Don’t panic – investment in units still adds up

It was enough to send a chill through the heart of any investor; a recent story in a Sydney newspaper warned that you could be paying almost $17,000 a month on your mortgage AFTER taking your rental income into account.

With figures like that, it’s a wonder the market isn’t being flooded with distressed sales of non-viable rentals. But it’s clearly not.

With rents going up by massive amounts as a chronic shortage of rentals settles for the foreseeable future, and with property prices falling or stalling with every whisper from the Reserve Bank, surely there can’t be a better time to invest in homes or hold on to what you’ve got.

It turns out those newspaper figures were at the pointy end of an extreme market. In fact, it was referring to a house bought for $3.5 million on a 90 per cent loan and rented for about $4500 a month.

On a 7.2 per cent interest rate, the balance was, indeed, nearly $17,000 in red ink.  The same comparison showed a unit bought in Manly for $1.85 million, pulling in $3500 in monthly rent was almost $8000 a month behind the eight-ball when mortgage payments of $11,300 were factored in.

So why would anyone even consider buying a property as an investment at those figures? And the answer is, you wouldn’t; these were poor investment decisions – possibly made when property prices were high and interest rates were low.

Sale prices have fallen and rents are soaring, so is it safe to consider investing in property? The answer is that it all depends on geography.

Take Lakemba, a suburb with a high proportion of renters (about 60 per cent) where property prices and rentals have been heading in opposite directions.

The official median unit price is $380,000 while the weekly rent averages at $360 – very close to the old rule of thumb of knocking three zeroes off the sale price to calculate the weekly rent.

But there’s a lag in those figures, which are averaged over five years.  In the past year, sales prices in Lakemba have gone down 12.6 per cent while rents have risen by 14.6 per cent.

Even if sales prices have bottomed out, as some experts say, rents are still rising. So what is the true picture, right now when investors might be thinking of taking the plunge?

Looking at the first 13 apartments with two bedrooms, one bath and one parking spot, listed in Domain, the average sale price is about $390,000 while the average rent is a smidgeon over $500.

Factor that into a mortgage with a 10 percent deposit and the same 7.2 per cent interest rate and you are looking at a net “loss” of only $383 a month. Calculate using a more realistic 20 percent deposit and that drops to a $118 loss per month  – either figure easily being swallowed up by negative gearing.

And then, of course, there is the capital gain over the next few years, as you come off a relatively low entry price.

All of this is not to say you should immediately invest in Lakemba.  But if you ignore broadbrush figures and panic merchants, you can find sweet spots where the cost of buying a property and the income from it match up – especially in the long term.

And “long term” is the critical phrase. Get your tenants on long-term leases so both you and they have some certainty for the future.  And, whatever you do, don’t panic.

A version of this column first appeared in the Australian Financial Review.