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RETIREMENT & LIFESTYLE PLANNING | |
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| ISSUE - 17 - APRIL 2003 | |
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Bombarded by mixed messa about poor investment returns light of recent sharemarket falls many investors are turning to the relative safety of residential property. However, achieving a successful outcome is dependent on investors being well informed and adopting the right mindset!
Home may be where the he is – but often not the dollar
As investors, it is important to recognise the differences between choosing a property a an investment as opposed to a personal residence. Many investors fail to recognise that the kind of property you like to live in does not necessarily make a good investment.
Emotions and personal circumstances will be the key drivers in your choice of home.
Chances are you’ll be asking questions like does the home have the right number of bedrooms? Does it have a provision for a small office so I can work from home? Is it close to family, friends, shops, social venues and amenities? However, when it comes to selecting an investment property, your choice should be based on solid business principles, not personal tastes. Your aim is to choose an asset that outperforms the wider market and will have perennial appeal to a broad range of tenants and potential buyers.
Unlike your family home, you don’t need to fall in love with a property you plan to purchase for investment purposes. In fact, we often tell clients that it’s probably better if you don’t like your investment – at least that way you will keep an emotional distance! Since an investment property is designed to make you money rather than appeal to your lifestyle and personal taste, the primary selection criterion must be to buy property that will achieve consistent capital growth. The value of high-quality assets grows because demand consistently outstrips supply. A good investment will double in value every 7-10 years and achieve capital growth of at least 7-8% per annum ahead of the prevailing inflation rate.
Unlike an investment property, your home doesn’t produce an income via rent (unless a room or annex is leased). Whilst it should not be the key reason to invest, rental income is important because it helps offset holding costs such as loan repayments, insurance, maintenance expenses and rates. Income-producing assets also attract tax and depreciation benefits. In retirement, your income from rent and other sources replaces your salary.
Comparing apples and oranges
Many investors and commentators tend to compare the residential property market with the sharemarket, but they fail to realise that comparing the two asset classes is fundamentally flawed.
Because the stockmarket is traded more frequently and visibly than the property market and because data and analyses are more readily available, many investors tend to apply stockmarket measurement tools and methods to assess the residential property market. And herein lies the problem! Investors and many commentators tend to view direct property as a subset of the stockmarket when nothing could be further than the truth. It’s truly a case of comparing apples and oranges.
Unlike stocks and shares, residential property is a basic commodity – everyone needs somewhere to live! Australia has one of the highest rates of home ownership in the world.
In our major cities in particular, perpetual underlying demand from homeowners underpins long-term performance. By contrast, sharemarket movements are primarily determined by business sentiment and company performance.
The two asset classes also have different ‘physical characteristics’ – property is tangible and three dimensional - you can walk through it, touch it, even demolish it. Shares are intangible. Furthermore, property is an individualised asset – every property is unique, whereas every share in a particular company is identical.
Demystifying property cycles
Every asset class is subject to shifting economic conditions and cyclical variables. These are simply part of the investment journey and as investors it’s important that we maintain a sense of perspective when assessing the medium to long-term potential of our assets.
Economic cycles in Australia vary in length. We had a 12-year cycle from 1961-1973, a seven year cycle between 1975 and 1982, and another seven-year cycle between 1983 and 1990. The most recent cycle began in 1991 and is our longest yet.
An economic cycle is commonly marked by two or more consecutive quarters of negative economic growth, or more technically speaking, negative GDP growth. Residential property cycles operate within the wider economic cycle. It is quite common to observe several property cycles within one economic cycle. More proactive economic management is resulting in longer, gentler cycles.
From a property perspective this means less volatility for investors, however, even as cycles become less volatile, we will continue to observe some cyclical aberrations, especially early in a cycle and near the end.
For example, if we look back to 1991-1993, growth in residential property values was quite flat. As economic conditions stabilised, growth returned to more normal levels of 7-10%. In the last four years we have seen unusually strong growth of between 10-15% per annum or more, especially in our larger capital cities. Both the early and closing stages of each property cycle display atypical patterns of growth whilst the middle years of the cycle show more characteristic patterns of supply, demand, rental levels and capital growth. The current moderation in capital growth is a natural cyclical phenomenon, and something to be welcomed rather than feared, for it will engender long-term sustainable capital growth, and realistic rental income.
Whilst everyone is keeping a close watch on the world economy, remember that there have been numerous similar periods throughout recent history. Rather than do nothing or maintain higher risk investment strategies, astute investors often favour perceived safe havens like prime residential property and fixed interest in these less certain times.
To a greater or lesser extent most property and economic cycles feature one or more periods of ‘crisis’ where investors have to make decisions based on incomplete information and ‘crystal ball gazing.’ Rather than engage in ‘knee jerk’ reactions, purchase top quality assets, hold for the long term and let time and natural capital growth work for you. This is a far safer strategy than trying to pick the top or bottom of a cycle.
The recent buoyant economic conditions, high capital growth, low interest rates and government incentives to first homebuyers have supported investor and first home purchases rather than rental demand. Just as growth patterns vary, variations in vacancy levels and rental yields are also a normal part of every property cycle.
The current softness in the rental market is likely to continue for another two years or so. It will reverse when one or more trigger factors cause demand in the first homebuyer market and some sectors of the investor market to abate – for example, a substantial rise in interest rates, higher unemployment, greater global uncertainty, more limited availability or withdrawal of the First Home Owners Grant, a drop in affordability and a reduction in the number of inner-city high rise units available for sale and lease.
Whilst the investment journey may be dotted with the unexpected, solid strategic planning and independent information are, without doubt, your best allies both today and in years to come.
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Your Life, Your Retirement. PO Box 1150N Armadale North Victoria 3143 Australia
Phone: 613 9824 6901 - Fax: 613 9824 6362
Email: publisher@yourlifechoices.com.auIS PUBLISHED BY
Copyright Retirement Publishing Pty Ltd 2001 -- ISSN 1031-6620 ACN 088 049 218
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