People often fear debt, and I completely understand that. In an ideal world, I would love to have no debt at all — and I’m sure many feel the same way. However, that’s just not the reality for most people.
Most of us don’t start off with a large sum of money sitting in the bank, ready to invest. We can’t just decide to go out and buy properties without some form of leverage.
However, the ability to use debt is why real estate is such a great investment. It offers a unique opportunity to leverage debt that is backed by a tangible asset — a real property — and is backed not just by a bank, but by the strength of the broader Australian economy.
When it comes to borrowing money to invest, real estate is a safer bet compared to, say, a margin loan to buy shares. The value of shares can be highly volatile, and companies can go bankrupt or disappear overnight.
We’ve all seen companies that were huge just a few years ago, only to find them struggling or gone today. With real estate, this level of risk is much lower, and historical data supports this.
One of the reasons property investment is so powerful is that you can start with relatively little cash. You could have $50,000 or $100,000, put that down as a deposit, and the bank might lend you ten to twenty times that amount.
For example, if you secure a loan with a 5% interest rate, the rental income from the property could cover most of your expenses. There are also tax advantages that make real estate an attractive investment option.
This ability to leverage is what allows people to keep investing and building wealth. When I think about investing, especially in property, I see it as a journey with different stages. You start off with very little, and your primary goal is to build more.
The way you do that is by leveraging debt to buy assets. In the early stages, you might have a relatively small asset base and a high level of debt, but over time, as the value of your assets grows, so does your equity.
Eventually, you reach a point where you have a substantial asset base, but you still carry a high level of debt, which costs money. That’s when you start thinking about the future. You might be tired of working and begin to contemplate retirement. However, you realise that you can’t just retire yet because there are mortgages to pay. But then you look at your situation and realise that you have a few million dollars in equity in your properties.
At this stage, you might decide to go through a phase of consolidation and debt reduction. The goal here is to reduce your debt because it’s costing you money, and you’ve already created a large capital base from a relatively small initial investment. By decreasing your debt, you free up capital, which leads you to the next question: “Now that I have this capital, how can I generate the income I need to stop working every day?”
For most people, the ultimate goal is to not have to work anymore. There are various ways to generate cash flow, but in my experience, I don’t believe that residential property is the best vehicle for cash flow.
Even if you own a property outright, with no debt, it still costs a lot to maintain. You might be looking at expenses like land tax, property maintenance, and other costs that can amount to 1.5% to 2% of the property’s value each year.
So, while residential property may not be the best source of cash flow, it is an excellent way to build the capital you need to achieve your goals. Once you’ve accumulated enough capital, you can then invest in something that produces more reliable cash flow like commercial property, allowing you to live comfortably without having to work.
Engaging a trusted buyers advocate through Henderson’s buyers advocacy service is your best chance at navigating the competitive real estate market.
