Hundreds of people have become millionaires by investing in residential property in Australia. This is hardly surprising when you consider that real estate in the country has a long and successful history of strong investment performance with a minimal risk. Unlike Hong Kong, the risk of investors seeing their wealth drop 40 per cent (or more) overnight is small. But also unlike Hong Kong, investors cannot expect to become property millionaires overnight. Investors can, however, accelerate the process dramatically by living outside Australia - with lower tax scales, a higher income and access to better financing. If investors want to build their property portfolios with minimal outlay, they should consider taking a fixed-rate interest-only investment loan for the first five years. Otherwise known as interest-only loans, these loans are not only more tax effective but compared to principal-and-interest loans require less cash to service. It can be seen from the calculations (see first table) that the interest-only loan would cost an investor just A$675 ($3,900) each month, as opposed to an outlay of A$1,085 a month with a principal-and-interest loan. By taking this approach, investors now have extra funds free to use for other investments, or to buy more investment properties. In fact, by paying interest only, an investor could finance two properties and it would only cost a little more each month than it would to pay one property off on a principal-and-interest basis. Worried about not paying back the principal? Let's see what happens after 10 years if the property appreciates at an average of just 5 per cent per annum (see second table). It is obvious that after 10 years of paying a principal-and-interest loan, an investor would have a lower loan balance than with the interest-only loan. But what is also obvious is that the principal-and-interest loan would have effectively cost A$49,200 more in extra payments to reach this position. Let's now consider what would happen if an investor chose to purchase two properties on an interest-only loan. The funding required would only be a bit more than for a principal-and-interest loan on a single property. Assuming the same 5 per cent capital growth, the combined equity in the two properties will be A$257,000 higher than the equity in the single principal-and-interest financed property, even though the debt started at a higher level and has not been reduced. While contributions have been only $32,000 higher with the two properties, the equity with the interest-only loan is 65 per cent higher. This differential will become even more marked as the investment continues to grow, or outperforms our 5 per cent capital growth figure used in this example. Of course, this exercise serves only to illustrate the benefits of an interest-only loan. Rental income will also increase over time, reducing investors' monthly outlay and enabling them to buy more properties. Michael Bentley is managing director of The Citylife Group
