Posted on August 5, 2021
BUYING PROPERTY IN UPMARKET AREAS vs New Estates
Buying real estate in an up-market suburban area may be costly and can offer significant capital gains.
We can use the ‘Rule of 72’ to compare this mathematically. As the ‘Rule of 72’ in our Insider Secrets Report states:
Growth of 7.2% pa = Price doubles in 10 Yrs
Growth of 10% pa = Price double in 7.2 Yrs
Lets assume that we hold the property for 10 years and the price doubles:
Twice 2 = 4
If 2 = Purchase price and 4 = sale price, then the capital gain will be 2
Twice 8 = 16
If 8 = Purchase price and 16 = sale price, then the capital gain will be 8
So you can see that the capital gains in the case of Example 2 are much higher.
This is only part of the equation however. The real gain is calculated by determining the net yield over time compared to the expected capital gain. What we need to determine is if the property investment will be positively, neutrally or negatively geared. And this will tell us whether our investment will cost us money to maintain or not.
From here, we have to assume the property is being financed 100% from borrowed funds. Of course, if you have cash in hand to make a high ticket purchase, e.g. $2M, then this is regarded as being a cash purchase and is not your typical property portfolio building investment scenario.
Let’s go back to our previous examples.
Assume cost of dwelling is $500,000 for a new off-the-plan property.
Rental = $ 480pw. This gives us a gross yield of 5%. i.e. ca $25,000pa
If the interest only loan is @ 5%, then my repayments will be ca $25,000 pa
Once I’ve calculated depreciation and other tax incentives, I can assume that the property will be slightly positively geared.
This means that over ten years, the property will have paid for itself and I can benefit 100% from the capital gains less the capital gains taxes if sold.
Assume cost of dwelling is $2,000,000 for an established property.
Rental = $ 980pw. This gives us a gross yield of 2.55%. i.e. ca $51,000pa
If the interest only loan is @ 5%, then my repayments will be ca $100,000 pa
Once I’ve calculated depreciation and other tax incentives, I can easily see that the property will be highly negatively geared. In fact, as the property is already established, there may only be a limited amount on depreciation that we may claim. Alone, just looking at rental verses holding costs, there is a deficit of $50,000pa that has to come out of my pocket. Over ten years this will amount to $500,000.
If the price doubles, then the capital gain will be $2,000,000 less my holding costs les CGT. I will still make a gain but it will be associated with a lot of out of pocket expenses. These expenses take away my ability to do other things with that money which could have improved my situation.
I personally wouldn’t put all my eggs into one basket and run the risk of no or minimal capital gains. With the same $2,000,000, I could have bought 4 properties that would not have cost me anything to maintain and hold, I would minimise the risk of getting capital gains or not and if the ‘Rule of 72’ held true, as it has for many decades, I would have created a higher capital gain through 4 properties in new estates, then one property in an established area.
Both of these examples are pretty basic as there are a lot more details involved. They have been outlined to give you an idea of what is required to determine if an investment in property is right for your particular circumstances.
Currently, with interest rates being so low, most new off-the-plan property investments are positively geared and easily affordable. If interest rates stay low and your property increases its value over time this may end up being a great financial decision. Affordability may be an issue if interest rates go up dramatically.
If you’d like to assess what you can afford as a long term investment, contact us and one of our consultants will be in touch.