What to consider before buying an investment property

With its strong history of delivering positive returns, it’s no wonder property investing holds such appeal for potential investors looking to expand their portfolio.

Buying an investment property is obviously not something you jump into without a lot of thought… Property investment in Australia is not just complex, it’s also variable according to location, with certain cities at different stages of the property cycle clock.

While potential investors may be attracted to property investment as a means to make money, there is much more to consider than just capital growth…

From rental yield and cash flow, to tax implications and out-of-pocket expenses, real estate investing is both intricate and involved – perhaps more so than the potential Australian property investor anticipates.

With that in mind, here are some of the more important factors to consider before the search for the perfect investment property begins.

Have you done your investment preparation?

As with any type of investment, successful property investment requires careful preparation.

1. Your financial goals: Creating the right investment strategy means having a full understanding of your financial goals. To do this, you may want to identify what goals you have, and when you want to achieve them.In terms of property investment, are you looking for an income stream? Or are you more interested in capital growth? What do you want to get out of your investment in property?

2. Your investment strategy: In creating your investment strategy you would generally take into account your financial goals and each goal’s timeline.

A financial adviser is often the best place to start, when designing your investment strategy, as they can help you find the best investment options to help you reach your goals, structuring appropriately for diversification and asset allocation. For example, will an investment property fit well within your investment strategy? Or would alternative property investment options, such as a mortgage or property trust provide a better fit?

3. Your tolerance for risk: The time frame in which you have to achieve your financial goals will usually affect the amount of risk allowable in each type of investment. To understand your tolerance for risk, consider how you would feel if one of your investments dropped significantly in value. If you invested in property and the value of that property fell, would you panic? Would you be able to cope financially if you were unable to find a tenant, or if you had to front the cost of major repairs?

4. Your tax obligations: To fully understand whether property investment is right for you, you may want to find out more about your tax obligations. It’s generally not recommended you make a decision to buy an investment property based on getting a tax deduction, but it is a good idea to know more about the way in which tax works with regards to property investment. This can involve reading up on capital gains tax  and depreciation schedules and of course, getting professional advice from your financial adviser or accountant.

Do you understand the importance of both capital growth and rental income?

Capital growth is not the only factor to consider when investing in property. Rental income can also be vital. In terms of assessing rental income, successful real estate investors often look to yield as an indicator of the investment potential of a property.

Tending to be annually based, yield calculations are expressed as a percentage of the asset’s market value. This percentage provides an approximate indication of the property’s rental income, compared with the value of the property. The figure calculated is gross yield, before any associated expenses are allocated.

However, choosing a property for high yield alone may have some consequences. High yielding properties may not offer the best capital growth, and may also result in negative cash flow or increased risk. With little capital growth, it becomes difficult for investors to expand their portfolio.

On the other hand, investors who choose to invest in property for capital growth alone may also hit stumbling blocks. Buying a cheaper property can result in higher maintenance and repair costs, reducing cash flow and the ability to find tenants. Without that rental income stream, and with higher expenses, the mortgage may become more difficult to manage.

Have you factored in your investment expenses?

Owning an investment property typically requires investors to cover various expenses. Having sufficient cash flow to finance ongoing costs – as well as unexpected expenses – is paramount. Investment expenses can include rent shortfall, either as a result of having an untenanted property, or having a mortgage that is higher than the rental appraisal.

Strata may also have to be covered, alongside insurance, rates and agents fees. Unexpected expenses could include paying for a plumber to fix the hot water system, replacing the roof, or rewiring the electrical system. Investors may also have to deal with rising interest rates on their investment mortgage.

Sound property investment advice from a financial adviser can help steer prospective property investors in the right direction, with regards to what would be expected of them as landlords, and whether property investment is indeed the right option for them.

You may also like to consider and discuss with your financial adviser, alternative property investment options to ensure you’re selecting the right investment vehicle for your portfolio.