Our local economy is looking more and more like a steep stall point is ahead

Question

Hi there, 

I currently have all my money invested in property, I own the house I'm living in which I bought in 2001 for $140,000 (It was not pretty) with some renovations and the bubbling property market it was valued at $300,000 nine months ago and have reduced my mortgage to $99,000, using some of the equity I bought a rental property for $305,000(100% mortgage paying interest only) returning $360 per week under a LAQC. Now this would be fine...... But im 25 and its time to do my OE, The house im living in has far to much sentimental value to rent out (and is in my own name) so ive decided to sell, but intend to keep the LAQC going. So I have $200,000 dollars to invest and I tend to agree with the theory the property market isn't going to do too much in the next year or so, but I haven't ruled out buying another property, Have had a small look at commercial investments but I don't know enough about it (But willing to learn), have also looked at the share market and decided that I would be willing to invest some more money that way ~$50,000 (currently have ~$10,000 in various shares), and have considered putting it in the bank at increasingly attractive interest rates. But to summarize, I only know property as investment and am unsure of what is going to happen in the near future and don't know if I want to invest in the market.

Your opinion would be appreciated

Regards 

Tim

Answer

Many folk have most all of their investment in residential property. Many have done very well and others not so depending a little on where the property was located among many other factors. It is neither right nor wrong to have such a concentration of assets but long term investment convention suggests that a spread of investments will treat an investor more kindly through a series of market cycles.

Your home property is currently conservatively geared (borrowed against) at around 33% to recent market value however adding back the rental property the debt/equity ratio is a little more aggressive at 67.11%. This position is generally regarded as about the medium level of indebtedness that any bank likes its clients to enjoy. From a client perspective, servicing this level of debt should also be reasonably affordable, provided income from all sources is solid.

Gross possible rent is around $18,720 per annum (6.14% per annum) and after reasonable expenses of ownership, rent collections, management, accounting, rates and insurance, say 4.40% before taxation and depreciation are considered. Take into account a vacancy allowance of six weeks per annum and we are left with 3.92% and then of course you may be working on a maximised depreciation model, (which may require claw back if you sell/hold for a period). With mortgage rates climbing above 9.00% you have a large servicing shortfall, before considering the cash-flow funding of repairs and maintenance. I assume the LAQC is structured correctly so will not make comment on this point.

Now we have the facts - next is the emotion. You appear to have made the decision to sell both properties. I can understand the ‘I don’t want anybody living in my house’ feeling but with the rental property the transaction costs of setting up the structures, and then selling expenses, need to be considered given you have purchased reasonably recently.

The $200,000 of investment funds then realised, if you do sell, should be invested in solid, short term cash investment if your OE is likely to be only around the normal two years or so (or less). There are many suitable investments from which to chose and an advertisement carried on this page is as good as many and better than most.

If the OE is going to be a longer event, three, five or more years, then maybe a more diversified approach could be considered. Shares and other fixed interest can be an option plus of course commercial property. A benefit of commercial property is that longer term both growth and cashflow are generally very solid. Access to commercial property is always hard when a lower level of available cash is the limiting factor. However listed property, property syndications and proportional title investments can be very rewarding. Listed property has the liquidity that other styles sometimes lack but all reward the investor with broadly similar benefits, long term.  Seek out somebody who has extensive experience in the property investment market (all styles) and get a good grounding in the different approaches from somebody who really knows.

Folk investing in smaller, poor quality commercial property in less than prime locations are those that are the ‘hard luck stories of investment’ in this sector. A tin shed beyond the black stump may seem cheap but there is generally good reason why.   Commercial property value, like all other, relies on quality of tenant, utility of the building and desirability of location.

Shares have been very rewarding over the last thirty months, and over ten years even, but with our local economy looking more and more like a steep stall point is ahead, be extra careful in your selection. Longer term fine - but shorter time frames need careful assessment.

Original Article published December 2005