How much could you REALLY make with property? The maths.
You keep hearing about your neighbours and friends making great property investments, but how much could you really make by investing in property?
In this article, we explain the basics of property investment economics and we demystify the real benefits and costs of investing in property. We will then show you examples inspired from real-life investmentsand compare their profitability. Let’s go!
The basics: Understanding acquisition and running costs
When investing in property, it is important to understand the costs associated with this investment. These costs can be split into two categories: Acquisition costs and running costs.
These costs typically include your stamp duty (typically around 4% of purchase price), your sollicitor cost (typically around $3,000), the fee from your buyer’s agent if you used one (typically 2% of purchase price) and the cost of potential renovations.
Acquisition costs are high, and this means investors typically keep their property several years before selling in order to compensate these initial costs.
Note that the deposit you will pay is NOT considered as a cost, as it is an investment.
Example: For a $500,000 investment, the acquisition costs could reach $31,000 excluding removations:
Stamp duty: $18,000
Buyer’s agent: $10,000
Once you purchased the property, there are several types of costs you will need to pay: Council, water, strata (unit only), building insurance (house only), landlord insurance, property manager fee, repairs and interests on your home loans.
Example: For a $500,000 investment in a 2-bedroom unit bringing a rent of $450 per week, the running costs could reach $2,700 per quarter excluding interest repayments. On a monthly basis, this means that your rental income will be $2,025 and rental expenses $900, which means a net rental income of $1,125 per month before interests. After paying the interests on your home loan, your total rental income could then be $525 per month.
Council: $400 per quarter
Water: $400 per quarter
Strata: $900 per quarter
Landlord insurance: $300 per quarter
Property management fee: $400 per quarter
Repair: $300 per quarter
Interest repayment: $1,800 per quarter
The importance of leverage
One of the main differences between property investment and other types of investments is the ability to borrow money from the bank to finance part of your investment (called ‘leverage’). This allows investors to multiply their gains when things go well.
Let’s take a simple example, excluding any costs incurred in the acquisition and selling process:
An investor purchases a property for $500,000 in January 2020 and sells it for $550,000 in 2021, as prices in this suburb increased by 10%. In order to purchase the property, the investor paid a 20% deposit ($100,000).
Excluding any transaction costs, the investor thus made a 50% profit on his $100,000 deposit, while prices only increased by 10%. This phenomenon, called leverage, is one of the reasons why many individuals invest in property.
How much could I make? The importance of making the right investment
Let’s look at 3 typical scenarios of property investments to understand how these could affect your profit.
Scenario 1: The false good investment
Peter invested in 2015 in a 3-bedroom house for $750,000 located 35km west of Sydney, attracted by a high rental yield of 5.5%. After 5 years, Peter decides to sell his house. Unfortunately, dozens of new developments have been built in the area over the period, creating an over-supply of 3-bedroom houses. He still manages to sell his property for the same price as he bought it 5 years ago.
Here is how much Peter made overall:
Profit from sale: $0 (bought and sold for $750,000)
Acquisition and selling costs: $60,000
Rental income over the period: $206,000
Running costs over the period (excl. interests): $60,000
Interest expense: $60,000
Overall, Peter only made a $26,000 profit over the 5-year period. This is due to an over-supply suppressing any capital gain and high rental expenses in the area (especially repairs).
Scenario 2: Defensive investment in a prime area
John bought in 2015 a 2-bedroom unit in Rose Bay for $900,000. The rental yield was low (3.4%) but John wanted to invest in a safe location, close to the harbour, schools and public transports. During the 5 years of ownership, prices in the suburb increased by an average of 4% per year, and John manages to sell his property in 2020 for $1.08M.
Here is how much John made overall:
Profit from sale: $180,000
Acquisition and selling costs: $72,000
Rental income over the period: $153,000
Running costs over the period (excl. interests): $48,000
Interest expense: $72,000
Overall, John made a $141,000 profit over the 5-year period. Moreover, if he holds the property 5 more years (and assuming price growth and rental yield remain constant), he could make a profit of $399,000, representing a 44% gain on initial deposit.
Scenario 3: Hybrid investment in an attractive area
Julia bought in 2015 a 3-bedroom house in Carimbah for $1,000,000. Julia invested in this suburb as she wanted a good rental yield (4%) in order to manage her monthly cash flows. She also wanted to invest in an attractive area, close to the train station with direct access to the city and the nearby beach. After 5 years of ownership, Julia sells her house for $1.17M (equivalent to 3.5% growth per year).
Here is how much John made overall:
Profit from sale: $175,000
Acquisition and selling costs: $80,000
Rental income over the period: $200,000
Running costs over the period (excl. interests): $42,000
Interest expense: $80,000
Overall, Julia made a $173,000 PROFIT over the 5-year period while managing her monthly cash flows. Keeping her house 5 more years could bring her a total profit of $482,000.
Before investing in property, buyers should carefully select the suburb and the type of property to invest in. An attractive rental yield is not enough to decide on where to buy, and investors should consider how likely it is that prices will increase in the medium and long term in their area. Finally, high acquisition costs mean investing in property is typically a medium to long term play, which requires investors to understand the long term supply and demand dynamics in each area.
Thinking about investing in property? Contact us! Our team of property investment experts are here to help!
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