The dos and don’ts of buying in a boom town
‘Boom towns’ across Australia have delivered many property investors some phenomenal returns in recent times.
In very short periods, rents and house values in boom areas can skyrocket to unbelievable levels. They offer huge opportunities to fast track wealth creation – but they are not for the ill informed and under-prepared. When it comes to the rapid-growth boom towns, what goes up usually comes down.
To make money and avoid getting burnt, you need to know how to read them.
DO buy a property that’s desirable to the local leasing market
Every area or market has its own leasing demographic – certain demographics want certain types of properties. A boom town is no different.
Tapping into the corporate leasing market is what most investors aim for in boom towns. Corporate leases usually mean maximum rent, longer leases and quality tenants, helping to reduce risk. But investors shouldn’t ignore the private market either. Corporate demand for rentals can rise and fall in line with project activity. The resident population is more stable. The more (quality) demographics your property appeals to, the greater pool of potential tenants. Make sure the property you’re investing in will appeal to more than one group.
The best way to determine whether a property you’re considering buying will appeal to the right tenants is to speak to a local agent. They should be able to tell you the locations, types, styles and configurations that are most in demand. They will also tell you the rent you could expect to receive from these types of properties.
Ideally, you want to select a property that will perform well in both boom and quiet market periods, offering extra security on your return during these periods.
It’s important to remember that almost anything will lease for a good price during a boom period. When the market starts to settle, you want to ensure your property will still be desirable to the RIGHT tenants.
DO aim for a secure lease
Many properties for sale in boom areas will come with leases in place. This is what you should aim for. Purchasing an investment with a secure, medium to long term corporate lease minimises vacancy periods and new tenant fees, and ensures quality tenants.
Be careful not pay too much for a property just because if offers an attractive lease. Compare the property and rental rates against other similar properties in the area to ascertain its comparable value.
Don’t get caught up in the hype!
When a boom town starts to run it generally receives a high amount of media exposure. Very quickly, everyone wants a piece of the action. Investors flood in and the market rapidly turns into a seller’s paradise. When this happens, it’s not uncommon for investors to bid well over the asking price to secure a property, desperate to not miss out.
Avoid getting caught up in the hype. Make an informed, well-researched decision. This applies to your chosen area, property type and timing. Ensure your finances are in order. When you’re ready to take action on your selected property, put a condition on your offer. Limit the consideration period to that day only. This will place urgency on your offer and get the seller’s immediate attention.
Don’t buy in at the market peak
Short term boom towns generally have one strong market run which typically lasts from three months to two years. Long term boom towns offer these same growth periods, however growth cycles will usually come around every three to four years. Long term boom towns offer multiple growth opportunities for both the short and long term investor.
The key to ensuring you’re not buying in at the top of a cycle (which will drastically reduce your chances of a return) is to understand how to read the market. If prices in the town have been increasing rapidly for 12 consecutive months, chances are the end of the growth period is imminent for that cycle. If the town has gone through a period of flat or negative growth over the previous 12 – 24 months, it’s likely that a long-term boom town may be ready for its next project-based upswing. Buying in at this point will reward you with capital and rental growth as the market recovers.
Short-term boom towns will continue to appear in Australia, providing opportunities for nimble investors to make a quick return if they get their timing right.
The established hubs, with their strengthening industry and continued civil investment, will experience ongoing growth cycles and will continue to reward those with a buy and hold strategy.
Is it a smart move to purchase a home before an investment property?
As Australians, we place a high importance on owning our own home. After a car, it is usually our next ‘big ticket’ purchase and is considered one of life’s major achievements – a symbol of a sound financial position.
But is it? Is buying a home as a your first property purchase really a smart move?
The old mantra of ‘rent money is dead money’ has been so entrenched in our culture that many of us fail to clearly assess the financial impact and consequences that can come with purchasing a home as your first property. The decision to purchase a PPOR first can weaken your financial position and servicing ability with banks, and increase your cost of living. More often than not, you will also find you have to live in an area that does not tick all your boxes due to affordability.
If you had the choice of purchasing your dream home in five years, or a lesser quality, poorly located home now – wouldn’t you wait?
A mortgage delays your wealth creation potential. Many first home buyers and beginner investors jump straight into buying a property to live in. In the vast majority of situations, it is going to cost you more to own your own home than to rent. To maximise your property investment potential, the best approach is to keep your living expenses as low as possible while you establish your investment portfolio; monthly mortgage payments on your PPOR will only hinder your borrowing capacity and slow your ability to grow a portfolio. Continue renting or live with family and resist non-essential spending while you improve your financial position.
How the living costs weigh up. An example of buying a PPOR versus renting and investing a $500,000 property in a positively geared market and continuing to rent:
- Deposit: $50,000
- Loan: $450,000
- Repayments (principal + interest, rate of 6%): $675/week
- Cost to you: $675/week
Positive investment property –
- Deposit: $100,000
- Loan: $400,000
- Rental income: $1,100/week
- Repayments (interest-only, rate of 6%): $461/week
- Profit: $639/week
- Rent a $500,000 property: $500/week
- Total profit: $139/week
All too often investors who choose to purchase a home to live in as their first property find themselves in a position where they have to wait a number of years to be able to purchase again.
While living in your own home may be tempting, the benefit of remaining in the rental market while you spend a few years developing your investment portfolio means you can fast track your portfolio growth and maximise your net worth.
A little sacrifice in the short term can mean a far better financial position and lifestyle in the long term!
Get positive about wealth creation
Last week the ATO released data from the 2010/11 tax year which showed that two thirds of Australian property investors claimed a total of $13.2 billion in losses on property during the period.
It has renewed debate over the government’s negative gearing policy which essentially rewards investors for losing money (while draining tax funds) by allowing them to claim a deduction on their interest payments and other costs associated with owning a loss-making property.
It is unlikely the government will abolish the tax benefits associated with negative gearing after the last attempt in 1985 which saw it quarantined for a period. This allegedly caused rents to surge (although there is evidence to the contrary) resulting in a swift reversal of the decision. Nonetheless, it has highlighted the need for property investors to ensure their wealth creation strategies are in fact creating wealth.
Some investors are drawn to negative gearing solely by the tax advantages, giving little consideration to the capital growth potential of the property. Regardless of the tax benefits, while an investor holds negative property, they are losing money, putting them at financial risk.
Other investors are prepared to absorb the losses, relying on speculative capital growth to achieve a return, which will only be realized at the point of sale. By comparison, positively geared property delivers a cash return to the investor immediately, providing a passive second income stream and the opportunity to fund their lifestyle and further investments.
It the meantime, negative property investors must dig into their own pockets to supplement the shortfall in rent thereby reducing their monthly cash flow and reducing their capacity to funnel earnings into other investments. And while interest rates are currently at their lowest level in half a century, any future rate rises can impact on an investor’s ability to make payments.
A common belief held by negative gearing enthusiasts is that positively geared property does not deliver good capital growth; the resources towns of the Pilbara and central Queensland have proved otherwise. Investors in these regions have been able to build sizeable portfolios in very short timeframes by taking advantage of the equity generated and extra income available to them to acquire more positive property. For some, their portfolios provide enough passive income to fund their lifestyle, allowing them to shift their focus way from work and onto family, travel and other pursuits.
A negatively geared portfolio does not offer this option. If a negative property rises in value during the holding period, any equity generated can be used as a line of credit, but it cannot be drawn as an income stream to fund living expenses.
Furthermore, negative gearing benefits higher income earners (which are on higher tax rates,) the greatest. Yet, oddly, the majority of negatively geared property investors are in the middle income tax bracket.
Investors considering negative gearing should proceed with caution. Assess your financial goals and investigate the strategies that are available to you.