Tips on buying your first investment property
When buying your first property investment in Australia, there are number of things to consider to ensure you make the right decisions. Here is a handy guide with tips to help you get things moving.
Why are you investing in property?
Firstly consider why you are investing. Are you looking for increased wealth, financial freedom, tax savings or just trust property (brick and mortar) as an investment? Be sure as to why, find out what problem you are looking to solve by puchasing the property. Consider what income you may end up retiring on or how much you will have to live off when you reach 65. Remember property is typically a long term investment class so you need to be willing to wait it out in order to get the best results over time.
Seek proper financial advice
Many more advisers, brokers and accountants are now able to advise you on the numbers of property investing and can let you know if property investing is for you or not. The value of knowing what the risks are from a cash flow and tax perspective will be crucial to you making a decison to buy a property investment. Also you will need to make sure you are structured correctly to make the most of asset protection strategies, home loan structuring, debt reduction and tax effectivenes.
According to Peter Koulizos and Zac Zacharia authors of Property Vs Shares, a good question to ask your accountant or adviser is "What experience do you have with setting up structures within which to buy property?". Paying for a second opinion could well be worth the difference between making a very expensive mistake or a small fortune. Get a good understanding of how much you are spending and saving now and much you can commit to buying a property for investment.
Now much can you borrow?
Find out how much you can borrow based on your income, expenses, rental income, assets and liabilities. The banks have strict lending criteria that most mortgage brokers can only help you with as they constantly deal with various lending instituitions credit policies. They should be on top of the lending requirements set by banks and often can smooth out the application and loan process plus ensure you have the correct loan structure in place. You can also approach the bank directly and ask your bank manager how much you can borrow, while his can be a faster approach you run the risk of not getting comprehensive advice. Banks want your business just like any adviser, accountant or mortgage broker except they are not independant of their lending products. Remember even if you get an indicative figure on how much you can borrow, doesn't mean you can afford it once you buy the property. Know your numbers and any identified limits or changes that may impact your future financial position. You can also use various website calculators that give an indication of how much you can borrow.
Getting a loan pre-approval
As above, once you know how much you can borrow, you will need a loan pre-approval to get some level of certainty that the bank will definitely lend you the funds once you find the property to purchase. This will give you confidence that you can afford the purchase once you find the right property investment either via sale or auction. Also ask about the loan package offering such as any features, benefits and potential discounts on interest rates. Be careful not to sign up for expensive credit cards, especially if you don't need one.
Invesment loan types and options
There are a lot of loan options available to you through the banking instititutions. These loans have a whole range of options and getting the right loan will will depend on your particular situation. Your mortgage broker can help you work out which banks may be best for your situation, plus explain what all the feature, benefits and terms and conditions mean.
An example of some of the features may include fixing your home loan at a lower rate, using a bank account to offset the interest costs, loan splitting to keep things more organise and structured correctly, interest only loans and line of credit. You may also want to ask about emergency situations like being able to have repayment holiday if things get tough or tight.
From a tax point of view, make sure you get advice on the structuring of your loans before you sign any paperwork as this could have a significant impact on your loan repayments and elgibility for tax deductions on loans. There have been numerous cases where people have borrowed in a way that has cost them thousands of extra dollars in taxes and interest because they were not aware of the structural issues.
Loan cost and purchasing costs?
When buying propery for investment there are a whole ranges of costs you need to take into consideration. Purchase costs on property typically include legals (conveyancing), stamp duty (this varies from state to state, see stamp duty guides), property and pest inspections (check for white ant damage). For example if you purchased a property in Sydney, NSW for $500,000 the stamp duty on this property would be around $18,000. Legals may cost in the range of $1,200 to $3,000, property inspection may cost up to $1,000 or more and pest inspections around $350.
Other loan disbursements or costs can include loan establishment fees and lender mortgage insurance which is payable if you intend on borrowing above 80% of the value of the property purchase price. Mortgage insurance (protects the lender if you default on your loans) costs will vary from lender to lender and can range from 1.5% of the loan amount and above. For example of you borrowed $450,000 to buy a $500,000 property then the loan ratio is 90%. According to yourmortgage.com.au the cost of lender morrtgage insurance would be estimated at $7,920 which is 1.76% of the loan amount. Note: This cost can be tax deductible, check with your accountant to see how this may appy to you.
Ongoing costs will be additional to making your normal interest or loan repayments such as strata fees, council rates, building insurance and property management agents fees. For a full list of ongoing running costs refer to our article on investment property cash expenses and deductions.
What about your other loans?
If you have other loans like credit cards and personal loans this can greatly impact the amount your will be approved to borrow by the banks. If these are as low as possible or paid off in full before you apply it can help with getting a larger loan amount approved to purchase a higher quality property investment if that is your goal.
Knowing how gearing works
Get a good understanding of how gearing works. Borrowing to invest mean you can have a much larger asset working for you to create wealth in the future, however it can also magnify the losses. There are three main terms to become familiar with which are, positive gearing, neutral gearing and negative gearing. Positive gearing is simply when the amount of rent your recieve is greater than the loan repayments and the costs of managing the property. This means it doesn't cost you anything more out of your pocket, in fact its providing a surplus cash flow. Neutral gearing is when the rental income covers exactly the loan repayments and costs so there is neither a surplus or a deficit. Negative gearing is when the rental income is less than the loan repayments and ongoing costs, meaning there is a short fall in the cash flow that you need to cover. The idea behind negative gearing is that you get a tax benefit for the losses (short falls) and you will acheive a level of capital growth greater than the costs of the holding the property over time. For more information refer to our guide on negative gearing.
Finding the right kind of property
Once you have decided how much you can afford and how your are going to structure your property purchase you will need to find the right property. This means research, due dilligence and getting solid property advice. Getting an understanding of property market in Australia can come from various sources of information, including the internent, magazines, research papers, property statistics (Biz Shrapnel, RP Data and Australian Burea of Statistics) and real estate agents or buyers agents. Get actively involved by going to the various area's you are looking to purchase in and having a look around to see what kind of people live there and what services or infrastructure is in place.
Actually seeing the area can give you an upper advantage, a good example is if you see a lot of younger couples around the area, then buying near shops, restaurants and cafes could be a consideration as lifestyle may be their preference. Of course if you outsource finding the right property to a property consultant it can save you a lot more time in finding a suitable asset, however you will need to trust their judgement and researched recommendations.
Also make sure you have look at comparable sales in the area and the rental income yields for properties that fit the same profile as the one your are looking to buy. This can provide an indication of whether the property your are purchasing is way overpriced or at market value. For example properties in Sydney, Melbourne, Adelaide and Perth all have different demographics and rentals will vary accordingly. So comparing in each segment will give you a better understanding of what rent you can charge and what people can afford to pay in your chosen location.
Take out the emotion
Remember this is an investment, not your home. You need to use your rational and logic not your heart. You're not going to live there so it doesnt need to be a perfect home, it needs to be a place that people in that area would happily live in.
If in doubt contact a property consultant who can help you with all of the above research and locating profitable property investments, you can access our growing network of property consultants by making a free enquiry here.
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