All You Need To Know about investing in real estate
With a raft of endless legislation coming in to make it more difficult to buy, own and manage buy-let property, many investors will be asking themselves, “can I still make a profit?” The short answer is yes. But investors now need to be far savvier about how they invest to make a profit. Here’s our short guide, ‘How to invest in property’.
1. How to invest in real estate: Planning your investment strategy
First things first. You need a plan. The great thing about having a plan is that it does not have to be right or wrong. You simply need a plan to give yourself a starting point for where your investment journey will take you. There is no doubt that your plan and objectives will change over time.
What is it you are expecting to achieve? How long do you want it to take? Start by working out where you want to end up, and you can work backward from there.
Are you looking for a single investment property, or are you looking to build a property portfolio to fund your retirement? There is no right answer to this question. You simply need to give some serious thought to what your long-term objectives are.
Your objectives need to be realistic. Building a valuable property portfolio will take a lot of hard work, research, and investment of your time. In reality, if you want to build a property portfolio that you can rely on to deliver long-term income, it will take several years or even decades to do that.
Things to consider
What are your strengths?
The first part of developing your investment strategy is to determine what your strengths are as an investor. For example, ask yourself:
- Do you earn regular bonuses, which means that you can allocate specific amounts of money at given points in time?
- Are you particularly handy? If so, it may make sense for you to buy an existing property that you can renovate at a very low cost.
- Are you earning your income in a low tax environment?
- Do you have a currency advantage?
Everyone’s situation is different. You simply have to determine where your specific skills, knowledge, and inputs are that can add value.
Younger investors and those on lower incomes will be trying to determine how they will ever get enough money to invest. For some, sadly, that may not be a reality – but for many, and even most, it will. Maybe you just need to think outside the box. And perhaps the journey might take longer than others, but two paths might be:
- Club together with friends – you might not be able to afford to buy alone. However, you might be able to club your capital together with friends and be able to invest together.
- Buy in a lower cost market – for investors living in, say, London or Sydney, buying an investment property in their home location may simply not be feasible. However, lower-cost markets might be a great alternative.
Where to invest?
In addition, your circumstances will significantly impact your tax liabilities which arise through the ownership of investment property. Consider the following:
- Australia – if you are an Australian resident (or citizen), you can purchase an investment property in Australia without additional stamp duty expenses. A non-Australian resident would have to pay an additional stamp duty of up to 8%.
- New Zealand – there is no stamp duty for either New Zealanders or foreign purchasers.
- UK – in the UK as a UK resident investor you will pay an additional stamp duty of 3%, and as a foreigner an additional stamp duty of 5%
How many locations you want to invest in will depend on your specific circumstances. My recommendation is that you track more than one market. I recommend that you look to track two different countries, and perhaps three locations in each of those markets.
Many people will feel uncomfortable with investing in other counties. However, there are several reasons why I think you should at the very least track other countries, even if you do not invest. The main two reasons being:
- Eliminating poor decision-making- it is not always a great time to buy in a given market. However, you may be able to purchase a property elsewhere. It makes far more sense to invest offshore where there is greater upside potential, rather than simply trying to make a deal work or paying down debt on an existing investment.
- Diversification – it makes a lot of sense to diversify across countries. Different countries and cities move in different economic cycles. Having investments in more than one location provides a higher level of income and growth diversification.
Tax is an especially important consideration for investors. After your finance costs, it will likely be your largest cost, so you need to consider the tax impact.
For example, suppose you are living in the UK and plan on buying an investment property. In that case, the income generated by the rental income will be taxed as income, and you will not get a significant benefit from offsetting interest expenses. Whereas for an international investor, the income generated by buying in London will likely only pay 20% income tax on the net profit, and if you have a UK passport you will qualify for a £12,500 tax allowance.
An example strategy for those wanting to invest in the United Kingdom may be to focus on short to medium-term trading over periods of growth, rather than a long-term hold, due to the inability to depreciate the asset or recognise the full benefit of tax relief on all of your interest expense.
Length of time
You need to carefully consider the length of time you intend to own property.
In Australia, even though the stamp duty you will pay will be higher as a foreigner, you can depreciate the cost of the building and offset the full cost of the interest expense. However, the costs involved in selling are much higher from a capital gains tax perspective.
In contrast, in the UK the stamp duty will be lower and so will the capital gains tax be in the event of a sale. However, the tax benefits are not as appealing from a long-term ownership perspective as you cannot depreciate the asset or offset the full cost of the finance.
Company versus individual
You should consider the advantages and disadvantages of buying and holding real estate in a company or a trust. Whether or not it makes sense will depend on your circumstances and objectives. Some considerations are likely to include:
- Australia and New Zealand – there is little benefit from a tax perspective in these countries, as the corporate tax rates are 30% and 28% respectively.
- Double taxation – by owning property in a company, you will potentially have to pay more tax if significant profits are generated, as you may end up having to pay both corporate tax on the profit the company generates and income tax on the dividends or salaries the company pays. There are ways to minimise this issue; however, it should certainly be a consideration.
Real estate is cumbersome, and it is expensive to change the ownership of the property. For example, if you want to move from ownership from a company to an individual, you will create a tax liability.
As you build your investment portfolio, one of the issues you will face as an investor is that of debt capacity. Regardless of the lender, the more property you own in a country, the more difficult it will become to borrow money.
Because banks do not work across multiple countries, the stress testing does not apply across multiple countries. You are likely to have to let banks know about the assets and property you own in other countries. However, in many situations, it will have little bearing on whether they will lend you money.
Currency benefits can significantly magnify returns. They can also add an extra layer of complexity and risk. However, much of this risk can be mitigated through the fact that your tenants pay rent in the same currency.
2. Do you research
You now need to determine and write down what it is you are looking to achieve. I would suggest that for most people, this will be a certain level of income that they want to generate each year. So, if you are currently earning say USD 100,000 p.a. it may be to generate a net income of USD 100,000 p.a.
Next, you need to determine what property you will need to own to generate that level of income after all of the associated expenses. Because property is such a good hedge for inflation you do not need to worry about growth rates because broadly speaking rents grow in line with inflation.
Next you need to determine a minimum of 3 markets that you want to focus on based upon the different taxation and ownership regimes. These will change for different people, I have given you a detailed overview of three markets Australia, New Zealand, and the United Kingdom you may want to focus on some cities in these countries or focus on other countries entirely.
Where you choose to focus is up to you. However, as a minimum I suggest you focus on countries for which you can easily determine and obtain the following:
- How property tenure works for domestic and international ownership
- Reliable market data
- Transparent information on taxation
Now that you have established your target markets, you need to develop your knowledge pool. Not only are you going to seek accurate market data, you will also need accurate information on tax and other regulatory information.
Quality of the information
You cannot make effective investment decisions without having the right information. If you make assumptions or decisions based on inaccurate or misleading information then you are setting yourself up for failure. That would be an expensive lesson in real estate investment!
Importantly, you will need to ensure that you are obtaining high-quality data. One of the biggest problems you will have is that there is a lot of information available. If you are serious about investing and building your knowledge base, you may well find you have to pay for market information. As an investor this is information which you should be willing to pay for; the reality is that collecting this data can be expensive but you should not be unwilling to pay for some of it. The cost of the information may be quite small relative to the impact it has.
When you are considering market data, consider the source. Sure, you can get research reports from agents for free, but how good are they? I can tell you from experience that the property agent market data generally has two issues:
- Transparency: There is an unwritten rule in big agencies that the research teams do not report anything negative about the market. Therefore, they rarely write something which says the market will go down in value (or down in value significantly).
- Bias: As an agent, you know which part of the market you are focused on, i.e., prime, non-prime, etc. You also know where your supply of new instructions will come from. Where do you think your research will focus? And, will it be positive or negative about the area? It is easy to skew and spin research, as if the numbers do not look great then it is easy to talk about growth potential!
What market data to track?
So, what information do you need to track? Well, the reality is, the more the better. The key is not to get information overload, but to understand what the information is telling you. Just remember, you are only really trying to understand:
- What point in the cycle is the market in?
- What is the reality of pricing?
- How is the market changing?
I have set out below what I think is useful market information to keep your eye on.
Demographic and general economic information
Demographic and general economic information will help you to determine the point in the market cycle you are in. Changes in demographics are among the most influential factors in rental growth and property value growth. This information will include:
- Location demographics: Average age, income levels, local school quality and ratings, migration patterns, and population growth all have an impact on a real estate market’s economic characteristics. Major demographic shifts can have a large impact on real estate trends for several decades.
- Crime rate: Safety is a key issue for all tenants. People want to live in a location that feels safe and secure, with low crime rates and strong levels of local policing. Criminality of whatever type will have a significant impact on tenant demand and rental growth.
- Local economic growth: Busy retail areas and high streets are good signs of active local economies. New employers are also great at improving growth expectations in a location. Economic growth tends to snowball, so the more growth that takes place, the more investment it will attract.
- Local amenity: What types of local amenities are in the area? Local retail, high streets, and commercial areas together with schools, banks, and local food and groceries shops are all important in underpinning local communities.
- Population growth: Typically, population growth is a result of other favourable factors, such as a low unemployment rate, an affordable cost of living, entrepreneurship, and access to a wide range of industries, to name but a few. If people are moving to an area, the number of potential buyers and tenants goes up.
- The ratio of tenants to owners: The ratio of rentals to owner-occupied homes is interesting to understand. Some areas just have more renters. If you are looking for income property, rental-oriented areas are naturally the best fit. However, if you are looking to trade property, you will want to consider locations that have high levels of home ownership.
Numerous government agencies and private research groups produce economic data. While some of this information can be quite heavy going, you will want to follow high-level economic indicators. These provide a great high-level overview of the strength of national and local economies.
- ‘Real’ Gross Domestic Product (GDP): The real GDP is the market value of all goods and services produced in a nation during a specific period. Real GDP measures a society’s wealth by indicating how fast profits may grow and the expected return on capital. It is labelled “real” because each year’s data is adjusted to account for changes in year-to-year prices. The real GDP is a comprehensive way to gauge the health and well-being of an economy.
- Monetary policy: Reserve banks use monetary policy to manage economic growth. Lower base rates will mean that the reserve bank is trying to stimulate the economy and generate economic growth, and higher rates will mean that the reserve bank is trying to cool down the economy. You need to monitor the interest rates set by reserve bank monetary policy in your target locations because they will impact mortgage rates, and therefore future values, and drive new developments and economic growth.
- Consumer Price Index (CPI): The CPI is a measure of the rate at which consumer goods are increasing (i.e., the inflation rate). It is calculated by tracking the price movements of a basket of goods and services used by an average household in the country. The CPI is a good measure of how much inflation is taking place in a given location, and a good indicator of general economic growth.
- Consumer confidence survey: Consumer confidence surveys survey random groups of individuals and ask them a series of questions about their general feelings on a range of broad economic measures, such as consumer spending and growth expectations. The basis of these surveys is that the more confident consumers feel about the current economic situation, the more they are likely to spend, and therefore the more the economy is likely to grow in the future.
- Unemployment statistics: The unemployment rate is a good indicator of the general health of the economy. It is assessed by government bodies and typically counts those people who are both not in work, and actively seeking employment. These measures can change between countries. Generally speaking, in most developed economies an unemployment rate at or around 5% is considered ‘full’ employment.
- Retail sales figures: Retail sales figures are data based on a random sampling of a series of retailers. Typically, larger items such as cars are not included in the measure. The measure is a good general indicator of economic confidence.
- Manufacturing and trade inventories sales: This data set is the primary source of information on the state of business inventories and business sales. Inventory rates often provide clues to the growth or contraction of the economy. Growth in business inventories may mean that sales are slow, and that the economy’s rate of growth is also slowing. If sales are slowing, businesses may be forced to cut the production of goods, and that can eventually translate into inventory reductions.
- Stock market: The stock market is also a measure that can be used to gauge future economic performance. The premise is that more people will buy shares in a company if there is an expectation that prices are increasing. Increased demand will increase pricing. However, because some stock markets are broadly traded, such as the US and UK exchanges, they can also be significantly influenced by outside forces.
- Household debt: Household debt is defined as the combined debt of all the people in a household, including consumer debt and mortgages. A significant rise in debt has historically coincided with economic issues.
As well as tracking demographic and economic data, you will also need to track housing data.
Macro housing data
Macro housing data is generally far easier to obtain than specific sales information, as large statistical groups generally publish it. It will include key housing metrics.
- Housing requirements: In most developed economies there is a shortage of housing in major cities. Many countries publish high-level statistics on what these are based on the overall level of supply and demand, together with expectations regarding new demand, including migration. There is good high-level data available in most countries about the volume of new housing that is required to meet demand every year.
- Housing starts and completions: These are also an important measure of future pricing and housing trends. How much housing is being built to meet future demand is a highly useful measure. If there is an undersupply of housing and no increase in new supply, then this indicates that pricing will likely stay the same or go up. Conversely, if there is an oversupply of housing and more supply is being delivered, then this will likely have a deflationary impact on house prices.
- New planning applications and approvals: There is a significant time lag between planning approval and the delivery of housing. So, new planning applications and approvals are a good leading indicator of supply constraints. However, just because planning approval is granted does not necessarily mean that the developer will build the property immediately.
- Mortgage approvals: The number of ‘new’ mortgage approvals (as opposed to re-mortgages) is an important indicator of housing activity, as it shows the general level of transactions.
- Average house price to income ratio: The average income to house price is calculated by dividing average house prices by gross average earnings. This measure is used to gauge the affordability of buying a home in various locations. The great thing about this measure is that it can be used in very specific locations, and can be used to compare different locations and changes over time. As the ratio gets higher fewer people will be able to afford to buy, and vice versa.
- Mortgage payments as a % of income: If mortgage payments are high, it is likely that house prices will not grow significantly without growth in real income or outside forces. However, this situation is also likely to indicate that rents may increase.
Pricing and market data
In addition to macro trends, you will want to access specific market data on the market you are looking at; this will include:
- Average Rents
- Average values
- Gross yields
What are these figures for your specific market(s) over a given time? Do not expect to outperform the market, so if you are considering a property wildly above these levels, it is probably not for you.
Understanding the taxation systems for the property is important as well as the general trends in what is happening. As you have seen, tax can have a significant impact on your investment return. Tax changes can happen quickly, and can have a significant long-term impact on growth.
You need to understand the regulatory environment. As a landlord, there will be obligations placed upon you, and you need to stay on top of them. Property managers will be able to assist; however, if you are self-managing your investment there is no excuse not to know – you have accepted that risk by not using an agent.
Breaches of landlord regulations can be very expensive, so one way or another make sure you have given some thought to information about future changes.
3. Build your network
Good investors have reliable networks that they can call upon to provide a sounding board for decision-making and share knowledge. You too should build your network. Unlike a social network where you mix with your friends, build an investment network where people know that you are connecting with them because you want their knowledge and advice. Likewise, they will want to connect with you too, as you will be a good potential client or referrer of new business.
There are multiple chat rooms and investment forums that you can get involved with to start developing your network. Importantly, do not forget the virtual parts of your network. Personal connections are great, but so too are virtual networks. In a post-COVID world, technology will continue to be of far greater importance than ever before in all manner of ways, including how we communicate with one another.
Below, I have set out some of the different resources you should consider in developing your network:
- Property investment platforms: It would be remiss of me not to promote my own business! There are many websites out there that provide access to high-quality real estate data, analysis, and investment tools. I think ours is the best, but you can decide for yourself. Visit our website at www.duvalglobal.com
- Blog sites and chatrooms: There are many good blog sites and chat rooms that talk about real estate and real estate investment. They are a great resource for you to use on your journey into property investment. There are many blog sites that you can join and subscribe to; I suggest you look around at what you are interested in. Again, follow our platform at www.proptechpioneer.com
- News feeds: Many news outlets have dedicated real estate news feeds which are worth looking at and reviewing. Likewise, there are other less well-known trade journals, such as the Estates Gazette or Property Week in the UK, or the Australian Property Investor. You may not want to pay for all of these, but most will send you their daily news feeds for free; even if you cannot access the stories, it is a great way to get a sense of property news.
- Property portals: Most countries have property portals where agents can promote property for sale.
- Accountants: You should know at least one accountant who can help you with preparing tax returns and give you some insight into the impact of various decisions. Tax is now a major consideration for those who want to be investors.
- Lawyers: A lawyer will be able to help you with the ins and outs of being able to purchase, and what is required. It would be great if the lawyer is familiar with the country you are looking to invest in. However, even if the lawyer is not familiar with the jurisdiction you are looking to invest in, they may be able to give you useful insights into how contracts work, and some avoidable issues.
- Property manager: You need to get to know a good property manager. You need to have someone who is dealing day-to-day with tenants, and who have their finger on the pulse. They will know what is required.
- Agent: You should have a network of property agents to talk to; all will be happy to meet and talk to you. You will find that you will be far better off talking to several agents rather than just one, to form your consensus. When you speak with agents, you need to remember that their impression of the market is limited to the buyers and sellers they come across, so the more of them you can speak with, the broader the view you will get. Do not just rely on one agent.
- Other investors: Of course, you will also benefit greatly from talking to other investors.
4. How to get the best deal
Now that you have planned your strategy, how do you execute it? You know what you want -execution is all about getting the right deal!
What is your risk?
You need to re-think the way you purchase property off-plan. The equation and thinking involved are not the same as buying a property in the secondary property market:
- Second-hand: There is a lot less risk involved in buying a second-hand property. Because of this, your risk-reward equation is completely different. Sure, you have the risk that something will go wrong with the building, or the rent does not work out to be what you expected. However, because the property already exists, there is an expectation that you have mitigated this risk and therefore will not be rewarded for the risk. Therefore, the only growth you should expect will simply be market return – which will be in line with the rest of the market.
- New-build: With a new-build, you are accepting a significant amount of both market risk and the construction risk of the developer as well as your own financial risk. There is absolutely nothing wrong with this. However, you need to consider how you are being rewarded for the risk you are taking. Risk should come with a reward, and you need to balance the advantages of buying a new-build against second-hand property.
The reality is you have several forms of risk to consider, which are:
- Market Risk – the market may change during the construction period, meaning you ultimately pay too much.
- Mortgage Risk – there is no guarantee you will get a mortgage, or get one on the terms you expected.
- Construction Risk – there is a risk that the construction may be delayed, or you might not get the property you bargained for.
- Insolvency Risk – there is a risk that the developer may go bankrupt, in which case you may or may not get all your money back.
In buying off-plan it is impossible to completely mitigate these risks, because the property you are buying simply does not yet exist. So, you need to accept that you are taking these risks.
Getting the best deal
What can you do to maximise your position in negotiations and get the best deal, and how can you drive portfolio performance?
You should accept that whatever happens, in buying off-plan you are taking a risk. How much is this risk worth? Well, it does not matter how much it is worth, it’s about how you leverage it. You leverage risk by reducing the developer’s risk and then seeking to be compensated for your own risk. How do you do this? By focusing on where their risk is.
- Buying point in the sales cycle: As an investor, your greatest advantage is that you can buy at any point in the sales cycle. And the developer’s risk is highest at two specific points in the sales cycle:
- At the very start of the sales campaign, when they need to sell the property to meet their pre-sales targets;
- Post-completion if they still have apartments and they need to sell them.
These are the two points in the sales cycle when you have the greatest negotiating leverage, so you should target these points in time.
- Developer type: Think about who you are buying a property from, and where their pain points are. A smaller developer may be constantly under pressure to sell, so you may always have a lot of negotiating leverage. In contrast, a larger developer may not be worried about further sales if they have met their pre-sales targets. Therefore, if you are buying from a larger developer you will probably only be able to maximise your position at the end of financial quarters or at the end of the financial year.
You should also see if you can reduce the specification so you can get a better deal. Most tenants are unlikely to pay more for a higher specification, so why shell out the cash for it if you don’t have to?
Additionally, why buy a property if all the tenant amenities will add significant costs to the purchase price and your running costs?
Market access costs
You need to think about what you need to make a purchasing decision. How you need to consume information about a property will directly impact your additional costs in purchasing a property.
There is absolutely nothing wrong with buying a property via an exhibition or sales event. However, keep in mind that there is a cost involved in doing that. So, if you need to have a coffee table brochure, a full exhibition experience, and augmented reality to get your head around the property you will buy, there is a cost to that. As the consumer of that information, one way or another, you will need to pay for it.
An alternative way of thinking about it is this:
- Buy in a good market where there is a high level of protection for consumers
- Buy from a developer with a good track record of delivery
- Make sure the contract affords you enough flexibility.
A significant amount of cost is built into marketing budgets, so if you can find a way to digest and understand the property without all of the costs involved, the developer should share these savings with you.
Buying in Bulk
Do not underestimate the power of buying in bulk! Ideally, you should try to find ways to bring together groups of other buyers or friends to purchase with you. Bulk investors typically get discounts in the region of 10 – 20% off the market price.
5. Be strategic
I want to leave you with a few final thoughts which you should consider as you hopefully build and develop a successful investment strategy.
As you start looking at opportunities and consider purchasing an investment for the first time or purchasing another property, give some thought to the following:
- Only go after the right opportunities: You can look at as many properties as you like, but just like in test cricket, you should only swing at the ones you can score on. It does not matter if you do not buy a property you have considered. There will be many other opportunities in the future. Your return will be impacted forever by the decisions you make when you buy. So, if you cannot get the right deal, move on and find something else.
- Focus on performance, not size: There’s no prize for just owning a lot of property – it’s easy to buy property if you just pay more than anyone else. However, there is a difference between a well-performing property portfolio and one which is simply big. Buy, manage well, and drive performance.
- Understand what motivates your seller: If you have a large, listed developer, they are going to do a better deal when their risk is highest. Buy at quarter dates, before launch, or at the end of the financial year. Think about the buyer spectrum in terms of where you want to end up.
- Develop a financial model where you can review your property purchase: Track the financials, so either use a system that allows you to do this or build your own model in Excel.
- Buy at the right point in the cycle: If the market is at the top of the cycle, then the only way for things to go is down. If the timing is not right, either wait or look to other markets where the risk/reward profile is better.
- Do not set a timeframe: You cannot set a day and time to buy – simply have a plan, know your strike zone, and wait. Do not be too anxious to invest, as you will ultimately suffer from this approach.
- Be realistic: It will take several years to develop and implement your plan. People telling you that it can be done quickly are trying to sell you something!
This short article summarises some of the advice, information and strategies I have written about in my book, Prosper – An Insider’s Guide to Investing Off Plan Property. If you’d like to learn more so you can make the best possible investment decisions, you can buy you copy here today.