David Johnston wrote this article for Domain and the Fairfax newspaper on October 22, 2019 .
Investing in property is a great way to build your path to financial flexibility and create your ideal lifestyle.
For most people, buying property is not only the most expensive outlay in life, it’s also the greatest wealth creator and the largest debt.
Combine this with it being the only asset we both live and invest in and you have a recipe for unparalleled emotional and financial complexity when transacting on property.
The nerve-jangling reality is that one wrong step can have a devastating impact on your finances and quality of lifestyle.
Given the factors, it is easy to see why property decisions can feel so overwhelming.
This is precisely why when assisting people to make superior property, mortgage and money management decisions, a common conundrum we assist people with is deciding whether to prioritise a future home or investment properties.
An investment property will affect your future home purchase
History suggests that a quality investment property will provide capital growth and income growth, which will grow your wealth at a greater pace than relying solely on savings accumulation or debt reduction.
Depending on your life stage, an investment property may be the more affordable option to leap frog you into your long-term home.
But if you purchase an investment property before purchasing the future home, it is vital to consider how this will impact your timeframe and ability to purchase.
Firstly, your borrowing capacity will be reduced. This will initially take you further away from the goal of purchasing your future home.
This is because almost all residential properties will be negatively geared if you borrow the full purchase price, which is a mortgage strategy you can use to optimise deductions and retain savings.
This means your cash flow will run at a loss and you will have to make up the shortfall. Most properties take anywhere from five to 10 years to become cash-flow positive.
When your investment property becomes positively geared, this does not automatically improve your borrowing capacity and ability to purchase your long-term home. This is because lenders stress test your ability to repay a mortgage by factoring in higher rates than you are paying.
Lenders also only take into account about 80 per cent of your rental income to factor in holding costs and vacancy gaps.
Furthermore, the investment property is not guaranteed to grow in value or income. Your financial return will be subject to your property selection and the market cycle.
This means that often it may be five to 10 years – rather than two years as many people think – before it’s possible to purchase the future home.
All too often, an investment needs to be sold to enable you to purchase the long-term home in your preferred timeframe. This will negate the investment returns, but there are a number of largely untapped mortgage strategies you can put in place to optimise your ability to keep the property.
The long-term home often takes precedence
From our experience, purchasing a long-term home is the top priority for achieving a successful lifestyle for most Australians.
The selection of our home plays a major role in who we spend time with, the external influences on our children, and our access to lifestyle drivers such as entertainment, shopping, cafes and the great outdoors.
For this reason, most investment strategies should be built around the purchase of your home, whether that decision is your next one or further down the track.
Inferior decision making can not only cause ongoing anguish and regret due to poorly executed lifestyle choices, it may also bring about significant financial losses through having to sell and buy multiple homes or investment properties.
If the long-term home has provided good capital growth, financial advantages include access to a greater amount of equity to harvest when you sell.
There are also incentives to contribute funds from the sale into superannuation if you meet the qualifications, including being 65 years or older and owning the home for at least 10 years.
The principal place of residence is also capital gains tax free and often our most valuable asset, and is exemption from the pension test and free from land tax.
Where should you compromise?
When assisting people to develop a property plan including a framework for a future home, we discuss where they see the family home sitting on an imagined lifestyle versus investment scale.
On one end of the spectrum, you will prioritise outcomes to enhance what is important to you on a day-to-day basis for your lifestyle. Whereas the other end of the scale would have you focusing on financial outcomes from the property purchase, and specifically capital growth if the property is unlikely to become an investment.
There is no right or wrong answer but by striving to understand your priorities, you will become clearer on where you are willing to compromise. This strategic approach will put you ahead of the curve to make the right decision for you and your family.
Selecting a home with strong capital growth drivers can reduce the number of homes you buy and sell, and the number of investment property purchases you need to make if you downsize.
A simple rule of thumb is the greater proportion of your wealth and income that is dedicated to your long-term home, the more you should consider the capital growth potential.
Prioritise your goals and set your plan
The keys to success is understanding the considerations that are important in a future home in advance of the purchase, then weighing up your options and determining your goals.
By clarifying your financial and lifestyle goals first, you can work through any conflict and set a course to follow as part of a long-term pathway that aligns with your values, risk profile and financial situation.
Often too much focus is placed on property investment decisions, yet it is clear that the family home demands equal consideration as part of your long-term property planning.
The statistics tell us that most people will retire owning one property, or worse, none, so gaining clarity on your future home strategy is paramount. Your lifestyle and investment success may depend upon it.
“Why you need to plan for your future home when buying an investment property” was first published Domain and the Fairfax newspaper on October 22, 2019