A Happy Accident? When Homes Are Better Investment Performers Than Investment Properties
As we spend time with our clients in deeper discussions about why they invested in property, we are seeing an interesting fact: many have bought homes that turn out to be better investments than the investment properties they bought. Yet the investment property was bought solely to make money. What happened in these cases?
WHAT DRIVES HIGH CAPITAL GROWTH? HIGH LAND CONTENT AND UNUSUALLY GOOD LOCATION
In many ways, the answer to that is contained in our recent Webinar – Property Investment 101 – the basic principles of successful property investment, which I strongly recommend you watch when you have half an hour of free lockdown time! Register Here. In there, we say that the first golden rule is this: land appreciates, buildings depreciate – so the more of your money that goes into the land and the less into the building, the better.
And for many people, perhaps by accident, that is what they do when they buy their home – often in search of a good lifestyle, space for kids or grandkids, they buy a house rather than an apartment and they often get a good amount of land with that. If buying in an established suburb, it is likely the house itself is somewhat older and the value of the building has depreciated a lot before they buy it, so most of the purchase price is really for the land underneath it.
This, commonly by accident, is often good property investment.
It is also why fancy renovations, while nice to live in, are generally poor investments.
Further, for your family lifestyle and convenience, you often try to buy walking distance to public transport, shops and other amenities. Often in a good school zone. So not only are you buying high land content, you are buying well-located land. Unusually well located land. Land in a location that is “scarce” – in that lots of people want it but there isn’t much available. So golden rule number two – buy land that has an unusually good “location, location, location” – means it will appreciate faster than less well-located land.
By contrast, many people when they buy an investment property feel they are constrained by budget to buying an apartment. In many cases they may have been better off buying a house in an outer suburb or regional city. Many investors buy a new apartment or even off-the-plan. It looks good and will be easy to let. Which is good, but it also means the value of that building and all those new appliances etc will go down, not up. And for “location” they focus on “buying in a good suburb” rather than WHERE in that suburb. Where you buy within a suburb is often more important than which suburb. You can’t buy “a suburb”, you can only buy an individual property, in an individual location, with a greater or lesser land content.
As a consequence, in our first detailed study of our clients’ investment properties – a sample of 170 of the properties we manage for you – we found the average capital growth per annum (something we call CAGR – compound annual growth rate) is only about 4% p.a. Yet the Melbourne market overall has a growth rate of about 6% p.a. over the last 20 years – 70% of that in owner occupied homes. That may not sound a lot of difference, but it is. Let’s assume you bought two properties in 2000 for $300K each. After 10 years, the better property (6% CAGR) is worth $537K versus the poorer property (4% CAGR) at $444K. After 20 years the difference is more than $300K – $962K to $657K.
So, for many of our clients, their homes may be appreciating at about the market average 6% CAGR and their investment properties at 4% CAGR or less – half of all the properties we evaluated were getting even less than the 4% p.a. amount.
TAX BENEFITS VARY BUT OFTEN FAVOUR HOMES OVER INVESTMENT PROPERTIES:
The differences get wider still when you take the tax impacts into account. Investment properties – especially new apartments – are often sold on the basis of their alleged tax benefits – through depreciation and negative gearing. Those benefits are real, but they are only about 1/10th as big as the differences in capital gains outlined above. But they also don’t take into account the bigger tax benefits people get on their homes – NO capital gains tax and NO land tax. These tax benefits are about 3 times larger than the tax benefits on the investment property. A summary of the different tax positions is in the table below.
In a recent example we modelled for a client, over 10 years on a $1m property bought as a home versus as an investment property, the difference in tax outcomes was about $300K better for the owner occupied home.
That assumes it was the same property. But if you also have worse capital gains performance on the investment property/ies (see above) because you bought the wrong property, the total difference would be even higher.
So for many of our clients, a combination of better capital growth (the big factor) and better tax benefits (a smaller factor) make their home a much better investment than the property they bought specifically to be a good investment!
That’s when we sit down together and talk about how to improve that situation – sometimes by buying a much better investment property, sometimes by buying a better home. Some of our clients love the fact that they may be able to get the lifestyle benefits of a better home as well as the comfort that it was a better investment.
To be absolutely clear, everyone’s investment property and everyone’s home are different – there are NO golden rules about the two – we need to look at all properties individually and then together, along with all your other financial and lifestyle needs, to determine the right approach for each family individually. The tax benefits for each property depend on many factors – your income, when you bought the property, it’s land component and so on – and we work with your tax adviser to make sure we have the correct information on your tax situation to apply to the property.
To review where you sit with all the property you own and plan a strategy to get the best financial and lifestyle options, call Evan 0438899301, Antony 0419381905 or Mark 0450101955 to tee up a chat. There is no charge for existing LongView clients – it’s part of our service to help you be a successful property investor.