Millennial Milestones – Is an investment property the next step?

When you are renting and feeling trapped paying off someone else’s mortgage you dream you will one day be on the other side. In fact, when I talked about saving for a home deposit, the main thing I heard was “pay off your own mortgage instead of someone else’s.”  Not bad advice for your own home but unfortunately, that no longer seems to ring true for today’s generation breaking into the investment market.

This year I have had an uptick in clients looking to buy their first investment property, but I fear the reality is far from what it once was. After a couple of years of seeing their own home go up in value, and with that equity twinkle in their eye, they feel like it’s time to have someone else pay off their mortgage in the form of a rental property.

The problem is, without doing the math, we treat an investment property like a milestone in our lives. A way to ‘level up’ in adulthood. We focus so much on if we can buy a property we don’t wonder if we should. Previous generations did not have the household debt we now have and it’s increasingly difficult to purchase an investment property and have it cover itself. Rents used to balance better with house prices and past generations borrowed lower percentages, keen to clear debt fast.  

Let’s break down some figures:

Using the equity in your home means taking out more debt against your home, debt with interest and repayments. Then you are taking a mortgage out on the new property. There are different ways to structure this too, however, let’s not go into cross collateralising today. The bottom line is you borrow 100% of the purchase price. Let’s use figures from my area, a regional city outside of a capital city. House prices are averaging $726,000 (hard to find one for that price that doesn’t need work, but they are out there) and rent is averaging $520 per week.

Assuming you didn’t borrow for stamp duty and other costs, the interest alone is $835 a week which means you are going backwards $315 per week without considering maintenance, management fees, insurances, rates, water and potentially, body corporate fees. This is assuming the tenants pay rent in full, on time, with no issues and the property is never vacant. Unlikely but let’s look at the best-case scenario. $500 a week negative is probably closer to the mark and even more for body Corp and maintenance. If you do all the numbers and say ‘yep, I’m happy’ then that’s fine, you need to make your own financial decisions based on your circumstances and how you feel. What if supply catches up to demand or property prices simply stall waiting for wage growth to catch up? Are you happy to be going backwards every week without the growth we have seen in recent years?    

What about negative gearing for long-term gain? Well, personally I am not a fan, and I can understand why the government hasn’t scrapped it to assist the housing market as I don’t believe it’s the silver bullet the general population feel it is. I asked an accountant once to explain this as it seemed to me, that people were losing $1 to save 30 cents, or a max of 45 cents in the highest tax bracket. What was I missing? Nothing apparently. He said, “that’s it, and it doesn’t make sense in the way most people use it, only if you were going to spend the money anyway.”

The last item I wanted to touch on is risk. A few years ago, a house in my old neighbourhood was completely trashed and abandon by tenants. I spoke to the owner who had only purchased the property 6 months prior. The tenants had been there for years and were great tenants (until they weren’t). This new owner had no rental income for quite a few months while paperwork was done to end the tenancy, and the house was cleaned and renovated. Insurance covered everything; however, they were unable to claim lost rent until the property was ready to lease, and the total loss quantified. Thankfully the first-time investor had family to assist them, many new investors would not be able to wear this, even temporarily.    

I think property is a great investment if you can buy it with as little debt as possible so it is producing income and you are going to keep it for a long time, however the 100% lend at today’s prices may not be the pot of gold they think it is. It’s always a good idea to seek wisdom, financial advice from good accountants and financial planners and do the research and numbers yourself!