Just flick through the pages of Your Investment Property, and you'll come across tale after tale of ordinary people who have built – or are in the process of building – substantial property portfolios. Million-dollar figures are bandied about with regularity as investors talk about how they're moving towards financial independence. It's an enviable position to be in, but how do you join the club?
The answer is that it's surprisingly simple – whether you already own property or not. Each and every property investor started exactly where you are now – with no experience in the world of property, and worried about making a wrong move. In fact, mustering the courage to start a property portfolio is often the most difficult part in property investing.
As long as you understand a few key concepts and are clear about your goals, property investing can become a much less daunting proposition.
The first puts money directly in your pocket. If the rental income from a property exceeds its costs, the remaining rent is the profit – these properties are known as cash flow positive. Cash flow positive properties usually have a gross rental yield of 9% or above.
The second way of making money relies on properties increasing in value. Property has historically increased in value, typically faster than inflation: you'll have already noticed this if you've bought your own home and sold it for a better price, making a profit.
As you borrow a fixed amount to buy a property, the increase in value is all yours – and as such you're making a profit. If you hold property for the long term, you can see significant increases in value – and as such make a significant gain.
Properties that exhibit annual growth of more than 9% are generally deemed to be good properties for this approach.
Both methods have their pros and cons, too.
Positive cash flow – pros and cons: While all investment properties eventually become positive cash flow in theory – once you've paid off the debt owing on the property – not all properties produce a positive cash flow to begin with. Indeed, most do not, and investors may have to search hard to find properties that will create an income from the outset.
However, because you are generating an income from the positive cash flow, you pay tax along the way. You get taxed on this extra income: money in the taxman's pocket is going to make it hard for you to create serious wealth. Also, many cash flow positive properties are in regional or outer areas, and can be quite sensitive to economic cycles; plus, while they do increase in value, their capital growth tends to be relatively slow. It can also be trickier to obtain finance for regional properties.
Capital growth – pros and cons: The strength of making profits through capital growth is that you can potentially make significant gains – particularly where properties are held for the long term. In fact, this is where most property investors make the bulk of their money.
These properties are usually more expensive than cash flow properties, in terms of purchase price, stamp duty and land tax, and it can be harder for beginners to enter the market.
Also, in the short term there is no guarantee that there will be capital growth every year. However, there are numerous ways to manufacture capital growth by improving, renovating, developing or subdividing properties – which can also increase their cash flow potential too.
So, seeing as types of properties tend to veer towards one or other of the main strategies, is one 'better' than the other?
Most market experts recommend pursuing a growth strategy, as the higher gain it typically results in is more effective for investors trying to build a portfolio of properties that will act as an asset base, and ultimately wealth creation. However, cash flow properties can be suitable for certain investors: beginners on moderate incomes looking to break into the market, retirees looking to fund lifestyles and investors with a largely growth-focused portfolio looking to offset the holding costs of their negatively-geared properties.
While property author Stuart Wemyss is certainly of the 'go for growth' school, he adds that investing for cashflow is better than not investing at all. He explains investors without the income to facilitate negative gearing can use a cashflow strategy as "a longwinded way to build an asset base" by purchasing positive cashflow properties and reinvesting the extra income to add value and slowly increase equity.
The challenge for every investor is treating the perfect balance between growth and income as a bonus, rather than a right and making a solid decision about which strategy best suits their personal circumstances.
Knowing when to begin developing a property portfolio is often harder than knowing how to begin a property portfolio.
Entering the investment market is typically done in one of two ways – either by saving for a deposit and buying an investment property as your first property in exactly the same way you would buy a home, or by leveraging the equity from an existing property as a deposit. This requires some or all of the original loan to have been paid off and/or the property to have increased in value.
Many investors will begin investing after they have paid their owner-occupied mortgage off and are beginning to think about financial strategies for their future. However, if you are waiting until your owner occupied home loan is 100% paid off, you might be jeopardising the full potential of your property investment portfolio.
Additionally, even though property in the short to medium term is expected to flatten or fall slightly, the long term prognosis is for overall growth of around 7%. Bear in mind, too, that the Australian property market does not move as one: different regions, cities and suburbs experience growth at different times due to different local economic drivers.
To keep up with the movements of the property market, you should aim to find time to log onto online property forums, sign up for electronic market updates and read magazines – such as Your Investment Property – which feature in-depth reports about top performing suburbs and comprehensive suburb listings. The most current of property data is vital in your ability to pick a good bargain in a range of property markets.