Ask Margaret: Should I invest in a tenanted property?

Hi Margaret,

I'm currently looking to get an investment property in Broken Hill for $69000 which is currently tenanted and is rented out for $180 a week.

I want your opinion on whether or not it's a good investment as the rent from it is more then double the repayments.

And it got tenanted within about three weeks of being advertised for rent.

Thanks,

Marcus

Hi Marcus,

It can be very tempting to invest in a property whereby the rent more than covers the cost of the mortgage on it. Cash flow is a very important aspect of property investing, as when a property can cover its own expenses and loan interest, then you only have to worry about getting a tenant in.

However, I urge you to think about an investment such as this one over the long term, and understand that capital growth is equally important in every investor’s strategy.

Over the past 5 years, the median value of Broken Hill has decreased by an annual compounding rate of -0.7%. Over the past 10 years it has had an average annual growth of -2.6%

Let’s imagine the next 10 years brings the same result. Your $69,000, after 10 years, would be worth $56,000, having lost for you $13,000 in that time. Sure, you haven't had to put in any money along the way, but if you have borrowed to buy this property, you are in the red by $13,000.  Even if, during that time, you paid of a chunk off the mortgage, the overall outcome has been a negative one, and not the kind of result we would like to see in a sound strategy.

In addition to being able to find a property which has a good enough rental yield to be able to cover its own expenses, the area must have growth drivers. Towns like Broken Hill have a notoriously bad track record for growth, due to itinerant population, lack of infrastructure and lack of population growth.  

When you become a property investor, price should not be the driving factor. You must also understand that growth has no relationship to the price you pay for a property. You would be far better to pay, say, $350,000 in an area that has all of the growth drivers, and get only a 5% return, than you would spend less in an area with a 10% rental return but a negative growth figure. Over time growth compounds so that, by the time you get to retirement, the property is worth far more than the bank loan on it, and the difference belongs to you. Do this often enough and you build a great net worth.

The final point to make is that, when a property loses value, your ability to leverage is also lost. Buying properties which grow means that you can, in the future, borrow against that growth to add more properties to your portfolio. When a property loses value, it’s harder to do this unless you are paying significantly more than the loss off the mortgage. If you cannot leverage into more property, then you cannot build a larger portfolio, and it’s really only through building a portfolio, rather than owning one or two properties, that you really start to see the value in property investing.

Stick to properties in areas with significant infrastructure development, a growing population and lots of families, and you will do far better with your property investing.  

Kind regards,

Margaret

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