finder.com.au speaks to managing director of Metropole, Michael Yardney, about how to build wealth from a young age.
When it comes to investing in property for the first time, you may feel like you’re in over your head. Lacking in disposable income and investment know-how, your chances of surviving the property market as you compete with cashed-up investors may seem slim.
Rest assured, investing from a young age provides you with the power of compounding, where time is your trump card. While investing early on demands a different approach and mindset compared to investing when you’re older, you can reap significant financial benefit – and for longer – if you invest cautiously.
Here are some pointers on how you invest in real estate in your prime years.
Why invest from a young age?
1. Compounding over time
The greatest advantage that young property investors have is time. Not only do young people have more years to learn about property investing strategies and markets, but they also have more time to recover if they make a poor investment decision. For instance, if you purchase a rental property when you’re 20 and you end up making a loss from the purchase, you have time to learn from your mistakes and recover- it’s a learning curve. On the contrary, if you’re nearing retirement at 55, and you make a bad investment choice, it’s more difficult to recover.
“We believe people should get onto the property ladder sooner rather than later because of the power of compounding,” Yardney says. “In other words, if you want to invest in property now, over time it will double in value.”
2. Financial benefit
Some of the main financial benefits of investing in property from a young age include:
Maximise cash flow: One of the objectives of property investing is to increase cash flow, or the money left over each month after expenses have been accounted for. Generally, cash flow will increase over time as rent increases, while your repayments will largely remain the same, and the mortgage will be paid off as you gain equity in the property.
Appreciation: The longer you own an investment, the more it will appreciate in value. While the opposite is also true – the property could potentially decrease in value – it’s likely that it will increase in value again if you own the property for long enough. The median house price increased by 14.1% in 2014 in Sydney alone.
Diversify your portfolio: Over time, you can buy several investment properties to build your wealth. The sooner you buy your first income-producing asset, the sooner you can diversify your portfolio and buy other investment properties.
Negative gearing and depreciation: As Yardney suggests, young people can benefit significantly from negative gearing and depreciation associated with real estate over time: “Many young people are using investment properties as a stepping stone, as it may be cheaper to own a rental property than a home. The repayments are subsidised by the rent and you end up getting various tax benefits such as depreciation and negative gearing.”
3. Control
Unlike other forms of investing, such as share trading, property investing provides you with a high degree of control. For example, if you get your property revalued and find that it has increased in value considerably, you could potentially charge higher rent.
Yardney explains: “As you get on in life, your personal circumstances change. You may get married and have two incomes, but then you may have kids and drop to one income. If such a situation arises, property investing allows you to let the magic of compounding work in the background.”
Obstacles for young property investors
There are many challenges that prevent young people from entering the property market. Yardney points out that the main obstacles for young property investors are a lack of knowledge and lack of affordability: “It’s a combination of a couple of things. It’s a lack of information, they don’t know a lot about it and they have misconceptions and myths that they’ve heard from their parents and the media. The other is affordability. They can’t afford what they would like to buy.”
Here’s a breakdown of some of the main challenges faced by young property investors:
1. Lack of disposable income
Whether you’re still studying or working on a part-time basis, many young people have relatively low disposable income compared to their older counterparts. This lack of financial resources may present a challenge, particularly if you want to come up with a 20% deposit for a loan in order to avoid paying lenders mortgage insurance (LMI).
For example, if you take out an investment loan of $350,000, you’ll need to save $70,000 to complete a deposit. However, don’t let your low disposable income deter you from property investing. While coming up with a deposit is an important step, this is only part of the equation, and there are many options for young investors to access finance, such as through a guarantor.
You can compare a range of guarantor loans here.
2. Lack of financial discipline
Yardney says that young investors lack financial discipline when it comes to saving: “The big obstacle is saving a deposit, but banks will now let you borrow up to 90% loan-to-value ratio (LVR), and you don’t need to have a very strong savings record.”
Many young people have a poor credit rating, but there are ways to improve your credit file. If you have any outstanding debts, such as a credit card balance or a personal loan, speak with your provider to organise a payment plan to ensure that you rid yourself of your debt as soon as possible. You should also ensure that you pay your bills in full and on time.
3. Inexperience
There is an underlying perception that young people can’t invest and that you shouldn’t invest until you have more “life experience”. However, your age makes no difference on your ability to learn and acquire new knowledge. If anything, you are more capable of educating yourself now than when you’re older.
Find out how you can get approved for a loan with bad credit.
When is the right time to invest in real estate?
Yardney says the right time to invest will depend on your personal circumstances: “The right time is when you’re financially ready and you can afford it. It may take 3-6 months to find the property of your choice, whether it’s a home or an investment, so I wouldn’t be trying to time the market.
“Clearly, you don’t want to buy at the peak of the property cycle if you think there’s doom and gloom about to happen. But every year there is some doom and gloom predicted. The media provides a conveyor belt of doom and gloom.”
8 mistakes made by young property investors
Many of the mistakes made by young investors are associated with having the wrong frame of mind about property investing.
Lack of research and knowledge: Knowing how to find a good investment location and property type are valuable skills to have, but young people often fail to research, which can lead to poor investment choices. Yardney says: “In Australia, there’s 1.7 million property investors and more than 90% of them never get past their first property. 92% never get past their second property. Only 15,400 own six properties or more. In other words, most property investors fail. So you’ve got to be careful about who you listen to and the strategies you use. If you go for cash flow, you may miss out on long-term capital growth.”
Property investing is for cashed-up baby boomers: This is a common misconception that deters young people from investing in property. While completing a deposit may be more of a challenge for a young person compared to someone at the peak of their career, there are many competitive home loans that are suitable for young investors.
Not thinking long-term: Many young people buy property without thinking about their future needs. As a result, they often buy properties that don’t accommodate for change. For instance, although a small, one-bedroom apartment may complement your budget and lifestyle now, what happens if you want to have kids in the next five years?
Buying only based on price: Many young people are preoccupied with buying a property that’s ‘cheap’ and use this criteria alone to guide their decision making. However, price should only form part of the investment choice. You must also consider a range of factors such as the location (does the suburb have growth potential?) and the market (is there positive buyer sentiment?).
Not saving early: As a young person, your strongest asset is time. By getting into property investing from a young age, you gain the ability to leverage the market and build your savings over a longer period of time. Try to get into a habit of saving by making regular deposits into a savings or transaction account, or follow a budget to boost your savings.
Buying emotionally: Many young investors are swayed by emotion and convenience when making purchasing decisions. Yardney says: “A big mistake they make is not having a strategy and buying emotionally. They tend to buy closer to where they live, close to where they want to holiday, close to where they want to retire. But sometimes it makes sense for people to buy interstate. You’re going to have a property manager anyway, so whether the property manager is in Sydney, Brisbane or Melbourne, it doesn’t matter.”.
Not reviewing property portfolio: Yardney says that young property investors should get into a habit of continually reviewing their property portfolio: “They should annually review their portfolio and see how it works. This is your employee, this is your property investment business. If it’s not working, you’ve got to look to improve it. Can you swap property managers? Can you do it up?”
Buying for cash flow: Many young investors make the mistake of buying for short-term cash flow rather than capital growth, as Yardney points out: “They think they need a bit of cash flow because they haven’t saved a deposit, but the problem is that you can never become wealthy with a small amount of cash flow. In Australia, there are two motives for property investment: buying for cash flow or buying for capital growth. Capital growth properties are slightly negatively geared, so you need more financial discipline, but the only way you save for the next deposit is through capital growth. It’s too hard to save for your subsequent deposit, so while the majority of Australians look for cash flow, the wealthy ones invest for capital growth.”
What risks are involved?
Unexpected expenses: You need to be prepared for unexpected expenses by ensuring that you have enough funds to cover contingencies. For example, if your tenant suddenly vacates the property, it may take a while to find another tenant, which means you’ll forego rent for a period of time.
Property value: While an investment that’s situated in a good area with infrastructure and nearby facilities is likely to appreciate over time, there is a chance that the property could decrease in value. This market risk may harm your capital growth over time, however this risk can be lessened through diversification, or by investing in different property types across different states.
Time-consuming: Managing a rental property takes time. You need to research the market and find a good property, advertise and find tenants, create a rental agreement or lease, design a budget for expenses and so on.
Liquidity risk: A savvy investor knows that they should have an ‘exit strategy’ in the event that they suddenly need to sell the investment. This risk is associated with the idea that you may be unable to sell a property should the need arise. To manage this risk, you should invest in an area with strong demand and positive buyer sentiment.
Economic risk: Although the Reserve Bank has eased monetary policy this year, and with a historically low cash rate of 2%, interest rates are predicted to rise early next year. This interest rate risk means that the cost can increase for a variable home loan.
Buying the wrong property: Unless you engage in thorough research, you risk purchasing a property that will not meet your investment objectives.
In order to minimise these risks, Yardney says that you should educate yourself and surround yourself with a good team. Young property investors should also treat their portfolio like a business: “They should treat it like an enterprise where each property is their employee and it should be checked once a year to make sure their employee is behaving.”
Tips for young property investors
Educate yourself
Subscribe to blogs, online forums and publications from sources such as realestate.com.au, Investor Assist, Australian Property Investor, Real Estate Investar and Property Investment Resources Australia to learn the ins and outs of property investing.
Research property prices, land tax and government charges as well as socioeconomic factors of the area to determine whether the region represents a good long-term investment.
Yardney says that young investors should become familiar with property investing and different markets:
“They should be educating themselves with all the information out there on the internet. But what they’ve got to understand is how property markets work and not believe the myth that all properties increase in value. They’ve got to understand about budgeting and personal financing. They need to learn about valuing properties and inspecting properties.”
Seek advice
Leverage a pool of qualified professionals by speaking with local agents and brokers to help you understand the market and decipher whether or not the purchase would meet your investment needs. With the help of a professional, you can come up with a ‘checklist’ of the property and market features required for your investment.
You may want to consult the services of the following professionals to help determine your investment strategy and borrowing capacity, as well as locate a high-growth area:
Property manager
Mortgage broker
Buyer’s agent
Financial planner
Accountant
Conveyancer
“They should find a proficient mortgage broker to help them get their mortgage,” Yardney says. “More buyers are getting a buyer’s agent on their side to protect them. They level the playing field because the seller has an agent protecting them so they should get a buyer’s agent to protect them.”
The ability to save and practise financial discipline is a crucial part of real estate investing: “If they haven’t got a big enough deposit, they’re going to have to learn some personal finance strategies. It’s easy for young people to put things on their credit card and take on extra debts. So they’ve got to learn the three fundamental rules: 1) spend less than you earn, 2) save the difference, and 3) invest the difference and keep re-investing it until you have a big enough deposit.”
“Learn to sacrifice and don’t borrow more than you can afford, especially in a low interest rate environment. When interest rates creep up, some people get caught out, so don’t buy off more than you can chew, because there are lots of hidden costs.
“When you rent a property, there’s the insurance, the rates and the bond, body corporate fees, the maintenance and the land tax. So you’ve really got to make sure that you understand all the costs – not just the settlement costs but the ongoing costs.”
Don’t buy based on emotion
Yardney says that young people should employ a team of professionals to avoid buying a property based on emotion: “Get people on your side, because it can be hard, particularly if you go to auction, as you get carried away with the momentum. How do you know what the property is worth? You don’t believe the estate agent and you can’t get a valuation for every property you look at.
“That’s why you get a buyer’s agent to protect you, but you have to pay a learning fee. You either pay it to the market where you overpay or you buy the wrong property that doesn’t suit your needs, or you pay it to someone to protect you. So be prepared to pay a learning fee.”
Plan for contingencies
You need to budget carefully to allow for contingencies associated with your income-producing asset. For example, your tenant may lose their job and may not be able to pay rent on time, or your contractor may fall behind schedule. If such incidents occur, you need to ensure that you have enough funds during the interim to cover repayments and other expenses.
Save early
If you want to invest in property, you need to start saving as early as possible. It may feel as though putting down a deposit on a property is out of reach, but you may only need $60,000 for a 20% deposit if you invest in a regional area such as Geelong.
To bump up your savings, you may want to contact a financial planner to help you create a budget. You should also get into a habit of making regular deposits into a high-interest savings account so you can show your lender that you have financial discipline.
Aim for a 20% deposit or family guarantee
As a rule of thumb, you should try to come up with at least a 20% deposit of the purchase price so you can avoid lenders mortgage insurance (LMI) premiums on your loan.
While putting down a 20% deposit may be challenging, it will save you thousands in having to pay LMI in the event that you default on your mortgage.
However, if you can’t complete a 20% deposit, you have the option of using a family guarantor. This is where an immediate family member allows the equity in their property to be used as extra security for your home loan.
If your parents are willing and able to become the guarantor, then this can be a great solution for young investors looking to borrow with a high LVR.
If you do this, make sure you split the loan in two portions: the portion your parents are guaranteeing and well as the portion that they are not guaranteeing. You should work on reducing the portion that your parents are guaranteeing so you can release them as soon as possible.
Pre-approval
A pre-approval offers increased negotiating power when it comes to agreeing on a price with the seller or agent. With pre-approval, you’ll be considered a preferred buyer as you have a lender’s approval already in place, which can help you win a bidding war against others who may not qualify.
In addition, pre-approval can reduce stress by speeding up the documentation process once you’ve found a property.
Shop around for a competitive loan
The investment loan market is highly competitive and this means you can find a mortgage product with features such as an offset account, the ability to make additional repayments, a redraw facility and minimal ongoing fees.
Sourcing a home loan with these features will mean that you can lower your mortgage repayments and interest charges so you can focus on servicing your debt and reaching your investment goals sooner.
To demonstrate, if you have a $350,000 mortgage at 5.5% interest over 30 years and you decide to start contributing an offset amount of $2,500 in the fifth year, you will save a total of $7,268.28 and chop four months off your loan term by leveraging an offset account.
Compare a range of investment property home loans here.
Co-borrowing
As a young investor, you may want to consider co-borrowing, which involves two or more owners agreeing to share the costs of ownership. This can be a good solution if you both have similar financial goals and circumstances.
Along with sharing the loan cost, the borrowers share additional costs such as stamp duty, strata fees or legal charges, as well as ongoing costs such as maintenance and repairs.
However, this also means that you’d be responsible for the other borrower’s debts if they can’t meet their repayments, so you need to make sure that legal documents are in place.
Renovate but don’t overcapitalise
It’s estimated that properties worth less than $200,000 typically require bathroom and kitchen renovations and upgrades in order to attract tenants.
Before embarking on a renovation, determine how much you can afford to spend and try not to overcapitalise. Get the property professionally appraised by a conveyancer and find out what you can do to improve the value of the property. Then get an estimate of what the property will be worth once the upgrades are complete.
Generally, you should budget 10% of the property value for the renovation. So, if your property is valued at $350,000, you should set aside around $35,000 for the project.
If possible, try to fund the renovation through your savings so you don’t have to pay interest on borrowed funds. To minimise renovation costs, consider DIY projects and using second-hand materials.
Look beyond the inner city
Many investors recommend that you invest in regional areas, such as Goulburn or the Hunter region, that have strong growth performance and infrastructure. If property prices appreciate quickly, you can then go on to diversify your portfolio.
For example, the average property price for a house in Goulburn is $324,000, which means you’d only need $64,800 for a 20% deposit compared to a $322,000 for a property in Sydney’s Lane Cove precinct.
While the average weekly rent for Lane Cove is $900 and annual house price growth is at 6.59%, the rental yield is just 2.91%, so it would take significantly longer to pay off this mortgage.
Investing in property for the first time can be exhilarating, and there is no better time than when you're young. Just make sure you determine a long-term investment strategy, consult the right professionals and conduct thorough market research so you can make the most of your wealth creation.
Images: ShutterStock
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