Thinking about buying an investment property? Nice one – you property mogul, you.
Though the truth is, there’s no straight answer to the question “should I buy an investment property?” because it depends on your goals, financial situation and long-term plans.
But if you play your cards right, it can be a financially savvy move and a smart way to build wealth.
So, while we don’t know your specific situation, this article will dive into the pros, cons and considerations so you can start to weigh up if it’s right for you.
Let’s start at the beginning: what is an investment property?
An investment property is a property you buy with the goal to make cash-money from it – either through rental income or the future sale (in some cases, both). Your second home or holiday home could also be considered an investment property, especially if you plan on selling it down the track or renting it out when you’re not using it.
In Australia, property can be a solid investment strategy if you play your cards right. So let’s look at the pros and cons.
What are the pros and cons of buying an investment property?
Buckle up, there’s a few things to consider.
Advantages of an investment property
- Building wealth – property investment can accumulate money over time and build your financial security, helping you stay a few financial steps ahead and set up your future.
- Relatively secure investment – people always need somewhere to live. So an investment property could be a more secure investment opportunity than say, shares. Not always though.
- Rental income – in some cases, you can make a passive income from rental repayments (AKA rental yields, which we’ll explore more below).
- Potential for capital growth – that’s a fancy way of saying the increase in property value over time. So when it comes time to sell, you could make a profit.
- Tax benefits – there are often tax benefits associated with investment properties that typically aren’t available as an owner occupier. For example, you could claim tax deductions on things related to your property, like mortgage interest, maintenance costs and depreciation.
- You can rentvest – a strategy where homeowners buy where they can afford, and continue to rent where they want. For example, it’s common to purchase a property in a developing or regional or rural area (where prices are generally more affordable) while renting in a more desirable inner-city area (that’s often more expensive). Learn more about rentvesting.
Downsides of an investment property
- Upfront costs – ok, this is often the biggest barrier to entry when it comes to property investment. You need to take into account things like a deposit, stamp duty, legal fees, initial expenses – which can all add up quickly.
- Mortgage interest – there’s no side stepping interest rates in an investment property. You’ll be exposed to the same interest rate fluctuations as you would if you were living in the property yourself.
- Ongoing expenses and homeownership costs: you’re responsible for any maintenance, property management and repairs that come up along the way.
- There’s always a risk – there’s always a risk of investing in a not-so-good area and having to sell at a capital loss (that is, selling for less than what you purchased the property).
- Capital gains tax – if you do sell your investment property for more than you paid for it (AKA make a profit) you may have to pay capital gains tax on the profit you made.
- Potential for bad tenants – there’s always a risk associated with who you’ll get inside your property – some tenants will make your life harder than others.
What to consider before you buy an investment property
You’re not going to decide to buy an investment property overnight (well, you shouldn’t, anyway).
So before you buy an investment property, it’s good to consider:
- Location
Location is a biggy. In fact, it’s one of the key factors in determining the success of an investment property. A well-chosen location can give you steady rental demand, capital growth, and strong rental returns. It’s a good idea to consider the nearby amenities (like schools, shops and parks), as well as the area’s population growth projections, and any future development projects.
- Market trends
The property market can fluctuate based on the economy, interest rates, and demographic changes. So it’s a good idea to keep your finger on the pulse with what’s going on out there. Start by researching recent trends in the local property market, including price increases, rental yields, and number of sales. You can also check the current vacancy rate (the percentage of rental properties that are currently vacant) which will give you a good idea of rental demand.
- Type of property
Weighing up an apartment versus a property with land? Well, in the investment world, apartments generally don’t increase in value as much as property with land. In saying that, there are always exceptions to this rule, and you could land on an apartment with great investment outcomes (and they’re often more affordable, too). The moral of the story: we can’t say for sure what’s a *better* investment, but make sure you factor in the type of property before you commit. Check out our article on buying an apartment to learn more.
- Age of the property
Older properties might come with higher maintenance costs, which could reduce your overall return on investment. On the other hand, newer properties might require less maintenance and offer modern features that appeal to renters, making them easier to lease. As always, it depends though.
- Property features
Things like the number of bedrooms, parking spaces, outdoor areas, and modern amenities, can all affect rental demand and the success of your investment. Think about what renters in the area are looking for: if you’re renting in a family-friendly area near lots of schools, there’s a good chance renters might be looking for more bedrooms and spacious backyards.
- Population growth and demographics
An area experiencing population growth often sees an increased demand for housing, which can drive both rental return and capital growth (booyah). Also take a look at the demographic profile of the area – are there more young professionals, families, retirees, or students?
- Vacancy rate in the area you’re interested in
We touched on this above under market trends – but we’re saying it again for good measure. Vacancy rate is a key indicator of rental demand in the area. A high vacancy rate suggests that properties aren’t being rented out quickly, which could point to a lack of demand or an oversupplied market. On the flip side, a low vacancy rate points to strong rental demand, which is a positive sign for potential investors.
- YOUR investment goals
Last but definitely not least, what are you looking for? Are you after a steady rental income or long term capital growth? For example, some investors might choose to forgo rental income for a little while, with the main goal being capital growth in the long term. Whereas other investors might be looking for that rental income from the get go.
Let’s talk about rental yield
Rental yield is the rental income you can expect from your investment property, compared to its overall value.
It’s a helpful calculation to compare properties, for example: “does investment property A (in Melbourne) or investment property B (in Sydney) provide more or less rent when compared to its value?”
It’s often expressed as a percentage, with the higher percentage equating to a higher rental return.
There are two types of rental yield: Gross yield (your rental income before expenses) and net yield (your rental income after expenses). Overall, net yield will give you a more realistic picture of what your investment returns.
Learn more about rental yield and how to calculate it.
So what’s this negative gearing business?
Negative gearing is when the expenses associated with owning an investment property exceed the rental income generated from that property (AKA you’re making a financial loss, at least for the short term).
Although it sounds backwards, it can actually be an investment strategy. Investors might enjoy tax perks, as they can offset the financial loss against other income (such as a salary) and reduce the amount of tax they would otherwise have to pay. Investors might also be willing to make a loss on property in the expectation they will achieve capital growth down the track.
So as always, it depends on your investment strategy and current situation.
As a side note: At Finspo, we’re home loan experts, not investment or tax experts. We’ve described negative gearing in a generalised way for the purpose of illustrating general concepts in this article, but for more information related to tax legislation check out government websites or speak with your qualified accountant.
Capital gains versus capital loss
Capital gains is when you sell your property for more than you originally paid for it (read: good), whereas capital loss is when you sell your property for less than you originally paid for it (read: not good).
There’s always a risk of selling at a capital loss, but it’s all about choosing the right investment and minimising that risk. Done well, you can boost the potential for capital gains.
When should I buy an investment property?
It’s a million dollar question (literally, in some cases).
But unfortunately, we can’t say whether now is the ‘right time’ as it’s what’s right for YOU. It always depends on your goals, situation and what’s happening in the market.
A Finspo home loan expert (that’s us!) can weigh up your situation and point you in the right direction.=regarding your borrowing power and home loan options but we don’t provide guidance on whether an investment property is the right strategy for you. Speaking with a qualified financial planner, accountant or investment advisor in the first instance is always our suggested approach.
Common questions about buying an investment property
Can I use equity to buy an investment property?
In many cases, yes. If you own a property already, you can potentially use the equity in your current property to help finance the purchase of an investment property.
If you’re new to the topic or need a recap – equity is the difference between the value of your property and the outstanding balance on your mortgage.
Should I buy an investment property before my first home?
We’ve said it once and we’ll say it again, it depends on your goals and situation. Buying a home to live in might be a priority for some first home buyers, whereas buying an investment property suits some first home buyers as part of a ‘rentvesting’ strategy.
How does buying an investment property differ from buying a home?
For starters, rather than looking for a home that YOU want to live in – you’re looking for a home that is forecasted to bring in good returns and meet your goals. It might also impact your home loan, tax return, and whether you’re eligible for first home buyer grants and schemes. Learn more about investment loans versus home loans.
Can I move into my investment property?
Yes, it’s yours afterall. If there’s no tenant currently occupying your property you’ll be able to move in at any time you please. If it’s currently under a rental agreement, it might take a little bit longer. It’s important to remember, if you change your mind and decide to move into the property, it may be too late to access any first home buyer grants and schemes, so it’s a good idea to get clear on your intentions before you make any moves.
Am I eligible for first home buyer grants and schemes?
In most cases, investors aren’t eligible for first home owner grants and schemes. Most states in Australia require you to live in the property for a certain period (usually 6 – 12 months) to access any first home owner grants and schemes. Learn more about first home owner grants and schemes.
Ready to get started?
At Finspo, we’re a team of home loan experts (but not the suit-n-tie wearing kind) here to guide you through the ins and outs of borrowing for property investment and set you up for a smooth property purchase.
Regardless of whether you’re still not sure if investing is right for you, or you’re ready to take the leap, meeting with a Finspo broker is easy, free and totally non-intimidating. Yep, we said free.
