Purchasing an investment property can be a good way to build wealth and secure your future. It can help improve cash flow, provide tax benefits, and is perceived as more stable than other investments – after all, everyone needs a place to live.
But, as exciting as those sounds, the entire process can be a little intimidating.
Purchasing an investment property remains one of Australia’s favourite ways to invest. A rental property should be used to increase your wealth and secure your financial future. There is a common misconception that property investing always produces positive returns; while this is true most of the time, it is not a quick way to riches.
Keep in mind that how well you manage your investment will determine whether or not it helps you achieve your financial goals. When you consider your rental income and the tax deductions you’ll be entitled to, the cost of owning an investment property can be surprisingly low.
There is no shortage of advice available on what aspiring investors should do to ensure success when it comes to property investment.
While many investors start out with the goal of making a fortune in real estate, only a small percentage of them make it past their first investment, and even fewer make real money by climbing to the top of the property ladder.
Property values will likely continue to taper from the heady heights of the boom as affordability constraints continue to limit borrowing.
This is why asset selection is so important, and why you need the right team to help you make the best investment decisions.
To assist you, we have compiled a basic guide to property investment for beginners that covers everything you need to know
What is an investment property?
Real estate purchased with the intent of earning a financial return is referred to as investment property. This return can be referred to as rental yield when the owner rents to a resident or a business. It could also be future profits if the property is successfully sold.
An investment property’s primary goal is typically to generate wealth and passive income. As a result, the characteristics of an ideal investment may differ significantly from those desired when buying a home for personal use.
USEFUL TIPS TO BUY AN INVESTMENT PROPERTY IN AUSTRALIA
There are several advantages to investing in real estate, but it is critical to have a strategy and make objective decisions based on what will provide the best returns.
Here are some key factors to consider ensuring your investment is a good one.
Examine your personal financial situation and budget
Understanding how much cash you have to invest in property and whether you can afford the cash flow impact of owning an investment property is an important first step. This can be as simple as listing all of your assets, including income and expenses.
Determine how much you have as a deposit (without overcommitting) or how much you will need to save for a deposit. When investing, most lenders prefer that you have at least a 20% down payment.
Choosing the appropriate property at the appropriate price
Choosing a property that is more likely to increase in value is the most important decision you will make when investing in real estate, so buying at the right price is absolutely critical.
Unlike purchasing stock, where the value of a company is obvious, real estate is more difficult to price; however, if you are patient and knowledgeable, you may be capable of buying an asset for less than its true market value. Do your research, find out what everything is selling for in and around the area, and you’ll quickly realise that you’ll become very good at calculating what a property is worth – you’ll know a reasonable deal when you see it.
Never buy real estate in an unfamiliar area, especially if approached by real estate spruikers marketing interstate or offshore properties; many of these real estate marketing companies are paid very high commissions, resulting in vastly inflated property prices. If you find a property you like but are unsure of its true value, we recommend contacting us or another lender to arrange for an independent valuation to be done on behalf of a bank. Once you have this information, you can often use it as a negotiating tool.
Get a pre-approval letter from your bank or mortgage broker
After you’ve figured out your personal cash flow and budget, talk to a bank or mortgage broker to see how much they’d be willing to lend you and what the interest rate would be.
It is recommended that you get pre-approved for a certain amount so that you can go property hunting with confidence knowing how much you can spend. This will also limit where you can buy and what type of property you can buy, such as a new or used house or apartment.
You should also consider how you will structure your loan, whether it will be interest only or principal and interest. Should you lock in the rates for a set period of time, leave them variable, or go half and half? The answers to these questions may vary depending on the current economic environment, and as always, seek professional advice before making a commitment!
Check the Age of the property
This is an important factor that can influence the cost equation. Investment properties typically have ongoing expenses, so you want to avoid purchasing a property that will be a drain on your finances due to maintenance costs.
Older properties may require more maintenance, depending on their condition; check everything, from the structure to the fittings and fixtures. Before you sign a contract of sale, have a professional building and pest inspection performed.
If you have the funds, you might be up for the challenge of renovating a property that requires minor repairs. However, if it requires extensive renovations, it may not be a profitable investment.
The depreciation schedule of the property is another way in which the age of the property will affect your finances.
Depreciation on investment property is a calculation of how much the value of the property and its contents including white goods, carpet, and so on, will decrease over time, and it is based on this calculation that you may be able to claim as a tax deduction.
Even if you have negative gearing, needing to replace the roof or hot water service in the first few months of ownership could significantly reduce your profits and negatively impact your cash flow.
It is therefore recommended that you hire a professional building inspector before you buy (and then once a year) to conduct a thorough inspection of the property to identify any potential problems.
It’s also a good idea to hire a qualified tradesperson who is licenced to do the work and has adequate insurance to protect you from poor workmanship.
Buying a property in poor condition isn’t always a bad thing because you can increase the value of the property by fixing it up, increasing your returns on both capital growth and rental income. You can’t do that anymore when you buy stock.
Find a good property manager and delegate responsibility to them
A property manager is typically a licensed real estate agent who is an expert in their field; their job is to keep things running smoothly for you and your tenant. They can provide ongoing advice and assist you in managing your tenants and obtaining the best possible value from your property; a good agent will advise you on when to review rents and when not to.
The property manager should be able to advise you on property law, as well as your rights and responsibilities as a landlord and those of the tenant.
The property manager will also assist you in finding the right tenant, conducting reference checks, and ensuring that rent is paid on time. It is also critical that you do not interfere too much with tenants because there are laws that give them rights, which you should always try to respect.
However, you should conduct regular independent inspections of your property to ensure that the tenant is taking care of your investment, but always go through your agent and give plenty of notice.
The good news is that the fee you pay your managing agent is usually a percentage of the rent you pay, is deducted from your rent, and is tax deductible.
Understand the market and the dynamics of the area where you are purchasing
Consider what other properties are available in the immediate area and talk to as many locals and real estate agents as possible – they’ll tell you if one side of a street is considered superior to the other. I always tell competing agents that I’m looking at another similar property to see what they have to say; it’s a good way to get inside information.
Make sure you do your homework and consult with professionals you can rely on. Accessing independent data from a source like RP Data can provide you with information such as average rents, property values, demographics, and suburb reports.
You can find a lot of information on the Internet, but if you want a free RP Data Report, please contact us and we will gladly provide you with one as we subscribe to their services. It is also a good idea to find out what changes are taking place in your neighbourhood, and your local council can often assist you with this. For example, a major construction project near your property may make finding a tenant at the right price more difficult, or a planned bypass may reduce traffic, raising the value of your property faster than expected.
Monitoring the market is an essential component of any successful real estate investment strategy. The first step should be to determine which market data or performance metrics to monitor. The following are some key indicators to keep an eye on:
Property value trends, including whether they are rising, flat, or falling. In this case, suburb sales data can assist you in determining which postcodes are experiencing rapid growth. If property values are rapidly rising, you may have discovered a booming suburb.
Days on the market (DOM)
A short day on market (DOM) metric indicates that a market is hot if properties are selling quickly. However, you must be familiar with the market, as this figure varies depending on location.
Rising rental yields, which are calculated by dividing rental income by the value of a property, indicate that there is a high demand for rental housing.
Rates of auction clearance
Auction clearance rates are calculated as a percentage of the total number of properties sold during a given week or month. Anything above 70% indicates a hot market, though this will often depend on the local area.
Rates of vacancy
Vacancy rates indicate how long a property is vacant, so look for falling or low rates in areas where rental properties are in high demand.
You can also use a variety of other factors to identify an area that is on the rise. Experienced real estate investors seek out suburbs or areas that have:
- A rapidly growing population will drive demand for your property.
- A thriving and diverse local economy with numerous job opportunities
- Local infrastructure investment includes new transportation links, amenities, and local services.
- Higher-than-inflation median household income
- Buyer demand outnumbers housing supply.
You should also consider areas that have the potential for growth in the next three to seven years.
Strategy for Positive Cash Flow (rental strategy)
Investing in real estate is a proven path to long-term wealth, but you should consider it a medium to long-term investment, so make sure you can afford to make your mortgage payments in the long run. You do not want to have to sell your investment property until you are ready, and if you are experiencing financial difficulties, this may force you to sell the property at an inconvenient time.
If the income from your investment property covers the interest on your loan as well as all other associated expenses, you have a positively geared strategy, also known as a positive cash flow strategy. The idea is that you can use this money to pay down your loan and increase your equity.
The only catch is that it’s surprisingly difficult to find locations that provide a rental return that covers your mortgage as well as all of the other costs associated with owning an investment property. This includes things like maintenance, loan interest, and a slew of other “hidden” costs that first-time investors frequently overlook.
The key to finding positive cash flow properties is to look in suburbs or towns with low prices and high rental demand.
The disadvantage of this is that positive cash flow properties are frequently, but not always, located in areas with lower capital growth. As a result, you’ll frequently have to settle for high income/low growth – an approach better suited to someone nearing or already retired.
Make yourself aware of the taxes that come with real estate investing and factor them into your calculations. Your accountant’s advice is essential in this regard because these can change over time. Stamp duty, Capital Gains Tax, and Land Tax must all be taken into account. Remember that interest rates can fluctuate over time, but the good news for property investors is that when interest rates rise, you can usually expect to be able to raise the rent.
You should also be aware that banks only consider 80% of the rental income when determining whether you can afford an investment loan. This is due to the fact that you will incur costs such as letting fees and vacancy rates; consider using this as a general rule. If you need assistance calculating the cost of holding an investment property, please contact us.
Use the equity from a previous property
Leveraging equity from your home or another property investment can be an efficient way to purchase an investment property. The amount of money in your home that you actually own is referred to as equity. It can be calculated by subtracting the value of your home from the amount owed on your mortgage.
For example, if your home is currently worth $750,000 and you have $250,000 left on your mortgage, you have $500,000 in equity. Using the equity in your current home can also allow you to borrow more money against your investment property, increasing your tax deductions.
Negative gearing can provide property investors with tax advantages if the cost of the investment exceeds the income generated. Australian law allows you to deduct your property borrowing and maintenance costs from your total income.
However, you can only get a tax break if you have other taxable income to begin with. So, while you are actually losing money on the property, the benefit is that the loss can be used to offset the amount of tax you owe on your other earnings. However, don’t buy an investment property solely for the purpose of deducting taxes.
Make the property appealing to renters
Choose neutral colours and keep the kitchen and bathroom in good shape. If you have a well-presented property, you will attract better quality tenants, and the last thing you want is a bad tenant.
Another point of contention is whether you should buy a home in which you would be happy to live. Some believe this will increase its value, while others are unconcerned. To avoid becoming overly involved, consider distinguishing between your own home and your investment; remember, it is your tenant’s home, not yours.
For me, it’s important to remember that the day will come when you’ll want to sell the property, and if a home appeals to both property investors and owner occupiers, you’ll have a larger market for the property, which will maximise your selling price. Owner occupiers, I believe, are willing to pay a little more for the right property because it becomes an emotional rather than logical purchase.
Investing in property vs other asset classes
While some warn against putting all of your eggs in one basket, many Australians prefer to invest in real estate due to its distinct advantages over other asset classes.
While investing in stocks can provide attractive long-term returns, it is more volatile and unpredictable than investing in real estate.
As a result, it is unappealing to low-risk investors, particularly those who are unfamiliar with the stock market.
Though you can study the stock market, knowing how to invest and investing wisely still requires specialised knowledge.
This can be very expensive. The stock market can also cause massive losses almost instantly, whereas real estate is a more consistent asset class.
Investing in term deposit savings accounts is low risk, but it also produces low returns.
One of the major advantages of investing in residential real estate is that the market is dominated by non-investors (homeowners), who do not think like investors and help to keep residential real estate prices stable.
How to Make Money from Real Estate Investing
The key is to understand how to invest in real estate. Real estate can be profitable in one of four ways, and if you get the combination right, you can profit from bricks and mortar.
They are as follows:
Capital growth – In order to build a solid asset base, your properties must appreciate in value at wealth-building rates (in other words above-average capital growth.) This will be due to high demand from both owner-occupiers (who drive up property values) and tenants (who help you pay your mortgage.)
Cash flow – Also known as rent.
Tax benefits – While you should never invest solely for tax purposes, a good tax strategy can help you manage your cash flow, reduce your tax obligations, and increase your bottom line.
Accelerated growth – Getting your hands dirty (metaphorically speaking) by purchasing a property that requires cosmetic TLC through renovations or a major facelift through property development is a great way to generate capital growth.
Inflation – Property investors have discovered that it is too difficult to make money with their own money. Instead, they’ve learned to leverage and gear using other people’s money. In other words, they obtain a loan. However, inflation erodes the mortgage’s value over time. For example, suppose you have a $400,000 mortgage on a $500,000 property today; in 10 years, your property could be worth $1 million, and you still have a $400,000 mortgage (assuming interest-only payments), but your $400,000 will be worth less because of inflation.
WHICH IS BETTER: CAPITAL GROWTH OR CASH FLOW?
When it comes to real estate investment, two somewhat opposing philosophies are frequently bandied about.
“Which is better?” is a common question among new investors.
To begin, there are the “Cashflow” supporters, who believe that in order to achieve positive cash flow, you should invest in property that can generate high rental returns.
In other words, you want rental returns that exceed your outgoings (including mortgage payments), allowing you to keep money in your pocket each month.
Then there’s the group known as “Capital Growth.”
Their prefered strategy is to prioritise capital growth over cash flow.
In other words, you must purchase a property that will produce above-average long-term value growth.
You could get a high rental return on your investment property in many regional centres and secondary locations, but you would get poor long-term capital growth in general.
Having said that, there’s no doubt in my mind that if I had to choose between cash flow and capital growth, I’d go with the latter.
It’s simply too difficult to save your way to wealth, especially with the meagre after-tax positive cash flow available in today’s property market.
As a result, stage asset accumulation is the first stage of wealth accumulation.
And, in today’s low-interest-rate environment, the cost of holding the property is at an all-time low.
My advice to aspiring investors is to recognise that wealth from real estate does not come from income because residential properties are not high-yielding investments.
Long-term capital appreciation and the ability to refinance to purchase additional properties create true wealth.
If you’re looking for a quick fix with cash flow-positive properties, you’ll struggle to build a future cash machine from your property – it’s as simple as that.
But here’s the point…
Because of its geographical location, a cash flow-positive property cannot be converted into a high-growth property.
However, knowing how to invest in property that can generate both high returns (cash flow) and capital growth by renovating or developing your high-growth properties is essential.
This will result in higher rent and additional depreciation allowances, converting high-growth, low-cash-flow properties into high-growth, strong-cash-flow properties. You can thus have the best of both worlds.
Simply put… Cash flow keeps you in the game, while capital growth gets you out.