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Buying an Investment Property
Investors have flocked
to property investments in recent times lured by the desire to make huge
capital gains. We outline 6 steps to investing in real estate.
People like property.
It's a relatively safe investment giving good solid returns. Compared to
shares, which can swing wildly in price, or cash, which is little more than
boring, property is an exciting investment that makes its owners feel good.
For anyone interested
in property investment, investors need to know what sort of property to buy and
the right price to pay. Returns come from two sources: any capital gains over
time and rental income.
As the property market
cools in the big cities, the chance to make huge gains in cities like Melbourne
and Sydney is diminishing. Combined with a high vacancy rate in those cities,
which has pushed down rental yields, investors need to take extra care to
select properties that will attract tenants and gain in value.
With an oversupply of
apartments looming in inner-city Sydney, Melbourne and Brisbane, investors also
need to ensure they don't pay too much for those properties. Prices are already
falling for off-the-plan apartments in Sydney and Melbourne; so don't pay more
than a property is valued. We advise you on how to do your research.
The Six Steps
Returns from investment property depend on six crucial steps and you need to
make sure you understand each one:
1.
Picking a good location
2.
Choosing a house or a unit
3.
Paying market price, not more
4.
Financing the purchase
5.
Securing tenants
6.
Using the tax system to maximum benefit
1. Picking a good
location
As a general rule the better the location, the better your chances that your
property will gain in value over time and attract suitable tenants. Choose an
area where the general quality of properties is good and the demand for
properties by tenants is high.
Proximity to the
central business district and major employment centres helps ensure good demand
from tenants and the capital gain of the property. Good access to public
transport such as buses, trams and trains is important. Areas near hospitals
and universities always attract high demand by tenants for rental
accommodation. Being close to schools, parks, shopping centres, childcare
centres and other community facilities can also help add value to your home.
The nicer the area and the more convenient it is to live in, the safer your
rental investment.
It pays to consider
locations where property prices are continually rising, such as inner-urban
suburbs and bayside or beachside suburbs. If you can't afford to do this,
consider suburbs that are close to the most sought after ones, as these also
tend to perform well.
Buyers should ask
themselves what will the area be like when it's time to sell? Are any major
developments planned for the area? You should ask the local council, developers
and real estate agents what's in store for the area in terms of new housing
developments, major roads, transport links and community facilities.
If you are buying a
unit, pick an area where there is a limited supply of units. Beware of buying
off-the-plan units where there are more units coming on to the market. The
Reserve Bank of Australia has repeatedly warned of emerging oversupply of units
in inner-city Melbourne, and other analysts warn of oversupply in inner-city
Sydney and Brisbane. So be extra cautious about buying in these areas.
2. A house or a unit?
Depending on your budget, you might decide to buy a house or a unit as an
investment property. The big plus for houses is that they generally gain in
value more than units. That's because it is the land that rises in value rather
than the structure on it. The big plus for units is that the rental return, or
rental yield, is generally greater than that on houses and they cost a lot
less.
Units
Units are more affordable to buy than houses. If you get a mortgage to buy the
property, your debt levels and interest costs won't be so high. If you are
negative gearing (where your mortgage interest costs exceed your rental income
and the loss is used to offset an investor's taxable income), an investor's
cash outflow or loss will often be less than if they had bought a house.
On top of that,
two-bedroom units generally earn more in rent as a proportion of the price you
paid for the property, known as the rental yield, than three-bedroom houses.
That's because units not only cost less, but are often located in inner-city
areas or convenient location, for which people pay a premium. The graph on page
x illustrates this trend for Sydney.
If you are buying a
unit, look for feature convenient to tenants like off-street parking and
internal laundries. There is nothing like a common laundry or no parking to cut
down the pool of tenants or buyers interested in your property.
Houses
If you're buying a house, look for property on a good size block in a good
location. As a general rule, the land component will be a major factor
contributing to the capital gain of your property over time.
Again, buy a house in
areas where the demand for rental housing is strong. This could be in an area
where the population is relatively young and where there are numerous families
with young children, or, again, in convenient inner-city locations or business
centres where tenant demand is strong.
Before you buy, you
should out check out whether the house is well maintained, and whether you'll
need to conduct major repairs that could prove costly. Look for features that
will attract tenants like parking, a good laundry and decent kitchen and
bathroom. Again, proximity to public transport and major roads is important.
3. Pay market value,
not more
A wise property investor won't pay more for a property than it is worth. Some
investors can pay too much, especially during the current property boom. A
buyer should assess independently the market value of a proposed property
purchase.
Ideally, a property in
a good location will tend to double in value every seven to 10 years. Ask an
agent for guidance on information on price growth in a suburb. You can also ask
the real estate institute in your state.
For more detailed sales
information on the property values, you can purchase a Home Price Guide from Australian
Property Monitors (APM). APM is 50 per cent owned by HWW Limited, the publisher of Your Mortgage
Magazine.
Each guide lists sales
in the previous 12 months in the postcode of your choice. A guide can be
ordered through the APM website
or over the phone on 1800 817 616 and costs $49.95 (prices subject to change).
4. Financing the
purchase
Real estate is an expensive investment and entry and exit costs are high. For
example, the median price of a residential property in Sydney is around
$450,000 and in Melbourne, it is well over $380,000. Add stamp duty on top of
that, and you're looking at close to $20,000 extra cost in Victoria and another
$15,000 in NSW. You also need to add legal costs such as conveyancing and
building, strata and pest inspection costs, which alone can add up to a few
thousand dollars.
You may need to borrow
a substantial sum, especially if you have your sights set on a house. The type
of loan you use will depend on the size of the mortgage and your own needs.
Some investors like interest only (IO) loans or lines of credit, but a
principal and interest loan will help you build your own equity in the property
more quickly than an IO loan and/or perhaps a line of credit.
5. Attracting tenants
Before you commit yourself to a property, you need to check whether you will be
able to find a suitable tenant that will help you repay your mortgage.
Check what the vacancy
rate is for the local area with the real estate institute in your state. As in
Sydney, vacancy rates might be high or rising which means you might have
difficulty finding tenants. Check also what is the rental yield in the local
area. Detailed statistics on rental yields and price growth are available from
Home Price Guide's extensive Investor National Report, available for $150 as a
one off report or 12 monthly reports for $995.
Again, buy in
attractive locations, where other people want to live as tenants or owner
occupiers like inner-metropolitan suburbs. No matter where you buy, ask
yourself if there is good access to transport, education, health, community
facilities and adequate parking.
6. Using the Australian
tax system
Under Australian income tax law if you borrow to buy a rental property, the
interest and rental expenditure you incur such as repairs and maintenance are
tax-deductible. If your costs including interest costs exceed your rental
income, the net loss can be offset against other income you derive, which means
you will be able to reduce the amount of tax payable on your other income. This
is 'negative gearing.'
A major item of
expenditure you are likely to incur is repairs and general property
maintenance. If you make initial repairs to a newly acquired property, the
expenditure is not tax-deductible as they are considered to be an improvement.
Improvements need to be added to the cost base of the property for capital
gains tax purposes.
If you make a capital
gain when you sell your investment property, only half the capital gain will be
liable to tax if you own the property for more than twelve months.
Check with your
accountant on what deductions you will be entitled to. As a word of caution,
don't rely on negative gearing to make money for you. It's the capital gain
that does that. Negative gearing only reduces the amount of tax you pay to the
taxman. It doesn't directly increase your wealth.
Good luck
For any investor, the main point is to do your research before you buy an
investment property. You need to investigate vacancy rates, rental yields and
market price to ensure your property investment gets you good returns.
Choose your property
carefully, think twice about off-the-plan purchases and don't expect negative
gearing to make you wealthy. That said, know what you can claim from the
taxman. The point is to buy a property to make a capital gain and boost your
wealth. But don't expect huge quick gains as the property market cools, just
aim for solid ones
