Investors have flocked to property investments in recent time s 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:
- Picking a good location
- Choosing a house or a unit
- Paying market price, not more
- Financing the purchase
- Securing tenants
- Using the tax system to maximum benefit
01Picking 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.
02A 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 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 (wher e 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.
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.
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.
03 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.
04 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 convincing 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.
05 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 re al 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.
06 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.
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.