Buying Your First Investment Property

There is no doubt that Australians love property. Not just as a place to call home, but as a preferred way to increase their net worth.

Buying an investment property is often touted as a sure fire safe way to build your wealth. There is no doubt that many Australians have made significant gains and profits through residential property investment. There are also a lot of people who have lost money via property investment. It’s not as simple as picking any property and expecting a good return.

If you are contemplating using property investment as a way to build your long term wealth, it is well worth your time to step back from the property selection step and start at the beginning.

As with any worthwhile long term endeavour, the starting point is developing a plan. Property investment is no different. It can be as simple or complicated as you want to make it. But, here are some key thoughts to consider;

1. What are you trying to achieve? i.e. how much do you need and by when?

a) Are you chasing capital growth, so you can eventually sell off properties and pay out your debts?

b) Are you seeking cashflow from your property portfolio?

c) Or is it a combination of the two?

2. The longer the time frame you have, the more flexible you can be with the yields and expected growth rates required.
3. What is your risk appetite? Will you lay awake at night concerned about the amount of debt you have, or how you will cope if a tenant vacates a property?
4. How will you protect your financial position if your income sources (ie rent and your salary) are interrupted?
5. What entity will you use to purchase the property? Ie your personal names, a trust, an SMSF etc.
6. Answering question 1, will guide you to the number and type of properties that you will need to accumulate over a given period of time.

The Numbers

Unlike buying a property to live in, property investment decisions are driven fundamentally by the numbers. Do they stack up? Will the property give you the level of rental and/or capital growth that you require to fit the criteria of your plan?

There is a big difference between having a rental property and having an investment property. When choosing your properties confirm as best you can via your research that it’s going to be an investment and not simply a property that you rent out. Be as certain as you can that you know how you will make a profit from the property.

Borrowing

This is the oil that makes your plan work. As with buying a home to live in the two key criteria are;

1. Borrowing Capacity - points to consider:

a) Do you have sufficient capacity to service current debt plus the loan for your first investment property? You can include potential rental income from your investment property into your borrowing capacity calculation.

b) Some lenders will make allowances for the tax deductibility of the interest that you pay on your investment loan. Both items help to improve your borrowing capacity.

c) The rental income normally will not cover the loan repayments. Be prepared to contribute some of your own income to cover the shortfall.

2. Deposit & Costs - there are two options available to raise the funds required to cover your deposit and purchase costs.

a) Normally comes from savings that you have accumulated. Unlike buying a property to live in, most lenders ( via mortgage insurer policies) require you to have a minimum 10% deposit, rather than 5% if you are buying and investment property. This is in addition to the funds you will need to cover purchase costs, which are typically 5% of the purchase price.

b) If you already have a property that you live in and you have sufficient equity in the property, it is possible to use this equity instead of cash to cover your deposit and purchase costs. This is a very common technique.

3. Loan Structures. Typically most investment loans are set up as Interest Only loans. There are two key reasons;

a) The cashflow of the property is improved as interest only loan repayments are lower than principal and interest payments. Most interest only loans do allow you to pay additional monies into them, but there is no requirement to do so.

b) Normally only the interest charged on a loan is tax deductible, not principal payments.

c) There are various combinations of investment property loan structures ie variable loans, fixed rate loans, split loans, offset account etc. The one you choose will be dependent on your circumstances and requirements.

4. Researching and Finding a Property - Have you considered how you will do this? Will you:

a) Do all your own research via the internet, contacting real estate agents, personal inspections etc.

b) Engage a professional business to locate properties for you?

c) Engage a Buyers Agent to work on your behalf to locate and negotiate a property for you?

d) Will you only consider buying locally i.e. within driving distance. Will this limit the range of properties you can consider?

e) Will you know a good purchase when you see one?

f) Have you got a checklist to help determine the property attributes that you require?

g) Can you keep your emotions separate from the purchase? Remember you’re buying on numbers, not whether it’s a nice place for you to live or not.

5. Tenants - there are plenty of upsides to buying an investment property that already has a tenant, as well as a raft of risks. Here’s how to minimise them.

Purchasing an investment property that already has a tenant means you collect rent from day one, with no vacant period and no lease fees to find a new tenant. The lease just carries on as it did before you purchased the property. Sound good? Of course it does. There are some possible problems to be aware of though.

It’s very important to check whether the lease on your prospective investment is current or the tenants are on an expired lease. If the tenants are off-lease, they can give a short period of notice and vacate the property, so those upsides mentioned above could come to zero.

A current lease, on the other hand, offers security, it also means that you are stuck with the lease, its conditions (or lack thereof), the current rental return and the tenants.

There are steps you can take to minimise your risk:

a) Make sure the bond has been lodged properly. Your agent will arrange for the bond guarantee to be transferred into your name on settlement.

b) Check the property condition report, making sure that it is a complete and accurate record of the property as you inspected it.

c) Ensure there are no rental arrears. If there are, or if a landlord has agreed that rental arrears can be taken out of a bond payment, stipulate that this amount is deducted from the purchase settlement amount.

d) Ask the leasing agent about the tenants and their payment record. You cannot demand that you meet the tenants, but attending the open house will give you a sense of how they live in the property. If possible, sight the tenants’ original application for the property and rental ledger.

e) Look at the yield for rental properties in the area and compare them to yours. You won’t be able to increase the rent until the end of the lease.

f) Be aware of any concessions or conditions that are either in the lease or have been agreed with the landlord or property manager, because these will become your responsibility. For example, does rent include electricity or other utilities? Has the landlord agreed to install a new oven or paint a room?

We hope the above information will assist you in getting started in property investment. Remember property is a long term game, unless you are aiming to buy a run down property, improve it and resell quickly.

Think about and write down your plan. Work out your numbers, both for borrowing and so you know how the property will make you a profit. Think like an investor, not as a person buying a home to live in.