What Is The Best Investment?
I am always asked this question, and my answer is always the same. “It depends” is my answer.
The truth is that selecting the best investment for a client depends on several things. Firstly and most importantly, it depends on their strategy. If their strategy is to build a high capital growth performance portfolio with the view to sell down assets upon retirement, their property strategy will be quite different to someone’s who is planning to pay down all debt and retire on the passive incomes generated by rent.
There is no right or wrong when it comes to determining the debt retirement approach after the acquisition cycle, not unless the investor either flip-flops without a plan and enters into property investment without a firm plan. Being clear about the end goal is really important, and engineering a sensible acquisition cycle to match the available time left until retirement, and the debt retirement intention is critical. There is no point saddling up for extreme debt in the hopes of catching strong capital growth if an investor has imminent plans to retire.
Property should be a long game.
The next thing that this question depends on is cashflow. Without adequate cashflow to service the shortfall of the rent vs outgoings, the investor will find that their investment property is draining their lifestyle budget to a point that it is impacting on their happiness and other commitments. Sure, every investor would love to own a stylish dream-house in an expensive, blue-chip suburb in a capital city, but we all have to start somewhere and we have to select property that is within our means.
Take this diagram as a guide. If the investor’s rental income is greater than the outgoings (ie. mortgage repayments, rates, insurances, property management fees and maintenance costs), the property is classified as cashflow positive. While cashflow positive properties exist, they generally aren’t found in our capital growth locations such as major cities. In most locations where capital growth is found, the cashflow on a completely financed property is negative. That means the investor contributes a financial portion to the holding costs of the property to meet the shortfall that the tenant’s rent hasn’t covered. Generally, the more valuable the property, the more significant this shortfall is. The investor will be required to continue meeting a monthly shortfall for as many years as it takes for the property’s weekly rental to grow. In many cases, this can be well over ten years depending on the property.
There are options that investors can consider in an effort to reduce this out of pocket figure, however it requires a compromise on the capital growth prospects of the investment property. For example, selecting a unit, townhouse, apartment or regional asset can actively increase the rental yield (the annual rental return as a percentage of the property’s value). However, it’s fair to say that long-term performance of these types of assets does not eclipse that of a house in an inner ring capital city suburb.
Note that I have not taken tax benefits into consideration and this is deliberate. With recent tax changes to depreciation and pending negative gearing changes on the horizon, it’s prudent for investors to calculate their raw holding costs.
The third element that this question depends on is diversification. If an investor owns three units in the same suburb, clearly a fourth won’t offer them market diversification. It’s well and good to enjoy the fruits of our labour when one particular approach has worked, but cycles exist, consumer sentiment varies, and governments can instigate change, whether it be local government planning changes or state/federal government initiatives to buyers. When it comes to property investing it pays not to put all of the eggs in the one basket.
The final thing that “best investment” depends upon comes down to the individual’s own appetite for risk and involvement. If risk aversion has plagued their past decision-making ability, a rough old house in an up-and-coming area demonstrating early gentrification may not be their best option. And if the investor wants a property that they can “add value to” or develop, but is so busy with their day to day life that they can barely make time for attending the open-for-inspection, this idea won’t match their needs. A passive investment strategy should be just that; able to be managed by others, requiring little or no attention, and delivering healthy returns long term.
Rather than asking “what is the best investment property?”, investors should only ask “what is the best investment property for me?”
Any advisor who suggests that one model fits all should be bypassed.