Club Property

How can you tell if real estate is the right investment for you?

The first important factor is how far away your retirement is. Property investment only begins to be a really viable option if you will hold the investment for at least five years. A smaller time period than that will expose you to all the risks associated with potential short term fluctuations in growth markets.

Thus if you have only two years to retirement and you take on property – and the debt associated with leveraging – and then the property goes down in value over the next two years, your losses will be magnified, and you will have no time available to stay in the market and wait until it has recovered. Odds are you will need to sell to relieve the pressure of the debt repayments (or continue to work into retirement in order to meet mortgage payments) and in selling you will crystallize the loss in value to your property.

If you have a five-year time frame and suffer a downturn in the property market during the first two years of investment, you still have another three years available, during which time the value of the property may recover and then increase beyond the amount at which you purchased.
Property is therefore only a suitable investment for those with the appropriate time horizons.

The next factor to consider is the amount of money you are able to comfortably put into a property investment. If a person has a high level of debt on an investment property then it will likely be costing them a certain amount of money per week to sustain that investment, even after the rental income is received and the tax deductions are made.

You need to decide how much you can reasonably spare from your disposable income each week, without affecting your lifestyle to a degree you will find intolerable in the long term. After all, you are going to be spending this sort of money every week over a period of many years. If it is too much for you to afford long-term, then you will be forced to sell your investment early, and will encounter all the same possible drawbacks of the person with the short time horizon.

You need to consider how realistic your contribution amount is, because it may not remain fixed. Interest rates and rental amounts fluctuate, so an investor may need to put in more (or less) money per week. Even if you have chosen a comfortable contributory amount, you may still at some point find yourself stretched (hopefully only for a period of months or perhaps a year) to an uncomfortable amount.

So if you have chosen an amount that is difficult for you to dedicate to your investments, market fluctuations may see this become impossible to sustain, and force a sale of the investment property.

It is worth noting that we set up a financial structure for the client that gives access to a certain amount of credit to assist in difficult times. This could not be a solution to difficulties lasting a period of years, but if the issue is one of several months duration, then we would expect our clients to have a buffer period.

So property investment is the right investment for the individual who has a comfortable amount of money they can put towards holding an investment, if that amount is sufficient to actually buy a suitable investment.

Equity is the other affordability factor to consider. The investor must have a deposit for a property purchase. Because most lenders will not allow more than 80% of an investment property’s value to be considered as security for a loan (and sometimes less), the remaining 20% of security must be drawn from somewhere else.
This will be either a sum of money or – far more commonly – an amount of equity in another property (typically their home).

So if an investment property is worth $300,000, the lender will allow a maximum of 80% ($240,000) of the property’s value to stand as security for the loan, and they will then require the other $60,000 to come either from the investor’s pocket (so that the total loan is only $240,000) or that the investor use $60,000 of the value from another property to provide the security for the loan on the new property (so that the total loan is $300,000.

Thus property investment is only suitable for a person who has either a lump sum in cash to provide a deposit or has equity available in another property.

These three factors essentially boil down to the questions: Do you have enough money available now to buy the property? Do you have enough available to hold on to the property? And will you continue to have enough to hold on long enough to actually benefit?

Further questions to ask would be:
Is gearing required to reach your goals?
Are you able to owe money for investments and still sleep comfortably at night?
Is your financial position such that you can buy the specific sort of property investment you need to reach your goals?

Failure to properly consider all these factors is where so-called property investment specialists have historically caused damage to the situations of investors.