Recently, I’ve been sharing my story with more people.
And it seems as soon as I mention property, there’s sometimes an assumption that we got rich off the east coast property boom.
Admittedly, I’ve been lucky in many other ways, which I wrote about recently.
And while I would love to say we made a lazy few million from holding real estate in Sydney and Melbourne which enabled our early retirement, that’s just not the case.
Now, we did make money from property as it was our investment of choice in the beginning. But the properties themselves didn’t actually boost our wealth as much as you might expect.
Yes, I know that sounds strange. There’s a few reasons for this. Let me explain…
Since we’re Perth based, we bought our first few properties in our home city, as most people do.
Having held these properties for 6-8 years now, the results have been poor. The Perth economy has struggled since the mining downturn from 2011-12, and the property market has followed suit.
On average, these properties have increased by about 5%, in total, over that time. Not each year. In total!
While this is disappointing, it’s not uncommon for a city to experience zero price growth for many years at a time.
Of course, there’s no guarantee, but I do expect the next 8 years to be better than the last. And most economic data is suggesting that the Perth economy is now steadily improving.
“Ok, I hear you, Perth didn’t do so well. But what about your other properties?”
So, luckily we decided to buy the next few properties in the eastern states. Two in Melbourne, one in Sydney and one in Brisbane.
We’ve made some better returns on these properties, but again, not as much as you might expect.
Because of the shorter time-frame involved with these properties (under 5 years) the gains have been partly diluted by…
Because we bought these properties from interstate, we used buyers agents. And while they did a good job, they weren’t free!
So, the transaction costs on a typical $600k investment property in Melbourne, for example, look something like this…
Stamp Duty – $32,500 (roughly 5% of the property value)
Buyers Agent – $15,000 (roughly 2.5% of the property value)
Settlement Costs – $2,500 (basically admin and bank fees)
Total = $50,000
This is a cost we need to recoup before we start making any money.
Also, remember rental yields aren’t exactly generous in the capital cities of Australia.
Yields for units tend to be around 4%, and houses even lower. After expenses and maintenance, which usually hoovers up at least a third of the rent, we end up with around 2-2.5% net yield.
I underestimated the costs myself in the early days. Surely, I thought, it can’t be that much?
Well it can. Sometimes we have a good run. But eventually, the costs somehow have a way of reaching 35-40% of the rent.
Even the staunchest of property investors can’t argue much with this point. The truth is, capital city residential property is a very expensive asset class to own, shown by transaction costs, low yields and large ongoing expenses.
With mortgage rates around 4.5%, it means we’re out of pocket about 2-2.5% per year, unless we put in a large deposit. Or, probably around 1.5% after tax benefits.
On a $600k property, this is around $9k per year.
As long as the property grows more than that on average per year (which is very likely), happy days. A well located property is likely to increase at least in line with household incomes. If it’s in a supply-constrained area with continual high demand from wealthy residents, it’s likely to do better.
These figures are fairly typical across our portfolio and from what I’ve seen, many other investors too.
So we have a scenario where the investment property is roughly $50k in the red from the start. And then, almost $10k per year out-of-pocket to hold.
Clearly, it doesn’t take much imagination to see that the first few years of price growth is just to break even.
After this, the gains are adding to your net worth. And they’re yours to keep. Well, unless you sell that is. Then, you’ll be up for more agents fees and some Capital Gains Tax.
We experienced strong rates of growth on a couple of our properties, which helped to boost returns overall, resulting in moderate growth for the portfolio.
Because of the way our loans were structured, and the price gains, we ended up with two properties with large equity in them. These are the ones we decided to sell off, so we could use that equity for dividend investing, creating a strong income stream.
Now I’ll agree, this is a somewhat unusual scenario and course of events. But it’s what played out for us.
Initially, we were only interested in property, because that’s all our comfort level would allow. The truth is, we just didn’t know a thing about the sharemarket and saw only scary headlines, like most people.
Then, with some experience in both asset classes and seeing the pro’s and con’s of each, we decided we should switch to shares for income and gain our financial independence.
(Side note – ideally, you’d hold any asset for a much longer period to see a better result, which we could have done, but as I explained in this article, our goal was early retirement as soon as possible. Therefore, we changed course when we realised it would shortcut our journey)
The Secret Sauce
So if we didn’t make a ton of money from property investing, where the hell did it come from? Bitcoin?
How about saving! Yes. That boring, old-fashioned technique that never seems to be cool (only among the strange underground FI community).
The last answer people want to hear, when they ask how it’s possible to retire early.
As I’ve written before, our savings rate was comfortably over 60% on average. Actually, with our tax rate heading to zero because of our negatively geared properties, it was higher. This meant even if our investments did just ok, the outcome was still a strongly rising net worth.
Remember, the truth is, to reach financial independence in 10 years or less, it’s all about saving. Compound interest takes a while to kick in, even though it’s powerful.
For folks like us, who want to generate freedom quickly – hardcore saving and investing for income will get the job done with little fuss.
Instead, all our savings went into deposits for properties, along with plenty of debt of course. The rest of our spare cashflow from our jobs was used to pay the shortfall along the way, while the portfolio steadily grew in value.
Notes on Forecasting
Some people may question why we bought in Perth at all. While it might be obvious to some (in hindsight), that Perth was a poor place to invest, it simply didn’t look that way at the time.
Perth’s economy was quite strong. Vacancy rates for rentals were low. Wages were growing at a decent rate. Population growth was high. And the property market was improving after a flat few years, catching it’s breath after the massive boom that ended in 2007. Even many research firms and experts were predicting growth for Perth property.
This is a good point to note. Asset prices of any kind, are not as easy to predict as some people claim. Many folks say they ‘knew’ what was going to happen. But did they? Anyone can make the right call once or twice. How many times does anyone call it correctly again and again?
That number is somewhere between none and not many!
However, I’m not saying that forecasts are a waste of time. Essentially, when we’re investing, we’re making a calculated bet on the future. So we do need to take some sort of a view.
But it’s important to think of a range of scenarios and then make our own judgement, on what we deem as the most likely outcome.
What Can We Learn?
- We learned that to reach your financial independence goals quickly, don’t rely on your investments. By that I mean, don’t sit and wait for your investments to do all the hard work. Pull your finger out and do some serious saving!
- Focusing on saving is a double win. As you lower your expenses, you boost your savings rate. But you also lower the amount you need to reach FI instantly!
- If your early retirement time-frame is 10 years or less, I would really question whether it’s best to load up on property. In our scenario it wasn’t the best idea. After all costs and making conservative calculations for capital growth, the numbers don’t look all that appealing. But for us, we simply didn’t know it was possible to retire so quickly, and without being multi-millionaire rich.
- Sometimes, property cycles don’t play out like you expect. And you could be forking out for years for a small or negative return.
- Simple and boring investing is under-appreciated. Yes, the returns look small compared to leveraging up. But leverage doesn’t always work in your favour. Obviously, if we have a large property boom in another city and you manage to catch the wave nicely, then it can definitely work for you, even with a short time-frame. However, I would caution against being too optimistic or using historic price growth as a guide.
- When looking at leveraged returns, be sure to calculate returns after costs. All costs!
Don’t get caught up in the glitzy magazine articles and the big numbers involved. I wouldn’t say we fell prey to this ourselves. Perhaps just under-appreciated some aspects of it, such as all the costs involved and the end game – actually retiring on property. But talking to others who have just started in, or are looking at using leveraged property, the excitement and lack of in-depth analysis is quite scary.
- Equity needs to be turned to cashflow to retire. One of the best cashflow generators in Australia is dividend-paying shares, due to strong yields and franking credits. Put another way, to retire on your residential properties, you’re going to need a far higher net worth than if that equity is invested in diversified Aussie shares like LICs.
It boils down to this…
Some of our properties performed poorly. Then there is massive transaction costs. And don’t forget the ongoing negative cashflow.
Add it up and we get a situation where our 9 years of strong saving generated a return that was just ok.
It’s an odd story perhaps. This isn’t the sort of quick-wealth property story you’ll read on the news websites. We’ve likely been slow learners and made a few mistakes. But because of our heavy focus on saving, things worked out great overall, so no complaints!
I’ve come to realise that having a steady stream of cash going out the door for property expenses, is not really an enjoyable way to invest, even if they’re increasing in value.
While dividend investing on the other hand provides constant positive reinforcement, with cash hitting the bank account effortlessly every 6 months or so, and none of the headaches and large expenses associated with property.
Irrational? Maybe. But very satisfying!
As of a couple of years ago, we’ve decided that an investment strategy based on rising income suits us much better than a strategy based on rising asset prices.
Basically, it’s just a different approach. And I believe, one that makes your financial independence plans much simpler and predictable.
With our desire to be financially independent as soon as possible, it’s clear why we became so attracted to Aussie shares. Our early retirement would simply not be possible had we stayed firmly in property.
Interestingly though, it would still have been possible had we bypassed capital city property and started in shares.
Yes, it sounds backwards and not what you’ll read in many other places. But it was true for us!
Remember, I’m no property bear. While we are slowly reducing our portfolio over time, we still have much of our net worth in property.
There’s plenty of people who’ll tell you how much money can be made from capital city property. I’m not here to disagree with them at all.
My aim is to provide some balance to the conversation from someone who doesn’t have a business depending on it, and who’s seen both sides of the coin, while managing to reach early retirement.
What are your thoughts on leveraged property? Is it part of your strategy for financial independence?