. The more property you have the more you make when prices move. Simple.
Why the middle of the market?
The reason you should stay in the middle of the residential market is twofold. Firstly, it is less volatile in terms of fluctuations in property values when compared to the higher end of the market, and secondly, the quality of tenants is higher than the lower end of the market.
The high end of the residential market is driven by the demands of the wealthy. Generally speaking, most wealthy people are in business of some form and as such their fortunes, and thus demand for high-end property, are directly tied to the state of the economy.
Another point to note is that the higher end of the property market usually has a very poor rent return when compared to the value of the property. Because anyone who can afford to rent an expensive home can usually afford to buy their own. As such, there is less demand for expensive rental properties and vacancy periods are also longer. So stay away from there!
At the lower, or cheaper end of the market, you are more likely to find your tenants from hell. Now we say this very carefully, because in no way do we intend to say that all poor people are bad tenants. We are just saying that bad tenants are usually poor.
It is also worth considering that every property you own does come with some sort of overhead on your time. Even with a real estate agent managing each of them, you will still have to give some of your time to each one.
So why would you buy ten $200,000 properties at the lower end of the market, when you can have four $500,000 homes in the middle of the market, avoiding the tenants from hell and having a lower management overhead?
Some investors like to boast about how ‘many’ properties they have, but the smart and more successful investors know it’s not ‘how many’ you have, it’s ‘how much’ they are worth.
So if you stay in the middle of the residential market, you’ll be able to buy more property, and your property values will be more stable – which is very important when you are trying to build a stable portfolio.
Why NEW Properties?
The next thing we will say is to buy new properties. Why would we say that? Well, there are several very good reasons.
6-12 month builders warranty. First of all, when you buy a new property, you get a 6-month builders warranty in most states. So one of the first things you do is instruct your new tenants to tell you every last thing that is wrong with your property. Now, most tenants would be shocked to hear their landlord actually encourage them to do that.
So when you’re adding that property to your portfolio, you’re going to have the most enthusiastic people in the world looking out for you to ensure everything is right with your new property, and that is the people who are living there! So they then send you a long list with everything that is wrong and you simply forward that to your builder. And your builder is obligated by law to fix them.
Very low maintenance costs. It also means that you’re going to have no maintenance costs during the warranty period on the property, which is excellent for your cash flow.
Good tenants. You’re also going to attract good tenants who are likely to stay a while. Everyone wants to live somewhere nice and being the first to live in a house is very comforting.
Depreciation. A lot of people simply do not understand what depreciation is. Depreciation is the ‘on-paper’ loss in value of the building over time. The Australian Tax Office allows you to claim that depreciation as a tax deduction. This can save you thousands of dollars every year. The only problem is that it tapers off as the years go by. So the newer the property is, the greater the depreciation claim will be.
For example, let’s say you have two properties, both worth say $400,000, but one is brand new and the other is 25 years old. The brand new property will cost you less to own because of its depreciation benefits. For the average investment property, this can be around $100 per week extra to your cashflow!
To claim depreciation on a property you need a “Depreciation Schedule” to be created by a Quantity Surveyor. (If you need Quantity Surveyor simply email your contact details to email@example.com and we will have a reputable one in your area contact you)
Join me tomorrow for our final part of this series when I explain Negative vs Positive Cashflow Properties.
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