Oh Property!

Property, it is the most commonly perceived "good" investment. I have just finished reading 47 Biggest Mistakes Made by Property Investors and How to Avoid Them by Helen Collier-Kogtevs and the book drips with a bias but it does have some interesting points.

The bias is common among Australian's who have seen a large appreciation in their residential property over the past 20 years. Helen in her book mentions many times a 15% return or that property typically doubles every 7 (10.4% per annum) to 10 years (7.2% per annum) plus net rental yields of say 2.60% which implies an expected yield of between 9.8% to 13%. This return over the long run is unsustainable, if someone can explain to me why property can appreciate at such a rate, almost double that of the median wage increase, I would be happy to listen. Essentially, people are wage earners and their wages pay for the rent or mortgage repayments, if the wage appreciates at a lower rate to property value, of course the prices will eventually get to an unsustainable level. Property is only good for an investment so long as people can afford to live in the area.

Despite this common bias, Helen does have some good points, namely:

• negotiating: Helen suggests aiming for a 10% discount and the discount can vary between 5 to 20%
• balancing the portfolio with negative and positive cashflow investments

These two points are significant. The first highlights one of the things I like about property investment the ability to negotiate, the only thing that you may get is a "no", the best possible outcome is a "yes". There are few other places where you are free to negotiate in such a way, I would love to be able to offer a stock holder a 20% discount for their shares. This used to be possible in unsolicited offers however ASIC has cracked down on that, and for good cause. Whilst I would love it, I know that it is unfair to the seller in a liquid market to accept anything than the best possible price. With property, the market is much less liquid and so negotiating becomes a fair and reasonable expectation.

The book also highlights the ability to borrow, while borrowing is great, one should prepare for the worse. Australia is certainly a lucky country but if you look over at countries like America, you can see the pain of too much debt. The only thing between a negative and positive cashflow investment is the amount of equity you put up. Helen agrees that the property portfolio should be balanced, this way, the investments as a whole are not taking cash out of your pocket.

Another interesting thing about property which wasn't covered in the book is that it is a mixture of two time frames, firstly, the land which is perpetual in nature and secondly, the building which decays, dates and depreciates. To be honest, the only appreciation should occur with the land, the building itself is a money drain (although rental income helps stem the tide).

So while I am not a huge fan of borrowing to the hilt to buy property there are a few key points that I like about property:

• Leveraging: the ability to borrow up to 95% of the value of the property is extremely attractive, I would suggest that the prudent buyer has atleast 20% of the equity and borrow 80%, there are significant savings as Lenders Mortgage Insurance (LMI) isn't required if you have 20% equity in the home. Also attractive is the significantly low rates of interest that one can borrow at and strategies that you can incorporate for tax purposes including tax deductions and an interest offset account.
• Cashflow: the property pays a weekly income of rent, this is attractive, particularly to retirees and I would suggest that property should be considered as part of a retirement strategy
• Negotiating: as mentioned, property is one of the only investable asset classes that are illiquid enough to be able to have some power in negotiating