Chapter 2

Developing Your Property Investment Strategy

IN THIS CHAPTER

Looking at investments options away from home

Using your holiday home as an investment

Understanding commercial real estate

Working out if rentvesting might work for you

Considering the possibilities - and risks - with flipping property

Weighing in on property development

Just as the day is long, so too are the real estate investment opportunities available; however, not all options are necessarily a sound strategy for you personally and financially. We mention in Chapter 1 that most investors (around 90 per cent) opt to buy one or two properties, usually within their home cities, and call it a day. Sometimes they can't add to their portfolios because the investment properties they've chosen have sucked up their borrowing capacity without producing significant capital growth and they simply can't qualify for finance to buy another one.

The smartest and most educated investors, on the other hand, understand the plethora of opportunities in real estate out there. They start their investment journeys with a plan on what they want to achieve, and look further afield for properties with capital growth potential. Often they tap into expert help along the way and also recognise that diversification is a smart strategy.

So, in this chapter, we outline some of the more advanced property investment strategies available to investors who want to grow a sustainable and capital growth producing portfolio over the long term. (We also provide a handy guide on 10 property investment strategies to consider in Chapter 9.)

Diversifying Away from Home

One of the most important rules of investing is diversification. That's the mantra of 'don't put all your eggs in one basket'. Why? If you drop the basket, all your eggs break. However, if you spread your eggs among many baskets, you reduce the chance of breaking them all at once.

The same rule holds true for property investment. Not only can it be dangerous for someone to have all their investment money in property only (many investors have some money invested in other asset classes), but investing exclusively in one geographical area is also dangerous. Most importantly, for first-time investors, that means buying in an area away from where you live.

If you own your own home, a good portion of your individual net wealth is affected by property prices in your neighbourhood. If your suburb sees a strong rise in values, that's great. It's obviously not so great if your home falls in value. So, what would happen if the only other major asset you owned was an investment property that you bought close to home? You'd be doubling up on your luck. If the area continued to grow, fantastic. If it fell in value, you'd be in double trouble.

The economic health of many large towns, regional cities and even suburbs in metropolitan cities can sometimes rest on the prosperity of one large employer. For example, say you live in a mining or tourism location. Many of your friends and family may be employed by those industries. What would happen if, for some reason, that industry experienced a significant downturn, and thousands of people lost their jobs? Such a collapse would be an economic disaster for those people and for all the local businesses where those people spent their incomes. A further effect would be to put a severe dampener on property prices, often for as long as a decade, as people moved on in search of work. If you owned your own home and an investment property in the area, a large part of your wealth would probably disappear overnight, and stay that way for many years.

Although probably time-consuming, doing the required research to invest in an area away from where you live doesn't have to be difficult - and you can take advantage of a plethora of experts to help you. You can begin by finding out the pros and cons of a few suburbs on the other side of town. Or you can look at suburbs in a larger town or city with an economy that relies on a different set of fundamentals or has a diverse economy that features a number of different industries. And, after you've had some practice and experience in owning rental properties, you may wish to further diversify your property holdings interstate.

See Chapters 5 and 6 for more on researching the earning and growth potential of different regions and specific properties.

Purchasing a Holiday Home

A common way for people with the means to expand their real estate holdings beyond their primary home is to purchase a holiday home. For Australians, this expansion is usually a place by the beach, in the bush, or by a river or lake - a home in an area where they enjoy taking holidays.

Why is this so? Many Australians grew up enjoying holidays at the family beach house, or with friends who had one. After the stereotypical 'Great Australian Dream' of owning your own home, another strong desire is to own a holiday home.

Many people hope to own a holiday home and rent it out when they don't want to use it, for perhaps as much as 90 per cent of the year. They often believe that they can own this wonderful place of their own and, because they also lease it out, claim the whole thing as a tax deduction. Wrong! The ATO only allows you to claim tax deductions for the portion of the expenses that are related to the income-producing activity (that is, when it is truly available for rent). If you occupy it yourself for significant portions of the year, the ATO only allows you to claim the portion of the year that the property was 'available for rent'. For example, if you use the property for 15 weeks of the year, you're able to claim only the portion of expenses that represents 37 out of 52 weeks of deductions.

Holiday homes are a strange mix of 'home' and 'investment property'. They can be both, but you need to be well aware of the special tax rules that apply.

The downsides to holiday homes can be numerous, including the following:

• Expenses: With a second home, you have nearly all of the costs of a primary home - including mortgage interest, property taxes, insurance, maintenance and utilities.
• Property management: When you're not at your holiday home, things can go wrong. A pipe can burst, for example, and it may be days or weeks before the mess is found if the property is not being rented out regularly to holidaymakers.
• Lack of rental income: Most people don't rent out their holiday homes, negating the investment property income stream that contributes to the returns real estate investors enjoy. If your second home is in a holiday area where you have access to plenty of short-term renters, you could rent out the property. However, this entails all of the headaches and hassles of having many short-term renters. These requirements can be managed by property managers, but higher costs are usually associated with this than with long-term rental properties. That said, you do gain some of the tax advantages of depreciation and expenses as with other rental properties.

Before you buy a second home, objectively weigh all the pros and cons. If you have a spouse or partner with whom you're buying the property, have a candid discussion. For most people, buying a holiday home is more of a consumption decision than it is an investment decision. That's not to say that you can't make a profit from owning a second home, if the chosen location experiences strong market conditions. However, your total potential investment returns shouldn't be the main reason you buy a second home. Don't forget to weigh up the value of your personal use versus the likely gains from income or capital gains. (See Chapter 6 for more on buying property in holiday areas.)

Considering Commercial Real Estate

Commercial real estate is a generic term that includes properties used for office, retail and industrial purposes. You can also include self-storage and hospitality (hotel and motel) properties in this category. More than a few Australians have turned a pub into both a successful business and a real estate holding.

Commercial real estate isn't our first recommendation, especially for inexperienced investors. Residential real estate is easier to understand and also usually carries lower investment and tenancy risks.

With commercial real estate, when tenants move out, new tenants nearly always require extensive and costly improvements to customise the space to meet their planned usage of the property. And you may have to pay for some of the associated costs in order to compete with other building owners. Fortunes can quickly change - small companies can go under, get too big for a space and so on. Change is the order of the day in the business world, and especially in the small business world.

So, how do you evaluate the state of your local commercial real estate market? You must check out, for a number of years, the supply and demand statistics, such as how much total space (and new space) is available for rent, and how that has changed in recent years. What is the vacancy rate, and how has that changed over time? Also examine the rental rates, usually quoted as a price per square metre. (We provide some information on commercial leases in Chapter 6.)

Commercial real estate is a...