Property
Property (real estate) represents ownership of land and buildings. When you buy property, you own a physical asset that can generate rental income and potentially increase in value over time.
Unlike shares or bonds, property is a tangible asset that you can see and touch. Returns come from rental income (cash payments from tenants) and capital growth (an increase in property value over time).
Property prices are strongly influenced by how much debt people can manage or take on. When interest rates are low and banks lend more freely, buyers can borrow larger amounts, which pushes property prices higher. When interest rates rise or lending tightens, buyers can borrow less, which can slow price growth or cause prices to fall. Since 1980 house prices have risen by around 15x; the main driver of which has been declining interest rates.
Property values move for two main reasons:
(1) Debt capacity – when interest rates fall or lending standards ease, buyers can borrow more, increasing demand and prices. When rates rise or lending tightens, borrowing capacity falls, reducing demand.
(2) Rent – Increasing rent triggers house prices to grow. Rents are influsenced by inflation, employement opportunities, wage growth, supply and demand, location, beds/baths/car configuration and quality of build. At the end of the day the rent is based on how much someoone is willing to pay; and this is tracked by the Housing CPI.
Property sits between bonds and equities on the risk–return scale. It offers steady rental income but lower liquidity than shares. Property requires significant capital, has high transaction costs, and is extremely susceptible to interest rate fluctuations.
Back in the 80s interest rates were at 18%, so to be able to afford the repayment banks would only lend 2-3x your income. Today interest rates are at 5%, so banks will lend 20x your income.
Unlike other investments which are assessed on their fundamentals, property is an emotional decision for the 70% of purchases that are buying a home for their lifestyle. They are willing to put everything they own into getting the best home they can afford.
If you have 10 people wanting to buy, and 10 homes up for sale, the person who can afford the most will get the best home. The second best home will go to the person who can afford the second most. How much each of them can afford is controlled by how much debt they can take out. If interest rates were to double, halving how much all ten people could borrow, it wouldn't change which house each person buys, just how much debt they had to get into to own it.
It's the same reason why first home buyer schemes which give $50k to first home buyers just raise prices by $50k, because all 10 people buying those types of properties can all afford another $50k.
Historical Trends (Last 30 Years)
Interest Rates
Rent (Weekly)
House Prices (Median)
Price = 2 × Rent / Loan Rate
Rental Yield = Rent / Price = Interest Rate / 2
Leverage and Debt Capacity
Most property investors use leverage (borrowing) to buy property. This amplifies both gains and losses. When property values rise, leverage magnifies returns. When values fall, leverage magnifies losses.
Property prices are strongly tied to borrowing capacity. When interest rates fall, buyers can borrow more with the same income, increasing demand and pushing prices up. When rates rise, borrowing capacity falls, reducing demand and potentially lowering prices.
Example: If interest rates drop from 5% to 3%, a buyer earning $100,000 per year can borrow roughly 20% more. This increased borrowing capacity increases demand, which can push property prices higher.
Rental Income and Yields
Rental income provides regular cashflow from tenants. Gross rental yield is the annual rental income divided by the property's purchase price, expressed as a percentage. Net yield accounts for expenses like rates, insurance, maintenance, and property management.
Example: A property purchased for $500,000 that generates $25,000 per year in rent has a gross yield of 5%. After $5,000 in annual expenses, the net yield is 4%.
Tax Considerations
Investment properties offer several tax benefits:
- Negative gearing – when rental income is less than interest and expenses, the loss can be deducted against other income, reducing tax.
- Depreciation – the building and fixtures can be depreciated over time, creating non-cash deductions that reduce taxable income.
- Capital gains tax (CGT) – when you sell, any profit is subject to CGT. If held for more than 12 months, you may receive a 50% discount. Your primary residence is generally CGT-exempt.
- Land tax – investment properties may be subject to state land tax, which varies by state and property value.
What to Consider
Purpose and goals – Property can serve different purposes: generating rental income, capital growth, or providing a place to live. Your goals will influence property type, location, and financing strategy.
Borrowing capacity and interest rates – Property prices are closely tied to borrowing capacity. When interest rates are low, buyers can borrow more, increasing demand and prices. When rates rise, borrowing capacity falls, which can reduce demand and slow price growth. Consider how rate changes might affect your ability to service debt.
Location and fundamentals – Choose properties in areas with strong fundamentals: population growth, employment opportunities, good infrastructure, and limited supply. Research local market conditions, vacancy rates, and rental yields.
Rental yield and cashflow – Calculate both gross and net rental yields. Ensure rental income covers mortgage payments, rates, insurance, maintenance, and property management fees. Negative cashflow may be acceptable if you expect strong capital growth, but it requires ongoing cash contributions.
Leverage and risk – Using debt amplifies returns but also increases risk. Higher loan-to-value ratios (LVRs) mean more leverage but also higher interest costs and greater exposure to price falls. Consider your ability to service debt if interest rates rise or if the property is vacant.
Transaction costs – Property has high transaction costs: stamp duty (typically 3–5% of purchase price), legal fees, building inspections, and agent commissions on sale (typically 2–3%). These costs can significantly impact returns, especially for short-term holdings.
Liquidity and time horizon – Property is illiquid. It can take months to sell, and you may need to accept a lower price if you need to sell quickly. Property suits long-term investors (5+ years) who can ride out market cycles.
Tax implications – Understand negative gearing, depreciation, CGT, and land tax. Consider how property fits with your overall tax strategy. Primary residences are CGT-exempt but don't offer tax deductions.
Maintenance and management – Properties require ongoing maintenance, repairs, and management. Budget for regular expenses and unexpected repairs. Consider whether you'll self-manage or use a property manager (typically 7–10% of rental income).
Diversification – Property is a significant, concentrated investment. Consider how it fits with your overall portfolio. Avoid over-concentration in property, especially if you already own your primary residence.
Risks and Limitations
Interest rate risk – Rising interest rates increase borrowing costs and reduce borrowing capacity, which can slow price growth or cause prices to fall. Higher rates also increase mortgage repayments, potentially creating cashflow pressure.
Liquidity risk – Property is illiquid. Selling can take months, and you may need to accept a lower price if you need to sell quickly. Transaction costs make frequent trading expensive. Unlike shares, you can't sell a portion of your property — it's all or nothing.
Concentration risk – A single property represents a large, undiversified investment. Local factors (job losses, infrastructure changes, oversupply) can significantly impact value. Unlike shares, you can't easily diversify across many properties without substantial capital.
Regulatory and tax risk – Changes to tax laws (negative gearing, CGT discounts, land tax) can affect returns. Changes to lending rules, tenancy laws, or local planning regulations can impact property values.
FAQ
Interest rates directly affect borrowing capacity. When rates fall, buyers can borrow more with the same income, increasing demand and pushing prices up. When rates rise, borrowing capacity falls, reducing demand and potentially slowing price growth or causing prices to fall. Property prices are strongly influenced by how much debt people can manage or take on.
Negative gearing occurs when the costs of owning an investment property (interest, rates, maintenance) exceed the rental income. The loss can be deducted against other income (like salary), reducing your tax bill. This strategy relies on capital growth to generate overall returns.
Rental yield is the annual rental income divided by the property's purchase price, expressed as a percentage. Gross yield uses total rental income. Net yield accounts for expenses like rates, insurance, maintenance, and property management. A property with $25,000 annual rent on a $500,000 purchase has a 5% gross yield.
Most lenders require a 20% deposit for investment properties (80% LVR), though some may accept 10% with lenders mortgage insurance (LMI). A 20% deposit on a $500,000 property is $100,000, plus stamp duty, legal fees, and other costs.
Stamp duty is a state government tax paid when you buy property. It's typically 3–5% of the purchase price, though rates vary by state and property value. First-home buyers may receive concessions or exemptions in some states.
Generally, no. Your primary residence (family home) is usually CGT-exempt when you sell it. However, if you use part of your home for business or rent it out, that portion may be subject to CGT. Investment properties are subject to CGT, though you may receive a 50% discount if held for more than 12 months.
Land tax is a state government tax on investment properties (not primary residences in most states). It's calculated on the unimproved land value and varies by state. Thresholds and rates differ, so check your state's rules. Some states have no land tax for properties below certain values.
Add up all rental income, then subtract all expenses: mortgage interest (not principal), rates, insurance, property management fees, maintenance, repairs, and depreciation. If income exceeds expenses, it's cashflow positive. If expenses exceed income, it's negatively geared and requires ongoing cash contributions.
Property managers handle tenant screening, rent collection, maintenance coordination, and legal compliance. They typically charge 7–10% of rental income plus fees. Self-managing saves money but requires time, knowledge, and availability. Consider your experience, time availability, and property location when deciding.
Property suits long-term investors (5+ years) who can ride out market cycles. Short-term holding is expensive due to transaction costs (stamp duty, agent fees). Property values can be volatile in the short term but tend to grow over longer periods. Consider your goals, cashflow needs, and market conditions.
Rising rates increase mortgage repayments and reduce borrowing capacity. This can create cashflow pressure and reduce demand from buyers, potentially slowing price growth or causing prices to fall. Ensure you can service debt if rates rise 2–3 percentage points. Consider fixing part of your loan to manage rate risk.
Yes. You can claim depreciation on the building structure (over 40 years) and fixtures (over their effective lives). This creates non-cash deductions that reduce taxable income. A quantity surveyor can prepare a depreciation schedule, which typically costs $500–$1,000 but can provide significant tax benefits.