Are property investors as rich as they appear?

Property investment has surged in Sydney and Melbourne in recent years, and many investors have amassed significant portfolios.

In addition, many Gen Y investors have made the headlines for having large numbers of investments to their name, often worth millions of dollars.

But are property investors really as wealthy as they appear?

In order to answer this question, it’s important to understand how investors manage to purchase properties in the first place.

Making sacrifices to enter the property market

Acquiring that first property is widely described as being the most challenging for investors and first-home buyers alike.

At this stage, saving up a significant cash deposit, or using a parental guarantee to top up a deposit, is the most typical buying approach. Without any assistance, most property investors and first-home buyers have to make immense sacrifices to save for the deposit, plus additional costs.

However, for those acquiring an investment property rather than a home, there is a significant difference.

While most investment loans are now subject to higher interest rates, lenders often see investors as being more serviceable than owner-occupiers who earn the same income. This is because tenants on a property can generate income for investors.

Research undertaken by Macquarie analysts last year found that someone earning $105,000 annually could borrow $813,000 as a property investor, compared to $588,389 as an owner-occupier.

Aside from their increased ability to borrow, investors can also get onto the property ladder much sooner by buying in affordable suburbs where they foresee good growth. In contrast, first-home buyers are restrained by where they are able to live and work.

Investors are also more frequently able to buy in more affordable suburbs, where deposits are already cheaper, such as regional locations or the outskirts of major cities. By purchasing cheaper properties, they’ll be able to buy more real estate in the future.

While every investor has a different approach, let’s assume our investor bought two apartments five years ago in an area favoured by investors, such as Sydney’s western suburbs, for $250,000 each (such prices were achievable in 2012).

Using equity to expand a portfolio

For investors, the fastest way to get a deposit for the next property is not to save again, but to use equity in their existing properties as it becomes available. This could require waiting for the market to increase in value or paying down a loan.  

Home equity is the amount left over when you subtract what is owed on a home loan from the current value of the property. With our investor’s two $250,000 apartments, the revaluation is likely to be $350,000 today ($700,000 in total), using a conservative estimate.

In this scenario, our investor initially paid $50,000 in a deposit for each property, meaning her loan was $200,000 per property ($400,000 in total).

Even without allocating any additional funds to paying off the homes, she has turned her $100,000 worth of deposits (two multiplied by $50,000) into a total of $300,000 because she has, theoretically, gained an additional $200,000 from the revaluations. This means the portfolio would be worth $700,000 and the remaining debt would be $400,000.

In this scenario, it would be possible for the investor to draw equity out of these properties to cover more deposits plus costs. This approach could be used multiple times to expand a portfolio beyond the 10-property mark, provided the investor doesn’t hit a “serviceability wall,” upon which the banks will no longer lend.

Making money from investments

If our investor decided to buy a $500,000 investment property using her equity, she could add a third investment property to her portfolio.

The value of her portfolio at this point would be $1.2m.

But if our investor sold her portfolio, she won’t walk away with $1.2m. In fact, she would be unlikely to walk away even with $300,000, which is the equity plus initial deposits.

When capital gains tax and selling costs are factored in, this can quickly erode the leftover value. Add to this the costs incurred by holding the property (including any shortfalls between the rent and mortgage repayments, improvements to the property, insurances, and other outgoings), and the leftover value can rapidly dwindle.

The majority of investors would not be selling at this point. In fact, many are willing to lose money in the short term, by paying more to hold an investment property than it makes in rent, in the hopes of harnessing future gains.

The majority of property investors buy with long-term growth in mind. However, if this growth doesn’t occur, they could be losing money due to the holding costs. And if values drop, it is entirely possible these investors could end up with mortgages costing more than what the properties are worth.
 

Collections: