For investors with average incomes, when buying property in Australia, is it better to go all-in on one "blue-chip" expensive property, or to diversify by investing in multiple smaller properties? Today, we'll do the math to see the differences in borrowing power, cash flow, risk, and ultimate investment return between different price points.
Expensive House vs. Multiple Smaller Houses? Big Differences in Borrowing Power!
First, let's assume a scenario: a couple, each earning $125,000 AUD annually, with no children, and weekly living expenses of around $750 in addition to $850 in rent.
In this situation, if they want to invest in property, how will the bank assess their borrowing power?
-
Scenario 1: Buying One $2 Million AUD Property
If they want to buy an investment property worth $2 million AUD with a weekly rental income of $850, according to the Commonwealth Bank of Australia's calculator, they can borrow a maximum of $1,392,200. This means they need to prepare a larger down payment or take on higher loan risk.
-
Scenario 2: Buying Two $1 Million AUD Properties
If they spread their budget and buy two investment properties worth $1 million AUD each, with a weekly rental income of $700 per property, their borrowing power increases to $1,618,300. This is a significant increase compared to the first scenario.
-
Scenario 3: Buying Three $650,000 - $700,000 AUD Properties
If they further diversify their investment and buy three properties worth $650,000 - $700,000 AUD each, with a weekly rental income of $600 per property (a conservative estimate), their borrowing power will increase again. If they can find properties with higher rental yields, such as $650 per week, their borrowing power could even increase to $1,729,100!
From the above comparison, we can see that banks place great importance on the rental yield of investment properties. Holding properties with better cash flow makes it easier to continue borrowing and purchasing more properties later on. Conversely, if the cash flow is severely negative, the investment path may stop at just one property.
Cash Flow: The Key to Investment Success
In Australia, the biggest risk in investing in property is not a drop in property prices, but a cash flow problem that leads to the inability to hold the property long-term and forced sale. Therefore, cash flow is one of the most important indicators we use to examine investment risk.
Let's continue with the above couple as an example and see what the cash flow differences will be when they hold properties at different price points:
-
Scenario 1: One $2 Million AUD Property
Assume they borrow 80%, i.e., $1.6 million AUD, with a 20% down payment, i.e., $400,000 AUD, and stamp duty of 4%, i.e., $80,000 AUD.
- Income: Assuming a weekly rent of $850, with two weeks of vacancy per year, the annual rental income is $42,500.
- Expenses: Including council rates, water rates, insurance, maintenance, agency fees, etc., and the largest expense - loan interest. Assuming a loan interest rate of 6%, the annual interest expense is $96,000.
In this case, they need to subsidize $64,673 of after-tax income each year to maintain this property, equivalent to subsidizing $5,389 per month, which accounts for more than one-third of their combined after-tax income. Even considering negative gearing, they must first withstand this cash flow pressure at the beginning.
-
Scenario 2: Two $1 Million AUD Properties
Assuming a weekly rent of $700 per property, the total rental income for the two properties is $1,400 per week, or $70,000 for 50 weeks per year.
- Expenses: Various miscellaneous expenses will be double that of buying one property.
Calculations show that they need to subsidize $47,190 annually to maintain these two properties, which equals $3,933 per month. Compared to buying one expensive property, they can subsidize $1,457 less each month, greatly reducing the cash flow pressure.
-
Scenario 3: Three $650,000 - $700,000 AUD Properties
Assuming a weekly rent of $600 per property, the total rental income for the three properties is $1,800 per week, or $90,000 for 50 weeks per year.
- Expenses: Various miscellaneous expenses are three times that of buying one property.
In this case, their annual expenses are further reduced, and the monthly subsidy amount is also less. If they can find properties with higher rental yields, such as $650 per week, the cash flow pressure will be even less.
From a cash flow perspective, holding multiple properties with high rental yields is clearly better than holding only one expensive property. The better the cash flow, the lower the investment pressure and risk.
Table: Cash Flow Comparison of Different Property Purchase Plans (Annual)
| Plan | Rental Income | Interest Expense | Other Expenses | Total Annual Expenses | Subsidy Required |
|---|---|---|---|---|---|
| One $2 Million Property | $42,500 | $96,000 | $11,173 | $107,173 | $64,673 |
| Two $1 Million Properties | $70,000 | $96,000 | $21,190 | $117,190 | $47,190 |
| Three $700,000 Properties ($600/week) | $90,000 | $96,000 | $25,098 | $121,098 | $31,098 |
| Three $700,000 Properties ($650/week) | $97,500 | $96,000 | $25,098 | $121,098 | $23,598 |
Risk Diversification: Multiple Properties are More Stable
In addition to cash flow, diversification can also effectively reduce risk. In the event of a vacancy, if an expensive property is vacant, all rental income will stop, and the pressure to service the loan will increase sharply. If you hold multiple properties, even if one is vacant, the rental income from other properties can still provide support, and the risk is lower.
In addition, if you need to sell property to cash out, investors who hold multiple properties can choose to sell some of the properties, rather than being forced to sell the only property, which provides greater flexibility.
Final Rate of Return: Long-Term Holding is Key
Finally, let's look at the final rate of return for these different scenarios. We assume that these properties are held for 5 years and sold after appreciating by $1 million AUD, deducting all capital gains tax and buying, selling, and holding costs.
-
Scenario 1: One $2 Million AUD Property
In this case, the total investment return for 5 years is 101%, and the average annual compound return is 15%.
-
Scenario 2: Two $1 Million AUD Properties
In this case, the total investment return for 5 years is 114.4%, and the average annual compound return is 16.5%.
-
Scenario 3: Three $650,000 - $700,000 AUD Properties
In this case, the total investment return for 5 years can reach a higher 118.7% (rent $600/week) or 123.4% (rent $650/week), and the average annual compound return is also higher.
Table: Investment Return Comparison of Different Property Purchase Plans
| Plan | Total Investment Return | Average Annual Compound Return |
|---|---|---|
| One $2 Million Property | 101% | 15% |
| Two $1 Million Properties | 114.4% | 16.5% |
| Three $700,000 Properties ($600/week) | 118.7% | 16.8% |
| Three $700,000 Properties ($650/week) | 123.4% | 17.5% |
From the above analysis, we can see that although the difference in final return rates is not huge, diversifying into multiple lower-priced properties with high rental yields is undoubtedly a more stable and safer choice for investors with average incomes. It not only lowers the investment threshold and cash flow pressure but also provides greater flexibility and the possibility of expanding the investment portfolio.
Of course, everyone's situation is different, and investment strategies should vary from person to person. The most important thing is to make the choice that best suits you based on a full understanding of various situations.