Chapter 1

Comparing Real Estate to Other Investments

IN THIS CHAPTER

Getting started

Contrasting real estate with other investment options

Deciding whether real estate works for you

Arranging your overall financial plans to include real estate

Watching out for performance statistics

The vast array of choices available to Australians can be both a privilege and a burden. Go to the supermarket in search of something as simple as bread and you'll know exactly what we mean. Choice is even more widespread when it comes to the world of investment. You have thousands of choices among property, managed funds, shares, bonds . the list is seemingly endless.

Allow us to help you through a portion of the cluttered world of investment. In this chapter, we start to explain how, why, when and where to invest successfully in real estate. And, even though we're advocates for property investing, we also take you through some issues to weigh up if you're wondering whether you have what it takes to make money and be comfortable investing in real estate. We share our experiences, insights and thoughts on the long-term strategy for building wealth through real estate that, at its core, is a fundamentally simple and low-risk investment strategy that virtually everyone with a long-term time frame and determination can understand and achieve.

Finding Your Motivation

It's never too early or too late to formulate your own plan into a comprehensive wealth-building strategy. Such a strategy can help with improving your financial future and ensuring a comfortable retirement.

One of the challenges involved with real estate is that it takes some real planning to get started. Without doubt, calling a stockbroker and purchasing a few shares in your favourite company is a lot easier than purchasing your first rental property. But buying good property can be more time-consuming than difficult. You just need a financial and real estate investment plan, a lot of patience, and the willingness to do some research and legwork, and you're on your way to building your own real estate portfolio - and you can even hire an expert team to do the heavy lifting for you.

The vast majority of people who don't make money in real estate made easily avoidable mistakes, which we help you steer clear of.

In this chapter, we give you some information that can help you decide whether you have what it takes to make money and be comfortable with investing in real estate. Unlike almost any other type of investment, real estate is hands-on. When you own shares in a company, you can't personally dictate how that company operates, or influence how profitable it is. Direct investment in property is the opposite. You're in control. Major decisions are in your hands. You can determine how to lift your income and how to raise your profits (or capital gains or equity). We compare real estate investments with other investments you may be considering. We provide some questions you need to ask yourself before making decisions. And, finally, we offer guidance on how real estate investments can fit into your overall personal financial plans.

Throughout history, some of the wealthiest people - regardless of their industry - have also increased their net worth via property investment in both residential and commercial assets. They have done so because they understand the profit potential of strategic real estate holdings. They invest in property not only for diversification and capital growth reasons, but also to supercharge their income streams.

Stacking Up Real Estate Against Other Investments

You've surely heard about or even considered many different investments over the years. To help you appreciate and understand the unique attributes of real estate, in the following sections we compare it with other wealth-building investments such as shares and running your own business, using key economic attributes.

Returns

Clearly, a major reason many people invest in real estate is for the healthy total returns (which can include both ongoing income and the capital appreciation of the property). Real estate can generate robust long-term returns because, like shares and small business, it's an ownership investment. By that, we mean that real estate is an asset that has the ability to produce income and capital growth.

Our research and experience suggest that total real estate investment returns are comparable to those from shares (about 7 to 10 per cent annually, measured over decades). And you can earn returns better than 10 per cent per year if you select excellent properties in the best areas and manage them well. That said, investing in real estate is accompanied by the following:

• Few knockout wins: Your returns from real estate probably won't approach the knockout wins that can be achieved by the most accomplished entrepreneurs in the business world or by picking penny-dreadful shares on the stock market and doubling your return in a month, but that is speculation rather than investment strategy. Real estate profits take time - profits are gained through hard work, good judgement, plenty of research, and tapping into expert advice and guidance when needed.
• Ups and downs: You're not going to earn a 7 to 10 per cent return every year. Although you have the potential for significant capital growth, owning real estate isn't like owning a licence to print money. Like stocks and other types of ownership investments, real estate goes through down as well as up periods. Most people who make money investing in real estate do so because they buy and hold property over a number of market cycles.
• High transaction costs: If you buy a property and then want out a year or two later, you may find that, even though the property has appreciated in value, much of your profit has been wiped away by the high transaction costs. Typically, the costs of buying and selling - which include stamp duty, real estate agent commissions, loan fees, property taxes, and other settlement costs - can amount to up to 10 per cent of the purchase (or selling) price of a property. So, although you may be elated if your property appreciates 10 per cent in value in a short time, you may not be so thrilled to realise that most of the capital growth disappears in selling costs.
• Tax implications: Last, but not least, when you make a profit on your real estate investment, the Australian Taxation Office (ATO) is waiting with open hands for their share. So, throughout this book, we highlight ways to improve your after-tax returns. As we stress more than once, the profit you have left after the ATO takes its bite is all that really matters.

HOW LEVERAGE AFFECTS YOUR REAL ESTATE RETURNS

Real estate is different from most other investments in that you can borrow (finance) a large percentage of the cost of the asset. The loan can often amount to as much as 80 or 90 per cent of the actual purchase cost of the house, depending on your other assets and what your bank will agree to. Thus, you can use a relatively small deposit to buy, own and control a much larger investment. You can borrow money to invest in shares - although we don't recommend it. If you do borrow to invest in shares, you're unlikely to be able to borrow as high a percentage of the purchase cost and your mortgage rate is likely to be higher. (You're also likely to be subject to margin calls if the value of your security drops in relation to the loan amount, meaning you need to reduce your loan amount, contribute additional security or sell part of your investment.)

So, when your real estate increases in value (which is your aim), your returns are leveraged to take into account your total investment (your own deposit, plus the borrowed amount).

Take a look at this simple example. Suppose that you purchase a property for $600,000 and pay a $60,000 deposit. Over the next three years, imagine that the property appreciates 20 per cent to $720,000. Thus, you have a potential profit (on paper) of $120,000 ($720,000 minus $600,000) on an investment of just $60,000. In other words, you've made a 200 per cent return on your investment. (Note: This example ignores cash flow - whether your expenses from the property exceed the rental income that you collect or vice versa and any potential lenders mortgage insurance - and the tax benefits associated with rental real estate.)

But don't forget that leverage magnifies all of your returns and those returns aren't always positive! If your $600,000 property decreases in value to $540,000, even though it has only dropped 10 per cent in value, you actually lose (on paper) 100 per cent of your original $60,000 investment. See the 'Income- and wealth-producing potential' section later in this chapter for a more detailed example of investment property profit and return.

Risk

Real estate doesn't always rise in value. That said, market values for real estate don't usually suffer from as much volatility as share prices do. You're far less likely to experience roller-coaster ups and downs with real estate market values. The reason is land - even if the building is removed from a piece of land, the land itself generally retains its value. With an apartment block, the value of the land might be as...