Residential Property Investing Explained Simply: How to buy residential property and build a profitable property portfolio

Seventy per cent of residential property in Australia is owner-occupied, and that is largely because buying property remains the ‘Great Australian Dream’; as a measure of financial success, it continues to fuel the market. But with house prices sky-high, it’s no longer the path to financial freedom and happiness – for many, it’s out of reach. Luckily, there are plenty of other ways to make excellent returns through residential property investing aside from snapping up a quarter-acre block.

Let’s take a look at some of the fundamentals of residential property investing. I’ll go into detail about each point later in this book, but a brief rundown of how it works is shown in Table 1.

Table 1: The fundamentals of residential property

Now, let’s compare residential property investing to some popular alternatives.

Saving versus investing

Whether you’re better off to save or invest will come down to a few factors, which are largely based on your appetite for risk. Regardless of what the residential property market is doing – it is always a popular water-cooler topic – you need to be comfortable and confident that your investing decisions feel right and are appropriate for your objectives.

There’s a reason so many people who invest in property choose residential: it’s more relatable, it’s easier to understand, and just about everyone lives in a residential property. But what comes with that is the highly emotive nature of the residential property market. This is compounded by the daily media reports and coverage – it’s easy to get swept away reading about other people’s seemingly grand successes or failures.

The truth is that sometimes it makes better sense to save. No one could have predicted we would end up experiencing two years of a pandemic of epic proportions, and if you are risk-averse, combining this with another uncertain, volatile experience (which investing is) could just result in sleepless nights.

Yes, there is security in risk-off markets (low-risk investments) when the market is pessimistic about the economic outlook; so, if you believe that you’ll need your money in the next year or two, it may make more sense to save. But think about this: when you put money in the bank nowadays, you usually lose money. This is because inflation erodes wealth, which is bad news for everyone except investors who park their investment money outside of financial institutions.

Here’s something to consider: if the market crashes, you might think it’s great to have cash again. However, it’s likely that the Federal Government will respond by inflating the currency, or pumping money back into the market to give it a boost.

Unfortunately, you are set to lose either way: you’ll get left behind when assets boom, or your wealth will start eroding due to the increase in inflation. If the government inflates the currency, then the cash you have is worth less. Overseas goods – electronics, cars, travel – will cost more in relation, further lessening the worth of your cash savings. So, while it’s great to have a cash buffer (say, 10 to 20 per cent of your total investments), holding cash is not a viable way to create wealth, in my opinion.

As an investor, in the worst-case scenario of the market crashing, you’d only lose money if you were in a position where you were forced to sell. However, by carefully structuring your purchases, keeping buffers in place and managing cash flow, you can ride out the bumps along the way.

The truth is that investing is a game of patience and should always be viewed as a longer-term proposition. The most successful property investors I work with choose to invest over the long term, and the longer your timeline generally, the better your investment outcomes. That’s the best way to protect your portfolio from volatility.

And don’t worry about trying to time the market, either – I am yet to meet a successful property investor who has sat on the sidelines waiting for a market crash!

Shares versus property

There’s always a lot of noise around the share market versus the property market. The preference for one over the other never fails to fill column inches every weekend in all the newspapers and magazines, with industry experts keen to champion their chosen vehicle. What you need to remember is that, once again, whichever option you choose will come down to your risk profile.

The great advantage shares have is that you can set up today and start trading. Most of the banks these days offer a trade account (there are numerous online platforms) with everything you need to start buying and selling shares immediately. Better still, there are no ongoing commitments such as monthly repayments, lenders’ fees or stamp duty.

When you’re set up and ready to go, shares can outperform property on a percentage basis. This means that your returns may be better, and your portfolio may grow faster. Another advantage of investing in shares is that the process of selling is much cheaper than with property, so it’s much easier to grow your portfolio. As a result, the share market is more liquid, with many bids and offers, and investors can enter and exit relatively easily.

However, the easier transaction process is a double-edged sword. Shares are more volatile, meaning that prices can fluctuate wildly over the course of the day – sometimes by as much as several hundred per cent. For investors who love the thrill of the market, this presents no problem: they accept that fluctuations occur in the short term but, generally, the value of their investments will steadily increase over the long term. However, it is a commonly known fact that most investors lose money in stocks (90 per cent is a frequently reported figure). Then there is the time element: they’re happy to dedicate the time to checking their portfolio daily to see how their investments are travelling.

For those who prefer a measured and conservative approach, this can be challenging. It can be unsettling to feel your money is at the mercy of the market, and to see it increase and then decrease over the course of just one day. Furthermore, using leverage in shares can be disastrous. It may seem like a good idea at the time to take on more risk by dramatically increasing your returns, but you run the risk of losing a lot versus gaining only a little, which could put your portfolio in a particularly vulnerable position.

Property, on the other hand, can use leverage better than any other asset class. This is because the value of property often increases faster than you can physically save your cash, which makes it more efficient and lower risk. Because of its lower knowledge barrier – most people understand the basic process of buying and selling real estate – property can also be great as a set-and-forget option, if that’s your investing objective. The tax benefits are excellent, and working with a great tax specialist will enable you to deduct many expenses you may not be aware of. Further to that, you can also outsource other elements of property investing to complementary specialists, such as buyer’s agents, brokers and accountants. All you need to get started is a secure income, and you’re on your way!

Cryptocurrency versus property

The cryptocurrency market has gained a lot of ground – and newspaper column inches – over the last few years, and I am often asked what I think about investing in crypto. It’s not hard to see why, either. It seems there’s no shortage of crypto funds, coins and investors who magically create incredible returns within short periods of times, and it’s easy to be seduced.

Essentially, cryptocurrency is a digital payment system that doesn’t rely on banks to facilitate the transactions. It’s a peer-to-peer system that can enable anyone, anywhere, to send and receive payments. It is not controlled by any country or government.

Cryptocurrency received its name because it uses encryption to verify transactions. This means advanced coding is used for storing and transmitting cryptocurrency data between users’ ‘digital wallets’ and to public ledgers (called ‘blockchain’). The aim of encryption is to provide security and safety. Units of cryptocurrency are created through a process called ‘mining’, which involves using computer power to solve complicated mathematical problems that authorise transactions; in return, you receive coins as a reward.

Cryptocurrency can connect people locally and globally without the need of banks. For instance, around 57 per cent of people in Africa – around 95 million people – do not have a traditional bank account. This high number of unbanked people undoubtedly causes problems, as there are limited economic options for countries to serve their citizens, and more than 70 per cent of the payments and money transfers in these countries are fraud. Problems also arise in countries like Ukraine and Russia when international governments freeze assets. Cryptocurrency provides a way to transact and hold strong value somewhere.

The first cryptocurrency was Bitcoin, which was founded in 2009, and it remains the best known today. However, there are now thousands of other forms of cryptocurrency that have different purposes and uses.

However, like many things that are shiny, the lustre can wear off. What you need to remember is that as fast as ‘hot’ crypto deals pop up, they just as quickly disappear. Furthermore, the technology moves fast. For example, Bitcoin is quite volatile, and at the time of writing its value has halved over the last year.

Often the founders of some of the new coins vanish along with the promises they made to investors, or their ideas don’t ever reach usability, which does nothing to create stability and trust in the industry.

If you’re thinking of cutting a path through crypto, a good rule of thumb is to ask yourself two questions:

1. Do I understand why this coin exists and what it is being used to accomplish?

2. Do I think this idea can work consistently in the real world?

Adding further complexity is that cryptocurrencies don’t have a way to be valued – so how do you know what you’re investing in with confidence? When your money is tied up in an unregulated system, you need to be very comfortable with risk.

REITs versus property

REITs (real estate investment trusts) are organised partnerships, corporations, trusts or associations that invest together in income-producing real estate. A key benefit of REITs is greater diversification: you can invest in hundreds of properties in different property categories, such as offices, warehouses, hotels, residential property, shops and healthcare facilities.

REITs also offer relatively low risk: you are exposed to property without owning it yourself, and you can have the property professionally managed, which saves you time and effort in the long run. It also requires lower starting capital. With lower risk and lower debt, it’s a fantastic option, particularly if you’re looking at investing for your retirement. Its potentially higher total returns also make it a strong-performing asset class to consider. By owning, say, a 20 per cent share of the asset, you will receive the full benefits as the asset price increases (a five-times return on cash invested). This can be very appealing for investors.

However, one of the best parts about investing in real estate is being able to add value through renovation or developments, and you can’t do that with REITs as you don’t have control over the properties. Another great aspect of property investing that REITs don’t offer is the opportunity to leverage your money. Also, it’s worth keeping in mind that the price of your REIT can change regularly (although REITs are much less volatile than shares or cryptocurrency), which can be highly emotional for investors, especially during recessions. Furthermore, the quality of asset still matters – don’t buy petrol station REITs, for example, as they will not be around for long after the implementation of electric vehicles. It’s best to consult your expert team before you make any big decisions.

Aquick scan along any residential street in most capital cities will reveal a multitude of housing types. Single-storey, double-storey, semi-detached, apartment – there are plenty of options and just as many price points, which makes for a fun weekend when you’re out house hunting. However, this is when you must make a crucial distinction to avoid costly mistakes. You are house hunting with your property-investing hat on, not your principal-place-of-residence hat, which means that every decision you make must be unemotional. Success in investing is a clinical numbers game, and you need to be careful not to get swept up in the aesthetics of a property. Ignore the sweeping verandah and the Victorian fireplace, and instead investigate how the right type of property will yield investing success for your growing portfolio. With this in mind, let’s work through the most common types of property that you should consider investing in.

CHAPTER ONE

Stand-alone house

A stand-alone house is just that – a freestanding house on its own block. In property investing, typically land value is the best contributor to properties increasing in value over time. The more land you have in a desirable location, generally the better the outcome. Given that stand-alone houses are on their own block, it stands to reason that they also offer the best land-to-house value ratio, and for that reason are the best performers for capital growth.

Another benefit of investing in stand-alone houses is that they don’t attract strata fees that are passed on to you to pay regularly. Strata fees cover maintenance costs associated with a property in a building comprising multiple dwellings, such as an apartment block. They’re also known as ‘body corporate fees’ or ‘owners’ corporation fees’. They cover things like maintenance of common areas and upkeep of gardens and amenities – the better the amenities, the higher the fees. As the owner of a stand-alone house, you won’t have to worry about ongoing strata fees, as you are the sole owner.

A further benefit is full flexibility. If you buy a house, you have absolute freedom to do with it what you like, subject to local council approval. You can go all-in on a complete overhaul, or you may have bought a house that only requires a partial renovation. If you have a vision, your best bet is to buy a stand-alone house to give you the land space to make improvements. Land is your greatest asset for long-term growth, particularly in areas where population growth is confined, such as an oversaturated region or an area by the ocean, in the mountains or by a river – they can’t make any more land!

The next step beyond renovating is to develop the land itself, again subject to approval. You could build a granny flat on the back or split the block into two with a dual-key. You could even build a series of townhouses or an apartment block.

It’s worth keeping your end goal in mind. It’s all well and good to refer back to my other book on commercial property investing and imagine life as a high-flying property mogul, but simply working with an existing house already on a good block will generally translate to strong results. This is due to demand – we love living in houses in Australia. There are also lots of tenants who have children or pets (or both) and will want a backyard, or who have growing families and relatives or guests requiring extra room.

Drawbacks

Because houses have more land, they attract higher price tags, which gives them a higher barrier to entry. With median property prices now past $1 million in some capital cities, it’s harder to find a bargain than ever before, so this can add significant time to your investing plans – you may need to wait to increase your capital to buy, or wait to buy that unicorn property (which doesn’t exist, by the way!).

Houses generally have lower rental yields than apartments but higher capital growth. As an investor, a high rental yield (the yearly rental income a property generates as a proportion of the property’s purchase price) is desirable, and anything above 5 per cent is great because it offers stability. On the other hand, capital growth (the increase in the value of a property over time) is desirable too. Investors generally chase one or the other, because properties that have historically offered good capital growth tend to offer lower rental yield, and vice versa. However, there are still many regions where you can get both a high rental yield and high capital growth. Beyond the eight capital cities, Australia has close to 200 regional cities with a population between 10,000 and 600,000, and each of these will have their own supply and demand constraints at any given point in time, as well as differing economic conditions; however, some have historically offered both high rental yield and high capital growth.

As an investor in a stand-alone house, you have to cover all costs associated with the maintenance. Houses generally have higher maintenance costs, as well as higher insurance costs. You