Investing in the Right Property – Part 2

Essentially, the factors discussed in part one will maximise your exit strategy and impact your capital appreciation. Broadly speaking, if a property ticks the boxes of quality, design, amenity and transport, naturally it will inherit strong rental demand. The remaining two factors determine your ability to hold on to the asset and the purchase costs of your property.

Purchasing a property can be a frustrating and exciting process. In many cases, more so on the second-hand market, investors missing out on properties can result in impulsive buying where properties are purchased above market value as they try to cope with the ‘fear of missing out’. Removing emotion and ensuring that properties are purchased at the correct price can be critical to maximising your potential capital gain.

So, the two micro-aspects of the model which I’ll delve into are:

  • Rent
  • Value

Rent

Rental income is the amount of money paid periodically by the tenant for the agreed use of the property. In Australian residential real estate, rent is usually paid weekly, fortnightly or monthly in advance to a trust managed by the landlord’s appointed agent.

Rental income is one of only two ways an investor can make money in real estate, the other being capital appreciation. For this reason, understanding the purpose of rent in your strategy is critical.

There are two priorities a landlord can adopt with regard to rental income:

Supplementing a long-term growth strategy: a common use for rental income is to balance regular expenses like mortgage interest, management fees and maintenance costs through a process known as gearing, which allows an investor to hold their asset for a long-term period. The intention is that this long-term holding period will facilitate a considerable increase in the asset’s value. Negative gearing is realised when the costs outweigh rental income after tax. The opposite, positive gearing, occurs when the rental income outweighs the expenses before tax, which would then incur a tax debt.

Providing a passive income: considered a more conservative approach, relying on rental income as a form of passive income is the alternative to a growth strategy. The type of property would differ in this strategy as the amount of rental income becomes a higher priority, creating demand for high-yielding assets. This greater focus on rental income usually comes at the expense of capital growth in the long term due to compromises in design and quality, as well as the type of person who is able to purchase the property (such as with student housing and defence housing).

Historically, long-term growth strategies have often proven superior to high-yielding strategies in Australia for two reasons. First, the average rate of growth for growth-oriented properties has often been higher than the amount of annual profit made on high-yielding properties. Second, the cash flow situation of growth-oriented properties tend to improve over the medium term, meaning that holding a growth-oriented property could also result in achieving passive income within a few years. This would allow the investor to have their cake and eat it too.

Value

There is an important distinction between value and price that causes many investors to become unstuck. Price is the evil stepsister of value, which changes based on less reliable factors. This is perhaps easier explained through the share market. When good or bad news is released about the economy the price of shares fluctuate accordingly: good news usually increases prices and bad news usually decreases them. In fact, even the weather has an influence on share prices. While the price is fluctuating, the performance of the underlying asset (the business) is relatively independent. This means a share can be over-priced, fairly-priced or underpriced based on the performance of the larger market.

The same occurs with real estate. If a local market moves into a temporary period of oversupply, the price can be influenced in a suppressive way. If a property developer has an inflated view of their ability to deliver superior quality homes, the price can be influenced in an excessive way. For this reason, establishing the inherent value of the asset within the market, as well as its unique value to you, is imperative.

The role of Blue Wealth’s research team is to identify markets where demand for property is high and will be in the long term but also to identify properties within the markets which will inherit the highest demand both on the rental and resale market. All Blue Wealth properties are assessed based on these factors.


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