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Episode 002 | Investment Strategies Part 2 – Tax Strategies And Location Scouting

Thursday, 23rd Feb 2017
Categories: Podcast

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Damian and Arin continue their conversation on investment strategies and unravel tax strategies, exploring positive versus negative gearing. They also explain how location plays a crucial role in your investment planning and how regional markets stack up against capital cities.

Welcome to episode 2 of our property investing masterclass

Last episode, we talked about some key fundamentals of property investing, such as compound growth and different types of property. If you missed our first episode, you can listen to it online here.

In today’s podcast, we delve deeper into tax strategies. As (aspiring) property investor, you have probably heard of negative gearing and positive gearing, so join us for a detailed discussion on what they are, how to leverage the benefits of each approach and what to look out for. Furthermore, we also talk about how to scout the best location to buy a property, and whether you should look in capital cities or whether regional towns offer more to investors.

Listen Now and Learn:

  • What is negative and positive gearing?
  • When should you buy a positively geared property?
  • Which is better for investment purposes, capital cities or more regional locations
  • When looking at specific suburbs, what makes a good investment location?

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Podcast Transcription

Property Investing Masterclass

Arin Di Camillo, Momentum Wealth: Welcome, and thanks for joining us for this, the second episode of our “Momentum Wealth” podcast series. My name is Arin Di Camillo, manager of the property wealth consultants at Momentum Wealth. And I’m joined again by our founder and Managing Director, Damian Collins. Damian, thanks for being with us.

Damian: Glad to be back, Arin.

Arin: Now, first episode, we started with the basics, but we did cover a fair bit of ground.

Damian: Yeah, we did. So looking forward today, to talking about some more aspects of how you make money through property.

Arin: Now, if it’s the first time you joined us, this is, as I said, the second episode in our podcast series in which we’re going to cover the fundamentals of property investment. Now we’re covering the basics, but it’s not just about selecting the right property, is it?

Damian: No, Arin. Look, if you want to make money in property, obviously, you know, buying the right property is certainly fundamental to making money, but there are a lot of other things to cover. First of all, you really need a property strategy, a plan of where you’re going, where you want to get to, because if you don’t know where you want to get to, it’s pretty hard to decide which way you’re going to go. So, having a strategy in place, getting the right finance is so crucial as well. And accessing the right loans, structuring your loans correctly, is really important. Managing your properties well, also vital.

And then when you get a bit further on your property investment journey, start looking at some other alternatives that can help speed up your wealth creation, such as property development. That might be directly doing it yourself on your own properties, or it can be through development through syndicates where you pool monies with other investors and you develop a property through a proper development manager.

And also, commercial property is an important part [for] when you get a larger portfolio as well. My philosophy is you always start with residential. That’s a great place to start. But if you’re going to build a big portfolio, you must have a decent component of commercial in that, whether it be direct or whether that be through a commercial property syndicate.

Arin: So it really does depend on where you are in your investment journey and what sort of risk profile you’ve got.

Damian: Definitely. There’s a lot to consider. If you’re starting out, it’s more likely you’ve got a good income. You might be… in residential, take a bit more risk. When you get to 60 in your property journey, it might be more about income stream, less about capital growth. And again, risk profile [is] really important. For some people, development is a great option and opportunity. They can make good money. But it does carry risk. For other people, it’s just not suited to them. They’re better off to stick to passive investment.

Arin: Sure. Okay, like I said, this is our second episode. If you missed the first one, go to our website and check it out. We covered a fair bit, starting with how land appreciates in value and buildings depreciate. We talked a lot about compound growth and how important that is for investors. We covered also our buy and hold strategy and why it’s important for investors not to flip properties if possible. And then we finished off with the pros and cons of different investment classes, which we’ll cover a little bit of today.

But this week, to start off with, we’ll be looking at some investment strategies. Now, last week, we had some good feedback about our bonus that we offered. So we’re going to be offering that again. Stick with us through to the end of the episode, and we’ll tell you what our bonus is for this week. So let’s get stuck into it. Ready to go?

Damian: Ready to go, Arin.

Arin: Excellent. Now this one is a contentious one. It’s come up a lot as recently as this year at a federal government level as well. We’re going to talk about negative gearing, to start with the basics, the difference between negative and positive gearing.

Damian: Sure. So negative gearing is where your expenses from your investment property are more than the income from your property and you get to claim that extra amount of loss from your rental property against your other taxable income. So, I guess a simple example, let’s say you rented your property for $500 a week, and that would be $25,000 or thereabouts for the year. But let’s say your property management fees, your rates and taxes, and your interest cost, which is generally the largest part of it, let’s say all that added up to $40,000 for the year. You’ve got a loss of $15,000. Now if you have a job or a business income in your own name, you can then offset that. That $15,000 loss then goes against your other income and is a tax deduction. So that means the property is negatively geared.

Positively geared is where obviously the income is more than the expenses. Your income might be $35,000. Your expenses might be $30,000. Then it’s positively geared up. Now, generally, these expenses are cash expenses. The only slight difference is depreciation. And that’s where if your… And your property, you can write off when you buy it. Or if you do renovations, you can write off the cost over a period of time. So it doesn’t actually cost you cash out of your pocket each year, but you get to write off a bit on your tax. So that’s an important part.

So I guess in terms of the fundamentals, look, I want all my properties to be positively geared, the reason being is that investments, where they’re negatively geared, you are still losing money, okay? So an example I used before, we’ve lost…your income is $25k, and your expenses are $40k; you’re still down $15;. You write it off against your tax. But at the end of the day, even if you’re in the top tax bracket, you’re only going to get back just under half of that money. So, you’re still going to be, at the best case, at least $7,500 worse off.

So I would prefer my properties to be positively geared. But the reality of the world in residential property is that good quality investments are going to come with lower rental yields. You’re not going to be positively geared from day one, unless you got a lot of equity in that. Most of us are borrowing 80% or thereabouts. So I want my properties to be positively geared, but I don’t want to buy rubbish properties, because a lot of the ones that are positively geared from day one are in regional areas, and we’ve seen that being a disaster over the last couple of years, or all those second-rate properties, they’re getting a higher rental return.

So, yeah, there’s no right answer. I guess the ultimate goal is to be positively geared because negative gearing just means you’re actually out of pocket, but the negative gearing helps us buy good quality investments and helps us subsidize the cost of holding those until they get to positive gearing. So the…in terms of the, you know, $15 grand is a lot of money out of your pocket in a year. A lot of people might say, “Gee, I can’t afford that. But because I’m having to use negative gearing, maybe now it’s only $8,000 or $9,000 after tax, I can afford that property.” So that’s the benefit of negative gearing. But negative gearing is not a strategy in and of itself because you are losing money. It’s a way to help you get good quality investments and help you subsidize those until they become positively geared.

Arin: So we’re looking for high growth properties that we might have to negatively gear into initially, but the same things that drive the capital growth of that property will hopefully turn the yield positive as well.

Damian: Definitely.

Arin: And away you go.

Damian: Yeah, absolutely, and that’s the thing. A good growth property, the rental yield will typically follow the growth and the value of the asset. And, obviously, all the markets go through rental cycles, up and down. But a good quality investment will turn positive, depending on interest rates. It could be between 5 and 10 years, but a good quality residential investment will get to positive gearing at some stage.

Arin: Sure, now, positively geared property gets a little beat up with spruikers around the place. Is there a place for positively geared properties right off the bat for an investor?

Damian: Well, in the residential context, the difficulty I found is that we look at this stuff as a business all the time. You know, we look at these properties… and I remember a lot of people were spruiking in properties in Maroomba in Queensland, and we know thn Pilbara in WA, Port Hedland, Karratha are positively geared and it was all wonderful. But the reason they carry a higher rental returns is they’re much higher risk, and people forgot about risk at that particular time. And we all know that they got burnt quite badly in those.

So, yes, you want positively geared properties, but I’m yet to see one that isn’t positively geared for a good reason whether it’s much higher risk or it’s in a much lower growth area. So there’s no magic solution here with all the positively geared and great growth properties from day one. But the reality is that most good quality investments in residential, again, to be positive, are negatively geared. Commercial, a different story, but residential, certainly.

Arin: Commercial, I was just going to say it opens up the debate, if you’re going for cash flow, would it be better getting the yields in commercial either directly or through a syndicate?

Damian:
Well, the… Look, commercial is definitely a better yielding prospect, and particularly, if you go through a syndicate or pool your funds with other investors. The fund can be quite diversified, or you can spread your investments across a number of funds. So that helps to reduce the risk. The only thing is that, historically, the growth in commercial has been lower. It’s been more around sort of inflation rates, you know, your 3%, 4% capital growth. So, again, that will come down to where you are in your journey.

So if you’re starting out, you’re looking for growth, you’re not going to get likely as much growth in commercial than you would residential. But if you’re after income, you get to that point in your life where “I want to quit my job. I don’t want to work anymore or run my business. then I need an income stream.” Well, that’s where commercial becomes far more important. So it’s horses for courses. There’s no ‘one is are better than the other.’ They’re just right for the right people at a particular time in their life.

Arin: So typically, you’d be suggesting moving towards commercial syndicates later in the investment journey, potentially transition to retirement.
Damian: Definitely. Look, our model portfolio would be a blended rate of commercial and residential that you might get somewhere around 5% net. So you might get 3% roughly net in residential, and 7% to 8% net depending on, again, the cycle. In commercial, a blended portfolio, and there might be direct or there might be syndicated properties that you would have a net return of around 5%. So start residential, particularly in your 20s, 30s, and even into your 40s. And then commercials start to come into play as you’re getting eager, depending on when you want to retire, of course, and stop working. But assume it’s 65 for most people. Then in your 50s, in that timeframe, we’d start looking more of the commercial space for investment.

Arin: All right, that’s a look at positive and negatively geared properties, also touching on a little bit of commercial. Now, we’re going to discuss commercial investment opportunities, both direct and in syndicates a little later in our series. For now, I want to move on to the next part of our topic, which is focusing on whether investors should be dealing in regional areas or sticking to the Big Smoke. Damian, what’s your immediate reaction to that?

Damian: Well, my investments, Arin, have generally been in the big cities. And the reason is that you’re looking for properties that are in high demand and limited supply. So one of the downsides of regional areas is that, even if there is good demand at towns 20,000, 30,000, 40,000, 50,000, then to bring on extra supply, all that means is, instead of being 5 minutes out of the city centre, you’re 7 minutes out. So it has… New supply can affect the value of properties across the whole city.

But when you’re in a big city like Sydney or Melbourne, where…you know, where they’re 4 and a half, 5 million, and they’re going to 7 or 8, or Perth or Brisbane where they’re around 2 million, and they’re going to 4 to 5 million, in those cities, the property is 40 kilometres out of the city. They really have very little impact on properties, say 8 to 10 kilometres out of the city, because they’re just so different in that location.

So the other thing is a lot of the regional towns tend to be very much focused on one industry or a limited number of industries, and that can certainly be an issue. If that particular industry has a downturn, that can have a big impact on property prices. And so a regional town is definitely riskier. And I just don’t see for a starting out investor any benefit. The issue with the regional towns, we saw people get burnt. Maroomba and Port Hedland, Karratha, those were the locations. They thought it was all upside. Now those properties are down anywhere from 50% to, I believe, 75% in case of Maroomba.

Arin: Well, we’ve got some great…I remember some great examples of us being very vocal about not investing in the North-West and you in particular having some arguments, talking clients out of investing up there a few years back, which have run to be true.

Damian: Yeah, because I guess they got trapped in the hype of the spruikers. And they thought “this is the best thing since sliced bread,” you pay pay $1,000,000 dollars, you get $2,000 a week. It’s a 10% yield, sounds awesome, and it’s going to go up forever. But, of course, now those properties are worth, in some cases, 400,000. It was never go continue up forever. In a town of 20,000, $2,000 a week is just crazy sort of stuff. So, unfortunately, a lot of people got badly burned. I was glad we could talk out as much as we could and pretty much everyone listened to us. We’re able to talk people out of going up there.

Arin: So with those areas, I’m thinking Karratha, Port Hedland, Newman. The properties there are almost below replacement cost. Does that then start becoming enticing for people again?

Damian: And, look, there will be a time to go back there. And I would say, look, they still in the longer term will provide higher yields than you will in the city because they carry high risk. And so for the seasoned investor, again, so when we’re looking at an investor’s circumstances, the starting point would be better to stick… safer in the big [five] cities in Australia, Sydney, Melbourne, Brisbane, Perth, and buy in good quality areas. You’re going to get a safer asset. You’re going to buy at… you know, more likely, always going to have a tenant or have a very low vacancy rate. And so that’s where you start out.

And once you have five or six residentials under your belt, you’re still in that growth phase, you’re still looking to do that. You might take a bit more speculative risk and go to… perhaps to Port Hedland or Karratha. And, as you said there, they are below replacement value. We still wouldn’t go there just yet because there are a lot of mortgagee sales. There is still a lot of forced selling to come. But, you know, in maybe 18 months to 2 years, there might be some really good buying opportunities for investors who can take a bit more risk. You still wouldn’t start it up there, it’s not the first place to start. But, yeah, they’re right again for the right person at the right stage of their portfolio. But people have to understand that the higher yields come for a reason. They’re not just risk-free investments.

Arin: So some of the factors that make the cities more reliable a bit, or lower the risk of investment, we’re looking at population growth and diversification of income and job?
Damian: Yeah. Yeah, that’s the thing. So if you are in a major city, we certainly know that each of the major cities in Australia has a certain industry that is stronger than others. So we know Perth is a more a mining-centred town. Queensland is a bit of a mining-centred town, but it has a few other things as well… or Brisbane I should say. Sydney and Melbourne are more based around financial services. So they tend to go… their economic conditions tend to rate a bit more to that. So even the big cities have an industry or industries that are certainly more important than… they’re more reliant on. But, nonetheless, they are far more diversified across the board so that they’ve got multiple sectors and … keeping them afloat. So that does help to minimise risk by just having that… having multiple industries.

So when we look at which cities to choose from, we’re looking at what are the industries behind it that are going to support long-term economic conditions. What is the pay like? That’s one of the reasons we don’t like the Gold Coast because it’s a great place for a holiday, but the main industries in the Gold Coast are retail and hospitality, quite low-paying jobs. So why would people be able to pay a million dollars for a house like they do every day in Sydney and Melbourne and even Brisbane and Perth? They won’t because there would be very few people in hospitality and retail who can afford that. So they’re the sorts of things that we look at.

Arin: Sure. And I mean look at the 2030 population forecast. Sydney and Melbourne both have a six mil. Perth and Brisbane both looking over three mil. I mean there might be some bumps on the way, but that’s pretty solid growth in the next…

Damian: Absolutely. And people is the number one demand driver on a citywide basis. So it’s really important I guess to contrast the… The population growth in a city is important because that’s more people coming into a city area to live and work and so forth. But I don’t want to buy in a suburb that’s got population growth because that means that suburb has land availability and supply. So that’s the two contrasting factors, but the city and population growth is important.

Arin: So exploring investing in the cities a bit further, what are the things that we’re looking for in suburbs specifically that would make us move towards that suburb as an investment opportunity?

Damian: So within the major cities, we’d be looking at… So once we have chosen the city, and the big four cities are the cities at the moment that we would long-term invest in, although, coming in in the 2016, 2017, Melbourne and Sydney are peaking. So long-term there… next couple of years, they’re going to be a bit softer. But longer term, they’re still on our recommended investment list.

So once you’re into a particular city, then the suburb you’re looking for is…we don’t want to buy in the most fashionable areas, the areas that everyone already knows are popular. So in Melbourne, you don’t want to invest in your Tooraks, South Yarras, your Hawthorn, Camberwells because they’re being well priced into the market that they are good quality areas. And same in Sydney, your Eastern Suburbs, or in… same Brisbane, Perth, you know, the well-established suburbs. If you talk about a suburb that everyone goes, “Oh, that’s a nice area,” well, that’s sort of being priced into the market.

So we want to buy in areas that people haven’t yet recognised, that have got the potential to be rerated, that they consider just average, or normal suburbs. They don’t particularly rate them very highly. In some cases, they might rate them even a little bit low in terms of the suburb. But we know that there are things that that area has that is going to get it rerated. So it might be that it’s perhaps, you know, next to some rejuvenating suburbs, it’s on the next wave out. It might have good public transport or new infrastructure coming to that area. It might be a freeway. It might be… We know in Western Australia there’s a train line going out to Forrestfield under the airport. So things that will make that area more popular.

Public transport is a big one for us because we know, in the big cities, Sydney and Melbourne, our two biggest, as the population growth has expanded, the congestion has got worse. People go, “I don’t want to drive to work every day. I want a public transport.” And a train particularly, they both would prefer, or a tram in Melbourne. So they’re really important factors that we look at in choosing a particular suburb.

Arin: West Australians are probably a bit behind the eight ball in terms of picking up their public transport mentality. But we are shifting that way?

Damian: We’re getting there slowly in Western Australia. It’s been interesting to watch the journey that…  I saw a study not long ago that still the vast majority of people drive, and the congestion is getting worse but obviously not enough for a lot of people to make that switch from the car to the public transport. Look, the public transport does have a few issues in that perhaps it’s not frequent enough. In the bigger cities, they come every couple of minutes. As we know, if you go to London or France, Paris, they have timetables. Or [in] Singapore, they just come all the time. So we’re not at that point yet. So it’s a combination; the more people start to use transport, the more frequent the services will be.

And, look, ultimately, you know, Perth is now two million, will be four million in the next 20, 30 years or wherever that might be. That’ll be the size of Sydney and Melbourne today. Those properties in those suburbs with access to good public transport will be definitely rerated by the market.

Arin: Sure. Now from transport on to future employment hubs, so I know our research guys spend a lot of time tracking where there’s going to be future employment hubs. What are we looking for there exactly?

Damian: Well, again, so when you’re looking at where people… people, when they make a location or a decision to live, it’s a trade-off. So it’s… what they’re trading necessarily might be on, you know, 40 kilometers out of the city. They might be trading a bigger house and a newer house and a block of land versus something close to the city where there’s less time to travel. And people judge the time travel based on what’s important to them and where they most often go. And for most of us, it’s going to be work, so most of us who are working five days a week. It might be, for parents, the schools, close proximity to a school. That certainly can be important if they’re going to run kids around every day as well.

So we’re looking for properties that are in good proximity to employment hubs and where there’s… Now, the issue, of course, in the main cities is that most of the employment or a lot of the high-paying employment, which is where we want to be chasing people with higher incomes or in areas that are going to get higher income earners in, they still tend to be the city, the CBD, but not always. There are other locations. They can be regional or… when I say regional, sub-regional parts of that city where they might be good job and prospects as well. Obviously, in Sydney, they’ve tried to make Parramatta a second city in Sydney. And, you know, each of the… Brisbane, Melbourne and Perth have strategic locations that the government has chosen for additional investment and jobs. So that’s something we definitely pay attention to.

Arin: I know our research guys spent a bit of time looking at the changes in employment type in suburbs as well. So we’re looking for leading indicators of more professionals moving into areas.

Damian: Yeah, so we get into the census data quite detailed and look at changing over time. It’s only done every five years. And, of course, the 2016 census didn’t go all that flush. So hopefully we can still get good data when that comes out next year. But we’re looking at, yeah, changing over time. So what are, you know, what are the jobs, so professional jobs in the… the ABS obviously have classifications for those. But we’re looking at those jobs that… Okay, well, it might have been 15% in 2001 census. In 2006, it went to 18%. In 2011, it might have gone to 21, 22. That’s a good sign that the higher income earners are moving in and over a period of time. And so, yes, we certainly do follow that because that’s a good leading indicator that prices are likely to rise.

Arin: So we’re looking at transport links, looking at employment hubs, changes of profession in an area. What about things like cafe strips and general amenities for an area?

Damian: Yeah, that certainly is becoming more important. People, either on their way to work or particularly on the weekends, they might go down for a coffee, catch up with friends, different sort of lifestyle. And, yeah, people have barbecues in the backyard, but, again, time-poor, they like to go down to the local café. I know, certainly I do, my Saturday morning walk, go and get a coffee. And, you know, it’s nice to have one in close proximity, and sometimes you get breakfast.

And so that brings in a vibe as well. If you walk down the cafe strips of a lot of suburbs, it’s just got a good vibe. People like to be around that. And, again, a lot of those locations, if you look back 20 years ago, didn’t have that. They were completely different locations. And all these things don’t happen over time. They take time to happen. But one of the things we do look for, is there… in an area, is there a likelihood, or is there an established one, or is there a likelihood that a good cafe culture, good vibe of an area is likely to happen in the years ahead?

Arin: So we’re looking for a vibe and a bit of atmosphere around a suburb. In contrast to, like, a cafe strip or where there are bars and restaurants and pubs, what about something like the new sporting ground in East Perth, Rivervale, there?

Damian: So you’re talking about, in Perth we’re talking about… so there’s a new stadium being built at Burswood and that’s replacing the old Subiaco Oval, which was definitely needed. I’m sure anyone in Western Australia would agree to that. They needed a new stadium. But, look, that has very little impact. You know what? If you’re a fan of one of the football teams, you’ve got 11 home games a year. Eleven times a year, you’re going to go there. If you’re really, you know, keen, you might go to both teams, 22 times a year. You’re going to work 240 days a year. That has a far bigger impact on the price you’re willing to pay for a house than a local football stadium.

And in some respects, the amenity… One of the football teams in Western Australia got their home facilities, which was some of it was available for the local community. It was a far lesser investment than the big stadium, but that will have a bigger impact on property prices because they’re facilities that the community can use every single day. So you’ve just got to think about it logically. It sounds great, “Oh, a stadium is nice to leave near,” but that reality is, it’s going to have that little impact on people that very few people are going to flock to that location just so they can walk… they’re a bit closer for eleven times a year.

Arin: Yeah. It doesn’t make much sense when you think of it like that.

Damian: Exactly.

Arin: So going back to the cafe strips, are we looking exclusively for areas that will have them in the future, or would we consider certain areas that have them now or up and coming in that mix as well?

Damian: And, look, some of them have… Again, ideally, we’d buy in a suburb that’s evolving. Some might have some of it. So an area we’ve bought in over time, Maylands in Perth, has started… has developed its own culture around the train station…

Arin: Yeah, around 8th Ave there.

Damian: Yeah, exactly. So that had an older style one there, but it’s been developing over time and it will continue to develop and evolve. So that’s certainly one. It’s hard to sometimes… And some of the newer suburbs don’t necessarily have a… like, a cafe culture. Or even some of the older suburbs, maybe built in the ’70s, you know, a different sort of style, but they more have, maybe, shopping centres around there that might be the hub where people go to. And there might be cafes and so forth, restaurants within the shopping facilities rather than necessary as a strip.

Arin: Okay. Right. So we’ve gone a fair way down the path of exploring regional versus the city opportunities. So, good explanations from Damian there around why the cities present some great opportunities and why particular suburbs might stand out more than others, not so much now, but for future investment based on the indicators that we use.

Now that’s all we have time for for this week. Thanks again for joining us. Damian, thanks for joining me and sharing your insights again.
Damian: Glad to be here.

Arin: Appreciate it. Before we go, at the start, again, we did say we’d have a bonus for you as we did last week. So if you want to go to www.momentumwealth.com.au/podcast and check out the summary notes there and some additional content that you can get into there.

We hope you join us for next week’s third episode where we’ll discuss some more investment strategies. We’ll be looking at buying new properties, off the plan stuff versus established properties. We’ll be talking about some off the plan stuff, house and land investments, where that fits in the mix, if at all, and also a bit about property management and why that’s really important to maximise your investment portfolio. So, thanks very much for joining us. Hope you enjoyed the podcast and look forward to your company next week.