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Property Investment Strategy: Your Three Elements of a Property Investment

We nominate land as the first element because, while apartments can provide sound returns for investors in particular situations, overall Investor Assist believes you should invest in land first, then work to build a new good quality  house to provide superior long-term capital growth potential.

While most properties tend to exhibit capital growth over time, some increase in value more than others. A good quality house with desirable features can help ensure long and rewarding tenancies, and easy resale.

Although we list property investment finance as the third element, it should generally be one of the first things an investor considers when contemplating a property investment.

Author: Don Crellin, General Manager, Resolve Finance.

At Investor Assist, we consider there to be three key elements to a property investment: land, build and finance. It is a successful combination of these elements that leads to sound property investments.  Conversely, getting any of these elements wrong may contribute to an outcome that does not meet expectations. Our property investment strategy revolves around these three key elements:

PROPERTY INVESTMENT STRATEGY ELEMENT 1: LAND

We nominate land as the first element because, while apartments can provide sound returns for investors in particular situations, overall Investor Assist believes you should invest in land as houses on land provide superior long-term capital growth potential.

Land as an investment is valuable

Land drives capital growth because it tends to increase in value over time, while buildings depreciate in value. However it’s the value of the land that counts, and land value can vary significantly between suburbs. It all comes down to supply and demand – as long as demand exceeds supply, opportunity for capital growth exists.

The following factors influence demand for land as an investment:

  • Scarcity of land in the area (i.e. how built up is the suburb, and how much new land will be available in the future).
  • The proximity to infrastructure, amenities and attractions such as schools, the CBD, the ocean or river and shops.
  • Convenience to transport options, including public routes and ease of access to major built up areas.

Of course, other factors can impact demand – overall housing affordability, changing demographics, interest rates and other economic factors – but these are largely out of the control of investors. 

Balance the factors to find the value of buying land as an investment

While scarcity, proximity and convenience impact land value, this doesn’t mean that the only suburbs worth investing in are established, expensive suburbs, since they won’t necessarily represent good value.

The key to finding the value of buying land as an investment is seeking the right balance of one or all of the above factors. This may mean investing in properties that may be valuable at some point in future. Finding value in this way means taking account of planned infrastructure development, land sub-divisions and public transport, amongst other things. In this regard, making sound property investments can be challenging.

PROPERTY INVESTMENT STRATEGY ELEMENT 2: BUILD

While most properties tend to exhibit capital growth over time, some increase in value more than others. A good quality house with desirable features can help ensure long and rewarding tenancies, and easy resale. Conversely, older buildings, or those lacking desirable features will prove harder to rent and may require upgrades or maintenance throughout the term of the investment.

It is simple logic, and yet investors often overlook the features of building an investment property in favour of an emotional decision about a location or a building style. Purchasing an investment property should be treated as a business decision. By sticking to an objective plan about the type of property you wish to purchase, it will help ensure your decision pays long-term rewards.

New property vs. old

Every property is different. From old to new, different properties present different opportunities. However, building an investment property brand new, will typically provide a number of advantages over an existing property in a like-for-like location:

  • New properties are desirable amongst tenants and will achieve a rental premium over a comparable older house.
  • New properties can be landscaped to a low-maintenance standard while older properties may have large gardens requiring ongoing maintenance.
  • New properties are unlikely to require any maintenance in the short to medium term, while older properties may require (potentially expensive) work throughout the investment timeframe – and these costs may be unknown at the time of purchase.
  • New properties can be built to appeal to tenant markets (for example, by including low maintenance gardens, adequate storage and security), whereas existing properties may need to be adapted.
  • New houses receive the full depreciation allowance on building costs and fixtures and fittings from the Australian Taxation Office.

Investor Assist generally recommends avoiding older properties as investments, unless the property is suitable for a complete refurbishment or subdivision, or is unique in terms of location or architecture.

House vs. apartment

When it comes to building an investment property, there are a number of advantages and disadvantages to either houses or apartments, and the decision will likely come down to your personal situation.

Apartments tend to occupy the high-yield category of investment, since the ratio of rent to value is typically higher than that achieved for houses. This may be ideal for investors who require a high level of cash flow to supplement their loan repayments. Apartments also require less ongoing maintenance, however are subject to body corporate fees, which must be considered when calculating overall investment merit.

When building investment property, it is clear that houses have the element of land that apartments lack. And while apartments in sought-after areas, or areas that are completely built up, may still achieve sound capital growth, Investor Assist believes the element of land is a vital point of difference. This is because land can increase in value when it is scarce, yet scarcity is usually not a driver of value for apartments, since there is the possibility that new apartment buildings may be established in nearby locations.

Consider your rental market

When considering a property investment it makes sense to take account of your potential rental market. While you may always be able to find a tenant, finding a desirable tenant that wishes to stay for the long term is more difficult. If you are relying on regular rental payments to supplement your mortgage, this issue becomes paramount. Consider the impact of changing tenants once every year; extra management costs, advertising and the cost of a vacant property for one or more weeks.

Consider the advantages of various types of tenants. For example, families may not be considered the ideal prospect for a rental property, yet they can be excellent long-term tenants, particularly where children are enrolled in local schools.

When weighing up the merits of building an investment property, consider the following:

  • Is public transport convenient?
  • Are there shops close by?
  • Is there existing demand for rentals in the area you plan to purchase? And what is the average rental return?
  • Who is living and renting in the area already? And is the property appropriate to the local demographic?
  • Does the property have adequate facilities? (including storage, security, a second bathroom for families etc)
  • Are there reasons for tenants to want to stay long term? For example, respected local schools.

PROPERTY INVESTMENT STRATEGY ELEMENT 3: FINANCE

Although we list finance of  investment property as the third element, it should generally be one of the first things an investor considers when contemplating an investment property. Investors are well advised to know their budget and limits, or even have the financing of an investment property pre-approved, before researching potential investment properties.

Knowing how much you can afford during investment property financing will help to narrow your property search. And the amount of spare cash flow you will have will influence what type of property you should invest in. For example, if you require a high rental yield to cover a large proportion of your mortgage repayments, you may find you are restricted to looking at apartments, semi-detached buildings or houses in regional areas that will deliver high rental yield. Conversely, if you can afford a deficit between your repayments and the rent you receive from the property, you are afforded greater flexibility in seeking properties that may deliver long-term capital growth for property investment finance.

The benefit of borrowing to invest for investment property financing

Borrowing money to invest (leveraging) has risks – mainly the risk you can’t afford to pay back your lender. However, borrowing smartly can also effectively increase the returns from property investments, in two ways:

1. Leveraging can multiply the gain of your initial cash deposit

In simple terms, leveraging an investment means you can invest in more than would otherwise be possible, and if your investment goes up in value, the return on your initial deposit is multiplied, as demonstrated in the following table.

PROPERTY SHARES
Deposit $40,000 Deposit $40,000
Bank will loan 90% ($360,000) Bank will loan 60% ($60,000)
Assume $400,000 Property @ 7% capital growth $100,000 Shares @ 9% capital growth
Return of $28,000 Return of $9,000
70% ROI 22.5% ROI
 

 

 

 

 

 

 

2. Leveraging can improve after-tax results

While borrowing involves paying interest, this and other loan costs are tax deductible. Where the overall cost of an investment property exceeds the income received from rent – in other words, negative gearing – it can result in the investor having a lower overall taxable income. The benefit can be a significant tax saving – although the overall value of negative gearing depends on each individual’s circumstances.

Negative gearing

Negative gearing is regarded by many people as the ultimate goal in property investment finance, but this is not necessarily the case for everyone.

Not all investment properties are negatively geared. If your investment property earns more in rent than the overall cost of the finance, it is effectively positively geared – and you will need to pay tax on the difference. This is not necessarily a bad thing – it depends on your financial situation, how much cash flow you require and how much the property gains in capital growth before you sell it. If you are unsure, it is always beneficial to seek professional advice on matters relating to tax.

Most properties, however, will be negatively geared, because the cost of servicing a loan is usually greater than the rent received. The following example explains negative gearing in a simple way.

Negative gearing: an example

An investor purchases a unit for $300,000, depositing $50,000 of their own money and borrowing the remaining $250,000 for the finance of an investment property.

The interest rate on the loan is 7% p.a., or $17,500 for one year, while the weekly rent is $300, or $15,600 a year.
 Ongoing costs including rates, water, insurance and maintenance are $2,600 each year.

Overall income for the year will be $13,000 (rent minus ongoing costs). And because annual repayments are $17,500, this results in a ‘loss’ on the property of $4,500. This investor’s annual taxable income is effectively reduced by the amount of the loss, which will result in less tax owed to the Australian Tax Office (depending on how much other income they earn from salary and other investments).

Different finance arrangements for different investors

There are a variety of loan types available to the investor looking at investment property financing. Some of the considerations include:

  • Interest only vs. principal and interest: While owner-occupiers seek to repay the principal on their loan, investors often choose interest-only loans and repay only the interest, which is tax deductible. The principal amount can then be repaid when the property is sold.
  • Fixed vs. variable: Fixed rates provide certainty of repayments, which may be valuable for investors who have a high level of gearing or minimal spare cash flow. However, locking into a long-term fixed rate may be disadvantageous where interest rates are steady or go down. Split loans, which combine both fixed and variable elements, are also available.

There are also a number of strategies available to property investors, who are financing an investment property, to either increase cash flow, or improve their overall financial position:

  • Interest in advance: This is a type of loan that allows an investor to pay the following 12 months’ interest in the current financial year, thereby bringing forward these costs and increasing the overall tax deduction.
  • PAYG variation: This strategy can help improve cash flow, where you have a negatively-geared property that will make a ‘loss’. It involves an application to the Australian Tax Office to reduce the amount of tax withheld from your regular salary (paid by your employer), thereby increasing your take-home pay. Rather than receive a lump-sum tax refund at financial year-end, the extra money can be put towards the ongoing cost of repaying your home loan.

The importance of a good financier

Having a sound relationship with a financial planner for financing investment property can provide unique benefits to the property investor, including:

  • faster application and approval times;
  • the potential for greater loan value where the financier has a sound understanding of an individual’s finances;
  • inclusion of rent in the assessment;
  • strategies to defer finance on a new property purchase while you sell a current property; andthe possibility for limited recourse loans, where the debtor has limited claim in the event of a repayment default.

If you would like to learn more about investing in property, downloading our Assist Kit is a great place to start. It’s packed full of great resources to help get you started, or contact one of our property investments specialists, they will be happy to help.

Or if you would like to learn more about financing an investment property , Resolve Finance are an award winning brokerage company with over 14 years’ experience in helping property investors set up and secure the right loan for their situation. As number 9 in The Advisor magazines Top 25 Brokerages, they know precisely what’s needed and when, and can coordinate it all for you. For more information on this topic please contact Resolve Finance at www.resolvefinance.com.au. For further information relating to accounting matters, please contact your Accountant. 

DISCLAIMER: This information is of a general nature only and does not constitute professional advice.  We strongly recommend that you seek your own professional advice in relation to your particular circumstances.