Over the past decade, I have written over 150 blogs about property investing. That’s enough content to fill four books! I’m always trying to publish thought-provoking and practical blogs that sometimes challenge conventional wisdom and empower investors to make better financial decisions.
While each property investing blog that I write is important on its own, I think there is huge value in bringing together all my evidence-based insights and analyses into one unified property investing methodology. So, here are my 4 golden rules rooted in evidence and analysis, plus some additional useful observations.
Rule 1: Focus on growth before you buy, and income after
When selecting a property to invest in, it’s essential to prioritise future capital growth over any other factors, such as income, as much as financially possible. The reason for this is simple: capital growth is driven by the location, whereas a property’s income is primarily influenced by the improvements on that land. While you can always improve a dwelling in the future, you can never change the land itself.
To maximise future capital growth, you should aim to purchase an investment-grade property. As outlined in this blog, an investment-grade property must meet all three criteria:
- A persistent imbalance between supply and demand. Supply should be fixed, meaning there should be no vacant land nearby i.e., a well-established, blue-chip suburb. Demand should be historically strong and diverse, coming from various buyer types such as investors, upgraders and downsizers. When demand consistently outpaces supply, prices always rise over time.
- Evidence of past growth over multiple decades. Past performance is often a reliable indicator of future performance, because long-term value drivers tend to remain stable. For example, a highly regarded private school or public-school zone positively influences property prices. Schools rarely relocate, and their presence is a matter of fact (not opinion), contributing to sustained demand in the area.
- A strong land value component. A property’s value is made up of the value of land plus the value of any improvements (dwelling). For a property to be considered investment-grade, at least 50% of its value should come from the underlying land.
We typically advise our clients to spend their entire budget on purchasing the best parcel of land on the proviso that the dwelling is at least tenantable. Over time, when it’s financially appropriate, the dwelling can be improved.
Once you have acquired an investment-grade asset, the next step is to focus on minimising holding costs. This can be achieved through making cosmetic improvements, minimising the cost of debt, optimising tax outcomes, and so on.
Rule 2: It’s important to understand property cycles
Buying the right property at the wrong time can still work out well in the long run, but you may need to hold the property for several decades to achieve the average return you expect.
On the other hand, buying the right property at the right time can be incredibly valuable, as it may enable you to invest more sooner and fast-track your progress toward your goals.
For example, starting in 2018, we advised many of our clients to purchase investment-grade properties in Brisbane. By 2018, the market had experienced an 8-year flat cycle, and I believed that there were signs (such as a return of interstate migration) that it was about to enter a growth cycle. Clients who bought properties for around $1 million in 2018-2019 are, on average, worth more than $1.7 million after a relatively short time, just 5.5 years.
This highlights why understanding property cycles is important: it helps you identify locations or property types likely to enter a growth phase and avoid those that are at the end of a growth cycle. While this is not a perfect science and unforeseen factors can impact future growth, it’s much better to factor in these cycles than to ignore them altogether.
The chart below illustrates distinct property cycles since 1980. In a blog earlier this year, I analysed all cycles since 1980 and concluded that growth cycles tend to last around 10 years, while flat cycles typically last around 7 years.
Not only do geographical markets behave differently over time, despite national factors like interest rates and the broader economy, but even different property types, like houses and apartments, can experience growth cycles at different times. For example, houses in Brisbane entered a growth phase at the start of 2019, whereas apartments did not begin their growth cycle until March 2021.
Rule 3: Understand the maths behind success
Successfully building significant wealth through property investment is not because property itself is inherently wonderful. Instead, it’s the combination of specific investment characteristics that makes property a powerful wealth-building tool:
- The ability to borrow the full cost of a property, meaning you don’t have to contribute any of your own capital.
- The negative gearing tax benefit, which reduces after-tax holding costs, i.e., your only capital contribution; and
- Investment-grade property returns consist primarily of capital growth, with relatively little income after expenses. Capital growth returns compound.
When all 3 of these attributes are optimised, they help investors accumulate significant wealth over time.
While you can borrow to invest in shares, borrowing to invest in property has three key advantages. First, it’s generally more cost-effective – interest rates for investment mortgages are lower than those for share loans. Secondly, there are no margin calls. If the value of your property falls, your investment loan will not be impacted if you are meeting its repayments. Lastly, residential property has had half the volatility of shares, which makes investors more comfortable with gearing to 100%.
When you borrow the full cost of a property, the only capital you need to contribute is towards the holding costs. Negative gearing tax benefits can significantly reduce these costs, especially if your taxable income is high.
Albert Einstein famously called compound interest the “eighth wonder of the world.” Capital growth in property is not taxed each year, only when you sell, which allows returns to compound over time. For example, a 7.2% p.a. average capital growth rate means your property’s value will double every decade. Compound growth is the simplest way to build wealth – it just takes time.
The formula for property investment success is simple: borrow the full cost, maximise negative gearing benefits, minimise holding costs, and maximise long-term capital growth (refer to rule # 1).
Rule 4: Consider future buyer capacity
The rule that “property prices cannot grow faster than buyer capacity” might seem obvious, but the underlying implication is fundamental. That is, you must consider who the potential future buyers will be and whether they will have the financial capacity to pay more for your property down the track. Specifically, ask yourself: will they be able to afford to pay twice as much in 10 years, and four times as much in 20 years (assuming an average 7.2% annual growth rate)?
Economists often argue that property prices can only grow in line with incomes. If your income rises by 10%, your borrowing capacity should rise similarly, allowing you to pay more. However, the reality is that wages in Australia, according to the Wage Price Index from the ABS, have grown at just 3.1% annually over the past 30 years. In contrast, property prices have consistently outpaced this growth. So, how has this happened?
In my view, property prices have grown faster than incomes for three key reasons:
- Credit Policy: Banking deregulation in the 1980s allowed borrowing capacity to increase by 2 to 3 times during the 1990s and 2000s. While credit policies tightened after 2017, households can still borrow 5 to 6 times their annual pre-tax income, which has supported property price growth. However, I don’t expect significant future contributions from this factor; future borrowing capacity is likely to remain stagnant.
- Urban Sprawl: Typically, when property prices in outer suburbs reach the median value (around $1 million), affordability becomes a major constraint. As a result, new buyers are drawn to new, greenfield suburbs and estates where houses are more affordable (e.g., $500,000). As these estates mature and become more established, prices rise to the median, creating a ripple effect. This cycle has been particularly evident in Melbourne and Brisbane and contributes to overall property price growth in major cities.
- Wealth Inequality: The wealthiest 25% of Australians are less dependent on income alone to buy property, as they have other wealth sources. Wealth inequality in developed countries, including Australia, has been growing and is expected to continue. For example, a recent Australian study showed that the average wealth of the highest 10% of households grew by 84% over the past 20 years, from $2.8 million to $5.2 million. Meanwhile, the wealth of the lowest 60% grew by just 55%. Nearly half of all wealth in Australia is now held by the top 10% of households.
The media often claims that housing is less affordable, but if that were true, property prices would not have risen so substantially over the past 40 years! The reality is that housing is affordable to certain segments of the population. As investors, it’s vital to understand who these buyers are and invest in the locations that appeal to them.
The key question is: what will buyer capacity look like in 10, 20 and 30 years? Just because your property in an outer suburb has increased in value from $650,000 to $1 million over the past 5 to 10 years doesn’t guarantee that this growth trajectory will continue.
Other important observations
When planning your property investments, here are a few other important observations to consider:
- Maximising negative gearing benefits is more important than minimising capital gains tax (CGT). A tax saving now is far more valuable than one in a few decades. This became clear in my analysis of using superannuation to invest in property.
- Using a company structure to own investment properties can help you maximise negative gearing, avoid any land tax surcharges, and minimise CGT.
- The most effective property investments are those with higher holding costs (negative cash flow) plus a high expected internal rate of return (IRR). My analysis shows that these types of investments generate the most wealth in dollar terms.
- Investing in property outside of superannuation is often optimal. However, if this prevents you from maximising the tax-free benefits of super, you may be better off divesting of property after retirement, as discussed here.
Dear Stuart,
The biggest factor affecting property investment is the high land tax, and as one approaches the 3 million land value it becomes a disincentive to invest, especially for residential property.
Yes, property taxation needs to be reformed. Resident Australians are paying a large burden whilst overseas corporations are enjoying nice tax breaks on build-to-let property. Its not very fair.