Nick Lockhart 31/10/2009

There are numerous “Ways To Profit From Residential Real Estate”; each with its own set of ‘pros' and ‘cons'. Outlined below are three of the more common ways people are making money from residential property:

1. Purchase Positively Geared Property:

‘Positively Geared' means all outgoing costs are covered by rental income alone. To achieve positive gearing, people usually purchase older cheaper properties… often in regional areas where there is less potential for capital growth.

It's important to understand, however, that investing in negatively geared property does not necessarily mean your property will cost money from your cashflow. Certain advanced Finance Strategies can be used to offer cashflow options and opportunities that most investors do not understand.

Warning:

Beware of those selling “positively geared” real estate where their figures are based on you only borrowing 80% of the purchase price. One should calculate a property as being either positive or negative based on borrowing 100% plus all your costs; using no cash of your own.

There are problems with choosing only positively geared properties:

· Living off the rent from an investment property means you will be paying tax on the income received.

· Regional areas are considered to be higher risk as they can lose their main industryemployer, (abattoirs, car manufacturers, mining etc) leaving you in a disastrous situation with no tenant and no capital growth.
There are numerous examples we could give; Ballarat in regional Victoria is just one. Ballarat offered investors (whose focus was on rental return rather than capital growth) “cashflow positive” property. However, in the early 1990's 9,000 Ballarat jobs were lost as the Kennett government closed schools, cut passenger rail services and slashed hospital budgets. Current Victorian Regional Development Minister, Jacinta Allan, in February 2008 said that “Kennett's slash-and-burn policies ripped the heart out of communities in country Victoria”.
Between November 2008 and June 2009 over 500 jobs were lost as a direct result of Ballarat's struggling manufacturing industry; and just recently, in July 2009, another 200 jobs will be lost as Lihir Gold quits Ballarat.

· To have a good income, after tax, this strategy requires a large number of properties; perhaps 60-80 or more. This number can be a big, big job to look after (definitely not “set ‘n' forget… for busy people”).

· Often people following this strategy will try to pay off the loans using principle and interest. This means they are paying around 30% more per month than an interest only loan, and that will greatly impede their accumulation of more property.

2. Buy, Renovate and Sell:

This means purchasing a property at the best possible price, renovating the property, then putting it back on the market hoping, that after all your costs, you are going to make a profit.

There are problems with the buy, renovate and sell strategy:

a. When you sell the property it becomes subject to Capital Gains Tax unless the property was your principal place of residence.

b. You need to buy and sell just at the right time – this is trading rather than investing… and timing is critical to realising a profit.

c. There is that enormous risk of the ‘unknown'. Unexpected problems with roofing, plumbing, electrical, weather and delays (just to name a few) can cause cost ‘blow outs'.

d. You are paying interest on a non income producing property (i.e. untenanted).

For most, this strategy is too much like ‘hard work'. There are those, however, who find this process exhilarating and rewarding.

3. Buy For Growth and Hold Long Term:

This is the most recommended strategy ;

With this strategy and subject to your affordability, you purchase properties in areas that have good potential for capital growth. You purchase new or near-new properties for maximum tax effectiveness and minimum maintenance; sticking to property that is median price for the area. While the rental income and available tax deductions are important to help you hold on to the property, the goal (or objective) is capital growth.

The advantages of the ‘buy and hold' strategy are:

a. Because you never sell the property you never pay Capital Gains Tax.

b. Being the most tax effective strategy you greatly reduce your ATO tax liability; thus increasing your retirement income.

c. Over time capital growth will increase your equity pool. There are many ways to use this equity to fund your lifestyle and living expenses, some of which are tax-free. Which strategies are available and best suited to you at any time will depend on both your situation and what loans a lender may offer at that time.

d. Your property portfolio should double in value approximately on average every seven (or perhaps 10) years. It should be noted that growth is not seen in a straight line; rather it is usually the last two years of a real estate cycle when most growth occurs.

e. Four or five median priced properties should give you between $1.5m and $2m in property value. After a real estate doubling cycle you would have that much again; but in equity. This number of properties held is considered very manageable, even for a busy person.

However, there are also problems with the ‘buy and hold' strategy:

a. This strategy takes time.

i. Where a person's income allows them to borrow the money to secure their four or five median priced investment properties in as many years, it will generally take them seven to 10 years to reach financial independence.

ii. Someone on an average income may take seven to 10 years just to secure their portfolio of four or five properties. In such cases it could take that person another seven to 10 years to reach financial independence. Most would consider this still to be a better option than Superannuation or other low risk strategies.

b. Capital growth is essential to the success of this strategy. Fortunately, Australia has some great areas ‘historically proven' for long-term capital growth.

c. It requires a mindset that you are comfortable with debt; that is the good kind that we call “Productive Debt“.

Decide Upon A Strategy

Before choosing the strategy that is right for you, you will need to undertake research to be “fully informed”. The next steps are (1) to develop a workable plan and (2) stay focused on and work that plan; avoiding the many distractions along the way