When you are buying an investment property it’s best to think with your head and not with your heart. The purpose of investing in property is to maximise your returns and not to find a property that you will spend the rest of your life living in.
To minimise your risks, research the area you intend investing in and the current state of the property market.
To start your search, pick suburbs or areas you wish to invest in. These may include areas close to the CBD or a trendy café strip or areas currently experiencing population growth caused by increased industry activity, such as mining. Also consider proximity to transport, shops and leisure facilities.
A real estate agent should be able to provide you with informed opinion on prices and market trends. They should also know what types of property are in high demand by tenants and current average rent prices.
Make sure you factor in all the associated costs such as maintenance, repairs and stamp duty when calculating your buying price range. Many investors also allow for a minimum of four weeks each year when they may not receive rent because of a changeover of tenants. Be realistic about what rental returns you will have on the property and make sure you research what the market is currently paying.
If you’re investing in a unit or townhouse, it may be worthwhile getting an appraisal of the body corporate records. A search agent will provide you with a comprehensive written report on the state of affairs of the building, allowing you to make an informed decision to purchase.
This is a brief overview of a few ways to get started, remember to obtain independent financial advice before making any decisions.
Common terms explained
Using the equity in your own home can be a cost effective strategy to get into property investment, especially when used in conjunction with negative gearing.
If you have built up equity in your home, you can use this as security for your investment property and to cover any associated costs of the new purchase. No wasting time to save for another deposit of money for fees etc.
An interest only loan means you can maximise tax deductibility over the loan period, and own a property at minimal cost, until you choose to change your strategy or to cash in on increasing house prices.
Steps to make sure it works for you:
- Minimise your outgoings and maximise your potential growth.
- Design a long term objective and
- Make sure your objectives match how you structure your finance.
- Make sure you know exactly what and how much you can claim in tax deductions before you invest.
- Get advice from a financial planner.
Negative gearing is when your outgoings to maintain a property are greater than the income you receive from it. The benefit to you is that the difference between the two (income minus outgoings) is tax deductible.
There are also a number of purchasing costs such as mortgage stamp duty, valuation fees and application fees that have tax benefits as well as a provision for non-cash expenses like fixtures and fittings.
Effectively managing the tax benefits of negative gearing means you can buy a property at minimal cost and to a large degree you can let tax deductions and rental income pay off your mortgage.
Deductions of purchasing costs (tax deductible over 5 years) may include
- Valuation fees
- Stamp duty of mortgage
- Bank application fees
- Mortgage insurance
- Consultancy fees
- Depreciation on other costs
- Building costs (2.5% p.a over 40 years)
- Fixtures and fittings (20% p.a)
- Furniture (20% p.a)
- Inspection costs (100% write off annually)
We advise you get specific advice from your accountant.
A positively geared property means that the rent received from your investment property is greater than the costs of owning it, including mortgage repayments and maintenance expenses. Positive gearing could be tricky because it relies on the rents being high in comparison to the purchase price of the property. Payment of a large deposit on the property is usually required to push it into the positive zone.
To generate a positive cash flow, investment costs must be lower or equivalent to the income received from the property, taking into account your rental yields combined with tax breaks.
The benefit of a property that generates a cash flow is realised when you sell the investment property some time in the future. This is because you won’t have to subtract the losses incurred over the life of the investment, as is the case with negatively geared properties.
Capital growth is the increase in the value of your property over time and is one of the main reasons people invest in residential real estate.
Historically, Australian residential property has experienced strong capital growth – the long-term average annual growth rate for property is about 9 per cent – but periods of stagnation and even decline are also part of the picture. The nature of the property cycle means real estate should probably be thought of as an investment with a 10-year horizon.
Research current house prices. Keep an eye on sale and auction results in the papers, or buy reports on specific suburbs from researchers like Australian Property Monitors’ Home Price Guide (www.homepriceguide.com.au). Talk to real estate agents and observe at auctions.
You should apply the same standards to a property investment as to any other investment, ‘benchmarking’ the potential return against what you might achieve elsewhere.
An important measure is a property’s yield. That can be calculated by dividing the annual rent it generates by the price you paid for the property and multiplying that by 100 to get a percentage figure.
It’s possible to manage a rental property yourself, and in so doing save a management fee that’s usually around five per cent of the rent. But it can be time-consuming and it’s hard to remain emotionally detached when you have tenants ringing up complaining about every little thing, or you personally have to deal with damage to your property.
The other option is to use the services of a professional property manager. They’ll have up-to-date information on what’s happening in the market and what tenants are prepared to pay. They’ll have prospective tenants on their books, and experience vetting tenants. Because they manage many properties, they’ll have access to reputable trades people at cheaper service fees.
And their fees are tax deductible.
Managing your financial risk as a property investor also involves insuring yourself against a myriad of potential hazards.
It’s up to your tenants to take out home contents insurance to cover their possessions, but you’ll need building insurance.
Then there’s landlord insurance, covering risks such as malicious or accidental damage to your property by a tenant, any legal liability should a tenant injure themselves, and lost rental income should tenants move out without paying.
Be prudent about renovations. The colour palette of the kitchen in your investment unit may offend your sensibilities, but it only makes financial sense to replace it if a better kitchen will stop the unit sitting vacant or lift the rent you can charge.
Make a ‘cost-benefit analysis’ of your renovations. If the kitchen is going to cost $10,000, and you’ll have to borrow the money and pay interest, but it will only add $10 a week to the rent, it’s probably better left alone.
Don’t overcapitalise by spending too much on design, finishes and fittings.
LVR stands for Loan to valuation Ratio. This is the measure of the amount of the loan compared to the value of the property. For example, if you have borrowed $160,000 and your property is valued at $200,000, the LVR would be 80%.