The pros and cons of investing in the Australian property market and your options for building an investment portfolio using property.
Unlike buying a home to live in, an investment property is usually bought with the goal of making money (usually via rent). So, things that might be important when looking to buy a home (such as proximity to your workplace) might not be as important in an investment property.
There are many reasons why investing in property continues to be a popular choice and is often seen as one of the best ways to invest money in Australia. However, mistakes can be expensive, so it’s always a good idea to think about why you’re investing in the first place, and whether it fits with your set of circumstances.
Pros and cons of property investment
Here’s a list of some things to consider when it comes to investing in property.
Property is a familiar and tangible investment that’s often easy to research and understand. It can also seem less volatile than other investments.
Plus, banks tend to be well-versed in property and often have a standard process to step you through.
The cost of buying and selling a property
On top of the hefty price of the property itself, there can be a significant entry cost to investing in property including stamp duty, legal fees, building and pest inspections, and loan set up costs.
Before you get started, it’s smart to have a clear idea of how much you will need for the entire purchase process, and when.
There are also more costs to consider, when you decide to sell, including capital gains tax and real estate agent fees.
Many of the costs involved with owning an investment property (eg advertising for tenants, fees paid on your loan, maintenance, etc) may be tax deductible.
Property investors can also potentially use the losses arising from negative gearing (where the income from the investment is less than the expenses) as a tax deduction.
Although many investors focus on the positive impact of tax deductions when deciding whether to invest in property, it’s important to remember the potential impact of capital gains tax which you may be liable to pay. This is a key difference between an investment property and a home to live in, as paying capital gains tax is generally not required for the home you live in.
And when it comes to negative gearing, the success of this strategy comes down to the investor, the property and the rental income. If the investment property makes a loss, you are solely relying on capital growth to provide you with any investment return. It is important to make sure you have sufficient cash flow overall to fund this strategy, including the possible increase in the loan repayments if the interest rates increase.
It’s a good idea to seek personal tax advice before embarking on these strategies.
Potential for long-term returns
Property can deliver long term returns if the value of the property increases over time. And of course, there’s also the potential to receive rent as a source of income before the eventual sale.
Positive gearing can be a long-term goal. Where the property income is greater than property expenses, it could provide the investor with a tidy side income.
There are no guarantees
There tends to be a common belief that Australian property values are likely to increase over time. However, that’s not always the case, and the property value isn’t the only thing to consider. When looking to buy for investment, research:
Access to equity in your property
Equity refers to the current market value of your property, minus the amount you owe on the property.
For example, if your investment property is valued at $800,000 and you still owe $300,000 on your investment loan, you’ll have $500,000 of equity.
You could use this equity to secure a loan for another investment – such as renovations, shares or another property investment.
To understand the equity value in your property, you need to organise a property valuation.
Equity isn’t a guarantee
Your equity isn’t a set number. The market value of your property can go up or down, so the equity you have in the property can also rise and fall.
What’s more, having equity in a property doesn't mean you can automatically borrow against it. That will depend on the lender and their loan criteria.
Another thing to keep in mind is whether you can afford it. Borrowing using equity will increase your debt levels and use your property as security. It’s wise to think about the long-term impact of taking on added debt and what the ramifications are if the investment does not provide the results you were hoping for.
More decisions within your control
Unlike investing in the share market, where the companies you invest in generally have their own management, you manage the important decisions for your investment property, including ways to increase its value, such as with renovations.
You can also take control of how quickly you pay down your home loan. This can help increase your equity in the property.
If you decide to make some physical changes to your property to increase its value, make sure you’re aware of how the changes will impact the value of your property and whether it’s worthwhile.
For example, if adding built-in wardrobes will cost you $15,000 but is likely to only add a further $10,000 value to your property, you might like to reconsider the extent of your renovations.
Tips for buying an investment property
Research and planning can play a big part in the success of your property investment. Here are some tips to help you get the ball rolling.
1. Be clear on your goals
It’s a good idea to consider the realities of the property investment alongside its potential benefits. Think about why you’re investing in the first place, and whether it fits with your particular set of circumstances – this will also help to guide your next steps. For example, you’ll need to make sure you can cover your loan repayments without greatly affecting your lifestyle, and consider if you’re comfortable with the risks involved, like a possible drop in market value or interest rates increasing significantly.
2. Do your research
Doing your research first will help you clarify your options. And there’s a lot to consider: from whether you’re looking for an apartment or a house, to suitable suburbs and how much you can afford to borrow with an investment loan (see point 3).
It’s also a good idea to decide whether you’re buying to make an income now, or as a longer-term investment. Then research the property’s potential for capital growth, rental income and ongoing costs.
3. Set a budget within your means
Lenders will generally ask for a minimum deposit of between 10% and 20%. You’ll also need enough upfront cash for things such as stamp duty, legal and conveyancing fees, insurances, maintenance, and interest on borrowings.
Also consider how the cost of your borrowings could impact your investment. Many Australians have variable interest rate loans, which means their borrowing costs can fluctuate. It is worth considering how changing interest rates could impact your investment, and looking at the options for fixed and split interest rate loans.
4. Check your credit history
Make sure the details in the credit history report are correct. It’s a good idea to do this before you start inspecting properties. Visit the ASIC’s moneysmart.gov.au for resources and more information.
5. Set your timeframe
Setting yourself a timeframe for saving a deposit and then purchasing a property will help keep you accountable to your goal and gives you something to work towards. However, make sure you keep in mind market conditions and have a flexible mindset in case things change.
6. Decide who’ll manage the property
If you’re time poor or live a long way from your investment property, you might want to appoint a property manager or real estate agent. Keep in mind that this service will incur property management fees.
7. Consider whether you need insurance
Acts of nature, building repairs, contents, and loss of rental income are some of the things to think about. The type of cover and the premiums you’ll pay can vary greatly depending on the provider and the policy you take out.
8. Budget for the little things
It’s not just the deposit you need to consider when saving to buy an investment property. You may want to do some renovations before you rent out your property, and you’ll also need to budget for ongoing property costs such as:
- council rates
- water rates
- strata fees
- repairs and maintenance
- property management fees
- estimated vacancy costs, including lost rent and advertising
- insurance, such as landlords’ insurance
- other charges, such as land tax.
Alternative ways to invest in property
If you’d prefer to access property on a smaller scale, you could consider opportunities that allow you to purchase a portion of a property alongside other investments – such as investing in property through the Australian Stock Exchange (ASX).
Some benefits of investing this way include greater liquidity, diversification across different assets, and lower transaction costs. However, be aware that share prices rise and fall daily, unlike bricks and mortar which can be seen to be less volatile. Some examples are outlined below.
Real estate investment trusts
Real estate investment trusts (REITs) are a type of property investment trust that pools investor funds and invests in different real estate assets on your behalf. These can be listed on the ASX and bought as shares. REITs can provide you with exposure to the property market that is more diversified than buying a single property, so it doesn’t rely on a single property value for generating returns.
Invest in home construction
There’s big business in building new suburbs or apartment complexes, and with that comes opportunity to buy shares in the businesses that develop these properties (property developers). It’s worth noting here that investing in construction development has different risks to investing in non-development REITs or property, so make sure you understand the investment risks before you make a move.
Self-managed super fund
If you have a self-managed superannuation fund (SMSF), you may be able to use the equity inside your SMSF to make property investment.
Whether you plan to buy an investment property or invest elsewhere, it’s worth speaking with your financial adviser beforehand so you can make sure it fits with your other life goals and your circumstances.
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