The first thing prospective investors need to know is what sort of property to buy and the right price to pay for it. If you want to make money as a property investor, you have to learn to do your research properly and thoroughly.
- Pick a good location
As a general rule the better the location, the better the 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 also 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 usually rise consistently, such as inner-urban 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. You should ask yourself ‘what will the area be like when it’s time to sell’? ‘Are any major developments planned for the area’? You can find this out by asking 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.
- 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 have historically gained 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 (where your mortgage interest costs exceed your rental income and the loss is used to offset an investor’s taxable income), your cash outflow or loss will often be less than if you 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 also often located in inner-city areas or convenient location, for which people pay a premium.
If you are buying a unit, look for features 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, which could prove costly. Look for features that will attract tenants like parking, a good laundry and a decent kitchen and bathroom. Again, proximity to public transport and major roads is important.
- Pay market value, not more
The single biggest mistake property purchasers’ make is assuming that the price quoted for a property is “reasonable” and in some way reflects market values. Not so. The price quoted is what the vendor/developer wants and may be as reasonable or as outrageous as they choose.
This is where research comes in. If you know that similar properties in the area have been selling for $350,000, for example, and the asking price is $400,000, then there’s either a very good reason to justify the higher price or the vendor is testing to see if you are prepared to pay the inflated price.
A wise property investor won’t pay more for a property than it is worth. You should independently assess the market value of the proposed purchase price. Ideally, a property in a good location will tend to double in value every seven to ten years. Ask an agent for guidance on price growth information in the suburb. You can also ask the real estate institute in your state, or check the suburb information on this website.
- Financing the purchase
Real estate is an expensive investment and entry and exit costs are high. 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 need 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 or a line of credit.
- 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 the vacancy rate in the local area with the real estate institute in your state, or on the suburb profile on the YIP website
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.
- Using the Australian tax system
Under Australian income tax law if you borrow to buy a rental property, the interest and rental expenditure, 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.
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.