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Q: What’s better; Cashflow properties or high capital growth properties?

When considering building a property portfolio it is important to consider both cashflow and high capital growth properties, I believe it takes both sorts of properties to grow a substantial property portfolio.

If you buy all cashflow properties, sure you aren’t having to fork out money every week for negatively geared properties, however you will soon run out of equity from growth to continue building your investment portfolio.

In reverse, if you are just chasing capital growth properties, one – you will want to have a lot of surplus cashflow that isn’t tied up in bills to support the properties and, two- you will soon run out of cashflow to keep building your portfolio and helping to pay your negatively geared properties.

This is why at Profolio we first consider your position, do you have lots of spare cash, are you looking for tax breaks, what’s your time frame, and what do you want to achieve? Then we work out what each property should be, maybe your first property could be high capital growth, that you could sustain the extra costs of for a while, then you buy a cashflow property to offset those costs, this way your portfolio ends up neutral again, meaning your investments are looking after themselves, then once you’ve built up equity you do that step again and again until you’ve met your goal. This way you are still going to be able to eat while building your portfolio, plus you get the benefit of growth.

Property investment is simple and it works, you don’t need to reinvest the wheel, you just need to do it right.

 

 

Q: What is a bond? I’ve seen it advertised with my superfund that I have money in it, but I don’t know what it is.

A: When you purchase a bond, you effectively are lending a company or a government money. The bond issuer is the borrower. It agrees to pay whoever holds the bond interest on a regular basis, and then to return the principal on the loan when the bond matures. This can make bonds attractive for people looking for a relatively stable investment.

Unlike a stock where you’re not sure of future cash flows of the company, with bonds you know exactly what they’re going to be as the interest rate they pay it back at is agreed before purchase, The only risk is that the issuer ends up defaulting and doesn’t pay the debt. The flip side of bonds’ low risk is that they have less potential than stocks for high returns. Bonds are usually used as a ‘defensive’ investment in your superfund.

The rate of interest a bond must pay depends in part on the creditworthiness of the buyer. Large, stable corporations pay a slightly higher rate. Bonds from companies with very poor credit ratings are known as junk or high-yield bonds. Junk bonds pay high rates to compensate for the risk that they will default. You will most likely not have these sort of bonds in your super fund.

Another variable key is a bond’s maturity date. That’s when the bond pays back its principal. Generally, the farther away the maturity date, the higher the interest a bond must pay. Just like a term deposit with the bank.

Except in cases of default, investors know exactly what they can expect to make on a bond so long as they hold it to maturity. But bonds can also be bought or sold on the bond market, which means a bond’s current value if you decided to sell it can fluctuate. When interest rates rise, for example, the value of existing bonds on the market will fall. To understand why this is, imagine you hold a 2% bond and rates rise to 2.5%. With a 2.5% yield now available on the market, no one will want to buy your paltry 2% bond, unless you cut the price. Likewise, bond prices rise when interest rates fall.

If you own bonds through a mutual fund as would be in your super fund, you don’t have the option of waiting until the bonds in the portfolio mature. You own a constantly changing mix of bonds, so the total return of the fund is determined partly by the daily value of those bonds on the market.

If you would like more help in understanding if bonds are the right investment for you, contact us for a complimentary consultation.

 

 

Q: I’m considering buying my first investment property. I’ve seen advertising for Defence Housing Australia, and it seems steady, reliable and backed by the Government. Is this something you would recommend for a first-time investor? 

A: As a general rule, I’m wary of any investment which is advertised heavily to mum-and-dad investors. Of course, there may be situations where this would work for you.

Here’s their pitch: DHA builds the home and sells it to an investor (usually via a ballot system, because they’re in high demand from mum-and-dad investors) at ‘fair market value’. Then the owner leases it back to DHA for around 12 years (and defence force people live in it). The rents are basically backed by the Government, there are zero vacancies, and if the hot water service goes on the blink you don’t get a midnight call — DHA just fixes it for you.

Sounds good, hey?

Well, hold your fire. These advantages come at a significant cost. Generally you’ll pay a 10 to 15 per cent premium for a DFA property, the areas that DHA builds in may not be high growth, and DHA charges a nosebleed 16.5 per cent management fee each year of the lease. I wouldn’t touch them with a barge pole.

 

Q: I bought a rental property that has increased in value considerably. The cash is great, but I’m wondering if I should sell high and invest in a different asset.

 

A: This is a situation where there really is no one-size-fits-all answer, says Sarah Rogers, a qualified property investment advisor, financial planner and mortgage broker.

 

To tackle this question, you’ll want to first get a handle on just how well this particular investment is performing relative to other assets.

Looking at the asset classes in general property and shares perform relatively similar returns with Australian residential property averaging 11.1% returns and Australian shares averaging 11.5% return, with shares been slightly more volatile. Of course this will depend on where and what you buy.

For a simple apples-to-apples comparison, take the property’s annual net cash flow (income minus expenses) and divide it by the equity in the home. You can use this yield to see how the income generated by this property stacks up against that of other investments, such as dividend-paying stocks.

To calculate your total return, take that yield and add it to your expected annual long-term price gains (what the percentage you expect the property to go up in value by). If your yield is 5%, for example, and you expect the value of the property to appreciate 2% a year on average, your annual total return would be 7%.

Next, you’ll want to figure out just how much you would have left to reinvest after you pay the real estate agent fees and the capital gains tax.

Remember, because this is an investment property and you have held it for over a year, you are eligible for the capital gains discount of 50%.

Assuming you don’t want to re-invest in actual real estate, the big question is where you should invest the proceeds of the sale – and is it better than what you already have?

You could look at alternative assets that have a similar risk and reward profile — dividend-paying stocks, real estate managed funds.

Investing in actual real estate takes time, lacks liquidity, and comes with some big strings attached. On paper, your investment property might seem like a better deal than any of the alternatives, but there are 50 other things you have to think about.

With real property there’s always the risk that you’ll have to pay in money for, say, a new roof or heating and cooling system. That’s one thing you don’t have to worry about with a managed fund or shares, however with shares and managed funds the ability to borrow to invest is not as high as with shares.