This week's blog is a long one, so this is Part 1 of a 2 part Blog – should you hold property forever?
I often get told, “why would I sell my investment property, I’ll have to pay capital gains tax”…
Lets get one thing straight, you only pay capital gains tax when you make a profit, so if you are paying capital gains tax, isn’t that a good thing? I mean what do you plan to do? Die with a portfolio of properties?
There are actually a bunch of reasons for investors to sell property but certainly comes down to everybody’s individual circumstances.
- Pay off home loan in lump sum payments
- Pay for renovations with cash (currently what I am doing)
- To become cash flow wealthy whilst you are young – 17% of us will die before we retire.. (found on answers.yahoo) that’s more than one in 6 of us.
- Cash Flow positive is great but if it is only $20 – $100 per week, would the profit from the capital gain get you more of a return elsewhere, eg reduce your home loan or in a bank at 5%
- Turn one investment property into three with a lower loan to value ratio (LVR)
Now I think the confusion here comes from the fact that many investors don’t really know why they are investing… the common answer I get is “to make money”.
But is it really?
How are you making money if you never sell? Sure the property may be cash flow positive, which is great, but that is for cash flow reasons. If you want to make large sums of money from property, then you must sell to realise the gains.
If your reason for investing in property is for cash flow, then holding property for long term (not forever) is a suitable strategy. This should only be the Game Plan after any non deductible debt has been paid off. Property is a great tool to get you to that position. So if you own your home or are investing in your SMSF, then this strategy works.
I mean think about it practically, you have a home loan of $350,000 and are paying 6% interest on the loan and have two investment properties that are cash flow positive by $100 per week and they have also increased by $100,000 each. Is the $200 per week extra REALLY going to help you pay down the $350,000 a lot faster?… the reality is that the $200 wouldn’t go onto the loan but would be spent living week to week.
Or would selling the two properties, putting approx $85,000 per property (after fees and taxes) on your home loan, reducing your home loan $170,000 make more sense???
The savings in interest are very similar at 6% but your principle and interest repayment is reduced by $249 per week. The important factor is your home loan has reduced by $180,000. Now that your cash flow has increased significantly, go back out and buy 4 properties (one at a time). Once they mature sell 2 and pay out your home loan in full. Because you still have 2 investment properties, you are already on your way to building a passive income. Properties now become long term. Part 2 (next week) will cover what’s next.
Home loan paid off… go have a holiday and celebrate. You have entered an exclusive club of the the 30%ers… yes 30% of property in Australia is unencumbered.
Now if the reason for investing is for lifestyle… and enjoying a lifestyle now, not just when we retire, then I believe you must be open to selling property at the right time.
And to throw a spanner in the works, I currently adapt a buy and hold strategy along with a buy and sell strategy as well… let me explain. I am in the midst of renovating my home and not wanting to borrow money to pay for renovations. So I simply sell an investment property that has matured within it’s property cycle and pay for the renovations with cash. On top of this I have a portfolio of properties that I will keep and that are generating a passive income.
You see, I am not attached to property at all… it is a vehicle for me to use which creates the lifestyle that I want to live, that’s it!
When I do sell, I make sure I replace that property with at least two new properties to keep the portfolio growing.
Recently I read quite a disturbing article. The article was talking about property investing and that you should never sell. On top of that it went on to say that you should borrow against the equity (once property had increased in value) to have some rainy day money so that if you happen to lose your job you could still make repayments and also to borrow against the equity for your lifestyle reasons.
For the 1% of High Net Worth individuals in Australia, this could be done… but for the other 22 million of us, that is simply unachievable.
Lets go into that:
- This only works if property values are always increasing and there is equity to borrow against. Now properties go through cycles up and down so this won’t work
- Your ability to service the debt becomes increasingly tougher as your debt is forever increasing and never being paid off
- If the properties are investment properties, the increase of interest accrued on the loans that you borrow for lifestyle reasons are not tax deductible
- If you borrow extra to have a buffer so you can make loan repayments “in case“ you lose your job, you really should question whether it’s the right time for you to be investing or whether you should look for a cheaper investment property that is cash flow neutral or positive
- What happens when interest rates go up, sure you may lock in early to get a great rate, but what if when that fixed rate matures and your loan reverts back to variable, that the interest rates are still high? That’s a dam big “what if”… when interest rates go up quite high, say mid 8%… property values decrease and deals become a plenty for those cash rich. If your property decreases below what you owe on the property and you cannot afford to make repayments, what’s happens? Well you simply go bankrupt… that’s what!
- What happens when you decide to slow down as you head towards retirement and want to work part time, you simply cannot afford to do so
And for those in the above scenario, maybe if they sold some property and paid down their home loan and or investment debt, their cash flow would increase and they would not be in that dicey position.
I have spoken with many investors that have been caught in that trap and simply spiral out of control. We all know people who have been in financial stress and the effects it creates, they can’t work, their marriages have problems, they simply make stupid decisions… at the end of the day, it’s investing and its not worth losing your job or marriage over…
Wow that got deep… especially for me, the guy who isn’t even married!
Next week I will go into what happens next, after you own your home… how to build a passive income.
And guess what? It also entails selling property…
Todd Hunter is director, buyer’s agent and location researcher for Sydney-based wHeregroup. He is an active property investor himself and amassed a portfolio of 50 properties by the age of 31.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.