Property Investment Fundamentals
Property cycles what causes them and how do they work?
Property has always been a favourite investment vehicle for Australians and you often hear the quote "Australia's love affair with property".
This is subconsciously because property is a basic human need i.e. shelter and it is something tangible that people can touch and see. This is why it is called "Real" estate.
It is also considered to be a safe secure investment and while residential real estate provides somewhat lesser returns than other forms of investment it is because of this safety factor.
In the investment housing market it is this "return" factor that tends to underpin the property cycle as follows;
Residential property traditionally returns around 5% gross in rental income but this tends to be affected by the number of properties available at any given time. For example during the recent housing boom everybody wanted residential property and of course supply and demand saw prices rising dramatically, so fast in fact that rentals had no chance of keeping up. This caused returns to drop to as low as 2% which of course saw the investor slowly pull out of the market causing prices to stabalise and then fall away slowly to a more acceptable level.
This naturally causes a shortfall in available rental properties and over time we have seen rental returns start to increase to the point where we are now seeing a shortfall of available properties Australia wide and of course rentals or "returns" are starting to increase. Property is once again starting to look a little more attractive as an investment vehicle.
As an attractive investment always attracts investors the demand for quality investment properties will start to increase and along with this demand/supply situation it is logical to assume that prices will move accordingly.
The question you need to ask yourself is "Do I wait like a sheep following the flock or do I get in now and reap the rewards?"
With any investment there is a level of risk but with residential property, the right finance package and the right management the risk is minimized. Provided you hold the property long term you are very unlikely to lose any money.
If you do the numbers on your own property/ies you would be aware that roughly speaking property, over the last 40, years has doubled in value every 8 years in Australia.
Where will you be in 8 years? Reaping the rewards or bemoaning missed opportunities.
The Reserve Bank recently increased interest rates again. Why does this occur and how do you best protect yourself?
Most of you will know that interest rates have risen again by a quarter of one percent. You may also be aware that they may move again by a quarter of one percent in the near future.
Many people become concerned when a tightening of monetary policy occurs but the reaction should in fact be quite the opposite. It is important to understand the dynamics of interest rate movements and why they happen.
The reserve bank has been given a charter by the government that basically states that inflation must be kept under 3% and wage rises below 4.5%. If the reserve feels that all the economic data points toward either of these levels being breached it will use monetary policy i.e. interest rates to force a correction.
By increasing rates they effectively suck money out of the general economy thereby reducing the capacity of people to spend, which slows growth to sustainable levels. This is why rising interest rates occur during times of great prosperity. A rising rate environment means that our country is enjoying the good times. When rates fall the reserve is attempting to put more money in your pocket which you will spend thereby creating growth and more jobs. Falling interest rates occur when the economy is in a rut.
So a slight tightening of monetary policy as we are seeing now indicates that we are in the good times and we should not be fearful of borrowing money to undertake sound investment strategies. The correct financial structure should take much of the risk away from borrowing funds. Ideally this structure should incorporate flexibility, protection and lifestyle to ensure that you minimise risk and are still able to enjoy your lifestyle while sensibly investing for the future. A combination of fixed and floating rates is important in your financial structure.
Remember, although nobody likes interest rates going up it is certainly not a reason to stop living now and planning for the future because the future is still going to come around whether you like it or not. Do not get caught in the media fear campaign, as they love to embellish a story and make it sound much more than it really is.
Equity
is the portion of your property that you already own. For example, if your home is worth say $200k and your loan is currently for $50k then you have $150k equity in your home.
Now let’s say you want to purchase a $100k investment property, but you don’t have any cash.
What you would then do is borrow 80%, or $80k, against the investment property. In other words the investment property would be security for 80% of the loan and the other 20% plus costs, you can borrow against the equity you have in your current home. So instead of having $50k on your home it would now be $70k. The money you have borrowed here is not tied to the investment property in any way, but you are able to get tax benefits from it since the purpose of the loan was for investment.
Leverage
Borrowing for an investment property is called leveraging, because YOU get all the capital growth. It is all about using a small out of pocket investment (around $1000) to realise the gains on a much larger asset.
Negative Gearing
This is a very misunderstood term. Negative gearing occurs when the income from your investment property (rent) is exceeded by the expenses on the property, (that is real expenses and paper expenses such as depreciation). When this happens you can off set these paper losses against your income, which then reduces the amount of tax you will have to pay.
Risks
It is imperative that before making any investment decisions, consideration is given (with the assistance of a qualified financial adviser) to its suitability or otherwise in light of your particular investment needs, objectives and financial circumstances.
There are risks associated with an investment in the Company. The following is a brief summary of what the Directors believe are the principal risks of an investment in the Company.
Market Risks
There are risks associated with the Company’s investments on the stock market, as with any investment on the stock market. These risks may include:
The market value of shares and other investments purchased by the Company can fall as well as rise. Share markets can be volatile.
Investing in shares carries risk. Whilst it is not possible to list all risks, these are the major risks that may affect the Company (and therefore you) as an investor:
Business Risk: This is the risk that a company selected to invest in does not run its business well. This poor business management can result in the income or capital growth expectations of the Company not being met. Business risk then becomes financial risk – that is, the value of the shares will drop and the Company will lose part, or in a severe case, all of its investment in that company.
Credit Risk: This is a risk if a company defaults on its debts because debt investors rank before share investors, and a subsequent wind-up of the company may deteriorate shareholder value.
Reputation Risk: Even very well-managed companies can face severe reputation risk for unexpected events. The management of these events can ruin a company’s reputation. For example, when an oil tanker runs aground – it is usually the oil company who faces the environmental repercussions. Any environmental, work-place or ethical misdeeds can cause a company’s shares to be devalued.
Information Risk: This is where the information given to the portfolio manager regarding the investment was wrong or incomplete. It may have been intentional or unintentional.
Market Risk: The price of any share has two components, the value placed on the company shares and the value placed on the market as a whole. When investors lose confidence in the market, the market component of the share price will drop. Even solid companies will see their share price drop when investors lose confidence in the market.
Political Risk: This can mean that the government is unstable. In Australia, it would mean that there is concern over the strength of the current government and the possibility of an election and a new government being brought in. It can also mean that changes in government policy will impact on the attractiveness of the market as a whole, sectors or specific companies. Political risk will also impact on the currency, which in turn will affect the ability of companies to import needed equipment or make interest payments determined in other currencies.
Income Risk: While many investors expect to receive income from their share investments, income or any level or income is not certain.
Liquidity Risk: This is the risk that when an investor wants to sell there will not be a buyer within what the investor considers a reasonable price range, or any buyers are not interested in the amount of shares the investor wants to sell. The ASX only provides the platform for buyers and sellers to meet, not a guarantee that there will be a buyer or seller for shares. Institutional investors, even in reasonably liquid shares, have to be careful that other investors do not know they are selling the shares because that can lower the share price.
Inflation Risk: When inflation is rising and the company cannot match these rises through increasing their prices, margins may have to be cut. Also, where inflation is rising, workers may demand an increase in their wages to keep up with it. Increases in wages only fuels inflation, as there is no increase in productivity for the extra wage earned. As inflation is associated with higher interest rates, some companies may be hit by lower margins and higher interest payments.
Investment Management Risk
There are risks associated with the management of the Company’s investments:
Past performance of the sub portfolios should not necessarily be seen as being indicative of future performance of the sub portfolios or the Portfolio.
The performance of the Company is dependent on the expertise and investment decisions of the Investment Manager and its key personnel. There is no guarantee that the Investment Manager will be able to retain its key personnel or engage suitable replacements for them. In particular, the continued involvement of Peter Spann or an appropriate replacement in developing the investment strategies of the Company is important to its success.
Management of the investments will be dependent upon the Investment.
