order to get your foot in the door you will need to make some personal
sacrifices and a change in the way you look at home ownership.
This concept could be one of the building blocks that helps get you to
the house you so desire. It is possibly a small step which can leap you
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into your own house at a much faster pace.
When talking about global warming, Al Gore once said, “You need to
phase down the danger and see this as an opportunity.” To me, this could
be said for all other problematic areas of change but in this case as a way
to overcome the obstacles to home ownership.
Investment property requirements
For the most part (but not always, which is why it is imperative you
do your homework on loans) you may still need a deposit of at least 10%
(unless you already have an existing property with equity.) This sounds
like a great deal of money, and it is, but that’s why you need to consider
the ways and means of getting that deposit together (see suggestions for
saving) and be realistic with the location and price of your investment
property choice.
The other aspect of this transaction usually involves ‘mortgage
insurance’.
What is mortgage insurance?
Mortgage insurance is the insurance that financiers require you to
take out (at a considerable cost to you), to ensure that should you default
or run into your own financial difficulties and the property needs to be
sold, the financier is covered for the amount owed and will recoup all the
monies owing via the insurance. This insurance is about the financier
limiting its risk.
The amount of mortgage insurance payable is dependent on the loan
and the amount you will need to borrow but, as a guide, the general cost
of mortgage insurance goes up from 0.8% of the entire loan for the first
5% extra borrowed to as much as 2% for an extra 15% borrowed.
Example:
80% of the loan borrowed = Nil mortgage insurance.
85% of the loan borrowed = 0.8% which could equate to an extra
$2,000.
95% of the loan borrowed = This could mean that mortgage insurance
is as much as 2% or in dollar value around $5,000.
This is based on an average loan of about $250,000.
Rates may differ slightly with each particular lender. The rates are
dependent upon the structure of the loan and the various deals in place to
procure you, the customer. In some cases the lender may incorporate the
mortgage insurance into the loan but either way it is an expense that
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needs to be considered when budgeting for the cost of the property.
If it is at all possible you should find a property that requires you to
only borrow 80% of the purchase price (which is all the more reason to
think in the lower price bracket). This is because if you kick in the larger
deposit, the lender/financier will usually cover the cost of the insurance
premium.
Once upon a time mortgage insurance was a frightening prospect that
most people tried to avoid like the plague and for very good reason. It
was an expense that added cost to the home without anything to show
for it. When the property was bought for investment purposes the cost of
mortgage insurance made the investment much less appealing. All of a
sudden the price of the property became might higher and therefore the
investment was considered much less rewarding or viable.
Now, as much as it is a burden, it can also be seen as just another
necessary expense. I for one see mortgage insurance as a necessary evil
and another expense, but still another option available that can and will
see you into the property market.
This is particularly important if you are already saving madly for your
first home during a property boom. While you are trying desperately to
save enough for a 20% deposit during a boom, you could also miss the
boat completely. This is because while you’re saving and not taking
action in the market, the market price on property is going up thousands
of dollars each week, constantly putting you behind. Let’s face it, if
you’re on an average wage or income it is virtually impossible to save
$2,000 to $3,000 per week. If you can, you don’t need to be reading this
book!
So in this case it is much more beneficial to forego the saving for a
20% deposit strategy in favour of a quicker and ultimately more
profitable solution. Mortgage insurance in this case may be an upfront
cost initially, but the increased capital gain over the boom period could
put you well and truly in front in the long term.
This is why I urge you to be aware and informed about what is
happening in the world markets. It can help guide you when making
very important decisions like this one.
If I did use this strategy… What sort of investment
property would I buy?
Look, there are many, many types of investment property choices out
there. They can range from commercial property for businesses to a
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penthouse suite for the elite. The type of property can be one that you,
the individual, feel comfortable with, but you have to make sure the
figures are workable plus ensure a level of certainty that you can manage
the loan. There are other considerations and they depend largely on what
works for you. What I am trying to say here is that some people feel at
home with holiday letting apartments, while others steer away from this
type of investment, preferring to focus on commercial investment. One
is neither better nor worse than the other, but the dynamics of how they
are let and the rate of return can differ immensely. Either way a person
may find that one or the other fits with their lifestyle, personality or just
plain comfort zone for investing.
What I recommend is the one that holds the least amount of risk, at
least in the initial stages. For me, it is residential ‘stand alone’ property.
Stand alone means that others don’t get a piece of the action, such as a
property consortium.
As well, I generally pick the lower to middle of the road type property
which provides a reasonable rent for the people most looking to rent.
Furthermore, with demand higher in these areas, the chance of
potential growth is also higher. On the other hand, in a premium market
usually only an exclusive group has the ability to buy, which limits the
prospects for future capital gain. That’s not to say that the cost of the
property won’t rise sufficiently, but with the money it would probably
take to purchase one prestigious property (not withstanding the risks
attached), I may have been able to purchase three properties in an area
with higher demand. This could give a higher return, less risk of not
finding a tenant and provide more capital growth.
This practice continues to work for me so I stick to it. I have,
however, moved out of my comfort zone and bought into other
arrangements and then come unstuck. It was not that the other
arrangements didn’t provide a return on my investments, but for me the
return
was never as good as residential property. In addition, there were
too many limitations attached and the potential for capital growth was
restricted by the fact that so many other properties were available in the
same block. Competition!
So I have found what I feel comfortable with and what works for me.
A property which will always have a demand for tenants is the way to
go. That means buying in the low to middle range. Even if the tenant
seems to pay a lesser rent than what is achieved in the so-called better
areas, you’re more likely to get recurring, ongoing rent, which makes the
rent return more definite.
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Not so at the higher end of the market. People w2ho usually rent at
the higher end are more likely than not to be temporary residence, who
have moved because of a job transfer or are waiting for their own house
to be built or located. The better the area and house the higher the
income needed to rent it, which requires higher income earners. IF a
recession hits or there is a glut in the market it is usually the higher
priced rental properties that feel it. Whereas, the low to middle range
remain in demand because people need to live somewhere. As housing
prices continue to rise, more and more people will be looking to rent and
the lower end of the market covers a higher proportion of the population,
for example: young people starting out; low to middle income earners;
people building their own homes who need reasonably priced
accommodation while their house is under construction; welfare
recipients; immigrants, those with job transfers etc, etc. Most people
know that the less money they spend on renting the more they will have
in their own pockets for purchasing later on.
The second thing to look for when buying an investment property
(and for that matter your own home), is the land content, that is, the
amount of land associated with the purchase of the building. An ideal
ratio of land apart from the building is 40% or more.
Why? Because land appreciates and buildings
depreciate. In fact, most buildings only have a life
span of around forty years. That’s why from the
moment you purchase your investment property you
can claim depreciation of the building on your tax,
while the land content appreciates in value over
time.
I own many units and townhouses and have been fairly successful
with capital growth, but I soon realised I could have done much better
had I purchased a house rather than units simply because there is limited
land content in my purchases.
I knew about land content, but never really took it seriously enough.
Through research and experience I have learnt that the land content of a
property is what grows in value not the building. As I said, the building
in fact depreciates, but provides the best means to getting back some of
your hard earned tax.
The other problem with units and townhouses is the ongoing body
corporate fees. The cost associated with those fees has continually eaten
into my cash-flow, preventing me from progressing forward at a faster
rate.
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I guess one other factor which will help towards making a sound
investment is location. Location involves the infrastructure around the
property and what future plans are in the pipeline. If the basics are in
place such as schools, shopping centres and medical facilities, the
chance of it being a good location is fairly high, particularly when it is a
growing area and employment can be easily accessed. Many would
argue that being close to cities is the only way to go, but I disagree. I
don’t believe rural areas and remote locations should be overlooked if
you do your research and find out what is happening in that area and
what potential growth there might be in the future.
Now, you may not get capital growth on a remote property, like that
of a city dwelling, but there is one huge advantage of owning an
investment property in a remote area, especially when it is close to a
mining or industrial development. That advantage often involves a very
healthy cash return. In other words, you can often purchase houses much
more cheaply in remote areas than those on offer in the cities, and the
remote rents are usually much higher, providing you, the investor, with a
great cash flow return for your investment.
Why is this so?
Basically, the workers of remote areas have to be housed somewhere.
Often, the workers are on contracts for a period of time and therefore
don’t want to commit to purchasing when they know they’re going to be
moving back to wherever home might be. Furthermore, the long-term
capital gain is a bit more risky, given that mines can close down and
‘ghost towns’ can emerge, so people tend to be a little more hesitant
about investing in mining or industrial townships.
A good example of what can happen is the demise of the
asbestos mine at Wittenoom, in Western Australia. The once-
thriving township of Wittenoom was home to 20,000 people
and had the infrastructure of schools, shops, an airport and
cinema.
My uncle emigrated from Scotland to work in the mines and
settled with his wife in Wittenoom in the 1950s and 60s. The
township was constructed in 1947 following the discovery of
asbestos in 1943.
In 1962, Dr Jim McNulty made the first documented
diagnosis of malignant mesothelioma, a form of cancer
relating to the exposure of the asbestos. It is the outer
membrane of the lungs which would result in a horror finding
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for the people who worked and lived in Wittenoom.
My uncle was one of those residents who did eventually die
from the condition.
The mine closed down in 1966 and with it went the residents.
I visited Wittenoom in 1980 and marvelled at the eeriness.
The signs around the town gave a strange reminder of the
dangers involved by living there, even breathing in the air.
Shops and homes were boarded up and the place really did
feel as though it belonged to ghosts!
Nevertheless, you would hope that we have learnt from past mistakes
and have put all the right checks in place to ensure a catastrophe like that
never happens again. The bottom line is that the risk needs to be
weighted up and if the area you’re planning to invest in is researched
properly, you may find that the mining company has a 99-year lease in
place and the mind has enough resources available to last hundreds of
years. So get informed!
In some cases the mining company will lease properties for the
employees and their families, or the employee themselves will seek
rental accommodation. Either way a demand is created in areas where
building developers don’t usually invest time and money into developing
pockets of land and building homes, mainly because the room for growth
is restricted. When the demand is high and choice is limited you have the
opportunity to get a premium price for rent, which often leaves a
cons
iderable amount of money in the hand over and above expenses.
Another aspect to consider, if you do decide to go this way, is that
any extra income derived from the tenant’s rent is taxable, but it is also
extra income that you didn’t have before, which can be used for
purchasing your own home. First, this shows a better income to the
lender, by improving borrowing capacity. Second, it puts more money in
your hand to re-invest… hopefully into your own home.
If you find that purchasing a house is going to be
harder and take longer than acquiring a unit,
then whatever you do, don’t hang back (don’t
wait). Sure, you may not get the same level of
capital growth as a house provides in the long
term, but a unit can still be a very good start.
Remember, getting into your own address is the
aim of the game and the sooner the better. Don’t
put off today what you can in effect do today!
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P.S. My first solely owned address was a unit and it gave me my
start!
Where do I invest?
I guess the best part about investing in your first property is the
ability to get into the market without necessarily struggling with high
local market prices. If, for example, you live in the heart of Auckland
NZ, or Sydney Australia, you are in a premium price bracket for housing
that very few people could actually buy into as their very first property.
Even if you can get a loan, the pressure placed on you to meet high
repayments can be detrimental to a quality of life.
On the other hand, the benefits of investing are many and varied. One
of the biggest incentives involves the ability to choose a less expensive
area to invest in. Investing gives you the ability to buy in another
locality, State or country area at a much more affordable and therefore
manageable price range.
So where should you invest?
All the way through this book I emphasise the need to stay informed.
Read about what is happening in the world in credible journals and stay
in touch with world trade issues. Influences in the world can and do have
a large impact on investing and I cannot emphasise this enough.
My Example
My first attempt at investing further afield, but I didn’t, was in
Western Australia. The property market hadn’t risen in price to the same
Goodbye Renting Page 7