CAN I AFFORD AN INVESTMENT PROPERTY?
It can be tricky to save. Rent, food, getting to and from work five days a week, phone bills, electricity, private health insurance, gym membership – they all add up. When it comes down to saving for a deposit, then, it’s no wonder so many people shake their heads with a down-trodden sigh. “I’ll never be able to do it,” “It will take too long,” “There’s no point anyway – by the time I save it, property prices will have sky-rocketed again” – and on and on the negativity goes.
Despite all of the doom and gloom around the question of affordability, however, there are countless Australians who have managed to save for and maintain their first investment property – and build a portfolio on top. These are the game changers of the new millennium – the players who have reimagined the Australian dream of home ownership into a vision of financial freedom through property investment.
This is exactly what our hypothetical friend, Mr Due Diligence, wishes to achieve. He is single, earns $80,000 a year and has $25,000 in savings – well done, old boy! But is this enough to get him to stage one of his extremely well thought out strategy – the purchase of a $250,000 investment property in a high growth, metropolitan area?
No, not really. But, luckily, Mr Due Diligence (we’ll call him Due for short) is a man of his name. By scrutinizing his cash flow and enlisting the help of a trusted financial planner, Due is confident it won’t be long before he is proud owner of investment number one.
HOW WILL DUE DO IT?
According to a study conducted by Suncorp Bank in 2015, the average Australian saves $427 a month, with Generation Y saving just over $100 on top of that (12.7% of personal income). Assuming Due fits into this category (which he does – being hypothetical and all) he can save $6,396 each year. He already has $25,000 at his disposal, but he still needs to save another $37,500 before he has reached his goal of $62,500 (25% deposit). This will take him almost six years. Like many other aspiring investors, Due is worried that by this time, property prices will have increased to the extent that a 25% deposit on a $250,000 property won’t cut it anymore.
STEPS TO HELP DUE (AND YOU) SAVE
Hasitha Perera is the founder and Principal Advisor at Dynasty Private Wealth, an independently owned Financial Planning Service, and Authorised Representative of GPS Wealth Ltd, which is the licensee. He says, when devising a savings strategy, it is important to have clear goals about what you would like to achieve, as well as have a clear picture of how you spend your money every week.
Here are some steps to help Due and you develop a savings strategy that may help to bring the purchase date of your first investment forward. The following advice is offered as a general guide to help you on your journey. Before embarking on any financial venture, it is important to consult a qualified and trusted financial planner and accountant in order to tailor the best way forward for you.
STEP ONE – SET YOUR GOAL
There are two goals you need to consider here: your deposit saving goal, and your capacity to maintain your investment each month. To work these out, ask yourself the following questions:
1) How much will you need to save to come up with a deposit?
It is advisable to save at least 20% of the purchase price plus an additional 5% buffer to cover costs such as stamp duty, legal fees, and other expenses.
2) How much will it cost to hold and maintain your property?
Nathan Birch advises investors to calculate the ingoings and outgoings of a property before committing to buy it. He says, it is important to have a realistic picture of a property’s cash flow, rather than having some vague notion of whether rent will cover the expenses. Use a spreadsheet to calculate all foreseeable expenses – not just mortgage repayments. Include costs such as council and water rates, strata fees, landlord insurance, estate agents’ fees and annual smoke detector fees. Remember to also include hidden costs like stamp duty, legal fees, land tax, utilities and unexpected renovations (some of these costs may already be covered by the 5% buffer within your deposit, however, it’s better to overestimate rather than underestimate costs).
Will the property’s expected rental income cover all of these costs, or will you be slightly out of pocket each month? If cash flow is negative, can you afford to maintain this? Will it be for the short or long term? And, what about if the property is vacant for a couple of months? Would you be able to cover all of these costs until you find a new tenant? Daniel Young says, it is important to have a buffer of at least three months’ rent in order to mitigate the risk of prolonged vacancies and reduced investment income. When it comes to maintaining the property, then, you need to be sure you can cover weekly holding costs plus have a three-month buffer in place.
By thorough research of the market in which he hopes to buy and doing the sums, our friend, Due Diligence, has identified that he needs to save $37,500 for a deposit and have a buffer of around $4,000 to cover rent in the event of a prolonged vacancy. By purchasing below market value, in a metropolitan area, he aims to establish a neutral cash flow from day one, with a view to this turning positive in the future. His total savings goal is $37,900, or $38,000 for good measure. He knows to aim for a property that has a self-sufficient cash flow, however, he decides to set a weekly savings goal that will enable him to cover any shortfall in holding the property (in case rent drops below market value). If the rent does cover all expenses as planned, he can use this money in an offset account to reduce his interest repayments.
STEP TWO – IDENTIFY YOUR SAVINGS CAPACITY
Now that you and Due have a goal, it is time to find out just how much you can currently save. Perera says, there are online budgeting tools that easily enable the user to identify their savings capacity. He suggests using the budget calculator on ASIC’s MoneySmart page. This will force you to think about what you are putting your money into each week as well as calculate how much you can save based on your current spending habits.
STEP THREE – SCRUTINISE YOUR SPENDING HABITS
Once you identify how much you can save each month, says Perera, you should measure this against the actual amount you have saved over the past year. Did you save as much as you could have? If not, why? Think about spending habits that you may not have considered when using the budget calculator, such as daily coffee purchases, online shopping sprees and expensive gifts you have bought. Is there a way to limit spending on luxuries so that you can save more?
Being an exemplar of diligence, Due included all of his expenses when filling out the budget calculator. No surprises there. He did, however, identify a number of weekly outgoings on luxuries that he could either cut out or reduce. He realised that bringing his lunch to work each day would enable him to save an extra $75-$100 per week. He decided that instead of spending $60 each month on his phone plan, he could cut down to $30, allowing him to save another $7.50 per week. He also set limits on the amount he spent going out on the weekend.
Perera says, it is important to be realistic when considering your spending habits. He says, if you find yourself regularly transferring money from your savings account into your transaction account, a trusted financial planner can set things up so that you cannot readily access your savings. This will help break unhelpful habits by forcing you to live within your budget, while your savings grow.
STEP FOUR – ASSESS YOUR TIME CONSTRAINTS
Once you have identified how much you can save each month, it is simply a matter of figuring out how long it will take to save your desired amount. By cutting out luxuries and reducing his weekly spend, Due found out he could reach his desired savings goal sooner than expected, but still not soon enough.
STEP FIVE – FIND THE BEST WAY TO FILL IN THE GAP
Perera says that engaging a qualified and trusted financial planner can help you to find the best way to fill in your savings gap. He says, after you have set clear goals, assessed your weekly spend, identified ways to reduce your expenses, and assessed how long it will take to reach your goal, a good financial planner can tailor an investment strategy to your needs. He says, if you are set to achieve your savings goal within three to five years, investing in shares will bring too much risk into the equation. If it will take longer than this, investing may help you to fill in the gap and bring you closer to achieving your savings goal. The key point to remember when investing in the stock-market is diversification. This offers more protection against risk than simply investing in one type of shares. Perera says, a trusted financial planner will devise a mixed bag of investments based on your goals, how soon you would like to achieve them as well as your appetite for and (financial ability to) handle risk.
Once you have achieved your set goal (while taking tax considerations into account), your financial planner will help you exit from these investments so you can move into the realm of property investment. It is wise to regularly review the performance of your shares in line with the expectations of your planner and the time constraints of your goals. This will enable you and your planner to rate how you are travelling and whether or not you should adjust your strategy. Just remember – all investment carries risk. There is no guarantee that investing in the stock market will bring you the results you aim for, which is all the more reason to have a good financial planner on board.
By investing in a mixture of stock options, Due aims to boost his savings, thus reducing the number of years it will take to reach his savings goal of $38,000. With the help of his financial planner, he has created a budget and diversified investment strategy that is based on a strong understanding of his spending habits, his goals, and his ability to handle risk. He feels confident that he will begin the first stage of his property investment strategy sooner rather than later. Why? Because he has exercised due diligence, of course.
This communication has been prepared on a general advice basis only. The information has not been prepared to take into account your specific objectives, needs and financial situation. The information may not be appropriate to your individual needs and you should seek advice from your financial adviser before making any investment decisions.