RECORD low interest rates and rising house prices mean buying into bricks and mortar is an enticing proposition for investors at the moment. Plus, many first homebuyers are looking to use an investment property as a way to hoist a foot onto the property ladder, before picking up a place of their own down the track … or living in the investment property when they can afford it.
We think that property can be a great way to grow your wealth over the long-term as long as you’re smart about it and don’t expect to become a mogul overnight.
But don’t be fooled, buying an investment property is very different to buying a place to live.
If you’re thinking about becoming a property investor, here’s what you need to know.
You’re buying for a different reason
Buying your own property is full of personal, emotional decisions. Can this place support my family for the next five to ten years? Are there good schools nearby for the kids? Do I actually like it?
An investment property purchase, on the other hand, should be completely objective. You’ll want to make sure the property is reasonably priced, with a strong rental yield and good potential for long-term capital growth.
Also consider whether the property will appeal to the types of tenants that are likely to want to live in the area, not whether you’d want to live there or not.
The financial benefits
Loans taken out to buy investment properties are generally considered ‘good debt’, as they generate income, provide tax benefits and the property can also increase in value over time.
On the other hand, loans for a property that you live in yourself are generally thought of as ‘bad debts’, as they don’t generate an income for you.
When you borrow money to invest in property, the borrowing costs and other costs of owning the property, including depreciation, can be offset against the rental income you receive.
If the income from the property is less than the cost of the loan (interest repayments and other property expenses), then the difference can also be claimed as a tax deduction against other income in a process known as negative gearing.
Just keep in mind that negative gearing isn’t a guarantee of making money. It relies on capital growth to offset the losses you’re making on the investment, so don’t be blinded by the promise of a tax deduction.
While there may be a tax deduction down the track there is a cash ‘negative’ every month which you need to cover.
Buying an investment property has many risks, some of which are similar to buying a place to live.
For example, interest rate are at record lows now, but if they were to rise quickly and you have a variable loan on the investment, your borrowing costs would increase dramatically.
Remember also if you can’t find a tenant for whatever reason, you’ll have to fork out for the entire mortgage by yourself. And a dodgy tenant can ruin both the property and the financial return.
Thirdly, many people don’t realise that investing all of your money into a property means that your investments are not well diversified, and this is doubly true if you already own your own home.
Finally, if you’ve only watched the market for a few years, you’d be forgiven for thinking that property values only ever go up.
But the reality is property prices can fall, and in some markets you might find it difficult to sell your place at all. You could even end up owing more money to the bank than your property is worth.
Despite these risks, there are a lot of potential upsides to buying an investment property if you approach it in a prudent way.
As always with any major investment, do your research, know what you’re getting into and don’t stretch yourself too thin.