Property Investor Zone is here to share property investment knowledge and help others get into the property market. The blog is also interactive so thanks to all those who sent in your questions! Please see below my answers to three of the questions that were asked, keep them coming in and I will do another Q&A Session soon.
Question from Dave, he asks:
“I’ve been investing in growth property for 6 years and picturing my exit strategy – Living off Equity – and wondered what your thoughts were on this given APRA and serviceability. Clearly the rent would provide most of the income (serviceability), which will increase steadily over time. My wife and I are both 33 and control 5 apartments in Sydney’s inner west. Clearly, we have plenty of time on our side and we earn a substantial income – so we can deal with the negative shortfall – I just need to determine how the LOE strategy will work over time.”
Firstly, I must admit I am not a big advocate of Living off Equity as an exit strategy or long term solution for passive income. As you have touched on there, this strategy is conditional on maintaining serviceability with the banks every year that you want to borrow more equity to live off. For me this brings in an element of risk that is beyond your control, the banks might not approve the equity top-up and APRA can enforce lending conditions which are not suited to this strategy.
This strategy might be permissible if you are still earning a good income (outside of rental income) and can service an ever increasing debt balance. It is also conditional upon the value of the property going up every year, which doesn’t always happen.
My preferred strategy would be to decrease the debt on the portfolio rather than increase it. This can be achieved by paying down the debt over time or by selling some of your properties to pay down the debt on the others at some point in the future. Once the cash flow from a portfolio reaches a certain level, the snowball effect allows you to pay down debt quicker whilst also providing a continual passive income.
As you say, you have plenty of time on your side and should be able to reduce the LVR on your portfolio to a level that gives you a sufficient passive income without needing to borrow equity from the portfolio to live off.
Question from Jane, she asks:
“What if the property market crashes?”
This is a great question, straight to the point and one that many potential investors ask. As with any type of investment there is always a concern that a market downturn might affect your assets and could wipe out your gains. It could even reduce the value of your investment to be less than when you bought it.
Unfortunately, the overall market or global economy is something that is out of your control. As with all risks though, you can take actions to mitigate against them and reduce the impact on you personally. The best way to mitigate against market risk is to only buy properties in areas with the right fundamentals that will always be in demand, i.e. not in single industry towns or new suburbs with an endless supply of new houses. You must fully research your target areas before you buy there and not let anyone else convince you to buy in an area without knowing all the facts.
If we look back in time there have been various market events that have had a huge impact on the economy, more recently the 90’s recession and the GFC in 2008, but property has been relatively immune to economic volatility or share market crashes. The reason for this is that everyone still needs somewhere to live, which is the single most important attribute of residential property – to provide shelter. During these periods of volatility, the property market might have taken a downturn, but as a whole it has never ‘crashed’.
If the global economy or the share market were to take a turn for the worse, the 70% of Australians who are homeowners aren’t all going to suddenly sell up and run for the hills, where would they live? Because of this important fundamental and the fact that property takes much longer to transact than other investments, the property market is less susceptible to big market changes. If we look at the Price Index of Capital City houses going back to 1986 there have been times of rises and falls but the index has never dropped below the previous peak:
The index shows the ‘average’ capital city prices which gives a good indication of the market as a whole, but there are thousands of sub markets within Australian property. Each sub market can and will behave differently at any point in time. For example, some of the mining towns in regional areas had a huge rise in prices during the mining boom and then came crashing down when the demand for accommodation disappeared, along with an influx of investors who created an oversupply of new properties. I would never advocate for buying in a mining town which is reliant on a single industry as this just elevates your risk, but by investing in a town or city which has a large and growing population, with multiple industries you can mitigate against volatility in supply and demand.
Property is a long term investment and you should always go into a new acquisition with the intention of not selling for at least 10 to 15 years, if ever. The effectiveness of capital growth increases the longer you hold your property due to compound growth and the snowball effect. You also spread your purchase and selling costs over a longer time frame. By taking a long term view and managing your cash flow effectively you should be able to afford to ride through any market volatility so that you can reap the benefits when the market will inevitably recover.
Question from Steve, he asks:
“How do you work out how much to pay for a property?”
This is another great question and one that more people need to ask before they buy property. So many people take guidance from the selling agent or rely on online automated reports, but the worst mistake is to base your offer on what other properties are advertised for.
Despite what some selling agents might tell you, advertised price does not equal ‘fair market value’ which is what you need to determine before making an offer. The laws in some states have changed to make selling agents be more realistic about the advertised price of property to avoid under-quoting. This is important in a warm or hot market, but in a cooler market selling agents and their vendors can still set a price expectation that is way too high and it is in these conditions that you must avoid paying too much by doing your research.
The scenario which most buyers struggle with is when there is no advertised price or the property is being sold by auction with only a ‘guide’ to work from. In either of these cases it is crucial to determine a fair price before you start negotiating or bid at auction.
The best way to determine fair market value is to make a list of comparable sales, ideally this would be at least 10-20 sales of similar properties in the last 6-12 months within a kilometer of your target property. You can use the popular real estate listings websites under the ‘sold’ section or subscribe to a property sales database which is more extensive.
When you have made a list of all the comparable sales in order of price, you then need to go through each one and compare all the key attributes against the property you are going to offer on. This can include but not limited to; block size, house size, age, condition, aspect, position on the street, position within the suburb, floor plan and of course, number of bedrooms, bathrooms and car spaces. You can get a good feel for each property if there are enough photos online along with the floor plan. Google maps, street view and aerial photography also help in getting a better understanding of each property and its context.
By doing this exercise you are trying to determine where your target property fits within the list of comparable sales. You might end up with a shortlist of 5 other properties that are very similar in attributes and price which helps narrow down your offer range. The key thing is to identify those properties which are superior to the property you want to buy as this sets the ceiling price that you shouldn’t go over.
Once you have done your comparable sales analysis you will be in a much stronger position when dealing with a selling agent as you will now be confident about what the fair market value of the property is.
*Please note that the above answers form general advice only and don’t take into account your personal situation and full financial position.
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