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The 7-step journey to property investment

August 23, 2019

Around two million Australians, or 9% of the population, own an investment property. It’s a profitable journey that can set people up for a very comfortable future, if done right from the start.

Step 1: Talk to a broker

Many people put off speaking to a home loan broker until they’ve found a property. A smarter strategy is to talk to the broker first. They’ll help you determine your goals and show you which path will get you there fastest.

Some of the things a broker will discuss with you include:

  • Different strategies, from paying down your current mortgage to leveraging equity for an investment property
  • Your risk profile and what you’re comfortable with
  • Possible cash flow and ongoing costs
  • Modelling different capital gain and rental scenarios
  • Negative gearing

Once you know how the numbers shake out, you can go property shopping with confidence. At Independent, we recommend Clarity Financial Group. They’ve a great track record and are structured so they get the same commission regardless of what lender you choose.

Step 2: Find a good contender

Some properties are better suited for investment purposes than others. It all comes down to what your investment strategy is. Our property management and sales teams can help you identify which properties would suit your needs.

Some things you may want to consider include:

  • What’s the rental demand for properties of this type in that area?
  • What appeal does the suburb have to potential tenants?
  • What are the current rental rates for similar properties in that area and how have they changed in the past few years?
  • How have property values changed over time in that area?
  • Are there any future development plans for the area that will impact rental demand?
  • What future improvements could you make to the homes/block that will impact its value?
Step 3: Assess affordability

The most important thing to know once you’ve found a potential property is, can you afford it? To find the answer, you’ll need to understand how to determine the cash flow and taxation implications.

Cash flow

  • The cash that flows to and from the property. You put money in to cover costs associated with running the property. You take money out by receiving rent.
  • When costs are greater than the rental income, the property is generating negative cash flow.
  • Negative cashflow is common, especially in the early years. Under normal circumstances, the rental income will go up over time and the property will become cash flow positive.

Approached sensibly, the long term gains of investing in real estate can make it very worthwhile. However, always make sure you know what the cash flow is before buying a property.

Costs to include in your calculations:

  • Mortgage
  • Council rates
  • Strata or body corporate fees
  • Property manager fees
  • Insurance costs
  • Utilities
  • Repairs and maintenance
  • Depreciation on assets

Your broker can help you work out the likely cash flow so you can see what the net out-of-pocket cost to you will be every month. They will also explain how depreciation impacts the cash flow, what deductions are available to you and what you can do to maximise your returns.

Negative gearing

If your investment property costs more to run than you earn in income, it has a negative cash flow—also described as being negatively geared.

Negative gearing:

  • Allows you to offset your losses from your investment property against your other income
  • Reduces the amount of tax you pay

To negatively gear your property you have to make a loss on it. This means that you must ensure you can meet the costs of running the property. Over time, as your investment provides a positive cash flow, you will receive extra income but pay tax on it.

Deductions

Investors in rental properties are entitled to tax deductions on their investments. The more deductions you have, the more likely that your property will make a loss on paper so that you can negatively gear it against your other taxable income. The kinds of deductions you can claim include:

  • repairs and renovations
  • advertising for tenants
  • depreciation
  • insurance
  • property agent’s fees
  • council rates

Be wary, though. The ATO scrutinises property investors closely so it's important not to claim more than you're entitled to. Some of the deduction criteria are especially complex, so always get professional advice from an accountant or other qualified financial advisor.

Independent has a range of trusted contacts we can give you if you’re looking for a financial advisor.

Step 4: Establish the right structure

The right loan structure is vital if you are to get the most out of your investment. Work with your mortgage broker to:

  • Decide whether your new loan should be a principal-and-interest (P&I) loan or an interest-only (IO) loan. Both have pros and cons.
  • Ensure that your investment loan and home loan are clearly separated. Combining funds can mean that you miss out on deductions or get stung by the ATO for over claiming.
  • Consider whether a fixed rate or variable rate mortgage suits you better. You can also fix a portion and keep the rest variable.
Step 5: Compare lenders

Lenders vary considerably in how they view investment loans. To make matters more complicated, products and policies are always changing, which is why we recommend talking to a professional.

Some other things that differ between lenders include:

  • Whether they offer the same interest rates for principal-and-interest (P&I) loans as they do for interest-only (IO) loans or charge higher interest for the latter.
  • How they assess borrowing capacity. When you’re applying for a loan for an investment property, banks will add the potential rental income on that property to your income. Some will accept a letter from the real estate agent estimating the rent. Others will require an independent valuer. In a few cases, the cost of the valuer is also passed to you.
  • How conservative they are in assessing risk and what factors they take into account.
Step 6: Purchase your investment property

If you’ve been through every step so far and engaged with the professionals for advice, you’re well set to purchase your first property. Congrats!

Step 7: Choose your property manager

A good property manager will help you build wealth through property. They’ll be working with you on a long-term approach to property management which should include:

  • Helping you choose an insurance provider that is right for your needs
  • Determining the right lease structure – should you be looking at short-term, standard or long leases
  • Marketing your property in a way that attracts ideal tenants
  • Managing the day-to-day of invoices, tenant requests etc. efficiently
  • Developing a maintenance plan to protect your investment

The key to a smooth entry into property investment is having the right people on your side. Get in touch with our property management experts and they can help you assemble a great team to make your entry in property investment a success.