Things you should know To buy an investment property generally requires a commitment to own the property for a long period of time. We are talking about residential investment property. The costs involved in buying and selling mean the property should be held at least 10 years. Reason to buy There should be a reason to buy. Many people buy investment properties in Australia due to the negative gearing aspect. There purpose is to reduce tax. This sometimes results in inadequate homework in assessing the property and monitoring its condition. If the property then performs unsatisfactorily they are put off. The main reason they buy is to reduce their tax which is not a good strategy on its own! Reason to buy can be varied and may be one of the following: We aim to buy this property on the coast and plan to retire there. The rental income will be used to repay the loan and we expect the loan to be repaid prior to us moving in. This will enable us to sell our current home and use the proceeds to live off. Our only current investment is via our superannuation which we understand is mainly invested in shares. We don't have confidence in investing in shares, however have a good understanding of the residential property market. We aim to buy a residential property within a 10 km radius within the next 6 months and will follow this up with another purchase 2-3 years later. The properties will be held for at least 10 years. We aim to buy a home needing some serious internal renovation work. The property will be rented immediately and then in about 3 years using our skills in the building industry we will renovate the home and modernise it. The home will then be rented again with a much larger rental figure expected. It is critical to the success of your investment property that you have a plan and reason to enter this investment sector. 
Can you afford it? Property investment is an area that is often given minimal research at the start. Costs can be hefty both at the start and on an ongoing basis. Most investors have sufficient funds to complete the purchase however underestimate the ongoing funding required. Maintenance costs are generally larger for investment properties than similar properties that are owner occupied. These regular costs usually comes out of the monthly rental cheque requiring more of your own funds to meet any shortfall on loan repayments. If you don't have sufficient information on costs talk to anyone you know who has a rental property. You could also try talking to property managers at Real Estate Agents. After all they manage many properties. An easier way is to budget 20% - 30% of the rental income to be used on non loan expenses. If you own a house 30% is probably more realistic while owning a unit usually has lower costs therefore 20% - 25% may be closer to the mark. After all Banks use these percentage as a guide when assessing repayment ability. Don't forget to factor in loan repayments. This is also not a bad time to calculate loan repayments at an interest rate of 2% - 3% higher than they are now. This will show you the potential out of pocket costs. What to buy? The options are many given the choice available. The decisions to make include: 1. Location? 2. House, unit or high rise? 3. Size of dwelling? 4. Additional features? The best location is often the one you know best, where you live. Unless there is a valid reason about the location that does not impress, go local. There has been a big trend in recent times for inner city apartments, conversions from warehouses and high rise apartments becoming highly sought after by investors. This type of investment is more risky than other options and not recommended unless you are an experienced investor. The best options are homes where people like you and I live. That's right. 3-4 bedroom houses in the suburbs or regional centres. Homes that are popular to live in. This means your investment property should have a strong likelihood of finding tenants on a consistent basis and being able to sell for a realistic price in a realistic time frame. Sure, there are probably more exciting investments, but this type of property is popular and generally the easiest to rent. As for other features, remember you don't have to live in it. Pools, spas, gardens that are high maintenance all mean extra work. And if the tenant isn't into gardening or cleaning you will have to wear the cost to maintain it. On the other hand ensuites, double carport/garage & basic outdoor living area are standard features these days. You will get higher paying tenants with all these features and an easier sale at a later date as well. If you mention property investment to people you can expect to be provided with stories of people who used to own a rental property and had a bad experience. These may be rent not being received and poor condition of house/unit by vacating tenants. It is a proven fact that a better quality house/unit will usually attract a better quality of tenant. There are no guarantees of course. If you can, look at buying an investment property that attracts tenants who can pay in the mid range of rent figures. You do not want a rental property in the bottom 25%. Common sense is the key when working out what to buy! 
Tenants The key here is to talk to Real Estate Rental Managers to find out how to get the best tenants. They know. After all you want tenants that pay on time and look after your investment. Generally the best properties have better quality tenants because they can afford the rent. Remember not all tenants rent because they can't afford to buy their own house. Many people due to work changes, move often and therefore prefer not to buy & sell each time. These people are just like you and me. In some cases their employers assist with part of their rent. They therefore have a greater incentive to do the right thing by you. Their employer who pays some of the rent would be very disappointed if the property wasn't looked after. These employers often have a high profile. Rental Managers Good rental managers are worth every cent of their fee. They will get a better type of tenant, regularly check the property and ensure the tenant is doing the right thing by you. Of course for varying reasons the rental manager can leave the Real Estate Agency that manages your property. If their replacement isn't doing as good a job and the Agency owner won't help, move agencies for a better property manager! It's your property so inspect it regularly! As previously outlined in the houses section, we had a rental property that because of a growing family and lack of care on behalf of the tenants, and lack of regular and thorough inspection by ourselves could not be sold at a reasonable price. We should have done more to ensure our investment was being properly maintained. Here are some ideas to consider: 1. Take some photographs when you buy the property so that you have proof of what the condition was like when first purchased. 2. Inspect the property thoroughly at least once a year. The inspection is to look for unsatisfactory care by the tenant and to look at areas that require some work. Remember it is easier and cheaper to repair and manage small problems before they become big problems. 3. Review both the tenant and the rental manager. Are you satisfied with both? Taxation Before you consider buying an investment property talk to an Accountant first. They will explain all the deductions that apply. These vary from depreciation on capital items (hot water service, carpet, oven etc). Other expenses are travelling to the property to inspect it once you have purchased it, rates, insurance and interest to name a few. 
Negative Gearing Negative gearing is very popular with Real Estate Agents in Australia who love to make general statements about the tax savings a rental property can provide. The reality is many of these properties cost money to have and the only benefit is a potential gain in property value. To explain it better look at it this way. Rental income $10,000 per annum Annual expenses $15,000 per annum ----------- Out of pocket $ 5,000 The loss on the investment property means the $5,000 can be used to reduce your taxable income and therefore reduce the tax you pay. Sounds good except the tax savings may be $2,000, so you are still out of pocket $3,000 for the year! Combine this with time spent visiting the property, authorising repairs or doing them your self and the dream of owning an investment property can turn sour. Now this example is very basic and doesn't take into account different tax rates depreciation or principal repayments, but it does show the reality. Only the interest is tax deductible, not the principal component. We suggest you talk to your Accountant/Tax advisor to explain it further. For many people this scenario is acceptable. They may be confident of capital growth and putting their own money into the loan is forced saving. The most important point to remember is negative gearing usually requires you to put money into the venture on an ongoing basis. As the time lengthens the expenses start to reduce in comparison to income and you may start to see a positive return. You need to understand this may take some time. N.B. If you have to borrow, make sure you talk to your Accountant/Financial Advisor first to explain taxation aspects and the problem with lump sum repayments. They will work through your particular situation. It is simply explained like this: To claim a tax deduction on the finance, the purpose of the loan must be to assist purchase the investment property or complete improvements to it. What happends when loans are repaid faster is that there is often funds that can be redraw. If the redrawn amount isn't spent on the investment property then that portion of the loan can't be claimed as a tax deduction. Capital Gains Tax Before buying an investment property in Australia you need to talk to your Accountant so you understand all tax aspects including capital gains tax. This tax is charged after the property is sold and takes into account purchase price and expenses not already claimed in your tax return (usually capital items). Capital gains applies whether you are deriving an income from the property or not ie holiday home and vacant land which is surprising to many people. The Australian Tax Office says we only have one prime residence and everything else is liable for capital gains tax. If you are in a situation where you lived in the property first then rented it out the rules become more complex and can't be covered here. As every situation is different get advice. Investment Property Scams A very attractive proposal may in fact be a scam. Property developers sometimes are offering rental guarantees to make the property more attractive. How it works is you may be looking at a property worth $250,000 and able to attract gross rent of $290 per week ie 6%. If 6% is the going rate in a particular area and a rental guarantee is offered on the same property at $315 per week the property may be offered at $275,000. In an instant the developer has gained an extra $25,000 in the sale price. All they have to do is arrange a tennant for 1 year and if necessary subsidise the rent. The difference between $315 and $290 per week is $1,300! The developer has made over $20,000 more than they should. This could be done a number of different ways ie - Pay the 1st months rent for the tenant
- Pay the difference each month
After the year the market will dictate what rent should be paid for your investment property. If you are offered a rental guarantee obtain independant advice either via a valuer or visit 3-4 Real Estate Agents in the same area to gain greater understanding of the local market. Happy Investing !
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