Are You Ready For An Investment Property?
Tuesday, June 17, 2014
There are those who will never buy a home. There are those who will buy one and consider the experience done. And there are others who see property as their ticket to big bucks – or, more realistically – a smart investment in their future. But building and maintaining a healthy property portfolio is not for the faint-hearted and has, along with great upsides, plenty of risks. So, can you generate a solid investment property income over the long term and stay sane?
First, take a step back from that question and ask yourself this: why do you want to own one or more investment properties? If you answer too much from your heart and not enough from your head, you may have to take a breather and rethink. Passion and intuition are all well and good and it’s fine to factor emotion into the purchase of your own home. But when we get to hard numbers and big debts and the business of property investment, some rational thinking has to balance the possibly irrational desire.
If you're thinking that property investment has both immediate and longer term financial benefits – if you play it right – then you may be heading in the right direction.
There are definite upsides. Negative gearing for instance. This form of tax break allows property owners who are landlords to claim tax concessions on mortgage repayments if they are higher than the rent being charged. The difference can be offset against income tax, for instance, thus reducing your tax exposure as well as helping fund your investment property mortgage.
Also think about the tangibility of bricks and mortar investment – as opposed to say bonds or shares – and the generally solid trends in house prices over the decades. Think about how state pensions are slowly eroding as a public expense and wonder about whether your super investments, if you have one, will cover your expenses when you stop earning an income.
Property looks pretty good.
But then, factor in added purchase costs like stamp duty or lenders insurance or ongoing costs like maintenance, vacancy vacuums, rental price downturns and you have a fairly complicated series of downside issues to deal with. Many of the likely costs vary state-by-state and between various service providers. And more properties mean more complications.
But let's say you've done your sums and have come up with ticks in all the right boxes. How should you approach your first investment property? (Don't say ‘on foot’. You know what I mean). Well, first it’s a long haul. This is investment to take you into retirement and beyond. So play the long game. Are you up for it? Is your partner or spouse? Your family? Your wallet?
You will need to understand a little about demographics and population trends. New and upcoming areas may be your focus or you may be settling for well-established and solid. Whatever your strategy, organisations like the Australian Bureau of Statistics have a wealth of data to help you out and various private property consultants produce property reports for just this kind of purpose.
As a rule of thumb, take a drive around a given area and count the For Sale and Sold signs or see how many real estate agents are in the area. These will give quick indications of the popularity of the region on the property market. Other basic checks, like flipping through postcode searches on online hubs like realestate.com.au to draw a bead on the current situation and trends are also also useful.
When choosing your home, you probably make your decision on a range of factors including emotion. For an investment property, as I noted above, your emotion is less important than that of your potential tenants. As such, make a rational decision based on your aims and your risk levels. An investment property is a business. Your home is something else.
And you won't be able to get away from those numbers and spreadsheets. Work out what you can afford in repayments and what your loan-to-value ratio is. Have a look at your current mortgage and other personal debts as these will impinge on your ability to borrow for your investment property. Assess the possibilities of stream-lining your market entry; a pre-approved loan for instance will obviously help you and will allow you to move quickly when you see a bargain say, at an auction.
Consider the regulatory breaks and barriers. Gearing your property investments is an important factor and whether you wish to make it negative (and thus claim a tax concession on the difference between loan servicing and rent), neutral or, positive (which gives you more cash but will need to be declared in your income tax), the important goal is maximise your cash flow.
The net gains of negative gearing need to be weighed with net losses like capital gains tax when you do sell your investment. This is a tax, folded into your income tax statement, based on your profit from buying and selling an asset.
And there are always unplanned expenses like maintenance and wear and tear. If you want to keep your tenants, it pays to be timely in responding to them. Your cash flow stream should also allow for periods of vacancy or late payments. Don't rely on incoming rent to pay for your groceries.
While rent can flow regularly, property in itself is not a liquid investment – it's been said you can't sell a room when you want to raise some cash - and so when the rent ceases for a while or when the plumbing packs it in in your rental property, or both, keeping yourself afloat may become an issue.
If you are building a portfolio, perhaps consider treating each dwelling as its own business and ensure that all expenses and incomes are separate. This allows you to better organise your finances and to constantly monitor your return-on-investment across your portfolio. Mixing it all in is possible, but much more complicated.
Once you've got your investment pile, should you self manage or pay an agent to do so. As this discussion shows, it's hard to cost the involvement of estate agents. And there's a range of fee structures, based on how full the service is. Self-management seems easier, but for multiple properties it can quickly become overwhelming.
So, plenty to consider. Entering the market to begin building a property portfolio can be daunting. But, as they say, if it was easy everyone would be doing it. The fact that it's challenging is kind of the point. Taking the risk is the issue. It's not for everyone but if you feel you can handle it, then go for it. The market awaits.