Category: Investing

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Why I Prefer To Own My Home Despite the Ongoing Costs of Home Ownership

Image by Comfreak from Pixabay

The debate between what is ‘better’ – owning your home or renting – is ongoing and fierce in the FIRE community. It seems that we are passionately in either camp, no matter which camp it is 🙂 

I have previously written about why I do not invest in real estate to help me achieve Financial Independence. However, I will declare here that I am firmly in the camp of owning my home.

But I do not believe in buying a house at all costs. I bought a house that I could afford, having saved 40% of the purchase price. And I could afford the mortgage repayment, at less than 25% of my wage. I also did not move around – I have lived in my house for 18 years now. Buying and selling incur many fees.

My indoctrination (?) about the importance of home ownership

As I grow older, I realise that a lot of my money values are influenced by my parents, my mother in particular.

All throughout my childhood, I lived in ‘company’ houses ie houses provided by the oil company that my parents worked for. Working and living in an oil town was not secure as it was always dependent on work contracts being renewed. 

For my mum, security signified having your own home. She was always conscious of the fact that we lived a temporary life in the oil town, that one day it would all come to an end. And when it does, she wants a house to call her own. 

I remember my mum extolling the benefits of owning your own home from a very young age. My parents built a house in their home town and rented it out while working and living in the oil town. Every time we visited my grandparents, it involved a drive past our house – it was almost like a pilgrimage. Mum would point to it and tell us – that is our house. She was so proud of having her own home.

I understand where that yearning came from. She grew up as a family of four renting a room in someone else’s house. My grandmother took in ironing to make ends meet. My grandfather drove a bus, among other jobs. Eventually, they were able to buy a shophouse to live in during their retirement, living upstairs while renting the shop out downstairs. That shophouse is still in the family despite both grand parents passing on many many years ago.

My Renting 'Season'

I love the concept of looking at my life in terms of ‘seasons’. And knowing that whatever season I am in right now, it will pass, just as surely as winter will pass into spring.

When I first came to Australia, I was an overseas student. I went to a boarding school in a regional town. (Less distractions, according to my parents!) 

After boarding school,  I got into university in Melbourne. While I did not hate boarding school life, I also didn’t want to repeat the experience. I was determined not to live in residential colleges – I wanted freedom and no one to tell me when to turn my lights out. So together with a friend from boarding school, we looked for a flat to rent.

It was all very exciting and grown up. We were responsible for paying our rent on time, cooking for ourselves and doing our own laundry. We had to figure out the best route to university via walking or public transport.

But looking for potential flats to rent was a major pain in the backside. This was before the internet – so we had to scour newspapers in the ‘To Let’ section, circle the appropriate ones and attend ‘open for inspections’. Sometimes we had to get keys from real estate offices and go out to the flats for an inspection. Sometimes we met the real estate agents at the potential flats. We often did all this in between attending lectures.

I moved three times in three years of university.

Living this lifestyle is fine in my twenties. But in my seventies? No, thank you. 

I don’t want to worry or feel anxious that the roof over my head is not secure, that I would be forced to look for another place to rent at my landlord’s whim.

I hope to be fit and healthy in my seventies but good health is not guaranteed. What if I have health issues, needing to be in and out of hospital … worrying about my home or lack thereof, will distract me from focusing on recovery.

Not to mention the packing and unpacking involved with moving house. Ugh!

So my very first major grown up financial goal when I graduated from university was to buy a house. To be fair, I was not thinking about old and doddery me at that time. I only wanted security and an asset whose value would hopefully have increased by the time I sell it.

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Staycation during Lockdown

I am grateful to have a job during this pandemic, very aware that many are not so fortunate. But I must admit that going to work every day has exacted a toll on me and my colleagues. Our workload has increased not because we are dealing with more people but because our processes are now so much more complicated.

Many of us have delayed taking time off as planned holidays were cancelled. Most do not want to spend their hard earned annual leave ‘to be just at home’, preferring to wait out the virus.

I decided I would take two weeks off even though I could not travel, as I really needed a break. Like everyone else, my travel plans have not come to fruition – I was supposed to be in London then Toronto.

I cannot remember the last time I was home by myself for a two week
holiday. Usually, if I weren’t travelling then I’d be busy with overseas
family visiting and running around like a chook without its head.

These two weeks in mid July coincided with Melbourne’s second lockdown, just before curfew and the 5km restriction was imposed. I stayed home for the full 2 weeks – it was blissful.

I appreciated my space, both inside and outside the house. I fell in love with my home all over again. It’s a space, a sanctuary I created and it’s where I feel safe. A place where I can rest and relax, keep the world at bay or invite it in. And I am ever more grateful to have this space now, where I can retreat to at the end of a crazy day at work, or fully enjoy during a staycation.

Ongoing costs of owning my home

I remember the day I bought my house at auction. This wasn’t my first auction – I had attended numerous auctions in the past, as research. I had also asked my Dad to bid for me on two previous occasions as I didn’t feel confident bidding myself. And on both occasions he did absolutely nothing as prices just rocketed away.

But this auction day was different. I told my Dad I would bid myself. I was so nervous but in the end, the house was mine.

Entering the house afterwards and signing the biggest cheque I’d ever written – for the 10% deposit – was nerve wracking.

But that was only the beginning of more costs – stamp duty, conveyancing, mortgage loan application fee … I needed another $20k on top of the purchase price.(This is not counting the costs of buying furniture and stuff)

While those costs are associated with the purchase of a home, there are ongoing costs of owning a home. For me, they fall into four categories:

1. Local council rates

2. Home and contents insurance

3. Utility bills

4. Maintenance

I do not mention a mortgage here as I no longer have one. Yay!

Local Council Rates

I just paid my local council rates. This is the bill every homeowner loves to moan about. Probably because it is based on how much the council thinks your house is worth. Obviously, you haven’t sold your house yet so you haven’t profited from any speculation that your house’s value has increased significantly. But all the same, you have to pay the rates based on that assessment.

Perhaps speculation is a strong word. The Victorian Government prescribes the method of calculating our rates so it’s not as if my local council can just decide to raise rates.

Their formula for calculating the annual rates are as follows:

Rate in the dollar x your property value

1. Rate in the dollar is the amount they need to raise ($94 million in my council) divided by the value of all properties in the municipality ($57.2 billion) which equals to 0.00164164 in 2020/21

2. Property value – this is where it gets interesting …

The Victorian Valuer-General oversees property valuations for the State Government and for the purpose of calculating local council rates. These valuations are calculated annually as at 1st January each year. Therefore this year, it was done before COVID 19’s impact on house value was felt.

The local council must use the Valuer-General’s assessment of Capital Improved Value (CIV) of your property ie this is the market value of the land, buildings and any other improvements you made.

I have found it to be generally lower than what property apps value. For example, Commbank property app values my property at $186k higher than the CIV listed on my rates invoice.

My rates have increased every year, regardless of what my property value is. And is my biggest fixed cost. I set aside $2000 every year to cover this cost in my ‘annual costs’ sinking fund.

Home and Contents Insurance

This is a non negotiable cost for me.

I have worked very hard over the years to pay for my house. I don’t want some disaster to befall the house eg a fire and having to start from scratch again.

In saying that, I do review my home and contents insurance annually to make sure that the sum insured is still appropriate. I never used to do this and the yearly premium would just increase every year without me noticing. I have also switched insurance companies and now pay less premium than I did a few years ago.

This is also an annual cost covered by my sinking fund.

 

Utility Bills

There are 3 utility bills I pay – electricity, water and gas.
 
1. Electricity
Tenants and homeowners pay for electricity. But as a homeowner, I can install solar panels, for example, to offset my electricity usage from the grid and therefore lower my electricity bill. Not many landlords would install solar panels on rental properties to help lower tenants’ electricity bills.
 
2. Water
This is where being a tenant is more advantageous – tenants only pay for water usage. Homeowners, on the other hand, have to foot the bill for system charges such as water supply and sewerage disposal, parks levy etc which make up the bulk of my water bill.
 
These are fixed charges; I can only reduce my water usage which is a tiny portion of my bill but still worth doing for the environment. My water usage has dropped to below 155L per day since I made an effort back in February to conserve water.
 
3. Gas

I am still trying to do something about my gas bill. An energy audit of my house found that there is hardly any insulation in the ceiling which explains why my heating costs are so high. As a homeowner, I can choose to rectify this by installing more insulation. Unfortunately COVID restrictions set in before I could install the extra insulation.

 
 
solar panels on roof of house
Photo by Vivint Solar on Unsplash

Maintenance

Houses deteriorate over time. And if you want to sell your asset later, you’d need to maintain it in a good condition so as to attract a decent price, rather than sell it as a renovator’s dream.

Of course, the original condition of the property is a factor. If you are starting from a renovator’s dream, then your expenses will be higher than someone who bought a brand new property.

I loosely divide ‘Maintenance’ into 3 categories:

– Improvements to home to increase comfort or liveability

– Repairs of things that have broken down

– ongoing upkeep of existing infrastructure

Home Improvement

For me, home improvements are made to improve my comfort and in the case of solar panels, reduce my electricity bills and increase my sustainability efforts. I am aware of not over spending on improvement projects – there is no point in over capitilising ie I spend so much that I cannot recoup my costs should I decide to sell the property.

Over the last 18 years I have installed:

– air conditioner units

– fly screens to all windows

– gutter guards (so I don’t have to climb up and clean my gutters or hire someone to do so)

– solar panels

Future projects include improving the ceiling insulation so I can reduce my heating costs, which is the main contribution to my gas bill.

Repairs to Stuff that Break Down

Then there are things that just break down from wear and tear over the years.

 

In the same time period, I have replaced:

– fences on two sides of the property

– the hot water service when it died

– garage ceiling after it collapsed

– a few window blinds

– the garage door after the motor died

Of course, all of the home improvements mentioned above will also deteriorate in their own right over time and sooner or later, will need to be replaced or repaired too.

 

Recently, I made a claim on my Home and Contents insurance to repair my porch ceiling which suffered some water damage. During this process, we discovered that we need to seal some bricks as part of the maintenance which is not covered by my insurance.

These repairs don’t include replacing the fridge that stopped working or repairs to the washing machine. My dish washer is now 20 years old and the washing machine 18 so they will be the next major appliances to need replacing.

Ongoing Upkeep of Existing Infrastructure

In my case, this is mainly the outdoors.

Removal of trees on my property and removal of huge overhanging branches of neighbour’s tree were the major one off costs over the years.

My ongoing cost here is a gardener who visits every 6-8 weeks. I struggle with this cost all the time, especially since discovering FIRE. In the first few years after I moved in, I tried doing the work myself. But it soon got overwhelming when I didn’t have much time over the weekends. So I engaged a gardener who have done a wonderful job of keeping my plants alive and ensuring my garden does not resemble a neglected and derelict property.

This is an area where I can definitely save some money. I have a lot to learn about gardening although since last year, I’ve enjoyed planting and harvesting my own vegetables. The vegetable garden is my baby – the gardener doesn’t touch it at all.
 
Future projects in this category include painting the exterior and interior of the house, something that needs to be done before I retire.

Funding the Ongoing Costs of Home Ownership

Utility bills are budgeted for under normal living expenses. Local council rates and home and contents insurance are taken care of in my ‘Annual Costs’ sinking fund.

Out of my 4 categories of ongoing costs of home ownership, maintenance is the biggest unknown. It varies from year to year – I never know what needs replacing. In the past, when I had a mortgage, I would redraw my excess payments to cover any home improvement / repair costs. 

But now that I no longer have a loan, I depend on my emergency fund. Which makes me nervous as home maintenance is kind of predictable, not in what may break down but that it is certain that things WILL break down and need replacing. And should not be considered as an emergency as such.

So I started another sinking fund specifically for home maintenance a few months ago with minimum amounts automated from my weekly wage.

And guess what? I’ve had to use it this week – because my front door lock completely broke and while the locksmith was here, I got him to repair another lock before that one too dies.

If I don’t have to use my emergency fund for urgent home maintenance issues, then it will last longer than my 6 months of expenses. When I first started saving for my emergency fund, I merely looked at how much I spent in a year which includes travel and some home maintenance expenses. I feel more secure now knowing that my emergency fund can stretch further.

But how much is enough to set aside for home maintenance? There seems to be accepted wisdom, especially for rental property investors, that 1% of house value is set aside for maintenance. But I am confused as to which house value to base it on – the original purchase price or the current market value. Because in my case, it is a significant difference – my house value has increased by two and a half times the original purchase price.

So right now, I will just continue saving a little each week towards home maintenance. I will review it when the fund hits $10k. But I have a feeling it won’t have a chance to hit 10k for a very long time. Because as my house ages, there are lots of bits and pieces that may need attention.h

Final Thoughts

While there are definitely lots of ongoing costs to owning a home, costs such as maintenance can be mitigated if you are good with DIY. Unfortunately I am not, so saving for repairs / improvements is my only option.

Costs can also be kept to a minimum if you monitor your usage of electricity, water and gas and review your home and contents insurance. In sourcing ie not depending on outside help is another great way to reduce costs.

But despite all these costs, I much much prefer to own my home. I value having a space where I am free to do whatever I like, without asking anyone’s permission. The peace and security I feel is priceless. I know that no one can kick me out of this house because I own every inch of it.

 

Which camp do you belong to - owning your home or renting?

Ongoing costs of home ownership | is owning better than renting
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Should Aussie Late Starters Invest in Real Estate to Achieve Financial Independence? I ask 2 Aussie FIRE experts

Should I invest in shares or real estate?

It seems that you must choose between the two asset classes. Australians are very passionate and have definite views about investing in property.

But what if you are a late starter? As in you only started your journey to Financial Independence (FI) at the ripe old age of 47, like me. Typically, your timeline is shorter. And you don’t have the luxury to be able to correct your mistakes and re chart your course of action.

On my Late Starter to FI series, I share other late starters’ stories and the strategies they used or are using to achieve FI and maybe retire early(ish).

I notice that many US late starters either already or aspire to invest in real estate, establishing a portfolio of short term or long term rentals to help them achieve enough income to be financially independent.

In particular, check out the following stories – House of FI, Contrarian Saver, What The FI, and Costa Rica FIRE

This is not the case among the Australian contingent, myself included.

I wonder why. Are we missing something?

Should Aussie late starters invest in real estate as a strategy to reach financial independence
Photo by Maximillian Conacher on Unsplas

Some Australian real estate facts and figures

The median house price in a capital city in Australia, its year on year growth, together with median house rents and rental yield* as per Domain for the June 2020 quarter are as follows:

Capital City

Median House Price

Year on Year Growth

Median House Rent Price

Median House Rental Yield

Sydney

$1143012

10.5%

$530

3.04%

Melbourne

$881 369

6.9%

$430

3.17%

Canberra

$819 090

9.3%

$575

4.24%

Brisbane

$582 847

2.4%

$400

4.60%

Adelaide

$553 036

3.0%

$395

4.46%

Hobart

$529 388

10.0%

$450

4.63%

Perth

$522 414

-1.4%

$370

4.65%

Darwin

$516 213

-0.1%

$480

4.85%

 *rental yield = annual rental income divided by property value, expressed in percentage
 
Also, as per Domain, the rental vacancy rates in capital cities in August 2020 - note Melbourne's rate (where I live) compared to a year ago:
 

Capital city rental vacancy rates – August 2020
August 2020July 2020August 2019MoM ∆YoY ∆
Sydney3.5%3.5%3%–↑
Melbourne3.8%3.2%1.6%↑↑
Brisbane2.2%2.3%2.2%↓–
Perth1%1.3%2.7%↓↓
Adelaide0.9%0.9%0.8%–↑
Hobart0.6%0.7%0.4%↓↑
Canberra1%1.1%1.1%↓↓
Darwin1.3%1.7%3.4%↓↓
National2.1%2.1%1.9%–↑
Source: Domain
Note: The vacancy rate represents the portion of available, empty rental properties relative to the total stock of rental property. The rental vacancy rate is based on adjusted Domain rental listings and will be subject to slight revisions over time.

Source: Domain

There is no doubt that Australian properties, especially in Sydney and Melbourne are expensive! The rental yields as shown above are the gross yields ie operating costs of a rental property has not been taken into account. Net yields will be much lower as a result.

One has to work hard to find properties that are reasonably priced, with good prospects of capital growth and/or better than average rental yield in an area of low vacancy rate.

How about the US market?

According to the National Association of Realtors (NAR), America’s national median single family home price in June 2020 quarter was $291 300.

The top five most expensive cities are San Jose, California ($1.38m), San Francisco, California ($1.05m), Anaheim, California ($859 000), Urban Honolulu, Hawaii ($815 700) and San Diego, California ($670 000)

What I found interesting too was the breakdown in existing home sales by price range in July 2020 –

$0 – $100k         6%

$100k – $250k  33%

$250k – $500k  41%

$500k – $750k  12%

$750k – $1M      4%

$1M+                  4%

In other words, 80% of homes sold in July 2020 was under $500k

One of my favourite podcasts is Afford Anything, where Paula Pant regularly teaches her listeners the ins and outs of real estate investing. She often talks about the 1% rule – ie the monthly rent should equal 1% of property purchase price (including all costs and renovations). For example, a $200 000 house should be able to rent for $2000 a month otherwise it is not worth your while. This translates to a 12% gross rental yield!

These are very different numbers to the Australian market.

Should Aussie late starters invest in real estate as a strategy to reach financial independence
Photo by Kyle Mills on Unsplash

Why I chose not to invest in real estate as a strategy to achieve FI

In part, it is to do with the above figures. But to be honest, as I wrote in my previous post, My Biggest Money Mistakes, I was in a financial inertia after purchasing my home.

I was so happy and content I achieved this goal that I stopped investing altogether. In particular, I  was tired of spending my weekends going to open houses and attending auctions. And I was nervous about taking on more debt. I was already working 60  hours a week – I really didn’t want the added responsibility of two or more mortgages. Plus the idea of being a landlord was terrifying.

So, with all those excuses, I basically missed the boat as property prices continue to hike upwards. Sixteen years later when I paid off my home, I made an appointment to see the loans assessor at my bank. I was 47 at this stage.

Banks had started to tighten their lending practices to investors – he wasn’t very interested in me. And to be honest, I really wasn’t comfortable with going back into debt again. But I thought I should enquire nonetheless as that’s what smart people do – invest in property.

When I discovered FIRE concepts, I was relieved that there was another way – investing in index funds or ETFs. As I learned about diversification of assets, I was glad that I did not go down the property investment route – so much of my net worth is already tied up in my house.

Don’t get me wrong – I am grateful that capital growth has seen my home appreciate in value – 2.4 times what I paid for it according to various home valuation websites.

But for me, it is time to invest in another asset class, and one that I don’t have to outlay a lot of money in the beginning.

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Since I do not have any personal experience in property investing, I reached out to two Aussie FIRE experts who are also real estate investors, for their views on investing in property for late starters.

Serina, The Joyful Frugalista and Dave from Strong Money Australia very kindly replied to my questions. They are giants in the Aussie FIRE and personal finance community, whose opinions I value greatly.

What are the advantages and pitfalls of real estate investing (both short term and long term rentals)?

Serina:

ADVANTAGES:

1. People prioritise property investing

A key advantage is that real estate investing is something that
people are more likely to make a priority as an investment. In other
words, many people are likely to make sacrifices to meet a mortgage
repayment but might not make the same commitment to making regular investments in other assets such as superannuation, direct shares or ETFs. That’s changing a bit with the FIRE movement, which has a focus on ETFs, but in general, owning property is a huge motivating factor!

2. You can negotiate

Good property investors are usually good negotiators. This doesn’t mean that you are like a vicious guard dog, snarling at real estate agents, yelling ‘take it or leave it’ and being generally arrogant. Far from it! It’s about having the courage to make offers lower than the real estate agent would like you to, having your finances in order before you look at property, impressing a real estate agent as credible and if sold at auction, reading the mood of the crowd. With property, it’s important to be prepared to walk away if it doesn’t suit your budget. There’s always a better one!

3. You can time the market

All investment classes go in circles, but property is often more predictable. When the economy is going well, when interest rates are low, prices are generally going up.

4. You can make improvements

Some people have natural design flare and talent, and love the challenge of a fixer upper. If this is you, then you may do well with property. The challenge is to avoid over capitalising. Another challenge is to recognise that while you might like red walls and pink fluffy carpet, not everyone will. Aim for middle of the road and conservative. (I once had an investment property with a mirror on the bedroom ceiling – purchased that way – and we struggled to rent it until it was removed. Yes, people noticed AND commented!)

5. Your tenant helps you pay your mortgage

Your tenant is contributing to paying down your mortgage

6. You can negatively gear

It’s easy to negatively gear – just buy something that is overpriced and don’t negotiate your mortgage! That said, for high income earners, this is a good way to buy property that is likely to appreciate in value over the long term. Yes, it is often best to buy positively geared property but for most people, these properties are hard to find. (Not impossible, we purchased one 2 1/2 years ago but that’s another story.)

7. You can leverage Other People’s Money (OPM)

Yes, you can borrow to buy shares but property is where loaning money really becomes advantageous. The careful use of debt is a good way to make gains with property.

8. You can park your emergency funds in your mortgage

Having a mortgage, and making additional repayments, is a great way to have an emergency fund AND pay down debt.

 

Should Aussie late starters invest in real estate as a strategy to reach financial independence
Photo by Nolan Issac on Unsplash

DISADVANTAGES:

1. Lack of liquidity

If something unexpected happens (say, a marital separation or sudden illness), it can be hard to sell up quickly. Yes, you can withdraw funds from an offset and yes, you can refinance. But if that’s not enough then it takes time to sell up and move on. Sadly, I know about the pitfalls of liquidity in property from personal experience.

2. Bad tenants

It’s easy to joke that your investment property would be so much better without tenants – and some people do buy and hold as a strategy – but anyone who has had a disagreeable tenant knows how upsetting it can be. I feel blessed that in 15 years of property investing, I have only had a few difficult tenants – and only two who I sought to remove due to failure to pay rent (only one successfully). Most things can be worked through.

3. Repairs and maintenance

If you are the sort of person who don’t have any money in your budget for unexpected expenses then property is not for you. Just this month, I had to pay $1300+ for a new hot water system. I was actually happy to pay this as my husband once tried to fix a leaking tap only to flood an apartment where the hot water system had rusted from within! Best to get onto those problems early.

4. The money pit

In 1986, Tom Hanks and Shelly Long starred in a classic comedy called The Money Pit about their efforts to fix a renovator’s nightmare. It’s easy to laugh, but I’m sure the owners of apartments in Sydney’s Opal Towers (and others affected by structural building problems) won’t see the humour! Some places are structurally unsound and, even if there is a property report, the cracks can appear later.

5. Some people shouldn’t climb ladders

 

Two older males  in my family have suffered falls while fixing problems in a property on a ladder, and while their injuries healed, I’ve heard stories of people who have suffered much more serious problems. The moral here is that if you aren’t sure that you can safely DIY things on an investment property, then don’t. If you are usually a humble accountant during the week, don’t become a weekend warrior on a ladder on a fixer upper if you don’t know what you are doing. You might hate to pay a painter or a gutter cleaner, but it’s much cheaper than taking months off work to recuperate.

6. Taxes, insurances and other costs

Rates, land tax, capital gains tax and insurances – these all go up and often go up more than CPI. And strata/body corporate is in a class of its own.

7. Poor body corporate management

If you purchase an apartment or town house, chances are you will have a body corporate. There will be a company engaged to carry out repairs etc (body corporate management company), and a committee of owners (executive committee). Earlier this year, I attended a body corporate AGM that was like WWIII. I was shell shocked for hours afterwards at the yelling on each side! Conflict aside, poor management led to a water leak in common property not being rectified, costing thousands more than usual. Poor management is a key risk.

8. Time

Even if you have a property manager, there is a greater time commitment involved in property than in other investments. For me, that includes body corporate AGMs, emails to strata managers, emails to property managers and sometimes even contact directly from tenants.

9. You can’t always choose your neighbours

Two years ago, the building next to mine was purchased by the government and converted to public housing. We know when it’s social security payday because there’s usually a party – a loud one. One day, I was walking my kids to school past three cop cars. You might ask – why don’t we move? Well, we like it here and we like having a small mortgage. But the neighbours have resulted in tenants moving out and owners selling, putting a downwards trend on prices.

10. Low rental vacancies

Rental markets go up and down, and this affects the price you can generally charge and the time in between tenants. When I first started residential property investing in 2005, we struggled for weeks to find tenants. It tends to go in waves. Just because rental vacancy rates might currently be low in your area, don’t assume it will always be the case.

11. People love to hate landlords

Sometimes, I’m hesitant to admit that I have investment properties. Many people, especially younger people, are upset about high property prices and like to vent against landlords. A common complaint is that open homes are full of cashed up older people, squeezing younger people out of the market. I’m not a fan of intergenerational generalisations. I’m proud that I am able to provide housing to people who need it. But be prepared to be a social pariah in some circles if you decide to invest in property.

Should Aussie late starters invest in real estate as a strategy to reach financial independence
Perth - Image by Sam Curry from Pixabay

Dave:

In Australia, the main advantage is the ability to use leverage (debt) to multiply your return. If you take debt away, residential property here is actually a pretty crappy asset. The net yields (after ALL costs) are relatively low, and the growth outlook isn’t great. But when you can borrow at low interest rates, even modest capital growth can be magnified into a decent return.

The pitfalls are numerous! Capital growth is notoriously hard to predict, as there are so many factors at play and things can and do change all the time. Costs are painfully high – both the purchase and overall running costs (council rates, water rates, insurance, strata fees, management fees, repairs, upgrades, vacancies etc)

These costs have added up to around 40% of the rent across our properties over the years. This means a 4% rental yield becomes 2.4% after costs. For an income stream which only grow with wages / inflation, this is a poor cash flow asset, which makes it very hard to retire on.

And then we have other areas in Oz which are better for cash flow like regional areas, but these tend to have worse demographics. You may be able to get a 7-8% yield, which will be about 4-5% after costs. A pretty decent starting point. But the population doesn’t grow in many of these areas which means there is little pressure for rents or prices to rise.

Short term rentals come with their own list of headaches and become more of a job than a passive investment asset. Because of that, even a high level of cash flow needs to be discounted by some type of ‘hourly rate’ that you pay yourself. I can’t really speak to this type of arrangement as we’ve never followed the AirBnB type strategy.

What does it take to invest in real estate?

Serina:

Both my parents are keen real estate investors. I grew up being part of buy and sell discussions. My Dad even used a bit of child labour for renos when we visited him on school holidays! (And no, we didn’t mind too much)
 
The key quality with real estate investing is courage.
 
It takes a lot of courage to bid successfully for a property or negotiate a purchase. It can be scary for some people – especially the first time! I purchased my first property in 2001 for $229 000. It was four bedrooms, two bathrooms and I remember thinking, OMG, I’m nearly a quarter of a million dollars in debt!
 
People who do well in real estate are generally the ones who have a good savings history, good credit rating, and stable full time jobs. This might sound boring, but boring is good to a loans assessor. Not only are you likely to get a loan with this good track record, but you are likely to get an optimum low fee and low interest rate product.
 
Another key quality is the ability to walk away. Do not, ever, become so attached to your dream castle that you can’t walk away. An agent will see it glowing in your eyes. “But don’t I deserve it, or want to make my partner happy?” you might think. “It’s so hard to find a dream home!”
 
The problem is this. Say you find your dream property, and then you get convinced to bid $20 000 more than you think a property is worth. How much more would you have to work in your job to pay for that?
 
The average weekly earning in Australia is $1 634 ($84 968 per year) – and that doesn’t include taxes, commuting, clothing and other costs. But assuming no taxes, you would have to work 12 weeks – three months straight – to make up for that cost. And depending on the amount borrowed, it could add years to your mortgage.
 
Eighteen months ago, hubby and I decided to bid for a property in another suburb. This was prompted by another big party next door, but also a desire to create a conventional home together after our marriage. We wanted fruit trees and a veggie patch!
 
We found an ideal deceased estate in need of extensive TLC. But the reserve price was already $100 000 more than what we thought it was worth. Walk away? We ran.
 
I’m so glad we did because within a year, my workplace turned toxic and I decided to quit. If I’d bought at that price, I would have been locked into my work for years.
 
 

Dave:

What it takes to invest in real estate in Australia is hugely different compared to the US. In the US, I’m aware that there are many cities where you can achieve a high cash flow from day one – in the region of 7-10% or so after costs. Not only that, but you can purchase in half decent cities for $100k.

These numbers are incredible – it couldn’t be more different to Australia! Our cities are highly priced with very poor income. Aussie property is mostly a bet on growth. And because of that, it requires patience!

As I said, there can be many, many years of no growth or falling prices. Even a decade of no price / rental growth is not unheard of. (I own property in Perth so sadly I know this all too well).

So if your time frame is anything less than 20 years, it’s probably not worth it. Especially when you account for the large buy/sell costs like stamp duty, agents fees etc.

Should Aussie late starters invest in real estate as a strategy to reach financial independence
Photo by Nicolas Gonzalez on Unsplash

Should late starters invest in real estate?

Serina:

Late starters are often on a higher salary and in more stable jobs than millenials. This gives them an advantage as their earning capacity looks good when applying for a loan – and even better if they don’t have dependents. They can also reap the benefits of negative gearing.
 
A key disadvantage, however, is that loan assessors generally prefer younger people as there is less likelihood that they will die before repaying the mortgage. A looming retirement is also something that assessors consider.
 
Mortgage criteria is becoming stricter; the last time we refinanced, we were asked detailed questions about how my husband (four years older than me, aged 52) would be able to service a loan in retirement.
 
I’ve noticed many people plan to invest in property as part of their retirement strategy. The idea that rents will help bolster your retirement income is appealing, and the prospect of a bit of renovating is also something that can be a fun hobby. But it’s worth considering that many retiree landlords are badly hit during COVID due to reduced rental income as affected tenants sought rent relief.

Dave:

I’d say no, they probably shouldn’t. I see some people thinking that property will solve their problems because they can sit back and have this magical asset compounding for them so they don’t need to worry about saving. This is lazy, wishful thinking.

I’m not saying it can’t work or that property is a bad choice. But if you’re starting later in life, you want to take control, and the best way to do that is to get a handle on your finances and build a strong savings habit. After that, it’s about finding a simple investment process to follow, while you spend the rest of your time focusing on your job, family, hobbies etc.

Not only that, but taking on large amounts of debt later in life is the opposite direction you want to be heading! Ideally, you want to be making your life less stressful and opening up more freedom over time.

This is best achieved with debt free investments which produce income for you with no headaches. As you save and your portfolio grows bigger, so will your passive income and level of freedom. Taking leveraged bets on property growth doesn’t strike me as the best match for this group of people!

So, late starters, will you use real estate investment as a way to achieve FI?

Thank you very much for your in depth and thoughtful responses, Serina and Dave. Your experience and insight in the rental real estate market is invaluable to us late starters.

There is a lot to digest here. Key messages are:

1. Our market is very different to the US – our numbers are nowhere as attractive as theirs – our purchase prices are high and our rental yields are low.

2. As late starters, although we may have higher salaries and stable jobs, banks do not favour lending to us, with our reduced timeline to produce income to service the loan.

3. Having a portfolio of investment properties is a LOT of work – make sure it’s something you enjoy doing. Consider the negotiating, managing tenants, property managers, real estate agents … not to mention the DIY part of fixing renovator’s dreams or counting the cost of paying others to do it.

4. How comfortable are you with debt? In good times when vacancy rates are low, your tenants will help you pay your mortgage. But what happens if there is a drought of tenants? Do you have the means to pay the mortgages anyway? Will you be forced to sell some properties to cover others?

Please do your own research – our circumstances are different and your risk profile may be very different to mine. Explore your market, consider venturing outside it (I haven’t presented any regional data here) and make an informed decision.

Aussie late starters, now that you have read Serina’s and Dave’s opinions and advice on real estate investing in Australia, will you explore this avenue to help you get to FI faster?

I know for myself, this has further convinced me to stay out of the rental property market and continue investing in my LICs and ETFs. I know myself – I have neither the stamina nor courage to enter the fray!

What about you?

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