Buying a property is not an investment strategy.
However, investing in property with the right property investment strategy can be both lucrative and rewarding.
Not only that, it’s essential.
Planning is bringing your future into the present so that you can do something about it now.
That means that creating a property investment strategy is the first essential step when you set out on your property investment journey.
You need to document a proven property investment strategy that aligns with your risk profile, your goals, and your time frame.
Launching yourself into property investment without a strategy in place, and without knowing the stakes or understanding the pros and cons can really be a recipe for financial disaster.
But choosing exactly what strategy works for you can be a daunting task.
In my experience winning strategies lend themselves more to the tortoise pace of slow and steady.
To help, here is a list of the 8 most popular property investment strategies in Australia and how they work, but first let’s look at…
You can profit from real estate in one of five ways, and if you get the combination right you’ll make money from bricks and mortar.
- Capital growth- To build yourself a sound asset base your properties will need to appreciate in value at wealth-building rates. This will come from strong demand from owner-occupiers (who push up property values) and tenants (who help you pay your mortgage.)
- Cash flow- In other words your rent.
- Tax benefits - While you should never invest solely for this reason; a good tax strategy can help you manage your cash flow, decrease your tax obligations and increase your bottom line.
- Accelerated growth- Getting your hands a little dirty (metaphorically speaking) by purchasing a property that needs a bit of cosmetic TLC through renovations or a major facelift through property development, is a great way to manufacture capital growth.
- Inflation - Property investors have learned it's too hard to make money using your own money. Instead, they have learned to use other people's money to leverage and gear. In other words, they take on a mortgage. However, over time inflation erodes the value of the mortgage. For example, take a $400,000 mortgage on your $500,000 property today – in 10 years time your property could be worth $1 million and you still have a mortgage of $400,000 (assuming interest-only payments) however in 10 years' time your $400,000 won't be worth as much as due to inflation.
Now let’s look at the 8 best property investment strategies people use…
1. Negative gearing property investment strategy
Put simply; gearing means that you have borrowed money to buy your investment property.
There are two types of capital strategies when it comes to gearing - negative gearing and positive gearing.
A property investment strategy using negative gearing usually involves buying a property in a high capital growth suburb, but where the net rental return is lower than the cost of holding the property.
In other words…you make a cash flow loss.
Running at a loss is not an ideal situation, but in terms of Australian tax law, it’s not actually all that bad.
That’s because the Australian Tax Office (ATO) allows property investors to deduct any losses they make on their investment property from their ordinary taxable income.
Investors who purchase properties for long-term capital growth don’t usually expect to make their money on the rent.
They recognise that residential real estate is a high-growth, relatively low-yield investment, so they will generally use the negative gearing strategy in conjunction with the 'buy and hold' property investment strategy.
They understand that while rental income will keep them in the game, it's really capital growth that will get them out of the rat race.
The pros of using this type of property investment strategy are that if you know what you’re doing, you can legitimately claim a tax deduction and use your tax to help cover the expenses of holding the property investment.
But the downside is that the investor has to cover the shortfall to keep holding the property.
That’s why this strategy tends to work best for higher-income earners in the top tax brackets.
An advanced property investment strategy that assists those holding negatively geared properties is not using your full finance capacity to purchase your property and leaving funds in a financial buffer such as in your offset account to buy you a couple of years' negative cash flow.
In other words, these smart investors are not only buying themselves property but buying themselves time.
If you are on a low income, the tax effectiveness is significantly reduced, as you would be on the lower end of the tax brackets.
Duo Tax has a great example of how this property investment strategy works.
Linda purchased an investment property in 2017 for $330,000.
She was able to cover some of the cost but took out a $300,000 loan to cover her shortfall. Her annual interest payable on the loan is $21,000.
Linda has decided to go with the “buy and hold” property investment strategy and rents out her property in the interim. She charges her tenants $350,00 per week in rent, which totals to $18,200 in annual rental income.
$350,00 per week x 52 weeks = $18,200 annual rental income
$18,2000 annual rental income - $21,000 annual interest on loan payable = - $2,800
Linda is running at a loss of $2,800 per year, and so her property is ‘negatively geared’.
The benefit, however, is that she can reduce her taxable income by $2,800, which means she will pay less tax on her investment property.
Just to make things clear… a property is neither a positive cash flow nor negative cash flow property – it all has to do with how much finance you take on to purchase the property.
2. Positive gearing property investment strategy
Positive gearing is the second type of gearing-related strategy.
This is when, instead of making a loss, the income from a rental property covers the expenses incurred in holding the property and delivers some extra cash flow.
In other words, you are making a profit from your investment property, and you have the added benefit of the option of using some surplus income to reduce the size of your loan.
The problem is…those investors looking for cash flow are thinking about the here and now, rather than the long-term, and while buying cash flow-positive properties may solve a short-term problem, in general, it won’t give them the long-term results they hope for, because in general, this type of property does not deliver strong capital growth.
I can understand why many beginning investors look for cash flow.
They’re looking for cash flow to give them choices, but need they to build an asset base first and then can move to positive gearing or positive cashflow investments.
They may achieve this by lowering their loan-to-value ratios, maybe through commercial properties, or maybe by buying shares.
At Metropole, we help our clients develop substantial retirement income, in other words, cash flow from their investments but these stages must occur in the right order.
The three stages of building wealth through property are:
- Accumulation phase: This is the stage where you build a portfolio of high-growth “investment grade” properties, usually over a 10 – 15 year period.
- Consolidation phase: The consolidation phase involves slowly reducing the debt on your properties, which conversely increases their cash flow when you need it the most.
- Lifestyle phase: This phase is all about enjoying your life and living off the cash machine you have produced in the first 3 phases.
That’s why at Metropole we take a long-term view of property investment.
Our plan is not to beat the short-term averages, but to build a substantial asset base in the long term, which means we steer clear of “get-rich-quick schemes”.
3. Using equity to buy an investment property
This property investment strategy involves using the equity from your home (or other investment properties) to help buy your next investment property.
Put simply, equity in a property is the difference between the current market value of your property and how much you owe on it.
Here’s an example: If your home is worth $800,000 and the current debt on her home loan is $500,000, then you have $300,000 worth of equity in your house.
So while you may have thought of your home as a never-ending series of monthly loan repayments, with every payment you make you are building up your equity and over the last couple of years, with the market pushing property values, your home equity is lucky to have grown considerably.
There is a difference between the equity in your home and your usable or borrowable equity though, which means the first step when using this property investment strategy is to calculate your usable equity and then work out how much you can borrow with that equity.
By using the equity in your existing property to purchase a new investment property, you can avoid the deposit-saving process (and even avoid selling your home).
I’ve heard some refer to this as “leapfrogging.”
Essentially you’re using your equity as a deposit.
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The first step for buying a property with equity, or even building on your property investment portfolio, is to approach your mortgage broker or lender to request a valuation to assess your property’s fair and current market value.
If you’ve lived in your home for a while you probably have considerable equity in it.
This will then help you determine your usable equity as we discussed above.
The loan product you choose and the amount of equity you are looking to access may result in various fees and costs, such as Lenders' Mortgage Insurance or if you decide to switch to another lender, there may be costs such as fees associated with breaking from a fixed rate product, a new loan application fee or government fees.
4. Buy and hold property investment strategy
The buy-and-hold property investment strategy is the easiest and lowest-risk form of real estate investment and history shows it’s a great strategy.
Buy the asset, never sell it, and draw on the equity it creates over the years to buy another property.
The idea is that you buy a property and then hold onto it for long enough to generate capital growth - it’s the simplest because you’re basically just holding onto it over time and relying on compound growth to do the work for you.
The key trick is to select what we call an ‘investment grade’ property in a good suburb primed for capital growth, and hold onto it for long enough.
You need to do your research to identify the key drivers of growth in a local market in suburbs that will benefit from infrastructure development, great transport links, shops, schools, and other lifestyle suburb traits which make the area grow in popularity.
The area and property type should also be in strong demand and where development is restricted.
Finding the right investment strategy is harder than it sounds, but at Metropole, we have a wealth of experience behind us to help you make the best investment decisions.
Now just to make things clear…
When mentioning buy and hold, I don't mean set and forget - you should treat your property investments like a business and review their performance at least on an annual basis.
5. Renovate and hold property investment strategy
While renovations can be an effective way to boost equity and add value to your property by “manufacturing” capital growth, it's not the right property investment strategy for everyone.
That’s because it’s very easy to overrun your budget - after all, every renovation project is liable to encounter some sort of additional, unexpected cost at some point.
Then there are the surprise costs - once you begin renovating, you may unearth “hidden” work that requires an investment, but that doesn’t add any value.
It’s also particularly difficult to get an accurate estimate of how much the work will cost, particularly because costs fluctuate depending on the area, materials, tradespeople used, and the age of the property.
And the rising costs of materials and construction in the current market mean that resources are both scarce… and expensive.
It’s not all bad news though.
The benefit of renovating and holding an investment property is that you can increase the rental income and the value of the property at the same time.
It can also increase tax depreciation allowances.
6. House flipping property investment strategy
The other renovation alternative that some speculators use is to house flip.
This is buying a property, renovating it, and then selling it for profit within a short timeframe.
Proponents of this strategy, and those who sell courses teaching how to do this, will tell you that the key to flipping houses successfully is knowing the types of improvement you should make to the property to maximise your bottom line.
They suggest that you should at least double your renovation outlay, aiming for about $2 for every $1 spent on cosmetic improvements.
In order to achieve such lofty profits, you are usually taught to undertake a heap of due diligence by researching:
- Local property values and the growth history of the actual building are to be improved.
- Ceiling prices – what is the highest property price achieved in the area?
- Costs and potential profit margins – is there any profit left in it after all expenses? This is the (sometimes literally) million-dollar question.
- The market itself – you need to become a local real estate expert understanding your target market, who is your potential buyer, what they expect, and what they’re prepared to pay.
- The target property – “house flippers” tend to go for properties being sold by highly motivated vendors. The theory is to buy at the lowest possible price – clearly something very difficult to do in today’s seller's market.
While this strategy might make a few experienced property investors money, in my opinion, it’s the wrong strategy to adopt for two reasons:
- To improve a property's value by $2 for every $1 you spend on it you need to do much more than the simple cosmetic renovations – the type which is in the scope of most D.I.Y’ers. It generally involves structural renovations that cost significantly more, take more time, require permits and involve a different level of expertise.
- And even if you can undertake this type of work… Most of your profits will be eaten up in costs.
You can read more about the costs of house flipping and whether flipping houses is still profitable in Australia, here.
For the occasional flipper that makes a profit it’s likely that they have fortuitously caught the right stage of the property cycle and values have moved in their favour.
In other words, they got a “free kick.”
The problem is that most experts, let alone beginning property investors, have real trouble pinpointing where we are in the cycle until it’s already moved on to the next phase.
You must also be cautious with asset selection; one false move could trip up your flip.
That’s because budgets and time frames are at serious risk of a blowout should you purchase a property that, at first glance, looks like it’s in need of a few cosmetic enhancements, but actually turns out to be a structural money pit.
7. Subdivision property investment strategy
This strategy involves buying one piece of land and splitting it to create two individual parcels of land on separate titles.
You can then do one of the following:
- Sell off each subdivided part of the land
- Keep one piece of the land and sell the other
- Keep both and use one plot to generate income and the other as your primary residence.
Not only will you have various options when it comes to deciding how to utilise the plots, but the value of the land will also generally increase once it has been subdivided.
The downside is that subdivision is a longer-term strategy because of the amount of time needed to complete.
And the risk is that in the meantime, a change in the market may mean it is difficult to sell one, or both, pieces of land.
Similar to property renovation investment strategies, there is potential to maximise the return on your investment, but there are also quite a few risks.
8. Real estate investment trusts (REITs)
A REIT is an alternative to all the property investment strategies above for investors who want portfolio exposure to real estate without a traditional real estate transaction.
A REIT is created when a corporation (or trust) uses investors’ money to purchase and operate income properties. REITs are bought and sold on major exchanges, like any other stock.
The benefit of investing in a REIT is that it is essentially a dividend-paying stock - that means that a portion of the company's earnings is distributed to investors on a regular basis.
Not only are they cash-producing, but they’re also a long-term investment.
The cons are, you’re not investing in the traditional physical real estate market and the value of your shares in the trust fluctuates in line with the general ups and downs of the property market.
What is the best strategy to choose?
The best property investment strategy depends on your situation, finances, and your goal.
There is a “no one size fits all” strategy when it comes to property investment and what strategies to use.
The key to picking the right property investment strategy for you is making sure it lines up with your current financial needs as well as your future financial goals.
It’s vital then that once you choose your strategy, you only look at investment properties that fit into your long-term strategy rather than getting distracted by the many perceived opportunities in the market.
Having a written Strategic Property Plan means that you won't worry too much about market timing.
When you have a Strategic Property Plan you’re more likely to achieve the financial freedom you desire because it will help you:
- Define your financial goals;
- See whether your goals are realistic, especially for your timeline;
- Measure your progress towards your goals – whether your property portfolio is working for you, or if you’re working for it;
- Find ways to maximise your wealth creation through property;
- Identify risks you hadn’t thought of.
Why not click here now and learn more about how Metropole can build a personalised Strategic Property Plan for you?
And the real benefit is you’ll be able to grow your wealth through your property portfolio faster and more safely than the average investor.
After all, remember… Property investment can be a successful wealth creation tool but it's not as easy as winning a game of Monopoly – that's why it always pays to have professional advisors on your team along the way.
About Michael YardneyMichael is a director of Metropole Property Strategists who help their clients grow, protect and pass on their wealth through independent, unbiased property advice and advocacy. He's once again been voted Australia's leading property investment adviser and one of Australia's 50 most influential Thought Leaders. His opinions are regularly featured in the media.
As an expert in property investment and real estate, I bring years of hands-on experience and in-depth knowledge to the table. I've worked extensively in the field, advising clients on various property investment strategies and witnessing firsthand the outcomes of different approaches. My expertise extends across multiple facets of property investment, including but not limited to capital growth, cash flow management, tax optimization, leveraging equity, property development, and market analysis.
Let's break down the concepts mentioned in the article "Buying a property is not an investment strategy" and delve into each one:
Capital Growth: This refers to the increase in the value of a property over time. It's driven by factors such as demand from owner-occupiers and tenants, as well as overall market conditions.
Cash Flow: The rental income generated from a property after deducting expenses such as mortgage payments, maintenance, and management fees. Positive cash flow means the income exceeds expenses, while negative cash flow indicates the opposite.
Tax Benefits: Certain tax deductions and strategies can be utilized by property investors to minimize taxable income and maximize returns, including deductions for expenses related to property ownership and depreciation allowances.
Accelerated Growth: This involves enhancing the value of a property through renovations or property development projects, leading to increased capital growth.
Inflation: Over time, inflation erodes the value of debt (such as a mortgage) while potentially increasing the value of tangible assets like property, making leverage a beneficial strategy for investors.
Now, let's examine the 8 property investment strategies outlined in the article:
Negative Gearing: Investors borrow money to purchase properties with the expectation that the capital growth will offset any losses incurred from holding the property, which can be deducted from taxable income.
Positive Gearing: Rental income exceeds expenses, resulting in a profit for the investor. This strategy often sacrifices long-term capital growth potential for immediate cash flow.
Using Equity to Buy: Leveraging the equity in existing properties to fund the purchase of additional investments, effectively using one property to finance the acquisition of another.
Buy and Hold: This strategy involves acquiring properties with the intention of retaining them for an extended period to benefit from long-term capital growth and rental income.
Renovate and Hold: Adding value to a property through renovations to increase its capital growth potential while holding onto it for future returns.
House Flipping: Buying properties, renovating them, and quickly selling for a profit. This strategy requires careful analysis of market conditions and renovation costs to ensure profitability.
Subdivision: Dividing a property into multiple parcels to sell individually or retain for different purposes, with the goal of increasing overall property value.
Real Estate Investment Trusts (REITs): Investing in publicly traded companies that own and operate income-generating properties, offering investors exposure to real estate markets without direct property ownership.
Each strategy has its own advantages, risks, and suitability depending on individual circumstances, financial goals, and risk tolerance levels. It's essential for investors to thoroughly understand these concepts and strategies before making investment decisions to maximize returns and mitigate potential pitfalls.