[Australia] Sale of investment property - index funds or more property?

[fabada]

Hi all,

My partner has a paid off apartment in Australia she used to live in (Primary Place of Residence/PPOR). As we have bought a house together, it's now an investment property (IP) she has rented out for AUD$800 p/w. We are both mid-30s with a young child.

Net rental yield on the apartment is around 2.5%, with average long-term capital growth around 3.5%. It's fully paid-off and worth approximately $800,000, with net rental income around $22,000. It was a nice place to live but I don't think it makes a lot of sense as an investment.

My view is that she should sell and either continue investing in a broad-based index fund (VTS/VAE/VAS) or at least in higher-growth property.

I understand she could use the $800,000 to purchase a couple of properties with leverage, but we're not too keen to take on extra debt above the mortgage on the family home. If she wanted to still have regular income (ie replacing the rental income) she could just invest more into VAS or A200 for the dividends.

Her risk tolerance is OK - she already has about $400k spread across US and Australian market indices - but we also don't want to over-invest in Australian property beyond the family home. We're also keen for a more hands-off investment - we have more than enough renovations to do on our home already. We have no debt beyond the mortgage.

People usually cite leverage as a key reason to invest in property over index funds, but with a big chunk of cash like this my weak view is that we'll be better off if she invests the money straight into index funds. But I know diversification never hurts so maybe the sweet spot is to use ~half the $800k to buy more property and the other half into index funds. Australians are a property-mad bunch.

Welcome any views, particularly on anything I might have missed on the attractiveness of property. Thanks in advance.

[rob]

With the increases in rental requirements (insulation requirements, rent increase limitations etc.) and the general discussion on change/elimination of negative gearing (a political topic I cannot say more about)... I would personally not jump back into property. If you wanted some exposure, you could always invest in some REIT style vehicles with part of the money (I think V has an ETF but might be wrong).

[jg12345]

1) sell the property (and perhaps the Australian market index. I don't understand why she is invested in US and Australia indexes. being invested in Australia does not seem a very smart choice tbh so I would also sell that)
2) don't buy more property
and
3) pay off mortgage? you don't say the mortgage rate
or
4) buy vangaurd ftse all world + global bond aggregate hedged to AUD at your preferred allocation mix. for exact ETFs, check boglewiki or posts from Andrew99999 and/or check passiveinvestingaustralia.com

[pennywiser]

We're also keen for a more hands-off investment - we have more than enough renovations to do on our home already.

We are in a similar situation. My partner owns a small flat which she purchased to live in before we met. When we bought a house together, she rented the flat out. Economics of owning a rental property changed for worse recently due to changes in taxation and regulation and the flat is not worth the hassle anymore, especially when we consider the cash flows it produces.

We decided it is better to sell the flat and maximise our pension contributions and tax free accounts, which should take few years. Then capital will be sheltered from tax as much as possible, as opposed to being tied up in a property where tax optimisation is very limited.

Additionally, having excess liquidity after disposal of the flat will allow us to take advantage of all company share options schemes, saving schemes etc which can be very profitable and tax efficient at the same time.

Flat is under offer now and ready to exchange contracts, but tenant is refusing to leave because she wants council to give subsidised accommodation, so we are going the courts trying to get her out (Section 21, probably bailiffs, the whole shebang).

No family with a small child needs that hassle in their life, especially if economics are not there. And as the saying goes, your stock portfolio won't call you on Sunday evening that the water heater has broken down...

[Valuethinker]

Hi all,

My partner has a paid off apartment in Australia she used to live in (Primary Place of Residence/PPOR). As we have bought a house together, it's now an investment property (IP) she has rented out for AUD$800 p/w. We are both mid-30s with a young child.

Net rental yield on the apartment is around 2.5%, with average long-term capital growth around 3.5%. It's fully paid-off and worth approximately $800,000, with net rental income around $22,000. It was a nice place to live but I don't think it makes a lot of sense as an investment.

You'd have to specify that a bit more - to yourself, if not to us.

My view is that she should sell and either continue investing in a broad-based index fund (VTS/VAE/VAS) or at least in higher-growth property.

I understand she could use the $800,000 to purchase a couple of properties with leverage, but we're not too keen to take on extra debt above the mortgage on the family home. If she wanted to still have regular income (ie replacing the rental income) she could just invest more into VAS or A200 for the dividends.

Important question: Is interest on the mortgage allowable against the rental income of the property, for tax purposes? (in the UK, it no longer is).

That is key.

Her risk tolerance is OK - she already has about $400k spread across US and Australian market indices - but we also don't want to over-invest in Australian property beyond the family home. We're also keen for a more hands-off investment - we have more than enough renovations to do on our home already. We have no debt beyond the mortgage.

People usually cite leverage as a key reason to invest in property over index funds, but with a big chunk of cash like this my weak view is that we'll be better off if she invests the money straight into index funds. But I know diversification never hurts so maybe the sweet spot is to use ~half the $800k to buy more property and the other half into index funds. Australians are a property-mad bunch.

Welcome any views, particularly on anything I might have missed on the attractiveness of property. Thanks in advance.

You've nailed my big concern re Australian property market - it's looked overvalued (big cities at least) for a very long time. Net rental yield of 2.5% when mortgages are ? 6%? is not a great bet, to be honest. And you cannot count on future price growth being what historic has been. The 4 big variables are 1). mortgage rates 2). economic growth of Australia 3). immigration outlook 4). housing supply constraints.

So in Canada:

1. has gone up, is probably not headed down quickly
2. is not looking too great at the moment
3. there will be a big crackdown, after unprecedented numbers of incomers
4. lots of good talk about building more homes, an absence of genuine constructive actions. But high housing prices are a massive election issue. One difficulty is that the Federal government can say what it wants, but municipal land supply is a matter for the Provinces and for the municipalities.

I don't know where Australia sits, but I do know housing price depressions have occurred in both nations' pasts (i have been calling for a Canadian housing price crash like a stopped clock for many years, and although prices are down, it's certainly not a crash as yet).

I would say:

- I would not double down by leveraging to buy 2 places. That compounds concerns you may have about overconcentration and increases your risk level.

- if you invest, you should globally diversify - make sure you are not further exposed to the Australian economy, more than its weighting in world equity markets

[andrew99999]

A paid-off home is often a poor investment. The reason is that you are missing out on a lot of deductible debt. Also, as it was a main residence, there may be very little CGT to get out of it and consider another investment in its place. Also, high yield often means lower growth, which would have two problems – lower growth in itself is a concern, and the higher yield means less returns after tax as you are taxed at your marginal tax rate in the year it is earned and without the 50% CGT discount.

Some options to consider:
* sell it and put it into the current main residence loan (or rather, the offset)
* sell it and put it into the current main residence loan, then draw it back out to invest in a diversified share portfolio
* sell it and put it into the current main residence loan, then draw it back out to invest in property

For #2 and #3, look up 'debt recycling'. Essentially, by selling and recycling the money through your home loan, you are making that portion of your home loan tax deductible for the life of the loan while the money continues to be invested in income-producing assets. If you go down this route, get an accountant to help with the debt recycling, as you might stuff it up and lose a lot of the tax benefits.

As for #2 vs #3, with shares (unlike property), you have
* no upfront fees
* almost zero ongoing fees with indexed investments
* no selling costs
* diversification through thousands of assets in dozens of countries to reduce the risk
* the ability to select lower-income investments to increase your returns via negative gearing
* liquidity to sell down in parts once retired to reduce tax or potentially end up paying no tax
* no property managers or tenants to deal with
* no lumpy bills of thousands (sometimes over 10 thousand)
* however, it is difficult to get additional leverage for cheap if you wanted to borrow from the recycled money into more leverage (although it sounds like this is not an issue for you)
* the stock market is priced daily, so you need to get comfortable with that (although you noted they already have 400k in these, so this might not be an issue either)