Beware of the yield trap many property investors fall into

15 Jul 2019

Expert Advice with Brett Warren 08/06/2019

Everyone need more cashflow don’t they?

And higher property investment yields mean more cashflow right?

The short answer is NO!

You see many investors set out with the short-term mentality to create more cash flow.

They think that by investing for cash flow they can replace their existing income and replace it with rental income.

Let me give you an real life case study….

Just this week, I sat with a gentleman who had it all figured out.

His goal was to buy five cash flow positive properties clearing $20,000 per annum after all expenses, making him $100,000 per annum clear when it comes time to retire.

In theory it sounded simple, until we started to talk about the detail and how it would play out in reality.

He hadn’t drilled down into the level of detail required to understand and discover why his strategy was floored.

Firstly, the excess rent is now a taxable income and he would be hit with a tax bill around $37,000 every year around tax time.

I went on to point out that we are at record low interest rates currently and should interest rates rise, that eats into his profit even further.

He was quite speechless when he realised that before he even had a chance to book a holiday his $100k was down to around half in the blink of an eye.

It is a flawed strategy and the reason most investors only end up investing in 1 or 2 properties, they get stuck.

With a lack of capital growth over the past decade, rents have still been steadily rising in Brisbane and there are currently some stronger yields on offer.

However, it still amuses me when I see both Sales Agents and Buyers Agents bragging of yields of 6% or 7%.

This usually means that the property has seen very little growth, but the rent has continued to rise.

Usually they are properties that are in very low demand from owner occupiers who drive the market and it is usually the investors that get sucked in chasing the higher yield.

This is a TRAP!

Sure, these investors may have a property that might cover the mortgage and even tip a few dollars into their pockets each year.

 But their property will never really grow in value significantly enough to create the level of wealth they’re chasing.


Here’s what the wealthy do
The wealthy are different, they take a long-term approach.

A couple of things they realise;

  • You can’t save your way to wealth, no matter your income.
  • Just concentrating on building your cash flow is a flawed strategy and will take too long, most people will never get to where they want to be.

The wealthy take a longer-term view and they look to widen their asset base with high capital growth assets.

They don’t get sucked in chasing high yields for short term game but rather higher growth for longer term gain.

You will notice almost all high growth, blue chip assets, have lower yields.

This is because they have a significantly higher rate of growth.

Cash Flow is obviously important, but Capital Growth can be life changing!


Finance
The days of 10 properties in ten years or 7 properties in seven minutes (!) are over, so it may even be questionable whether this potential client I saw could ever afford to service his goal of owning 5 properties.

It is now about quality versus quantity and rather than the number of properties, start to understand and focus on the quality and size of your asset base.

Take a long-term approach and look to build a strategy that focusses on growing your asset base.


The Bottom Line
Many investors are attracted to high yields as they focus on the short term and building or replacing their income.

The wealthy do things differently, their focus is growth and building an asset base for the longer term.

Yield investors often get trapped with finance and can’t progress as their assets do not grow in value.

And this is one of the main reasons the majority of investors really only own 1 or 2 properties.

In time, excess rental income is absorbed in taxes, fees and interest rate rises and what’s left over is generally far from wealth building levels of income.

So instead…build an asset base first and then your assets will give you choices in life as well as spinning off lots of income.

It could be life changing!

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Brett Warren is a director of Metropole Properties in Brisbane and uses his 12 plus years property investment experience and economics education to advice clients how to build their portfolios.
He is a regular commentator for Michael Yardney's Property Update.



Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.

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