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Investing 101: 11 things to know before you invest in property

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While any sort of investment carries risk, planning for the future and considering all its implications can facilitate successful investment. Because of the relative stability and potential for growth, most borrowers in Australia prefer investing in property as the right investment for them. However, there are a lot of things to consider before deciding to invest in property.

1. What is an investment property?

Investment involves acquiring an asset with the motive of profiting in some way while retaining your original investment in the future. Investment properties can be a great way of creating additional income. They can be either short term or long term investments depending on the return you wish to make.

You might use an investment property for rental income, or you might hold/develop it to resell at a higher price point. Either way, knowing how to identify a good investment property in your housing market is important.

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2. Which suburbs should I invest in?

The primary objective of investing in a property is to profit either through high rental yields or through an increase in value. For achieving this, it can be smart to invest in “growth suburbs”, that are likely to or already are increasing in value with time.

It can help to invest in an area and housing market you’re familiar with. This way you can expect to pay certain prices for things and have an idea of how any market changes may affect the neighbourhood. Keeping an eye out for up and coming suburbs can also be a good idea.

Look at a property’s DOM (days on market). This can tell you just how sought after an area can be. If the rent prices in a neighbourhood are steadily rising, this can be a good indication that potential rental tenants are willing to pay steeper prices. Similarly, if a suburb’s vacancy rates are low, this means that rental income is high and the chances of an investment property doing well there are higher.

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3. What drives growth in property value?

owner-occupied-home This is arguably the most important thing to understand before investing in property. Besides the rental yield of a property, your prime source of profit from property investment is going to be from the increase in its value over time and that makes it important to understand why value grows before deciding where to invest. There are many things about the property, its location and the market conditions that drive growth in a property’s value -

Location

The importance of location can not be stressed enough and a property’s location arguably affects is value even more than its features. A property’s value is likely to have a high growth rate if it is located in a good neighborhood with easy accessibility and low crime rates. The location of a property within a neighborhood will also be of importance - people with families find houses far from roads safer and quieter.

Nearby amenities

The availability of amenities, public facilities and most importantly, good schools near the property will likely improve your chances of the property’s value growing in the future. According to a recent report on School zones by Domain, property prices in areas near top schools tend to grow much more, by up to 10 to 15 percent. All parents value a property close to a top school more and therefore it makes a lot of sense to consider properties near such amenities.

Supply and demand

It is in line with economic theory that the price of a property grows when demand increases. Properties in areas with high population growth are much more likely to grow in value because the increased demand for real estate in these areas will lead to consumers valuing homes more. It can be smart to consider investing in property in areas where the population is likely to grow more.

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4. How do I choose an investment property?

Just as you would when buying your own house, you need to take into consideration the things people would look out for in a property. The demographics of a city or a suburb can massively change the return on your investment.

Suburbs with high performing schools will attract families who look to prioritise their kid’s education and want to live close. If a property lies within a school catchment zone, you might find that potential tenants are willing to pay a higher amount to grab a desirable location.

Similarly, a younger demographic might depend on public transport more than others to commute around the city, which makes easy access to public transport an important thing to consider when deciding which property to invest in.

5. What is rental yield?

rent It’s important to understand rental yield so that you can calculate what your profit and losses might be when investing to rent. Rental yield measures the amount you generate each year from investments.

Rental yield is used to examine profits and cash flow. There are two types of rental yield: gross and net. Gross yield is calculated through annual rental income and property value, while net yield is calculated by including all expenses involved.

Calculating your expenses and potential profits is important before investing, it’s best to be as prepared as you can. The rental yield of a property will eventually determine the success of your investment and that makes it one of the most important things to understand.

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6. What is the difference between investing in a unit or a house?

The basics between the two remain the same. Location is still an important aspect of any investment property, what changes might be the target demographic you’re interested in renting out to or reselling to.

A unit or house could be built on the same piece of land but will incur different construction costs, different maintenance costs, attract different audiences and therefore command different rental yields. An apartment might attract younger individuals, while a house might interest a family and therefore command a higher rental yield.

Another difference between the two is the fees/levies you might find yourself paying as a landlord. It is common for homeowners to be required to pay much higher council rates than those for units. Interest rates also vary between any property. Creating a budget and factoring this in will help you decide whether to invest in a unit or a house.

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7. What’s the difference between owner-occupied and investment?

What you intend to do with a property determines what loans are available to you. Owner-occupied means that any property you purchase is intended for use by yourself and your family.

On the other hand, an investment property is one you do not live in, but either rent out or resell. These differences will change the requirements and process of applying for a home loan.

8. What loans are available for investment properties?

Investment loans generally incur slightly higher interest rates than owner-occupied home loans. Investment home loans often have stricter eligibility requirements and will often require a higher LVR (loan to value ratio). Just as with a standard home loan, there are different choices between rates.

  • Variable rate loans depend on changes made in the cash rate by the Reserve Bank of Australia (RBA) and offer flexibility by making extra repayments.
  • Fixed rate loans charge the same amount of interest over a fixed period which provides security and easily manageable cash flow.
  • Split rate loans offer both variable and fixed rate features.
  • Interest only loans have you repay only the interest on your loan for an initial set period, leaving the initial loan amount borrowed untouched.

The different types of investment loans include:

  • Standard home loans - these can be extended to cover the purchase of an investment property
  • Margin loans - these are specifically used investments in eligible shares and managed funds by using the underlying security as collateral for when you don’t have enough equity in your home or don’t want to borrow against your home.
  • SMSF loans - Self Managed Super Fund or SMSF enable you to borrow using a self-managed super fund.

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9. What investment interest rate can I get?

interest-rate-impact Most lenders offer different ways to pay interest and repay the loan. You can either pay a “fixed rate” where your interest rate is fixed for an initial period (usually 5 years). This offers you stability of payments and ease of planning. It is best to look for a loan then gives you this ability to lock in a cheap rate when the market rates are lower.

You can also have the traditional “variable rates” where the interest rate offered varies with market rates (due to the movement of the cash rate set by the RBA). This gives you the chance to make much lower interest payments when the market rates are low. It may make sense to get a variable rate loan when you expect market rates to be lower for the next few years.

You also might have the option to make “interest only” payments for an initial short period and start repaying the principal later. This can enable investors to pay much smaller amounts initially and better manage their expenses when they can’t afford to make high payments because their income and rental yields are low. This can especially help investors with prior debt repayments.

It is important to know that these options are available and can save you a lot of money or help you in periods where your cash inflow is low. Consider which method of repayment best suits your current and expected future circumstances before investing in property.

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10. Are there any extra fees?

Managing and maintaining an investment property can sometimes entail a lot of unanticipated costs. You may be required to pay high council rates, repair costs, insurance costs, etc. If you do not have the free time to manage the property then you will need to hire a property manager that takes care of billing and other issues with your property but charges a fee for these services.

There may also be various entry and exit costs attached with acquiring and getting rid of your property. As with most things, there are always additional costs to be aware of that may alter the outcome of your investment. Some investment loans might include:

  • Lender’s Mortgage Insurance (LMI)
  • Administration fees
  • Establishment fees
  • Discharge fees

Before you consider investing in any property, budget all the expenses you expect to incur and plan how you intend to meet them. Only invest in a property if it is likely to cover its own expenses through the rent if your goal is short term profit.

Read more about the hidden costs of buying a home here.

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11. What are the tax implications?

There are various tax implications that arise from owning an investment property. It can be important to consider these implications before investing as they can have large scale financial impacts. You will be required to record all tax-deductible expenses and declare any rental income in your tax returns.

According to the Australian Taxation Office (ATO), your maintenance, interest and other expenses from owning an investment property can be claimed as tax-deductible. This means that you will pay taxes only on your income (including rental) minus all these expenses. It is smart to maintain records of all these expenses right from the start.

If you sell your property in the future and earn a profit because of the increase in the value of your property, you will be subject to a capital gains tax (CGT). If your investment property is not earning you any rent (for e.g. - holiday homes, farms, etc.) then you are still subject to CGT on sale but you cannot claim your maintenance and interest expenses as tax-deductible because they don’t generate any rental income.

Consider all these tax implications before deciding where and when to invest because these can affect your financial well-being. If you expect high rental yields and expect to make a profit because your expenses (maintenance and interest payable on loan) are lower than the rent, then this is called “positive gearing”.

At the same time, you are “negatively geared” if you incur an investment loss because your investment expenses exceed your rental income and you only expect to benefit from capital gains in the future. Both these situations will reduce your tax payable but it is important to consider your financial situation before you borrow to finance an investment property.

Keep in mind...

Investing in a property is a massive milestone in anyone’s life. It’s important to understand exactly how investments work in order to get the most profit and positive gearing. In this list, we have explored the different things to consider before investing in property. Due consideration of these factors that may influence the success of your investment should be your mantra.

Property investment can be tricky but after analysing everything that can go right and the possible pitfalls, you should feel more confident. Talk to one of our Home Loan Specialists today to understand how you can improve your chances when investing!

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The information in this post is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.

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Tags: interest rate, refinance, new purchase, investment, investment loan, capital growth, gross rental yield, fixed interest, interest, interest only, interest rate, capital gains tax

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