Property Investment is Hard Work

[Meisterin]

This morning a gentleman came into my office complaining that he has not gained very much from investing in property. His story was very interesting.

1998 Purchase house in Sydney for $430,000 Total cost $455,000

2006 Sell house for $765,000 net capital gain $320,000 after agent and legal costs.

After paying his capital gains tax he would have approximately $240,000 in his pocket. That is having an average capital gain of approximately $27,000 per year from 1998.

But his outgoings of the property on interest paymenets were approximately $36,000.00. Thus without renting the property out he makes a loss of $9,000 per year.

Assuming that the average rent for the 9 years is about $400 (starting from $300-550)per week he got approximately $20,000 per year making his net return on property $11,000 per year for 9 years. (I did not put negative tax gearing into the equation because it just about cancelled out the managing agent commission and small maintenace on property and vacancy)

Looking at this scenario even though $11,000 gain per year is not a bad return on the property, I don't think it's a super return because he had approximately $86,000 locked in, which he could have just put in the bank and gained 3% after tax returns. If you put into the equation the lost opportunity for $86,000 that could have been sitting in high interest or term deposit account that is a loss of approximately $3000 per year making his net return on the property only $8,000.00.

What this example is showing me is that if you are going to eventually sell the property it's probably not a very good investment unless you put extra work into it such as:-

1. You do cosmetic renovations on the property to create more value thereby achieving a higher sale price without over-capitalising;

2. You develop the property- sub-dividing, developing into mutiple dwelling;

3. You use the equity in the property as security to invest in other investments generating higher returns;or

4. You use the equity in the property to buy more property.

If you stop at just one property and sell after a big capital gain, your probably feel that $8000 per year was not really worth it considering the hassles that you had to go through in terms of organising finances and dealing with tenants and managing agents over the years.

But if you keep expanding your property empire, because you don't have to pay tax, you can use full capital gain of $27,000 each year rather than $8,000 (had you sold), on other investments to create more wealth for yourself. This means that you have to be busy educating yourself and thinking about how you will invest the equity to create better returns for yourself.

This also demonstrates to me that wealth creation through property is an on-going process and hard work. You have to use the equity or do something to the land to create more value constantly to actually make a quid from the property. If you are going to stop at one or two, and then just expect to property price to rise, you will probably feel like this gentleman that property investment was not worth all the efforts he had to go through. (I admit that had he sold about 3 years ago, he would have gotten much better price)

I guess this anecdote makes me think a little more about property and reassess my plans for acquiring properties in the future because once I am in it, I have to be in it totally or I will only make a small gain and feel that my hard efforts to save up for a deposit and to downgrade my lifestyle was not worth it.

What does everyone think?

Do you agree with my observation?

 

[Peter Parker]

If you are going to stop at one or two, and then just expect to property price to rise, you will probably feel like this gentleman that property investment was not worth all the efforts he had to go through. (I admit that had he sold about 3 years ago, he would have gotten much better price)

This would have approximately doubled his per annum 'profit' due to (i) the higher price and (ii) lower outgoings. And then it would have looked much more worthwhile.

He held for approximately one complete cycle so got average results.

But he still benefited from leverage and was better off than putting it in a term deposit.

He should just be lucky that he didn't buy in 2003 and want to sell now!

I think it's fair to conclude that the longer you hold property for, the less important cycles become as the bottom of (say) the second or third cycle is still likely to be well above initial purchase price. However when there are substantial negative cash flows involved, as in this case, the picture gets a little more complicated.

Peter

 

[WildDog]

I know several people came to the same conclusion, ending up selling their properties, go back to good old fashion way, save more spend less and buy and hold in equity market. More time on their hands to enjoy finer things in life.

For me if I do hold property I do intend to pay it off very fast (5-10 years each max) and just have a 1 or two for stable income from rental and the rest of the money in other ventures.

my PPOR I paid it off in 7 years.

Guess it come down to personal circumstances of what you want out of life and where you want to go and what risk you are willing to take.

 

[FrankGrimes]

Interesting example. Your friend bought a great time and still got some good capital gain, if he kept holding I imagine it would have been neutral soon or maybe it was already

He also lost a fair bit due to capital gains tax and selling fees, he would have been far better off keeping it and using a LOC to invest further.

That being said he's still made a fair amount of money? 240k is 240k.

Just my thoughts..

Grimey

 

[landlubber]

hifi,
There's something I'm missing in the calcs.
1) Purchase $455K in 1998.
2) You say his skin in the game was $86K
3) Therefore loans were $455 less $86 equals $369K
4) You say interest was $36K per year.

That calcs out at ~10% interest ?
No way ...from 1998 to 2006 interest rates have been ..like around 6% roughly?

What am I missing ??
LL

 

[The Y-man]

Looking at this scenario even though $11,000 gain per year is not a bad return on the property, I don't think it's a super return because he had approximately $86,000 locked in, which he could have just put in the bank and gained 3% after tax returns. If you put into the equation the lost opportunity for $86,000 that could have been sitting in high interest or term deposit account that is a loss of approximately $3000 per year making his net return on the property only $8,000.00.
What does everyone think?

Do you agree with my observation?

Bit confused with this bit...... (too much maths involved.... )

Assuming initial invested amount is $86,000, with te rturn of $11,000 pa, that's 12.7%pa return after tax compared to 3%pa after tax on a bank account?

Even if you look at it as $8k pa, that's still 9.3% pa after tax.... and at the end of the day, I feel there is relatively little hard work involved with properties (compared to an IT helpdesk anyway!!)

Maybe I have missed something?

Cheers,

The Y-man

 

[simonjulie]

Hi hiflo
I must have done something wrong with my calcs below.
Here is an assumption based on your friends investment rented for that time period.
PP=$455
His total set up cost=86K
total interest to bank and holding costs loss for life of investment =$45K
sale price=$765
real increase on investment:
$765K-$45K=$720K
pay out original bank loan $370(approx?)
$720K-$370K= $350K-$86K(original investment)=$264K before tax profit over the 9 years.
Did he not triple his original investment over that time period? Sorry if I missed something.
Kind regards
Simon

 

[The Y-man]

For me if I do hold property I do intend to pay it off very fast (5-10 years each max) and just have a 1 or two for stable income from rental and the rest of the money in other ventures.

Interesting - opposite to our tactics where it is to aggressively refinance and draw down as much as possible, as often as possible. We then use this capital in our other ventures.

Cheers,

The Y-man

 

[MichaelW]

$720K-$370K= $350K-$86K(original investment)=$264K before tax profit over the 9 years.
Did he not triple his original investment over that time period? Sorry if I missed something.
Kind regards
Simon

Simon,

My thoughts exactly. That works out as 34% pa simple interest on the $86K invested over 9 years. i.e. 307% / 9 = 34%pa.

I think I'd be very happy with an investment yielding a 34%pa return personally. So many people overlook the power of leverage and OPM when doing their calcs. Its not mensa but it still seems to elude most investors.

Ah well, I'll just keep borrowing as much as I can and leveraging as much as I can and let OPM work for me.

Cheers,
Michael.

 

[landlubber]

Have these guys ever read Jan's books ?

M-white ,
I'm with you big-time in big scoops !

Combine the 1) leverage and 2) the negative gearing and 3) it doubles in value every 7 to 10 years ...and THERE IS no other game in town for the 'average' wage earner .

Jan gives any number of examples of "internal rate of return" in her books !
Make me wonder if some people ever read 'em??

LL

 

[simonjulie]

Simon,

Ah well, I'll just keep borrowing as much as I can and leveraging as much as I can and let OPM work for me.

Cheers,
Michael.

As long as you have a good SANF there aint nothing wrong with that.
Cheers
Simon

 

[rj]

Developing is where its at baby ..

*does a little dance*

RJ

 

[alexlee]

I agree with the others. The returns are a lot better than you think.

If you JUST look at the prices, buy $430k in 1998 and sell $765k in 2006, you're looking at 7.5% per annum. This is the sort of figure that the shares v property crowd usually cite to say shares (which averages 10% or so) is better than property.

Your numbers look low. $300pw for $430k and $550pw for $765k. You're also talking about $36k in interest on a loan of around $365k, which is 10%?

Using your numbers, you're right. If you buy a property that averages 3.5% yield long term, using a 85% LVR loan paying 10% interest with 7.5% capital growth, it’s NOT a very good investment.

However, if you assume a more normal property (5% yield, interest of 6% which would be roughly CF neutral long term). You put in 86k for control a $430k propety. At the end you have profit of approx $264k. So the investor has tripled his investment in 8 years AFTER TAX.

That's not a bad result, surely. THEN imagine if he'd borrowed against the property over those 8 years and bought just ONE more property with it.
Alex

 

[Meisterin]

hifi,
There's something I'm missing in the calcs.
1) Purchase $455K in 1998.
2) You say his skin in the game was $86K
3) Therefore loans were $455 less $86 equals $369K
4) You say interest was $36K per year.

That calcs out at ~10% interest ?
No way ...from 1998 to 2006 interest rates have been ..like around 6% roughly?

What am I missing ??
LL

I agree it looks impossible in 1998 to get a loan for around 6%... but that's what he told me. On average of around $3000 per month.

 

[Meisterin]

Hi hiflo
I must have done something wrong with my calcs below.
Here is an assumption based on your friends investment rented for that time period.
PP=$455
His total set up cost=86K
total interest to bank and holding costs loss for life of investment =$45K
sale price=$765K
real increase on investment:
$765K-$45K=$720K
pay out original bank loan $370(approx?)
$720K-$370K= $350K-$86K(original investment)=$264K before tax profit over the 9 years.
Did he not triple his original investment over that time period? Sorry if I missed something.
Kind regards
Simon

The numbers look impressive and it is a good return and that would have been the way I looked at it.

But if you actually put the cost of debt into equation the return is quite low.

But what I am trying to say here is that if you just buy property and do nothing and just wait for a good time to sell you won't make much money from it.

To actually benefit from the property you have to look at refinancing every few years to free your equity so that you can make further purchases like this and make approx 3% net gain each year (if you had 10 of these properties you would be making net $80,000 each year) or use the refinanced funds(because of cheap rates compared to other securfities) to invest in shares or managed funds or investment schemes to create further wealth.

The point I am trying to make is that if you are going to only buy one or two and do nothing further but service the debt and wait until the next cycle, you can end up feeling that property has done nothing for you. Just forced you to save harder and make you live like a pauper.

However, on the other hand, if you used the equity that has grown over the years to invest it could give you greater returns. If you use the equity of, lets say 6% each year, and use the equity as a deposit for next purchase, then you could achieve same returns but double the net amount that you get in your hands. Or had you used your equity to invest in shares that went up in value by 5% and gave you 4% dividend that would have given you further return for your money.

But finding a property to buy is not easy. You have to do your due diligence, do your numbers and it takes work. This could take up to months or even couple of years depending on your strategy of buying (if you buy in the same area, then it won't take as long as buying in inter-state, an area that you are totally unfamiliar with). It is constant work!!!

People just going on blind advice that property will go up in value is not going to really experience the great gains as you suggested. Most people do not like to spend hours researching when they have the choice of going out after work or spend time enjoying their hobby etc...

You have to keep the money that property is generating working buy borrowing against equity.

So making money from property is not easy. You have to keep working at it to make it work for you. It's like another job, but with flexible hours and with potential to make more if you put more hours to be creative.

If you do nothing, you will only make what the cycle gives you. (low)

If you put more work into it you can make fortunes(?). So making money from property investing is hard work.

Am I making sense?

 

[alexlee]

I agree it looks impossible in 1998 to get a loan for around 6%... but that's what he told me. On average of around $3000 per month.

I think you mean it's impossible to have to pay 10% interest on a mortgage in 1998. What did your friend do, get a personal loan?

Bottom line: yes, his investment returns aren't that great. That's because he paid 10% interest on a 3.5% gross yield property. YET he still made money. That's not a bad result on what are, honestly, REALLY BAD NUMBERS! He would have done even better had he refinanced and bought more property.

I mean, would you buy a 3.5% gross yielding property at 10% interest now? I thought 3.5% gross yields at 6% interest (Sydney at its peak) was crazy. I think Perth now (3-ish yields) is crazy too.
Alex

 

[The Y-man]

I think you mean it's impossible to have to pay 10% interest on a mortgage in 1998. What did your friend do, get a personal loan?

Alex

A low-doc maybe - they are much cheaper and easier to obtain now, but not back then.

Cheers,

The Y-man

 

[The Y-man]

To actually benefit from the property you have to look at refinancing every few years to free your equity so that you can make further purchases like this and make approx 3% net gain each year (if you had 10 of these properties you would be making net $80,000 each year) or use the refinanced funds(because of cheap rates compared to other securfities) to invest in shares or managed funds or investment schemes to create further wealth.

The point I am trying to make is that if you are going to only buy one or two and do nothing further but service the debt and wait until the next cycle, you can end up feeling that property has done nothing for you. Just forced you to save harder and make you live like a pauper.

However, on the other hand, if you used the equity that has grown over the years to invest it could give you greater returns. If you use the equity of, lets say 6% each year, and use the equity as a deposit for next purchase, then you could achieve same returns but double the net amount that you get in your hands. Or had you used your equity to invest in shares that went up in value by 5% and gave you 4% dividend that would have given you further return for your money.

Agree. Hence one of my posts above. The Melb market for instance hasn't moved much from my little perspective since 2003. Hence the drawn down equity was used in other markets - mainly shares and derivatives.

Incidentally, the returns are more like 20-30% pa growth plus dividends over the past few years.

But finding a property to buy is not easy. You have to do your due diligence, do your numbers and it takes work. This could take up to months or even couple of years depending on your strategy of buying (if you buy in the same area, then it won't take as long as buying in inter-state, an area that you are totally unfamiliar with). It is constant work!!!

I think it's actually pretty fun - I enjoyed the days of cruising the streets, going to opens compared to being couped up in front of the computer looking at charts..... but horses for courses I suppose

People just going on blind advice that property will go up in value is not going to really experience the great gains as you suggested. Most people do not like to spend hours researching when they have the choice of going out after work or spend time enjoying their hobby etc...

You have to keep the money that property is generating working buy borrowing against equity.

So making money from property is not easy. You have to keep working at it to make it work for you. It's like another job, but with flexible hours and with potential to make more if you put more hours to be creative.

If you do nothing, you will only make what the cycle gives you. (low)

If you put more work into it you can make fortunes(?).

At the end of the day, investing is a business - you need to treat it like one. You can choose to pump a lot of your own time in, or pay other people to do it for you (automation). Example, using buyer's agents, property managers, etc Downside of automation is a lower return than you might get doing it yourself.

So making money from property investing is hard work.

I still think it's harder work to have a day job as a help desk phone jockey....

Cheers,

The Y-man

 

[landlubber]

maybe yes ..maybe no

Hiflo,
I agree with what you say ..sort of ....but only in as much as your 'mate' fell for the trap of many uninformed new investors where (a) they buy one IP (b) they hold it throuh one cycle (c) they go "wow" I'm a genius, it's doubled/gone up x thousand bucks (d) now must be the time to sell.

The answer is "Please, go study some books". You did just did the HARDEST bit and then you "checked out" before the real game starts. Over the next 7 to 10 years it will double again ...And the rents will increase as well !!

The real IP game starts when you have "equity" to release. From this point on you have NO more of your OWN money in the game unles you choose to have ...it's all OPM. You use that equity as 20% deposits with more leverage and more OPM and then (as long as you can service the debt) it snowballs!

I've said it so many times forumites must think I got shares ...but it's all in Jan's books. But, you won't get wealthy with one or two. You gotta think about 15 or 20 IPs ...and you gotta hold them for two cycles and it CAN be done !!

And "no" ..it's not hard work in my opinion. It has it's moments, it's frustrations, but , hey, what doesn't ??...but after (say) 20 years I still don't consider it as hard work.

In fact, please fell fre to show us what you think is an "easy" way to make a few million ?
We're always willing to learn.

LL

 

[alexlee]

No-one said it's easy to be an IP investor, hiflo. However if you work diligently at it for 10, 20 years (part time, outside your 'normal' job) you can build a fortune. Compared to being stuck in an office 50 hours a week for 45 years, I know what I'm picking.

If it was too easy everyone would be doing it.
Alex