Should I borrow to buy an investment property? Pros and Cons…
So the big question is… will the returns be high enough?
There’s no simple answer, but we’ll give it a go. Income returns from residential property are typically 2 to 4% p.a., income being the net rental income (after rates, insurance, R&M, agents fees, vacancy etc.) on the value of the property. So these returns are not high and it’s best to analyse these figures carefully.
And you need to consider capital growth – even if unknown it’s possible to speculate. Capital growth has been strong over the long term, especially in capital cities, thought this doesn’t guarantee it will be in the future. If you can research the options thoroughly and identify a type of property and location that will be more desirable in the future, then you may achieve sound future growth.
Institutions allow you to borrow 100% of the cost (or even more if you have plenty of equity in your home), and gearing accelerates returns, both gains and losses. However, you are putting ‘all your eggs in the one basket’… But it’s a forced savings plan which is positive.
You have to make payments, so vacancy can be a disaster. Make sure you can afford it.
And future growth from now? Big gains of the last 25 years have been driven by falling interest rates 17% to 5%. Rates are now at the bottom and likely to start rising again next year, which will be a negative influence.
You can still do well from residential property if you choose the right location, but you’ll need to do a lot of research, and select the location very carefully.
What alternatives do I have?
There are several alternatives to investment property. You could convert savings plans into managed funds e.g. $100 p.m. or $1,000 p.m. Growth funds provide strong returns long term, or you could borrow a lump sum to invest in shares and funds.
You can borrow anything from $20,000 to $500k, and you can borrow against your own home or via a margin loan using the investments as security for the loan.
It’s also possible to do instalment gearing e.g. $500 p.m. contribution and borrow $500 per month. Shares and growth funds fluctuate more than property but are cashable at any time in a few days, therefore they are highly liquid.
With all gearing of property or managed funds the returns need to be higher than the cost of borrowing (interest).The interest is tax deductible for any investment borrowing to buy property, funds or shares.
Another alternative to borrowing to buy property or managed funds is to simply put more into super voluntarily… i.e. large salary sacrifice. Just be sure to stay inside the maximum super contribution limits. All monies go in pre-tax pay… so tax is saved.
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