Why people invest in property
Put simply, the aim of the property investment game is to make money. Some people invest in real estate as a form of regular income (cash flow), while the goal of others is to create a big nest egg for the future (capital growth). In many cases, investors can achieve both outcomes from the same investment or portfolio of properties.
When you start down the property investment path, you’ll need to do plenty of research. Whether you take the cash flow avenue for a passive income (earnings you don’t go out and work for), or take the long-term capital growth route and wait for property to gain value over time, your strategy will play a big part in the type of property you buy.
Ultimately, it’s a numbers game and you’ll need to be in it for the long haul to see the best financial results.
Choosing a capital growth strategy
If you wait long enough, property values almost always go up. But as a savvy investor, you want to be sure that growth is sufficient to cover general inflation and all the holding costs over time – with a nice healthy sum left over.
Without a crystal ball, no-one really knows what a property is going to be worth in the future. However, with educated analysis you can get a pretty good sense of what types of properties in certain locations have solid growth potential.
To get started, find out the median property values in the suburbs you’re interested in. Purchasers can buy suburb reports from online data companies such as CoreLogic or PropTrack, which include historical median sale prices, demographic information, asking rents, rental vacancy rates and past population growth. Be sure to differentiate between unit and house median prices so you get a clearer picture of how different property types perform.
Focusing on suburbs that have already had great price growth is a good place to start, but you’ll want to ensure there’s sufficient reason for values to continue to rise in those areas. This will require extra homework outside of data reports.
While eventual capital gain might be the end goal, this strategy could also be advantageous at tax time if the property is negatively geared (i.e. it’s costing you more to hold than the rental income it provides). Property investors making a loss on their investment may be able to offset their annual tax bill by claiming a deduction for the full amount of rental expenses against their rental and other income – such as salary, wages or business income.
Choosing a cash flow strategy
Just as the name suggests, this option means you’ll have a steady flow of cash coming in the form of rent. This is also referred to as positive gearing (i.e. it’s costing you less to hold than the rental income it provides).
For this to work well, you’ll need to choose a property capable of generating enough rent to more than cover the holding costs. It’s therefore important to invest in a rental market that is always sought after by tenants and won’t be adversely impacted by things like seasonal and cyclical work or student movements.
Finding areas with strong rental demand and yield is key to assessing the financial viability of an investment property. Rental yield is simply a calculation of how profitable a property can be, based on the expected rental income balanced against the costs of holding it.
Rental yield can be calculated in gross and net terms. Gross rental yield is the annual rental income divided by the value of the property, multiplied by 100 to get a percentage.
Calculating gross rental yield
- Take the total annual rent received.
- Divide the rental figure by the property’s value.
- Multiply the figure by 100 to get your gross rental yield as a percentage.
Let’s do the numbers. If you purchased a property for $750,000 and the weekly rent is $500, then multiply this figure by 52 to get the yearly rental amount.
500 x 52 = 26,000
Gross rental yield: (26,000/750,000) x 100 = 3.46%
Net rental yield is slightly more complex, as it factors in all the fees and costs associated with owning a property – such as repairs and maintenance, strata levies and council rates.
Calculating net rental yield
- Add up the total yearly holding costs.
- Take the total annual rent received.
- Subtract the holding costs from the yearly rental income.
- Divide this figure by the property’s value.
- Multiple the number by 100 to get the net rental yield as a percentage.
Using the same numbers for gross rental yield, we’ll add on $4,000 a year in holding costs.
Net rental yield: [(26,000 - 4,000) / 750,000] x 100 = 2.93%
Even if you choose a cash flow strategy, you’ll likely still want an investment property with the potential for healthy capital growth. It means you can be earning a passive income and still get a great return on the day you sell. However, the main difference here is that you’ll be earning a regular income from the investment, so you’ll be taxed on that income, just like a job.
Unearthing the hidden costs of an investment property
To avoid any nasty surprises, make sure you’ve thought about all the potential upfront and ongoing expenses that come with owning an investment property. Typical costs you’re likely to incur include:
- purchase costs, including a conveyancer, building and pest or strata reports
- loan establishment fees
- stamp duty (also known as transfer duty)
- lenders mortgag e insurance (required for applicants without a 20 per cent deposit)
- whitegoods or appliances considered as permanent fixtures
- utility connections, where necessary
- interest and annual fees on the home loan
- building and/or landlord insurance
- strata fees or land tax
- council rates
- property management fees
- maintenance costs.
Choosing a property with potential
Finding the ideal investment property isn’t just about crunching the numbers. Property experts will tell you that, unlike buying a home, an investment property should be bought with the head – not the heart. And while it’s great advice to keep your emotions in check, putting yourself in the shoes of future tenants makes perfect sense. Location is king in real estate, so consider neighbourhoods that include:
- established or rapidly improving infrastructure, including any planned highway upgrades for regional areas
- public transport options nearby, including walkability to train stations and bus stops
- proximity to (or planned expansion of) amenities, such as schools and hospitals
- zoning for sought-after public schools
- shopping centres and community facilities
- easy access to parks, cafes, walking trails or beaches
- a low crime rate
- aesthetic attributes, like tree-lined streets or appealing streetscapes.
On the other hand, you’ll want to look out for any future projects that could decrease property values, like residential overdevelopment or major arterial roads being built through a suburb. While the address is important, the property type also needs to meet demand in your chosen area. Consider homes that have:
- the right size or layout for the local demographic (i.e. studios might not be sought after in family neighbourhoods)
- private outdoor spaces, like balconies and gardens
- secure or off-street parking
- reasonable strata fees (e.g. are you willing to pay for a pool if you’re not living there?)
- low maintenance, or for older properties, factor in future renovation bills.
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