(An excerpt from “What I Didn’t Learn From School But Wish I Had”)
Why invest in real estate?
One reason is because many people have made money out of real estate and I expect many more people to make even more money in the years to come. It is an easily accessible market that has many favourable advantages. If you are using real estate, make sure that you do your homework properly. Like any investment area, there are both sensible and risky ways of investing in real estate. Depending on your experience, determination and skill you can just as easily lose money as make money in real estate.
Millionaires from real estate
The intelligent use of real estate can enable ordinary Australians to become millionaires in about 10 years or less. Despite the ‘concept’ of property belonging to the ‘rich’, most Australian property investors earn below the average wage (which is currently around $50,000). So property is clearly not just for the super wealthy; it is for anyone who wishes to increase their net worth in a steady, appreciating environment.
Bear in mind that if you wish to be one of the ‘wealthy’ people in the future you should probably be using property to your advantage. Statistics show us that home ownership is increasing in Australia. As property prices keep rising, less and less people are able to afford their ‘dream home’. It is expected by the year 2010 that only 40 percent of Australians will own their dream home. This is down from 73 percent in 1980. Thus there is a definite trend of many people side-stepping real estate. This means that these people are going to be ‘renters’ for their entire lives.
Personally, I like to buy property with no money down because I do not like to tie up cash in property if I can avoid it. I have learnt how to buy property virtually no money down. Many years ago I purchased several properties in Brisbane; $600,000 worth of property which I purchased at around $40,000 below bank valuation and my only cash outlay was around $2,400. That means an instant profit of $40,000 and I do not have to pay for these properties for over a year. In a year those properties were worth close to $800,000 with an outlay of virtually nothing.
In the meantime the cash saved by not out laying a 10 percent deposit on these properties is tied up generating returns from share renting strategies, rather than putting the 10 percent deposit into a trust account with a real estate agent with zero returns. You can see how investing is not a bad hobby especially when you get to a point where you do not need the money. It is fun and you can do a lot of things with it.
A lot of statisticians say that on average across the board, property has doubled on average every 7 to 10 years in the last 150 years in Australia. Not all property though. Some people have properties that double in value in 5 years, while some properties may take 20 years to double in value; it obviously depends on the location and quality of the property and the price you pay for it.
For instance, John and Sally are earning $50,000 a year and they want to replace their income. I am going to suggest that just by buying two investment properties they could achieve this. Let us look at how they can buy two investment properties to allow them to retire. $50,000 a year is approximately $35,000 a year after tax. So would you be committed to buying two properties in the next decade if you could retire from them?
In year one of the plan we are going to buy one property. The properties I tend to buy are often around $300,000 that we will use for this strategy. The second year we do not buy any property and in the third year we buy our second property. You do not have to buy 100 properties and become a property guru to make this work. In 10 years time these properties could be worth $600,000 each. That is 10 years after you buy them, especially if you are buying them with good criteria and they are good quality properties. A tip —always make your plans conservative as it could take 10 years or longer.
I generally buy properties in capital cities because these properties will continue to grow. I have some properties outside capital cities that have made phenomenal returns but I prefer capital cities; you have to decide your own criteria.
The strategy is not going to work in a small country town because the property will not double in 10 years or even 100 years and could even go the other way. Imagine Broken Hill; property does not double every 10 years in Broken Hill. You can buy a property for as little as $1,300 in Broken Hill; because of the downturn in mine related work people are leaving town and your property will just sit there.
If the property doubles in 10 years (ideally 7 years, but 10 to be conservative), this is $300,000 in extra money we have made over 10 years on each property, a total gain of $600,000. You probably purchased these properties with a 10 percent deposit (unless you have learnt to buy with virtually no money down) and borrowed the difference. Now your properties are worth $600,000 each and you have earned $600,000 from capital growth.
John and Sally need $35,000 a year net to replace their current incomes. They are probably thinking that if they buy the property they will have to work harder. If they buy and sell to make a profit, they generally have to pay capital gains tax. In this strategy we are going to buy a good property and ideally keep it forever. It is worth $600,000. They need $35,000 net cash to replace their income. Where can John and Sally obtain that money from?
What about a line of credit?
A line of credit allows us to draw equity/cash out of property by setting up a bank account from which to draw this down. John and Sally can draw out $35,000 in the first year. Is there any law saying they cannot spend that money? The banks do not care where John and Sally spend the money as long as they meet their commitments. In year 2 John and Sally can do the same thing and draw out another $35,000 and draw another $35,000 in year 3.
Are they spending money they worked hard for or are they spending money they made out of thin air while they slept? John and Sally do not want take any more money out of that property even though they could. Remember, John and Sally have waited 10 years before the commenced drawing this money down.
In years 4, 5 and 6 they could take say $35,000 out of the second property. The money is just sitting there so why not use it? If they do not use it when they die someone else will get it, so they might as well use the money they have made.
Six years after the first property is worth more than $600,000, being in a capital city, a good growth area, it may be worth $900,000 to $1 million. That is if it has doubled in 10 years to $600,000, six years later it could be in excess of $900,000. We will use that as an example. That gives John and Sally another $300,000 which is sitting there available to be used. John and Sally have not finished using the first $300,000 and they now have another $300,000; and the property keeps increasing in value whether they like it or not.
Now if John and Sally are not careful, they could get into a cycle of making more money than they spend, which can mean they have more money than they need for retirement. Do John and Sally have to pay income tax on the $35,000 per year that they are drawing out? The answer is no, because it is not income. John and Sally are spending thin air and there is no tax on thin air as yet! That money is legally tax-free. The ATO will let you do that because it is borrowings; also if you do not invest and buy properties to house Australians the government will have to.
Do you have to pay back this debt or do you simply have to meet the interest payments? The answer is you never actually have to pay this debt back unless you choose. This is what insurance companies are for; they take your money to insure your debt. When you die, your debt and your life insurance will pay out the properties. If you want to pay this debt you can, as critics may say this is a debt-ridden strategy.
However let us consider what a real debt strategy is. Most people work hard to try to pay off their property. Is that really smart? No, because they have been taught to work hard for money and they have to get out of this way of thinking, out of this mind set. The banks do not work hard for money.
Have you noticed that the banks own the biggest buildings in the cities? Do you think the banks are working hard to pay off these buildings? The banks know that they are increasing in value. Do you think that the banks are not pulling that money out and using it?
McDonalds makes more from its real estate than its hamburgers because they use that real estate as equity to reinvest. A lot of wealthy people understand this and that is why they are wealthy. Gerry Harvey for instance of Harvey Norman fame creates a lot of his wealth from the properties he develops for his franchised Harvey Norman stores.
If we wanted to pay off the debt with this strategy and live off the rent, we could now sell the second property and use this money to pay off the first property, thus wiping out our debt without having to work hard to pay the debt. This is another example of working smart versus working hard — a different way of looking at money.
I have illustrated this as a concept only. Obviously in reality there
are obstacles that may have to be overcome, such as qualifying for finance, getting good valuations and being comfortable spending equity (thin air) rather than just leaving it to go to waste and dying with it unspent. Or what if the property market goes flat?
Then you may have to adjust your plan to a 15-year plan rather than 10 years, or 5 years as it has been in recent times. Is this still preferable to no plan or the pension plan? I would say, most definitely!
However if you understand the concept you are 80 percent there.
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