The Money Mummy Guide to Investing is back and this week we are going to look at the risk and return characteristics of property investments and how these could fit into your overall investment strategy.
Now as Australian’s we are renown for being in love with property. It is easy to see why, residential property has been an amazing performer, such that we now have some of the most expensive residential property in the world. I will have to admit, I have a bias against Australian residential property as an investment, right now. Simply because on most measures it is simply unaffordable. How many people do you know who are struggling to buy a property? So despite low interest rates, in my view there is little room for property prices to keep on climbing. (I will also admit that I said this five years ago when we brought our family home, at the height of the global financial crisis (GFC) and was proven completely wrong as property prices continued to climb!)
Now I am no expert in property investment (given my bias I have never brought an investment property) but here are some of the main advantages of investing in property:
- It is an investment that you can see and touch, so in that sense it is easier to understand than say an investment in shares
- Property returns, over time are seen as less volatile than shares
- You can earn rental income as well as benefit from capital growth, if the price of your property increases over time
- In Australia there can be tax benefits in purchasing an investment property, if the property is negatively geared (ie. the cost of the interest on the loan is larger than the rental income received)
The main negatives of investing in property include:
- The rental income, particularly nowadays, quite often does not cover your mortgage repayments or other expenses so you might have to use other income to cover these costs.
- Your returns from your property investment may be vulnerable to changes in interest rates, depending on the structure of your loan.
- If you urgently need to raise cash, selling the property might take a long period of time.
- You will have to cover all the costs if the property is left untenanted for a long period of time or if the tenants do not pay the rent. You are also at risk that the tenants may not look after the property as you expect.
- Entry and exit costs are high, for example stamp duty and real estate agents costs.
- Residential property is a chunky investment. If this is your main investment plus your family home you might lack diversification in your investment portfolio. This means you are very exposed to any decline in residential property prices. This was a hard lesson learnt by many American’s during the GFC (Global Financial Crisis).
It is often forgotten that property investment does not just have to be about buying a house or a flat. There are many different types property investment that can be accessed through a managed fund or investment on the stock market (I will talk about these two forms of investment in a later post). For example, within the property segment you can invest in retail property (ie. shopping centres), office buildings or industrial buildings. Some investments offer you pure exposure to these segments or a mix of the three. Each segment is driven by the same overall characteristics as residential property, it is all about collecting rent and capital gain in the overall price of the property. However, each segment has slightly different drivers, for example shopping centres (retail) is more related to how much consumers are shopping, where as office buildings are more related to the growth in business spending.
If you are considering an investment in property right now, make sure you get some good advice. Beware, there are many property spruikers out there who encourage you to borrow heavily and build large property portfolios quickly, this will leave you dangerously exposed to any fall in property prices. Prices are high, so be careful and think hard before you commit my fellow investors!
If you liked this post check out the rest of the series by clicking on the links below:
* Please note this post is for your general information only and does not constitute financial advice