Let me begin by saying that the reason is not buying the wrong investment property, picking the wrong end of the market or even misjudging the supply and demand ratio. We call it a “systematic reason”, because the problem is inherent in the system that we all live in. It affects everyone of us and it puts most property investors automatically into the loser’s corner even if they are are not aware of it. Let me explain why.
If you have been investing in residential properties for the past 10 years or so, or you know a few other property investors who have done this, you would find that 90% of the time property investors don’t seem to enjoy good cash flow from their investment. In other words, they find they don’t really have more income to spend, unless they start selling their properties, which hopefully after tax may eventually give them some money.
I am sure for most property investors this was not the picture that inspired them when they first started investing. We were all sold a much brighter future than that. So where has it gone wrong?
The system we are in
Let’s look at the following diagram first.
In the above diagram, you can clearly see that Australian residential property prices are matching the growth of the Australian Money Supply, which is around 8.6% increase each year.
Winners and losers
Looking at Australia as a system, like a big room with a lot of people in it, let’s find out who are the winners and who are the losers.
Let’s say if your income is $100k a year, you usually get a CPI increase each year of say, 3%.
But the system you are in has had 8.6% more money added to it each year for everyone inside to share. By the time the increase in money hits your pocket, you only have 3% more, not 8.6% more as it should be.
So somehow you are missing 5.6% (8.6% - 3%). Even if you take away the 1% population increase (i.e. 1% more people sharing the money), you are still 4.6% (5.6%-1%) worse off than the year before.
So you can almost say that someone inside of the system has got their hands on your 4.6%. They are the winner and you are the loser.
Hence if you just work for a wage that has CPI increases and do nothing else with your money, you are likely to end up in the loser’s corner.
Now let’s say you are investing your money in the home you live in. You manage to buy an average home which grows at 8.6%. What happens then depends on whether you have borrowed the money or not: If you didn’t borrow any money, your home value increase will meet the money supply increase and you will find yourself just breaking even because your cash flow is neutral (you don’t have to pay a mortgage). If you did borrow money to buy your home, then your home value increase will break even, but your cash flow will be negative due to your mortgage repayments, so you are still worse off. So a home owner with no mortgage is neither a winner nor a loser, but a home owner with a mortgage can easily be a loser.
Let’s say you are investing your money in a rental property and you manage to buy an average rental property that grows at 8.6%. You will have the following 3 scenarios: If you didn’t borrow much money (say less than 50%), you will be getting ahead because the value increase of the property will break even with the money supply increase, but your net rent will actually put you ahead. If you borrowed at 50-80%LVR (Loan to Value Ratio), then you will be at a break-even position. This is because the value increase of the property will break even with the money supply increase and your cash flow from the rental property will also be neutral (depending on your tax situation). If you borrowed the at 100% LVR, which is the most common way property investors acquire additional rental properties, then your cash flow will be negative. With the property value increase breaking even with increasing money supply, you are automatically falling into the loser’s corner.
(For those who are analytically minded, your average investment property growth 8.6% matching money supply growth 8.6% means you are breaking even on the numbers, and if you look closer, you can take off 1% as capital gain tax out of the 8.6% on the property growth side, and take off 1% population growth from the money supply side, they will still be even. Hence we can categorically say as long as your properties are growing at the average growth rate of 8.6%, you are not better off or worse off from the growth aspect, it will come down to whether your cash flow is positive or not to determine whether you are better off or worse off.)
This is why most property investors automatically end up in the loser’s corner.
Long term winning formula for property investors
You can see from the above analysis, you can’t get ahead by simply buying better cash flow properties with lower growth rates than the net money supply growth. You can’t get ahead by simply buying higher growth properties with severe negative cash flow either.
If you want to get ahead over the long term, you need to achieve the following two conditions at the same time:
You need to buy rental properties that over the medium to long term can grow at or above the net money supply growth of 8.6%, and; Have positive cash flow from these rental properties.
The first condition is a lot easier to achieve if you stick to solid growth suburbs with a reasonable population. The second condition is a lot harder as it requires the investor to pay down the debt quickly to reach the level where the cash flow can become positive. Unless you have a lot of surplus income each year, debt reduction can be a slow and never ending process.
The Buy and Hope Strategy
Most property investors fall into the trap of the “Buy and Hope” strategy. They hope that the income from their rental properties will one day be high enough to cover their interest repayment and expenses, so they don’t focus on turning their cash flow positive as a high priority.
That thinking works in theory, time will do its work. But in reality it often keeps the investor in a negative cash flow position year after year, and worse still, more negative each year.
So what happened to that good old Excel spreadsheet projection we all did when we first started? There are two major hidden forces here that work against us ever seeing our cash flow turn positive:
We are going backward in real terms each year by being in the loser’s corner in a system that needs us to get both 8.6% growth and positive cash flow to get ahead; Once the negative cash flow momentum started, like anything with a momentum, it will get into its own element and take us further down the negative cash flow path. Hence most property investors can’t stop leveraging more of their existing equity to buy more properties as soon as they see their existing properties go up in value. On the surface, it is smart leveraging, but really it is a negative cash flow momentum that gets the better of us.
Summary
So the systematic reason why most property investors fail to get ahead in Australia is that the money supply keeps growing at 8.6% a year, and we are swimming against the current. So if we are not swimming faster than 8.6% (i.e. making 8.6% more money each year), we will be going backward automatically.
Have you ever pictured what an ideal property portfolio should look like?
I think it should have the following characteristics:
It produces 8.6% growth consistently over the long term and into the future; The net positive cash flow from the rental properties can cover all our lifestyle expenses and is ever increasing; All rental properties in the portfolio have no strings attached (i.e. they are everyday rental properties which can be rented and sold without restriction or dependence on other people’s performance.)
Unfortunately, most property investors are not aware that they are investing in an environment which automatically put them into the loser’s corner. Hopefully by being aware of the bigger picture, we can all move out of that corner quickly and become winners.
I know quite a few people who have tried property investing, but never really got ahead. There seem to be several reasons for this, and most of them relate to 'rules of thumb' that don't always hold true, such as: * It has to be negatively geared to reduce your tax * Land appreciates, buildings depreciate * Only buy new so the depreciation schedule is good * Yield is unimportant * Property managers are a waste of money * If you don't sell you don't make a profit
For many people, they don't seem to have really thought about how property investing fits into a wider investing strategy, and about what they are hoping to achieve. Simply buying and hoping is a crap strategy.
I know quite a few people who have tried property investing, but never really got ahead. There seem to be several reasons for this, and most of them relate to 'rules of thumb' that don't always hold true, such as: * It has to be negatively geared to reduce your tax * Land appreciates, buildings depreciate * Only buy new so the depreciation schedule is good * Yield is unimportant * Property managers are a waste of money * If you don't sell you don't make a profit
For many people, they don't seem to have really thought about how property investing fits into a wider investing strategy, and about what they are hoping to achieve. Simply buying and hoping is a crap strategy.
FWIW, I've broken every one of the above 'rules'.
I was thinking of your point with property managers being a waste of money. Do you rent your properties out yourself? Is it a pain in the ass dealing with tenants?
I was thinking of your point with property managers being a waste of money. Do you rent your properties out yourself? Is it a pain in the ass dealing with tenants?
He broke those rules - which means he doesn't think property managers are a waste of money ...
I put trolls and time wasters on my ignore list so if I don't respond to you, you are probably on it ....
I thought I was investing in property as a way of preserving and increasing my capital and providing a good vehicle for saving, not preserving my share of the overall money supply. Incidentally, it has been very successful in achieving my goals.
I like stinkbug's rules, not so much because they are rules you have to live by, but because they all highlight things we need to think about (and maybe break the rule after some thought.)
1. It has to be negatively geared to reduce your tax. No. It doesn't. However, having a way of saving before-tax dollars instead of saving after-tax dollars certainly helps, even if you end up paying tax through capital gains tax.
2. Land appreciates, buildings depreciate. Very true. I always look for a high ratio of rates/body corporate.
3. Only buy new so the depreciation schedule is good. Total bullshit. 1) There is almost always huge premium for new housing that negates any tax benefits you get down the line. 2) You pay for depreciation 1:1 and you deduct it at, at best 0.48:1
4. Yield is unimportant. Total return is important. Yield is actually an important part of total return, but not the whole story. Don't sacrifice total return for yield would be my way to say this.
5. Property managers are a waste of money. A good property manager saves you money, saves you time, and is a good source of advice. A bad property manager will let scumbags turn your property into a meth lab. Choose a good property manager, read the monthly reports carefully and build a relationship with them. Use the time you save doing something productive or enjoyable in your life. You have better things to do than collecting rent and serving notices of breach.
6. If you don't sell you don't make a profit. Don't know what to make of this. It is literally true, but not useful. If you don't sell, then over time a liability turns into an income stream. For most of us that's a good result.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
I thought I was investing in property as a way of preserving and increasing my capital and providing a good vehicle for saving, not preserving my share of the overall money supply. Incidentally, it has been very successful in achieving my goals.
I like stinkbug's rules, not so much because they are rules you have to live by, but because they all highlight things we need to think about (and maybe break the rule after some thought.)
1. It has to be negatively geared to reduce your tax. No. It doesn't. However, having a way of saving before-tax dollars instead of saving after-tax dollars certainly helps, even if you end up paying tax through capital gains tax.
2. Land appreciates, buildings depreciate. Very true. I always look for a high ratio of rates/body corporate.
3. Only buy new so the depreciation schedule is good. Total bullshit. 1) There is almost always huge premium for new housing that negates any tax benefits you get down the line. 2) You pay for depreciation 1:1 and you deduct it at, at best 0.48:1
4. Yield is unimportant. Total return is important. Yield is actually an important part of total return, but not the whole story. Don't sacrifice total return for yield would be my way to say this.
5. Property managers are a waste of money. A good property manager saves you money, saves you time, and is a good source of advice. A bad property manager will let scumbags turn your property into a meth lab. Choose a good property manager, read the monthly reports carefully and build a relationship with them. Use the time you save doing something productive or enjoyable in your life. You have better things to do than collecting rent and serving notices of breach.
6. If you don't sell you don't make a profit. Don't know what to make of this. It is literally true, but not useful. If you don't sell, then over time a liability turns into an income stream. For most of us that's a good result.
You make a lot more sense than Bill Zheng.
Any expressed market opinion is my own and is not to be taken as financial advice
I thought I was investing in property as a way of preserving and increasing my capital and providing a good vehicle for saving, not preserving my share of the overall money supply. Incidentally, it has been very successful in achieving my goals.
I like stinkbug's rules, not so much because they are rules you have to live by, but because they all highlight things we need to think about (and maybe break the rule after some thought.)
1. It has to be negatively geared to reduce your tax. No. It doesn't. However, having a way of saving before-tax dollars instead of saving after-tax dollars certainly helps, even if you end up paying tax through capital gains tax.
2. Land appreciates, buildings depreciate. Very true. I always look for a high ratio of rates/body corporate.
3. Only buy new so the depreciation schedule is good. Total bullshit. 1) There is almost always huge premium for new housing that negates any tax benefits you get down the line. 2) You pay for depreciation 1:1 and you deduct it at, at best 0.48:1
4. Yield is unimportant. Total return is important. Yield is actually an important part of total return, but not the whole story. Don't sacrifice total return for yield would be my way to say this.
5. Property managers are a waste of money. A good property manager saves you money, saves you time, and is a good source of advice. A bad property manager will let scumbags turn your property into a meth lab. Choose a good property manager, read the monthly reports carefully and build a relationship with them. Use the time you save doing something productive or enjoyable in your life. You have better things to do than collecting rent and serving notices of breach.
6. If you don't sell you don't make a profit. Don't know what to make of this. It is literally true, but not useful. If you don't sell, then over time a liability turns into an income stream. For most of us that's a good result.
What I was getting at is that some property investors believe in following rules, but I advocate using your brains and experience to know when such rules should be broken.
For many people, they don't seem to have really thought about how property investing fits into a wider investing strategy, and about what they are hoping to achieve. Simply buying and hoping is a crap strategy.
Another little nugget from Stinkbug's post. Very true.
I plead guilty to a little bit of "buying and hoping" in my early years. It turned out well, but not through any genius on my part. In particular, right now I find that I am overweight property and not as liquid as I would like to be. In future, I will be looking at reducing my residential property exposure as a percent of total exposure and consider some of the following:
1. More shares, with an emphasis on good money management on the portfolio. ("Buy and hold" for shares is, like "buy and hope" on housing, a bad strategy.)
2. Do buy long-duration fixed income when yields are high and you think the economy will turn down. If interest rates drop then the value of your bonds will go up.
3. Right now I am looking at trading out of some portion of residential and buying rural land. Agriculturals might just be the hot commodity for the next decade.
BUT
Bad as "buy and hope" might be as a strategy, it sure beats "whine and spend", which is what a lot of people seem to be doing right now.
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