Checklist for buying an investment property

Investing in the right property can be a good strategy to grow your wealth.

But keep in mind that property investment does not mean instant riches. Here are some things to consider to help you maximise your investment returns.

What is an investment property?

An investment property is a property that has been bought with the intention of generating a return on the investment, via rental income and/or capital gain.

Because investment properties aren’t used as a primary residence for the buyer, things that would normally be important when buying a home (such as being close to your office) aren’t important when buying an investment property. Investors can take a more analytical approach based on financial factors like rental yield and potential for capital growth, rather than personal likes and dislikes.

Different ways to buy an investment property in Australia

Using equity

If you already own a property, you can use your existing equity to buy an investment property sooner since you won’t need to save up for the whole deposit, which can take time.

This is called a home equity loan, where the borrower uses the equity in their property to cover the deposit on a new property, using the current property as security for the loan.

Buying with a partner

Two incomes are better than one when you’ve got a savings goal as big as a house deposit in mind. Your combined gross income often means you can borrow more and potentially get a more competitive interest rate particularly if you both have solid repayment histories and good credit scores under your belts.

Using your superannuation

You can buy a property through a self managed superannuation fund (SMSF) as long as the property is an investment property, not one in which you plan to live.

If you’re buying an investment property through an SMSF there are much higher set up costs associated. For example, you may need to have a very high combined superannuation balance to cover the costs of setting up an SMSF, high bank fees, and the required deposit for the investment property. Some lenders require a minimum 30% deposit when purchasing an investment property through an SMSF.

Rent-to-buy

Rent-to-buy schemes (also known as rent-to-own) are where renters are given the option of purchasing the property they’re renting after a set period of time, usually three to five years, at a pre-agreed upon price.

During the rental period, tenants have to pay rent as well as an additional fee for the option of buying the property at the end of the lease term. Some rent-to-buy schemes also charge a non-refundable deposit and other outgoings like stamp duty, insurance and building maintenance - costs an owner occupier would typically incur. These costs then get deducted from the final sale price if the renter decides to go through with the purchase of the property.

However, rent-to-buy schemes are very controversial in Australia and have even been banned in a few states.

Checklist for buying an investment property

Find out how much you can borrow / how much equity you have

Before you start looking for investment properties the first thing you need to know is how much you can borrow as this will determine your property search.

Your borrowing power will depend on the strength of your loan application and your trustworthiness as a borrower. If you own another property you can use the equity from that property as a deposit for your investment property.

To calculate the equity in your property at any time, simply use the following formula: Property value – loan amount = equity

Calculate your equity

Get pre-approval

Investors can often miss out on securing a property because they’ve delayed getting their finances in order. This is why it’s a good idea to secure loan pre-approval before you even start looking at investment properties. Getting pre-approved means you have a better idea of how much you can borrow and secure a loan more easily.

Manage your risk

Property investment is a long-term investment strategy so you should be committed to that property over a longer period of time to build up equity. Unlike other forms of investment like shares or managed funds, you can’t just sell part of your investment property if you need money quickly.

Understand tax implications - negative gearing

One of the biggest perks of investing in property in Australia are the generous tax tenefits on offer, the most popular one being negative gearing. Property investors can take advantage of negative gearing if their investment expenses exceed their rental income and they incur a loss. That loss is then offset against your other assessable income like your salary and investment income.

Understand the cash flow strategy

Before you buy a property you need to understand your cash flow strategy. A positive cash flow investment means that it earns more than it costs to own. It means that the generated income of the property should be larger than the mortgage repayments and other outgoings. A negative cash flow strategy means outgoings will exceed rental earnings. You can then claim your annual losses against your taxes, and wait for growth in the value of the property to generate positive long-term returns.

Choose the right type of property

Are you buying a house, apartment or holiday rental? The type of property you purchase will determine the amount of rent you will receive. Usually, a house has better capital growth but an apartment has a better rental yield.

Pick the right location

A lot of investment advice suggests that investing in a property is all about the location. Look for a desirable area that has strong potential growth in the future that is likely to increase in demand. You should also consider the proximity to public transportation, schools, shops, markets, health care and other amenities, which will also have an impact on rents.

Know your target renters

The type of property you buy should appeal to your target renters. If you are buying a property near schools and parks, couples with children are more likely to be your potential renters. But if you are investing in a property that’s near a university, students from that university are more likely to be your tenants.  

Look for the right property manager

Property managers will manage your property by showing the property to potential tenants, collecting rent, and organising repairs. The management fees that you pay them are tax deductible. You can also manage your own property to avoid management costs, but it can be time consuming as you will have to do everything.

Select the right mortgage

For most investors, mortgage repayments will be your largest expense so it’s imperative to get the right loan. A popular choice among property investors is interest-only home loans because the entire monthly repayment is tax deductible and the size of the repayment is smaller, although it is important to remember that the principal will still ultimately need to be repaid.  

Bottom line

It’s important to do your own research before you invest in a property. Research the market, assess your financial situation, and compare properties in the area to get an idea of how much your rental yield is likely to be. 

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