The average investment loan size stands at just over $600,000, which means that half of all investors borrow more than this amount to acquire an investment property. However, in my experience, most investors tend to spend less than $1.5 million on a single investment property.
It’s important to note that many individuals own more than one investment property. This brings me to an interesting comparison: should you invest in one property worth $3 million, or opt for two properties at $1.5 million each? I like to refer to this strategy as “jumbo property investing.”
Now, if you think this analysis doesn’t apply to you because your budget isn’t in the multimillion-dollar range, you might want to reconsider. The principles discussed here can be relevant to many investment scenarios.
Our preferences are shaped by many factors
One of my mentors is very wealthy, and he considers a budget of $3 million to $5 million to be suitable for investment properties. His views on investing have been shaped over many decades, influenced by his own experiences and those of his clients. These views have helped him accumulate a lot of wealth, so it’s hard to argue against them.
In contrast, if you were to ask the average Australian, I’d guess that most would feel that a budget of $500,000 to $700,000 is adequate for purchasing an investment property.
Setting aside the issue of affordability, since many Australians simply cannot afford a $5 million property, it’s worth exploring how our beliefs about investing and money are formed. For many, these beliefs are influenced by our upbringing, personal experiences, and the people we surround ourselves with.
When it comes to making significant financial decisions, it’s best to avoid letting personal beliefs cloud our judgment. Don’t let limiting beliefs hinder your ability to make the best possible financial decisions.
Buyer’s agents must target affordable markets
If most Australians spend less than $1.5 million on an investment property, then it stands to reason that most buyer’s agents will have the most experience in this price range. As such, their views will be shaped by their experiences and knowledge and therefore likely shape their advice.
When approached with the question; if I have a budget of $3 million, should I invest in one property or two or more, most buyer’s agents would recommend spreading the budget across several properties. To what extent is this advice influenced by their experience? Are they recommending that because that is what they are most familiar with?
What does a jumbo investment look like?
With a budget of $4 million in Melbourne, you could choose between investing in two single-fronted, two-bedroom terrace houses in, say, Carlton or a single three-bedroom home in, say, Armadale. Let’s take a closer look at these two options.
According to the 2021 Census, there are only 2,218 houses in Armadale. While not all these homes are investment-grade, this data clearly indicates that family homes on over 400 square meters of land in Armadale are quite scarce assets, especially the handful of picturesque streets that have few apartments. As the push for greater density in inner-city suburbs intensifies, which it inevitably will, these properties are likely to become even scarcer.
In addition to their scarcity, these larger homes offer alternative productive uses due to their land size. An owner has the flexibility to build a larger, newer home, extend the existing dwelling, or, depending on planning regulations, potentially develop the site into multiple dwellings (apartments or townhouses). These alternate uses may become more valuable in the future as the demand for increased density continues to grow.
On the other hand, terrace homes have limited potential for enhancing their productive value. They are typically single-level residences that occupy most of the block with small backyards. Typically, the only option for adding value is limited to constructing an additional level (such as a third bedroom), although that can be quite costly.
In summary, the main advantages that a jumbo investment can offer are twofold: (1) acquiring a higher-quality asset that is scarcer which should drive its value higher over the long run and (2) securing a property with potential for alternative productive uses.
An example of a jumbo investment
The challenge in finding comparable examples in Carlton and Armadale is that recent growth in Melbourne has been below average. Over the past 27 years, the median house price has appreciated at a rate of 6.4% p.a., which is about 1% below the long-term average. More recently, in the last 7.5 years, growth has been much more modest at just 2.64% p.a., which is about 0.50% p.a. less than inflation.
I have previously referenced this work by Nerida Conisbee. She concludes the most expensive 5% of houses and apartments in Australia have exhibited higher rates of capital growth over the past decade.
That said, I want to share a compelling example from a property purchase made by a client with a multimillion-dollar budget last year.
In mid-2023, our client, with the help of a great buyer’s agent, purchased a block of four Art Deco apartments in an excellent street in Prahran. The land size is 670 square meters, which is large for Prahran. The client purchased this property for $2.95 million, which was essentially land value. While the building itself was structurally sound, the units were in disrepair and required extensive cosmetic renovations, including new kitchens, bathrooms, plumbing, flooring, and paint. Our client invested just under $500,000 in the renovations. When factoring in buying costs like stamp duty, their total expenditure on this investment was slightly more than $3.6 million.
In terms of income, the four apartments generate gross rent of $144,000 annually, with a net income of circa $107,000 after accounting for direct expenses including land tax. This results in a net yield of just under 3% p.a., which is quite high for an asset of this value. After considering tax benefits from negative gearing, depreciation, and interest costs, we anticipate that the current cost of holding this property will be about $63,000 p.a., after tax.
If the value of this property appreciates at a conservative rate of just 6% p.a. over the next 20 years and they sell it, I’ve calculated that their internal rate of return will be 17.9% p.a. after all taxes. This return is net of all holding costs, selling costs, and capital gains tax. The high projected return is largely due to the relatively low holding costs resulting from cosmetic renovations.
If they choose to sell in 20 years, I project they will net over $3.7 million in cash after all costs and taxes, in today’s dollars. An investment balance exceeding $3 million is likely to provide most people with a very comfortable retirement, as I’ve discussed in detail here.
In addition to benefiting from the property’s growth over the coming decades, there are alternative productive uses for this asset. Subject to council approval, there’s potential for development; there’s space at the rear for additional apartments, or someone might choose to build a family home, as 670-square-meter blocks in Prahran are quite rare. Alternatively, our client could strata-title the apartments and sell them off individually.
The advantages of jumbo investing
The goal of investing in property is to choose assets that can achieve an average capital growth rate of over 7% p.a. over a multi-decade period. To accomplish this, you need to own assets with limited or decreasing supply that benefit from very high demand. Naturally, assets with lower supply and greater demand have a higher likelihood of meeting or exceeding that 7% p.a. growth benchmark.
This brings us to the first advantage of jumbo property investing: you can afford to invest in significantly higher-quality property, which increases the likelihood of achieving satisfactory long-term capital growth. Put differently, it reduces your investment risk. It’s important to note that most buyers in this price range have alternative sources of wealth beyond just borrowing capacity, which is often linked to household income. These alternative sources, such as inheritances, can further drive property price growth.
The second advantage of jumbo investing is the ability to target properties with alternative productive uses. If the property’s value doesn’t appreciate at 7% p.a., you may be able to create value by exploring these alternative uses for the property.
Risks with jumbo investing
Underperformance is likely to be your most significant investment risk. This can happen if you invest in a poorly chosen asset, or if the geographical market itself underperforms, like Melbourne has since the end of 2016. It’s essential for investors to work with a reputable buyer’s agent to minimise the risk of investing in the wrong property. And if you can hold your investment for 20 to 30 years, that should help mitigate any geographic market risks.
Another risk to consider is a substantial increase in holding costs. When you borrow several millions of dollars, your cash flow becomes more sensitive to changes in interest rates. Additionally, jumbo investment properties tend to have high land values, making them more susceptible to changes in land tax rates. If you are conservative with your budget, this risk should be manageable.
The final risk involves reduced flexibility. If you own multiple investment properties and your circumstances change, forcing you into a situation where you must reduce debt, you can sell one property while keeping the others. However, if you only own one asset, you’ll need to sell the entire property to address your financial situation. This isn’t as significant a risk if you have other investments and have borrowed conservatively.
What can non-Jumbo investors learn from this?
Even if you don’t have a multimillion-dollar investment budget, there are key lessons from this discussion that can still benefit you.
First, it’s crucial to reflect on any financial beliefs you might hold that could lead you to make suboptimal decisions. For instance, being overly conservative with your budget may prevent you from achieving the best possible outcomes.
Second, when it comes to property investment, it’s generally wiser to concentrate your resources on one high-quality asset rather than spreading them thinly across several average-quality properties. From both a returns and risk perspective, having higher-quality property is typically a better strategy than owning multiple lesser-quality properties, as discussed here a few years ago.
If you can afford to make a jumbo investment?
If you have a multimillion-dollar investment budget, it’s essential to choose your advisors wisely. As the saying goes, “To a person with a hammer, everything looks like a nail.”
You need a financial advisor with a deep understanding of both property and shares. They must have the experience to evaluate a wide range of property investment options, considering various price points and locations in different geographical markets. They should be able to create a personalised investment strategy that aims for the highest returns whilst minimising risk. This could include making a jumbo property investment – at least it should be one of the tools in their arsenal that they can draw upon.
