How to future-proof your property investment strategy

Significantly tighter credit, the potential abolition of negative gearing and increase in the capital gains tax rate, falling property prices, new apartment supply… these are some of the head winds facing property investors today.

Given these challenges should you give up and not invest in property? I don’t think so. In fact, good investment opportunities tend to reveal themselves during times where there is negative sentiment and/or uncertainly.

I would like to share with you four tactics that you can employ to mitigate many of the above risks and ultimately enjoy quality long-term returns.

Tactic 1: Invest with owner-occupiers

It is prudent to invest in a location and type of property that suits owner-occupiers equally as well (if not better) than investors. By doing so you increase your pool of prospective purchasers which will help drive property price appreciation. Also, if future changes in tax legislation negatively impact investor demand, the owner-occupier market will still underpin demand for your investment property.

The chart below from CoreLogic (from 2016) sets out the percentage of units and houses owned by investors. Most inner-city high-rise residential towers are often marketed to investors and due to the sheer quantity of these apartment towers, they are probably responsible for skewing the percentages somewhat. However, this sector is a good example of one that you must avoid like the plague – for lots of reasons including that fact that this it is dominated by investors.

units v houses

Tactic 2: Invest before 2020

The Shorten government has stated that its ban on negative gearing and higher capital gains tax rate will only apply to properties that are purchased after a yet to be determined date. That is, these new rules will not apply retrospectively to property you already own. Assuming the election occurs in May 2019, I expect that it will take at least one year to draft and pass legislation. As such, perhaps the earliest practical start date for these new tax rules would be 1 July 2020. Therefore, if you purchase an investment property before this date you will still enjoy the current negative gearing benefits and 50% capital gains tax discount.

Tactic 3: Level up on quality

As discussed in my recent article in The Australian newspaper, if the ALP’s tax policies are implemented as proposed, they will reduce the after-tax long-term return on property by 26% from 12.6% p.a. to 9.3% p.a.

The best way to mitigate the negative impact of higher taxes is to generate higher returns. And you cannot expect above-average returns from below average quality assets. Therefore, you absolutely must invest in the highest quality assets that you can afford.

In my book, Investopoly, I talk about how notionally there are sub-grades with the class of investment-grade properties and these will have an impact on the potential investment returns that you can enjoy. I have provided and excerpt below (click to enlarge).

property investment strategy

Tactic 4: future-proof your loan structure

When it comes to borrowing, the best starting assumption these days is that you may not have access to more credit in the future, so you should take whatever you can get now. Therefore, if you are going to invest in a property, borrow the full cost (using equity in existing property) and putting all existing and future surplus cash in a linked offset account is the best approach.

In regard to repayments, consider opting for principal and interest repayments as it will save you approximately 0.48% p.a. in interest (as interest only loans attract higher interest rates). Better still, you might consider running your repayments through a line of credit so that is soaks up the principal portion of the repayment. This will give you the best of both worlds i.e. the lowest interest rate whilst minimising the cash flow cost of the investment through only funding interest only.

The point with this tactic is that due to much tighter credit, getting your loan structure right is even more important today.

Remember, we are playing the long game

I have written about this a lot previously but it’s a good reminder. A lot of the potential risks facing investors today have been experienced before. They will have an impact in the short run, but not in the long run. The property market has generated very good returns over the past 3 to 4 decades. Over this time, it has endured many changes in tax (far more severe than what are on the cards today), double-digit interest rates, economic shocks, market crashes and so on. The risks today are nothing new. If you are investing in property you are best to take a very long-term view and ignore any short-term worries. Long term investors that are focused on quality are always rewarded.

Uncertainty your friend

I recall attending an auction in October 2008. Two weeks prior to this auction, Lehman Brothers filed for bankruptcy and the share market was in free-fall (it lost 35% of its value between September 2008 and March 2009). According to the media, the end of the world was nigh. It was a very volatile time. Anyway, back to the auction, I bought the property for $1.21 million. In a normal market it was probably worth $1.4-1.5 million. This property would be easily worth $2.5 million today (due to personal circumstances I don’t own it anymore). My point is, during times of uncertainly and low consumer sentiment, opportunities can arise but only if you are looking for them.

Therefore, perhaps now is not a bad time to start investing in property. That said, I don’t think there is good or bad time to invest. You do it when your circumstances allow it. Ignore the media and run your own race.