Hello, and welcome to The Australian's Money Puzzle podcast. I'm James Kirkby, the web editor at The Australian. Welcome aboard everybody. I think if you are a property investor, or, if you aspire to be a property investor, or, even if you are a veteran property investor, I expect one of the most difficult things with property is because it's illiquid, right, because you can't sell a bit of it. You can't
sell ten thousand dollars worth of property. Most people, most of the time, really don't know how their property is faring until the day they sell it. So they buy it, they hold it for ten years, they sell it, and then they look back and they go, okay, well that worked out. It's so much paranum. But that really isn't
quite good enough. In recent times, I've met so many people who have been disappointed with certain property investments, specifically in the city apartments Indian major cities, which haven't really worked out, or certainly haven't worked out as well as they were told they were going to work out. Because once upon a time everyone was told, hey, by property, it doubles every ten years, we'll all be fine. That is not the case. That hasn't been the case for
a while. My friends very good, but it's not that good. And all property is local. So I'm going to talk today about this issue and some other key issues that are emerging. We've seen a spike in interest only lending. What's that about now? I assume that the interest rate cuts are on the long fingers, shall we say, because don't you know, there's now economist saying I wouldn't be waiting until early next year for interest rate because they may never come with the election of Trump, by the way,
our Trump. Of course, we're going to deal with Trump and what's happening in markets. We will do that on this Thursday's show. Look out for that now to help me to guide me through the issues I just waid for you there on Property Investment is a regular on the show and a regular contribution to the Australian. Stuart Weams of the pro Solution Private Clients Group. How are you, Stuart.
I'm really well, James, and thanks for having me back on again.
Sure the audience would fondly remember you standing for me when I was on holidays, which now seemed like a long time ago. Even though to come back in early October. But you know, that's life.
I suppose I feel far more comfortable being the guests than the host, that's for sure.
Do you. One of the things you often mentioned to me, and I want you to just sort of explain it and discuss it with our listeners today is internal rate of return. So I mentioned it at the start. The professional investors, they've got this running tap, if you like, on their investments called internal rate of return, these BC funds and private equity funds. Yes, that's for ten years, but they don't sit there unfolded hoping it will all work out. They keep a running tab on their investments
in trying to rate of a chain. Tell us how an investor, potential investor can do that in property.
And it's really important to understand how an internal rate of return behaves, James, and I'd say that particularly for property investors, because property investors are borrowing money and then their service in the loan and then the hopefully gets there.
First of all, what does it actually mean? What's the difference between my return and my internal rate.
Of Internal rate of return is the return that you receive back from the or taking into account the amount you've contributed to an investment over many years. And if I draw an analogy, say between say a forestry investment. Let's say I want to grow some trees and then harvest those trees. And let's pretend that when I first buy the land and the trees to plant on that land, I borrow the full cost of that acquisition that cost.
But of course those trees are going to take twenty years to grow, and over that time, I'm going to have to service the interest on the loan that I used to buy the land and the trees. The tree is going to be water and care and so forth, and I'm going to have to contribute to that, and that'll be my contribution. Because I've borrowed the initial cost, I haven't put any of my own money in, but I'm putting my own money in each year over the
next twenty years. In twenty years time, I'm going to harvest those trees and hopefully then sell the timber l whatever I might want to do, and that will be my return. If I'm putting in ten thousand dollars a year for the next twenty years, two hundred thousand dollars, what return am I going to earn on that two hundred thousand dollars that I've drip drip fed in over the last twenty years, and that'll be the capital at the end of the day. An internal rate of return
expresses that as a percentage and annualize compounding percentage. And the reason that's important, James, is because if I'm investing in forestry, or if I'm investing in an investment property and it's costing me ten twenty thirty thousand dollars a year, the question I need to be asking myself is what return will I earn and is there something better that
I can do with that money. So if I'm getting a fifteen percent after tax return from investing in property, fantastic, that's probably better than super It's probably better than the share market. But if I'm earning something substantially less than that, then I might want to be thinking about have I chosen the right property, Am I managing that property well? Or should I in fact invest in a different asset class.
And speaking as I mentioned at the Stark, people who are disappointed but property investments when they finally sell them, maybe if they did this exercise earlier, they wouldn't get such a disappointing outcome because it's similarly for the investor. The investor says, oh, well, the yield you know everyone's talking about rens goes to the roof. But as it turns out, my yield there's only three or four percent, and my costs my oldest six or seven percent, and
I have all the costs on top of that. So I'm absolutely tendent upont the price of this apartment being much higher when I sell it. So let's take that example. Then here's the investor. It got this apartment. I got to use an apartment because I think it's probably the ideally proxy here got an apartment, cut it for three or four years. The idea was to hold it for ten years. How would they do the entire later to turn exercise on that.
Look, you got to spreadsheet it and use the calculator. I don't think people investors necessarily need to do that calculation themselves. Their advisors probably should, but they don't necessarily need it. They just need to understand the relationship. And maybe I can give you some examples between say a high income low growth property and a low income high
growth property, so the complete reverse. And let's assume that we get a nine percent total return, it's really just the makeup of income and growth that equals that nine percent. And so the low income property is yielding one and a half percent growths rental income terrible yield, that's not very much, and seven and a half percent growth, and the high income property six percent income three percent growth.
And let's compare those two because it's important to not only look at the intern rate of return, but actually the dollars at the end of the day as well. So in both those scenarios, the internal rate of return for the low income properties ten and a half percent if I hold it for thirty years, sal it and walk away. That's after tax. The high income property six percent income, three percent growth. Intern rate of return is eleven percent, so pretty similar, but just a little bit more.
And the reason for that is that high income property it's producing a very high income, so my contribution is a lot less. The property starts to in fact earn a positive income after twelve or thirteen years, and if I'm holding that property for thirty years, then most of the time it's giving me income. And that's why the intern rate of return is so great. But when we look at the actual dollar value return in thirty years
time when we go and sell that property. The high income property is going to put about half a million, five hundred and twenty thousand dollars in my bank in today's dollars. Okay, so that's not a bad injection.
What are you vesting these estimates on.
The income and growth so the total historical averages, yeah, exactly right, yep, ok. Whereas the low income, high growth property is going to put two point eight million dollars in my bank account in thirty years in today's dollars. Now, two point eight million dollars, James, would be enough for anyone to run a perpetual portfolio. So that is that
they could have a very enjoyable and comfortable retirement. So sometimes as property investors, we when we go and buy a property, what we want to do is trying to balance between income and growth. But the reality is that's the wrong approach. You're actually leaving you're actually foregoing too much in terms of return by doing that. What you should do, what property investors should do, is do property
invest in two steps. At the acquisition stage, obsess about capital growth because that's the time when that's going to be locked in. It's going to be what type of property, what sort of land value component, where is that land? How much land do you have? All those things are factual, they'll be locked in when you buy it. There's not much you can do to change the outcomes after you've purchased it. But after you've purchased your property, forget about
growth because you've already locked that in. Start obsessing about holding costs. Can we make cosmetic improvements to the property to increase its rental yield? How do I minimize my interest costs? Am I maximizing my tax benefits my negative gearing? Because the outcome is I bought this property, I hope that I'm going to achieve a six or seven percent average compounding capital growth rate over a very long period of time. You're not going to get that every year,
but over multi decade periods. And so now my goal is to limit the amount I have to actually best in this asset, which is you're holding costs, and that's where the focus should be. The mistake of a lot of people make is that they try to even out those two elements when they buy the property, both yield and growth, and the result of that is that they end up either really compromising in terms of performance and outcome financial outcomes.
Let's take a break. When we come back, we're going to tell the listeners the nature of these properties and where they might be. Back in a moment. Hello, Welcome back to the Australians Money Puzzle podcast. I'm James Cabbin. I'm talking to Stewart Wims of the Full Solution Favorite Dim script. Now, if you recall first part of the show, we talked about this very important issue for the investor and the the attraction if you like, of strong income
yield on your property, which translates very simply as high rents. Okay, that the rent that the rents are high as a proportion, that is, of the price you'll property and you have
a strong renting yeed. Traditionally, the place where you found high rental yields was in the regions and basically the deal was in the center of the city you had low rents, that is, low rental yields rental yields, and in the bushelly in the regional towns and at the very fringes perhaps of the cities you had higher yields and you couldn't expect such price growth. That was the deal? Is that the deal still, Stuart? Where do we get these high yield properties? Yeah?
But COVID skewed the data a little bit, James. It's good the data around property a little bit, and I think what it's doing is inviting investors to make mistakes. And the mistake is that what if I'm going to go and buy a property, I need to think about, on average over a very long period of time. I'm talking hopefully multi decades, what will my average returns be? And you can't always use most recent returns as an indicator for that. So I've seen a lot of buyers
agents online saying, look, we're buying this property. Not only is it yielding, giving us a good yield four or five percent, whatever it might be, but look at the growth over the last five years, and that's fantastic. When you add the yield and the growth, you might end up with a total return of twelve percent. But do you really think you're going to get twelve percent from that asset over a thirty year period, because that's a pretty ambitious assumption. I think the answer is it's unlikely.
And typically you're either going to you're going to need to make a compromise. Are you going to compromise on income or you compromise on growth. It's one or the other. And ironically, if you look at the internal rate of return calculations, even if you can find a balance between both, that's an inferior outcome on the internal rate of return perspective because you're actually not getting one or the other. Really, So.
Are you saying you should go boots and all into one or the other. That you should seek knowingly as the extent that you can ever know, But the extent that you can know and you do your homework, that you should know what you're buying, that this is a capital growth property and I know the yielder is low, or this is a yield property and I know the capital growth will be modest, But look at this yield in my dollars today. This is really working out for me.
If you can achieve an average return of seven point two percent over thirty years, your property will be sick worth six times than what it is today. There's no easier way to make money than compounding capital growth. It's always going to beat the income yield, almost irrespective of what that asset costs you. Within reality, the outcome is going to be great. The outcome is going to be a comfortable retirement.
Where are these properties geographically?
If you want to take an approach where you've got the highest probability of earning seven point two percent or more, then you really need to think about scarcity and scarcity and demand, and you want to be in an area where demand. The potential buyers their capacity isn't directly linked to their household income. They've got other sources of wealth and then supply in terms of scarcity in terms of
supply as well. So this is really blue chip. Blue chip suburbs are going to have the fundamentals that are going to drive higher and higher growth, And we can talk about density and all those sorts of things. All these things add to the scarcity of these sorts of assets.
So it's not necessarily regional non metropolitan property residential.
Well, if you invest in a regional location, you've got to ask yourself what haircut am I going to take on capital growth and what's the opportunity cost of that. Now, it's quite possible to buy in a regional location that is well established but by a really good area in that regional location, in that regional town, buy in the best street possibly or something that is very sought after. So you can still apply this methodology to regional areas
as well. But essentially what you're trying to do is not by the diamond, but by the pink diamond, by the asset in the street that's always going to be in demand, and that way, the people that can afford to buy into that area will continue to push those prices forward.
Terrific. Okay, Now, one other things I wanted to talk to you about since I've got you this week is you and I both noticed we didn't get a chance to talk about this, but in covering the bank results, I noticed that the interest only loans as a percentage of the book, if you like, in National Australia Bank, which is just happened to be the bank result I
was looking at, had popped higher. And it struck me that, of course, when investors are very confident operating markets, they will invest, and they will invest interest only, and more importantly, banks will handle over interest only loans. They've been slow to do it for some years, the clearly starting to do it again. What do you make of that.
I think it's probably more borrower led than a reflection of credit policy. James. A couple of years ago, obviously, interest rates are really low, and at that time, a lot of investors, certainly in our experience and our business, a lot of investors said, given interest rates, I can fix for two years at two percent. Sorry, interest rates are so low, I may as well start repaying some principle, And so a lot of investors went over to principal
interest repayments on those low fixed rates. Obviously, the fixed rates of most of them have matured expired, and now they're realizing that because interest rates have significantly increased, of course the dollar value repayment is much higher, and so a lot more clients are speaking to us about going back to interest only repayments now that interest rates at
a much higher setting. I think credit policy is loosened slightly, but I don't think that's the reason for the increase in interest only lending.
And i'll interest only do you have a set position on it, or is it case by case basis.
I think if you're in acquisition stage, so you're young, many years away from retirement, then your goal probably is to acquire as many growth assets as possible, and having interest only setting will probably help you do that. If you've already established a good asset base and it's really about consolidating, then in that situation sometimes principal interests makes sense. Personally, I've always been interested, only more recently I've had a
few loans flick over to principal interests. I'm pretty comfortable with that. It helps me build a bit of equity in the property as well. So it just really depends as your stage of life, I think is the key one.
Well, and do remember, folks, the interest only assuming a bank will give you one. The issue is that your loan doesn't go down, so you're paying that interest every year the years pass, and your loan on the fourth years as big as the loan as big as on the first year. Why do you inflation? Of course, a little bit of inflation would help help that situation, Stuart, it's not a problem when you are in that situation, particularly if you fixed and you can't fix on interest
only loans as well. This probably isn't the climate to do it, but just making that point that you can. Okay, let's have a break and we do some questions. Hello, Welcome back to The Australian's Money Puzzled podcast, and I'm James Kirby talking to Stuart Weems. Our first question this week is from Paul. He says, I believe most people are happy for our taxes to be spent on helping
the true battlers into social housing. We've all heard, however, about the occasional social housing occupants who trash their property. What guarantees will governments give to the voting public that such problems will be quickly and effectively handled. Okay, that's interesting, Paul. One of the things I think I think many people would would would be on broadly in principle. Agree with you there that social housing is needed, it has a place,
and it's important. And not only that, but not much housing was built for many years in many of the key cities under both labor and liberal administrations, so they're catching up now. It's also true the statistics show that that their maintenance levels are higher, and they have that issue. I think that I don't think you can change that issue in any substantial where you probably just have to take it into your numbers and allow that though I
think that's all they can do. They can they can note then numbers are higher and issues such as as damage to property is higher at that level of the market. To take it as a truth if you like of that market and you work as best you can around it. And obviously, if I'm an investment point of view, if it's the case that such housing has been put before private investors, they would allow for that. I think to add to that, Stuart.
My only observation is that state governments are very keen to ensure that private landlords have maintained very high standards with their rental properties. But it doesn't seem like states do the same with public housing. And I think perhaps the rules should apply to the government just as much as they do private investors. Not really related to the question, but I thought i'd like to mention anyway.
You totally chocked down in Yeah, okay, all right, and can you see this? Would you actually read the first one from Dan?
From Dan? Yeah, definitely. Dan Wright's one of my relatives is sixty five years old, no debt, lives the full life of travel, but does not own their own home, and they have a super balance of one point sixty five million dollars. What should they consider, for example, should they buy a small property? What do you think, James.
Well, I would say, if it's the case that they have no property whatsoever, this is never advice then, and this is information only. But it is the case that there is a sixty five year old couple in Australia and they have super of what was the number, one point sixty five million between them, and they don't own their own home. They are asking they are walking into the most difficult situation because the entire tax system is loaded in favor of the homeowner, and pension access too
is loaded in favor of the homeowner. And if you had one, I'd be very crude about this, But if you have one point six million and you spent a million on a home, then your access to the pension would open up because the home isn't included. But all those assets, the one point sixty five that you have outlined that your couple own there non property, they are every dollar is going to be included in pension access, and I could say that you're probably wiped out in
terms of all the benefits in there. So that's what stands out there. Should they buy a home, If they don't have a home, they should buy one, I would think. So, I mean, I don't want to give individual advice, but I would say, in the scenario outlined for any Australian couple, then you are walking into higher tax or at least less beneficial arrangements as you're older, if you don't own your home. But what do you think of that? Sure?
I was thinking along the same lines James, like, if they put a lot of that wealth into the family home, they would certainly open themselves up to a part pension that have to spend maybe one point three to get a full pension. I'm not sure I would do that. And then you would say, hang on, you're pulling money out of an environment that's tax free. Home is tax free. So the only thing I would add to it is if I was in their situation, my concern would be longevity,
risk and security. Having your own home gives you a lot of security. So I would buy a property maybe somewhere around that million to one point two, and I would buy it with an investment lens. I would buy an asset that is going to give me good capital growth that I also would like to occupy for the next ten to twenty years. But if you apply it with an investment lens. At least your money is going to be working hard for you and the capital any capital growth is not going to be taxed. Of course,
we would be tax free. So that's a pretty good outcome, probably just as good as super almost if you buy well.
And if it looks like your numbers on your income, which will fall of course, having spent to buy a residential property, a home, that is, as Stewart pointed out, you must holistic view allow for the fact that your access to the pension suddenly opens up because the home is not included. That is one of the great big tax shelters in our society, and someone should be aware of them and be very I would be very still to turn my back on them that way. Okay, Now,
Billy seeks clarification on the land tax scenario. If you choose to vacate your primary place of residence over summer and later for another week over easter, and you choose to earn an income off Airbnb during those periods, does this make you eligible to pay land tax? I don't know the answer, but INSTINCTASMI yes, what's the story? Shirt?
I don't want to add to the negative Victorian economy sentiment. But I'm afraid my answer will I only checked out in New South Wales and Queensland. Of course, we don't know where Billy's property is located, and there was no issues there. You could earn a little bit of income as long as you didn't rent the property out for more than six months. But you'd have to look at your individual state legislation to really check this. Unfortunately, in
twenty one, Victoria changed the law. You can't earn one dollar from your property now. It used to be similar to other states. If you're rented out for more than six months, it's no longer your primary place of residence from a land tax perspective. In Victoria they change it in twenty one. So even if you rented out for two weeks, bang, you've lost your primary place of residence exemption and you'll get a land tax bill and it
relates to the previous tax year. Right, So the land tax years a calendar years, which means if I rent out my property my home this year, next year, I'll get a land tax bill. Pretty harsh, I.
Reckon, Yes, yes, so yes, pretty harsh. And of course there's this albatarge between the states. Now, where one state is clearly the least attractive to invest in fiper image is Victoria. And part of the price of that, of course, is that in a federation where people can easily choose between states, they do. I just I might actually take a second on that shore. It with you. One are the things we have mentioned this before about Victoria and
the difficulty being an investor there. And I saw where Moody's, the rating agency, had run some numbers on mortgage delinquencies and it turns out that Victoria is the highest. Now so we have the weakest property growth in Victoria, we also have the highest rate of mortgage delinquency. Did they tend to go hand in hand that in price the
start for all mortgage delincouncy goes up. And as an investor who could invest anywhere in Australia, do you see that as becoming a bargain basement basically or are you too worried about the regulation risk in Victoria?
I mean, delinquencies in area's rates in Australia have been They sometimes report there's an uptique, and there certainly has been the last couple of.
Years, and they are very low. I'm just going to say that they're they're reasonable, right, but they're going the wrong way.
Yeah, they're very low. Victoria's population growth has been pretty ordinary with interstate immigration or migration. I should say it's actually turned positive now, which is maybe the green shoot sign that the economy, particularly in Victoria, is recovering. The shrinking population is not really great for the economy either,
and then you've had higher interest rates. I don't think Victoria is shooting the lights out from that perspective, but I think if we take a long term view, which we must when we're investing in property, I'm very optimistic about Victoria, particularly for a few different reasons. But it's going to be a federal issue. The federal government needs to solve the Victorian issue in terms of getting the
economy back on track and getting the dead inline. Otherwise it impacts Australia because Victorian's economy is significant contributed to the overall GDP in Australia. So it's not only a state problem. It is if not already, it will become a federal problem as well.
Okay, very good, and of course as the hold issue to state that, but we were put that to one side for the moment. Very good, Thank you very much, Stuart. Every now and again we should actually stand back on the show when look at some of these elementary issues as an investor that are at clickable to you wherever you are, whatever you're doing. Internal rate of child is one of those things. Nice a lot, s Georg Williams of pro Solution Private Clients.
Thanks James fun as always, appreciate it.
Great to have you on the show. Folks. Let's have some emails the Money Puzzle at the Australian dot com dot au happy to receive your observations, questions, complaints. Also, we would really appreciate it if you would mention the show to someone you know. That's that's our that's our bit of internal marketing here. And thanks again to our producer Liah Samuel Glue. Talk soon.