Is real estate investing worthwhile?

[Alchemisst]

I have been considering an investment property mainly for the negative gearing tax savings. Would it be worthwhile or is it better to just keep more in the index.

[deborah]

I don’t have any investment property. However, it’s good for diversification, if you know what you’re doing. Certainly, people like @Ozlady are heavily into investment property, and it’s worked well for them.

Most investments, including shares can be negatively geared, so I don’t think negative gearing is a good reason to decide to invest in something you don’t understand well. You need to be able to distinguish between good and bad investments. We had someone on the forum some years ago who had several investment properties in mining towns when there was a slump. Because she was negatively geared, she was in a lot of pain, especially when it became difficult to find a renter.

[lush]

I think it is. We clearly have a housing crisis underway and that does not look to be resolved in the near term. If it is something that you can manage financially, a well located property can bring significant gains.

[Dicey]

Indexes never, ever call to say the toilet's broken.

[Alchemisst]

I don’t have any investment property. However, it’s good for diversification, if you know what you’re doing. Certainly, people like @Ozlady are heavily into investment property, and it’s worked well for them.

Most investments, including shares can be negatively geared, so I don’t think negative gearing is a good reason to decide to invest in something you don’t understand well. You need to be able to distinguish between good and bad investments. We had someone on the forum some years ago who had several investment properties in mining towns when there was a slump. Because she was negatively geared, she was in a lot of pain, especially when it became difficult to find a renter.

Other investments such as shares can be negatively geared, however the interest rates are much high and the leverage much lower. It seems like the everything here including taxes are geared towards property. I don't think the U.S has negative gearing for example?

[Gremlin]

Other investments such as shares can be negatively geared, however the interest rates are much high and the leverage much lower. It seems like the everything here including taxes are geared towards property.

I've seen this blanket statement several times in different forms on many investment related forums.  It's simply not true.  The security determines the interest rate.  The purpose determines the deductibility.  The investment doesn't have to be the security.

We've negatively geared both property and shares at various stages.  We've positively geared property and shares for much longer periods of time than negatively gearing them (which I understand is not necessarily the norm, but actually helped us sleep at night).

There was a place for both.

There's definitely more time required in managing an investment property than in shares.  Even with a good property manager doing most of the legwork.  With a dud property manager, and there are plenty of them out there, it can be an extraordinary amount of time (and money!). 

To answer your initial question though, I would never choose an investment mainly because of perceived tax advantages.  It has to meet the purpose as an investment first and foremost. 

For us, we held an IP for about 15 years that provided diversification, regular income and some capital growth.  It was an underperformer as an asset.  You can't hold 'the index' in property, so you're going to either be a genius who outperforms or a mug who underperforms.  Depending on how much research you do, it increases the likelihood of genius or mug, but there's also plenty of moving parts outside your control.

[WayDownSouth]

Other investments such as shares can be negatively geared, however the interest rates are much high and the leverage much lower. It seems like the everything here including taxes are geared towards property.

To answer your initial question though, I would never choose an investment mainly because of perceived tax advantages.  It has to meet the purpose as an investment first and foremost. 

I can tell you 100% this piece of advice above is THE best and simplest and wisest answer you will get. If you don't really hear what he's saying, you're getting too far ahead of yourself. Focus on the word PERCEIVED which he wrote, that is extremely important.

[Gremlin]

*blushes*

Aww shucks!

[Alchemisst]

Other investments such as shares can be negatively geared, however the interest rates are much high and the leverage much lower. It seems like the everything here including taxes are geared towards property.

I've seen this blanket statement several times in different forms on many investment related forums.  It's simply not true.  The security determines the interest rate.  The purpose determines the deductibility.  The investment doesn't have to be the security.

We've negatively geared both property and shares at various stages.  We've positively geared property and shares for much longer periods of time than negatively gearing them (which I understand is not necessarily the norm, but actually helped us sleep at night).

There was a place for both.

There's definitely more time required in managing an investment property than in shares.  Even with a good property manager doing most of the legwork.  With a dud property manager, and there are plenty of them out there, it can be an extraordinary amount of time (and money!). 

To answer your initial question though, I would never choose an investment mainly because of perceived tax advantages.  It has to meet the purpose as an investment first and foremost. 

For us, we held an IP for about 15 years that provided diversification, regular income and some capital growth.  It was an underperformer as an asset.  You can't hold 'the index' in property, so you're going to either be a genius who outperforms or a mug who underperforms.  Depending on how much research you do, it increases the likelihood of genius or mug, but there's also plenty of moving parts outside your control.

Not too sure what you mean here, I looked into leveraging into shares but the interest was always much higher, and the amount I was able to borrow much lower than a mortgage.

[deborah]

You usually borrow money with something as security eg. your house. Money is borrowed for a purpose eg. to buy shares. The security and the purpose don’t have to match. The interest you pay on the loan is based on the security. The tax deduction is based on the purpose.

Your accountant should be able to tell you how to do this so the interest is low and the tax office agrees that the purpose of the loan is share investment.

I agree with everything gremlin has said.

However, if you really understand the property market and are prepared for the pros and cons, it’s a way to diversify, and it can give pretty good returns, just like buying individual shares rather than the share index. But both can blow up in your face if you don’t understand what you’re doing.

[Alchemisst]

You usually borrow money with something as security eg. your house. Money is borrowed for a purpose eg. to buy shares. The security and the purpose don’t have to match. The interest you pay on the loan is based on the security. The tax deduction is based on the purpose.

Your accountant should be able to tell you how to do this so the interest is low and the tax office agrees that the purpose of the loan is share investment.

I agree with everything gremlin has said.

However, if you really understand the property market and are prepared for the pros and cons, it’s a way to diversify, and it can give pretty good returns, just like buying individual shares rather than the share index. But both can blow up in your face if you don’t understand what you’re doing.

In this case i'm not using a house as security, which is why i'm saying that housing seems to have much better lending terms, including if you are using the house as security. Without that the terms are much worse.

[deborah]

Why won’t you?

[mjr]

I think that negative gearing to reduce tax is a poor basis to justify an investment.  I don't want to be negatively geared, by definition it means I'm losing money.

Deborah has already mentioned diversification and that indeed is a good reason.  However, I have a PPOR to provide tax-free real estate exposure and it sounds like you do too.  Granted, being a PPOR makes it pretty well unable to be liquidated.

Reasons I hate property as an investment vehicle:

It's illiquid.  You need to sell everything to access any capital gains.  This invariably will be taxed heavily given our income tax thresholds.  Yes, there's the capital gains discounts but still.  You have to weigh up your negative gearing tax "savings" against what you'll pay when you sell.

Yield on residential property are very low.  2-2.5% is not uncommon.  Given how illiquid property is, yields may matter more to you than they would as opposed to focussing only on total return, it's typically a long time between buying and selling.

The goverment hits you with land tax and stamp duty.  These are much more expensive than MERs on index funds.

Real estate agent fees.

Maintenance (see Deborah's blocked toilet example). Tenant issues.  Inspections.  Depreciation schedules.  Insurance. Valuations for insurance purposes.  Fire safety.  They go on and on.

Equities are of course the main alternative.  Returns are comparable, some years equities are better, some years it's real estate.  Pay brokerage once on buy, once on sale.  MERs are low or non-existent for direct share ownership.  No on-going government or other fees and charges.

Need to access funds if dividends aren't enough ? Sell off just what you need to keep income taxes low.   This reason by itself is huge.

[WayDownSouth]

I think that negative gearing to reduce tax is a poor basis to justify an investment.  I don't want to be negatively geared, by definition it means I'm losing money.

Deborah has already mentioned diversification and that indeed is a good reason.  However, I have a PPOR to provide tax-free real estate exposure and it sounds like you do too.  Granted, being a PPOR makes it pretty well unable to be liquidated.

Reasons I hate property as an investment vehicle:

It's illiquid.  You need to sell everything to access any capital gains.  This invariably will be taxed heavily given our income tax thresholds.  Yes, there's the capital gains discounts but still.  You have to weigh up your negative gearing tax "savings" against what you'll pay when you sell.

Yield on residential property are very low.  2-2.5% is not uncommon.  Given how illiquid property is, yields may matter more to you than they would as opposed to focussing only on total return, it's typically a long time between buying and selling.

The goverment hits you with land tax and stamp duty.  These are much more expensive than MERs on index funds.

Real estate agent fees.

Maintenance (see Deborah's blocked toilet example). Tenant issues.  Inspections.  Depreciation schedules.  Insurance. Valuations for insurance purposes.  Fire safety.  They go on and on.

Equities are of course the main alternative.  Returns are comparable, some years equities are better, some years it's real estate.  Pay brokerage once on buy, once on sale.  MERs are low or non-existent for direct share ownership.  No on-going government or other fees and charges.

Need to access funds if dividends aren't enough ? Sell off just what you need to keep income taxes low.   This reason by itself is huge.

Another excellent post...

"I bought 3 properties 4 years ago and sold them all last week and doubled my money!"

The same person who says that is spending twice as much today for the same exact lifestyle they lived 4 years ago so what was their real gain? A ton of running around and dealing with crap that wasn't required at all? Great investment... Better to do something you enjoy!

With that said, I'm not saying there is nobody who exits their property (yes, even residential) with great gains but people definitely fail to see the larger picture and focus solely on the digits.

[Lukim]

I currently have 3 investment properties (and my wife has 2).

I have agents who look after them.  Generally, I have not had a lot of problems but when you get a problem, it can be a real pain in the neck.

In the past I have twice had horror tenants who basically destroyed the inside of the properties before leaving in the middle of the night (the damage was a lot more than the rental bond and even accessing the bond in NSW was difficult).

I currently have one where there is a plumbing issue - that I can deal with but it has caused damage to the apartment below and I am now in a dispute with the owner below and the body corporate.

The cash returns on investment properties are not great.

Investment properties are not liquid and getting in and out of them is very expensive (stamp duty, agents fees etc etc).

I would just think carefully about it and not be guided by potential tax losses.

[jaysee]

I agree with WayDownSouth's take.

Also there seems to often be an implicit (unstated) assumption that leverage = good. I would question that assumption. Especially given the current climate of high and rising interest rates.

If you want to increase your risk exposure in stocks there are safer and simpler ways to do so without leverage, e.g. tilting to small-cap value. This can be done by simply investing 20% of your stock portfolio in a split such as AVDV/AVUV/AVEM. (See: https://www.optimizedportfolio.com/ben-felix-model-portfolio/). This is what I've done.

But that said, if you have a passion for property and are willing to treat it like a small business venture, I wouldn't discourage you. You can probably make a decent return on it.

[WayDownSouth]

I agree with WayDownSouth's take.

Also there seems to often be an implicit (unstated) assumption that leverage = good. I would question that assumption. Especially given the current climate of high and rising interest rates.

If you want to increase your risk exposure in stocks there are safer and simpler ways to do so without leverage, e.g. tilting to small-cap value. This can be done by simply investing 20% of your stock portfolio in a split such as AVDV/AVUV/AVEM. (See: https://www.optimizedportfolio.com/ben-felix-model-portfolio/). This is what I've done.

But that said, if you have a passion for property and are willing to treat it like a small business venture, I wouldn't discourage you. You can probably make a decent return on it.

I know plenty of people who have made good & quick returns on real estate, but they're usually in the construction trade.

I think being a homeowner and being able to upgrade your home and/or location to something better without increasing your monthly payment (if you have one) is good, so good for them. Also, owning a shitload of homes (like 25+), or an apartment building, or a few strip malls, etc. can definitely be legit business but for the average person, real estate is a shitty investment - especially if you're paying a mortgage.

I mean, sure, once it's all paid and done you DO hold that asset, but when you consider the garage full of tools, your afterwork/weekends spent mowing lawns, all the things you had to buy to maintain the property, the cost of taxes, etc., that renting can often be cheaper and easier. On the other hand, if you're buying somewhere to live permanently, have no kids, and are buying cash, well, in that case who really cares if the price goes way up or way down because it's yours from the first day (assuming you keep paying taxes on it) until the day you die or sell it.

I feel a lot of conditioning has been put into buying a home being some wonderful investment. In reality, most of us become slaves to interest and the mortgage payment...

Some people really do enjoy flipping, buying, renting, owning a few homes... And hey if that's your cup of tea that's fine too but I think I align heavily and for very good reason that real estate is a pain in the ass and there are 100 faster, better, less-hassle ways to find MUCH larger returns. At least for the average person. A lot of this really depends where you live, what you know, and what kind of capital and credit you have.

[jaysee]

I mean, sure, once it's all paid and done you DO hold that asset, but when you consider the garage full of tools, your afterwork/weekends spent mowing lawns, all the things you had to buy to maintain the property, the cost of taxes, etc., that renting can often be cheaper and easier. On the other hand, if you're buying somewhere to live permanently, have no kids, and are buying cash, well, in that case who really cares if the price goes way up or way down because it's yours from the first day (assuming you keep paying taxes on it) until the day you die or sell it.

I feel a lot of conditioning has been put into buying a home being some wonderful investment. In reality, most of us become slaves to interest and the mortgage payment...

These were all major reasons I avoided property so far.

I wanted to pursue a minimalist and somewhat carefree lifestyle, travelling and living abroad, taking long breaks from work. I've done all the above and had a pretty good time of it overall and wouldn't have done anything different.

Now I'm starting down early retirement, renting a small but very comfortable space and enjoying a slower pace of life.

If 20 years from now real estate outperforms all my investments, I'm not sure I'll regret the opportunity cost. For me money is a tool, I don't want it to be my master. Whatever wealth I can accumulate and hold on to is purely a utility for me to buy time to explore my real interests, which are vastly broader than money. Rather than lock my wealth up in an illiquid asset like a home I want it to be mostly there for me to draw on at a moment's notice.

Through a mix of stocks, directly-held bonds and cash, I think I'm in a position to navigate whatever the future holds. If there's a protracted downturn, I'll reduce my lifestyle, maybe work a bit. If there's an upturn I'll enjoy a fancy holiday or two. If (more likely) there's a bit of both – volatility – I'll just try to keep calm and ride the wave, enjoying the upsides whenever I can.

I quite like this quote from Chinese philosopher Lin Yutang:

“He is seldom disillusioned because he has no illusions, and seldom disappointed because he never had extravagant hopes. In this way his spirit is emancipated.”

I aspire to be like that.

[deborah]

You can also invest in real estate on the stock market.

[WayDownSouth]

I mean, sure, once it's all paid and done you DO hold that asset, but when you consider the garage full of tools, your afterwork/weekends spent mowing lawns, all the things you had to buy to maintain the property, the cost of taxes, etc., that renting can often be cheaper and easier. On the other hand, if you're buying somewhere to live permanently, have no kids, and are buying cash, well, in that case who really cares if the price goes way up or way down because it's yours from the first day (assuming you keep paying taxes on it) until the day you die or sell it.

I feel a lot of conditioning has been put into buying a home being some wonderful investment. In reality, most of us become slaves to interest and the mortgage payment...

I wanted to pursue a minimalist and somewhat carefree lifestyle, travelling and living abroad, taking long breaks from work. I've done all the above and had a pretty good time of it overall and wouldn't have done anything different.

Now I'm starting down early retirement, renting a small but very comfortable space and enjoying a slower pace of life.

If 20 years from now real estate outperforms all my investments, I'm not sure I'll regret the opportunity cost. For me money is a tool, I don't want it to be my master. Whatever wealth I can accumulate and hold on to is purely a utility for me to buy time to explore my real interests, which are vastly broader than money. Rather than lock my wealth up in an illiquid asset like a home I want it to be mostly there for me to draw on at a moment's notice.

Through a mix of stocks, directly-held bonds and cash, I think I'm in a position to navigate whatever the future holds. If there's a protracted downturn, I'll reduce my lifestyle, maybe work a bit. If there's an upturn I'll enjoy a fancy holiday or two. If (more likely) there's a bit of both – volatility – I'll just try to keep calm and ride the wave, enjoying the upsides whenever I can.

I quite like this quote from Chinese philosopher Lin Yutang:

“He is seldom disillusioned because he has no illusions, and seldom disappointed because he never had extravagant hopes. In this way his spirit is emancipated.”

I aspire to be like that.

I live somewhat similarly. Sometime I feel I should have pulled the trigger on a couple small cheap-o homes just to have them but never did. DOn't really regret it. There's always money to be made if you hold the right skillset or can adapt quickly - especially if you have the cash catalyst for it.
These were all major reasons I avoided property so far.

[jaysee]

You can also invest in real estate on the stock market.

Yes true!

Some specific kinds of liquid property investments I'm aware of:

• Property-related firms, e.g. Mirvac (MGR)
• Real estate investment trusts, e.g. VanEck (MVA)

The tricky thing is – do any of these really hedge against increasing house prices / rents?

I'm not sure that they do. Property firms may have fluctuating valuations as with any business and REITs tend to be commercial property which has seen declining value relative to residential.

I think this is not real-estate-specific, but rather is part of the more general problem of hedging inflation, for which there seems to be no simple/easy solution.

IMO the best one can do is:

• Get exposure to independent risk factors - i.e. international diversification in stocks + small-cap value tilt - to minimise one's portfolio volatility without sacrificing real return
• Hold some assets that track inflation when stocks are all down, e.g. an inflation-linked bond ladder
• Hold some cash in high interest accounts for short periods of unexpectedly high inflation, as interest rates tend to rise during those periods (as we've seen recently)
• Live a frugal lifestyle - I've found that my personal inflation tends to lag broad inflation when I live more frugally than the average person, e.g. renting just a room, eating more cheaply, not owning a car, etc. Basically reducing the surface area of expenses should reduce your exposure to inflation in general.

Any one of the above on its own would help, but all combined should help a lot.

[Alchemisst]

You can also invest in real estate on the stock market.

Yes true!

Some specific kinds of liquid property investments I'm aware of:

• Property-related firms, e.g. Mirvac (MGR)
• Real estate investment trusts, e.g. VanEck (MVA)

The tricky thing is – do any of these really hedge against increasing house prices / rents?

I'm not sure that they do. Property firms may have fluctuating valuations as with any business and REITs tend to be commercial property which has seen declining value relative to residential.

I think this is not real-estate-specific, but rather is part of the more general problem of hedging inflation, for which there seems to be no simple/easy solution.

IMO the best one can do is:

• Get exposure to independent risk factors - i.e. international diversification in stocks + small-cap value tilt - to minimise one's portfolio volatility without sacrificing real return
• Hold some assets that track inflation when stocks are all down, e.g. an inflation-linked bond ladder
• Hold some cash in high interest accounts for short periods of unexpectedly high inflation, as interest rates tend to rise during those periods (as we've seen recently)
• Live a frugal lifestyle - I've found that my personal inflation tends to lag broad inflation when I live more frugally than the average person, e.g. renting just a room, eating more cheaply, not owning a car, etc. Basically reducing the surface area of expenses should reduce your exposure to inflation in general.

Any one of the above on its own would help, but all combined should help a lot.

Usually I see the recommendation is to not choose specific factors/ sectors with indexing. Also the liquid investments miss out on the main benefits of property like cheap(er) and higher leverage, tax advantages (negative gearing/ inheritance etc). I guess the other lure is potentially a paid off house, not having to worry about lease renewals or moving house unless you choose to etc. I have been pretty anti property investing but I do see a lot of benefits too.

[Dicey]

Indexes never, ever call to say the toilet's broken.

Update: Nor do they call to say the garage door opener is on the fritz, just two months after we spent ten days prepping the entire house for a new tenant.

Update #2: Less than six months ago, we bought a new Whirlpool refrigerator to match the appliances we installed in another property. It won't freeze correctly. It's been serviced SIX times under warranty. Lowe's won't help. Whirlpool will only help if the repair service says it can't be fixed, but "fixing" it is how they make their money...

[bluecollarmusician]

A good piece of advice I picked up somewhere along the way:  "You make money on the day you buy an asset, not the day you sell it."

Perhaps worth considering- everyone's situation is different.  I love RE, and it has been very good to us, however our barometer for success was buying value property when the numbers made sense. (Worth noting, we aren't buyers in today's market...primarily because the number's don't make sense.)

Buying for a perceived tax advantage or with the hopes that some other crazy buyer will want to "pay" more in the future can be very speculative.  That doesn't mean it can't work out.

I do know some very high earner's who manage to net-negative cash flow properties for significant savings, however they tend to be outliers who are generating lots of income from another source and the RE is more a store of value that they can write off than an "investment".

[twinstudy]

Main advantage is leverage - you won't be able to borrow as much at such a low interest rate early in your journey - but that advantage gets diluted with time.

Depreciation has been nerfed, and that was the best way to turn a positive cashflow investment into a negatively geared investment. Negative gearing is about to be reformed, my gut tells me, so it's a moot point anyway. To the relatively modest extent that negative gearing is useful, it's offset by greedy state governments imposing terribly high land taxes on investors.

One thing that hasn't been talked about enough is the legislative changes to cap rents to 'market rate' (which in practice heavily reduces rental increases, as market rate is now a ceiling instead of a median) and to prevent landlords from terminating leases (which also lessens landlords' market power). In aggregate, this is the biggest single factor hurting the utility of property as an investment. Imagine if you couldn't sell an underperforming share. Ridiculous. I now vet tenants very carefully and won't take on even a slightly marginal tenant. No more years of goodwill rental non-increases, either.

The main advantage of property is that if you buy good property (3BR family homes near schools) you will have an endless supply of tenants and the more property you have the less everyone else have; in theory, over time, property should condense and that leads to greater rent seeking potential. But governments can override that.