What You Need to Know About Investing in a Rental Property

Buying a rental property as an investment is a major milestone for many Australians both young and old. A good investment property will increase your wealth and provide security for your future. A common misconception surrounding investment properties however is that they are an easy first step towards financial success and guaranteed to bring about positive returns. This is somewhat true, but only if you’re smart enough and work hard enough to bring it about.

Many factors must be taken into account before purchasing a rental property for the purpose of renting it out to ensure that you don’t end up in the gutter of the street you’ve brought into. Before you dive head first into the property investment pool, it’s critical that you first check the depth. Read on to find out what you need to know about investing in a rental property.

Rental Property Is a Safe Investment, but It Requires Research and Market Knowledge

Investing in real estate is arguably the most widespread strategy for wealth creation in Australia. It’s not as sensitive to minor market fluctuations as shares or start-ups, and property can be quite easily attained if you have the capital. This makes it a comparably safe investment.

Its objective nature however means that while on one hand you may be able to snag a bargain; there is also risk that you may overpay for it. Patience and knowledge is the key to buying an investment property for rental purposes and getting it at great value for money. Some of the benefits of investing in a rental property include:

  • Property is less volatile than shares or other investments.
  • You can earn a rental income if the property is tenanted
  • If your property increases in value, you will benefit from a capital gain when you sell
  • Most property expenses can be offset against rental income, for tax purposes
  • You’re investing in something you can see and touch

It’s Much Easier to Buy An Investment Property if you Have a Plan

For an inexperienced property investor your best option is to purchase for a steady rental return. By working out a strategy first you’ll soon be able discover where the best places to buy are located. This includes looking at vacancy rates and potential for growth within your area of interest. You should never purchase property in a town or suburb that you’re not familiar with.

If you do find a property that you like or a locale that has potential but you’re unsure of values, we suggest talking to a few agents and getting your hands on some recent sales. It’s also your responsibility before investing in a rental property to know all risks involved.

BUT, There Are Risks Involved and It’s Your Job to Know Them

Like all investments, real estate does carry inherent risks. Thorough planning, a reliable property manager and a healthy dose of common sense can mitigate these. Sometimes though, all the preparation in the world won’t save you from the many pitfalls that come with rental properties. Consider the following:

  • Your property could sit vacant between tenancies, lowering your overall return
  • You could be subject to excess repair costs if a troublesome tenant damages the property
  • You could incur legal expenses should you need to evict a bad tenant
  • You will have to pay a property management fee if you choose to employ one
  • You may find it hard to liquidate an investment property if you require cash quickly

The cost of getting into property is also quite high when compared to other investment such as shares. This makes is doubly important to know how and where you can save money, thereby improving your profit margins.

There Are Generous Tax Concessions That You Can Take Advantage Of

When it comes to investing in a rental property it’s essential you know how to take advantage of the many tax concessions available to you. One of the main tax benefits as it applies to rental property investments is negative gearing, which is when the gross rental income of your property is less than the total costs involved with owing the property.

This means that if you earn other taxable income, you are actually taking a loss on the property. The advantage of negative gearing is that the loss can be used to reduce the amount of tax on other earnings.

Another aspect relating to tax on rental properties is positive gearing. Positive gearing occurs when the total rental income of a property is more than the total costs involved with owning the property. A positively geared property gives you a secondary income, which is desirable, however it is taxed accordingly. Positively geared investments can also deliver a capital gain if its value increases when it comes time to sell.

You Will Need to Find a Loan That Suits Your Investment Goals

These days there are a number of investment only loans available, all spruiking various benefits, which may or may not be applicable to your situation.

Finding a loan that suits your investment goals is one way you can make buying a rental property easier and safer. Loans that offer interest only repayments, loans that you can split and loans that allow you to take a repayment break all have obvious rewards. If you take the time to find a loan that’s tailored to your property investment needs, you will undoubtedly save yourself unnecessary stress or fees further down the track.

Consider Hiring a Property Manager – They’re More Than Worth Their Fee

As tempting as it may be to save a few hundred dollars a year on the services of a property manager, take it from us they’re worth every cent. Not only do they live and breathe property management, they can also take care of all those time consuming tasks associated with tenants and rental properties.

The fee for a property manager is also negligible at the end of the day, as it can be claimed as a tax deductible. In addition, it’s usually a highly competitive rate in a hot market. Think about them as another way to limit the amount of time you spend on non-moneymaking activities and reduce all the pressure that goes with being a DIY manager.

Never Underestimate the Benefits of Buying in a Great Location

One phrase that’s trumpeted by real estate aficionados around the world is ‘Location, location, location’. The main reason why it’s such a popular catchcry for property investors is that a good quality location will ensure vacancy is minimised, high rental rates and a better calibre tenant. In a good neighbourhood or town your house will be occupied, cared for and the rent will be paid on time. In determining location, ask yourself these questions:

  • Are amenities convenient? Parks, shopping, transit, walking/biking trails, businesses etc.
  • Have property values increased, stayed the same or decreased over the past few years?
  • What are other rental properties in the area renting for?
  • Is the area predominantly rental or owner-occupied?
  • Is this home in a good, desirable school district?

There Are a Number of Ongoing Costs Involved That Will Determine Affordability

Buying a property for the purpose of renting it out isn’t a once off transaction. There are many costs that must be factored in during the purchasing process in order to determine affordability. Before jumping into the property investment market, you’ll need to discern whether or not your finances can handle this type of commitment.

A health check of your cash flow is critical. Do you have a steady income? Do you have a rainy day fund? Are your debts paid off? And will you still be able to meet your retirement-saving goals? A financial planner can help you a great deal here, and talking everything over with them will help you invest in a rental property with clear limitations.

With their help, you’ll also learn how to calculate all of the potential expenses you may face, including those that are only once-in-a-decade (new appliances, a new roof, new carpet and paint). Remember it’s also better to estimate all costings AFTER tax. This way you can get a better overview of just how much you’re going to be spending.

It’s Easy to Become Emotionally Attached ¬– Keep an Objective Perspective!

Buying an investment property requires an almost robot like analytical approach. This is to say that you should never try to picture yourself living in the home or apartment if you’re only investing in a rental property that’s going to be tenanted anyway.

With all the renovation shows on TV these days it’s easy to be swept up in the glory and perceived simplicity of finding a property you love, renovating, then renting or flipping for a profit. At the end of the day, it is an investment property, and you’re buying it for the rental returns and the possibility of capital growth. Keep that at the forefront of your mind when you’re viewing properties and you’ll be much better off.

Investing in a Rental Property Is a Long-Term Strategy

Remember that investing in a rental property is a long-term strategy, and you should not rely on the hope that a tenant will continue to renew the lease or that property prices are going to rise straight away.

The longer you can afford to commit to a property the better. As you build up equity in it through your rent, only then can you consider purchasing a second investment property. Try not to get too avaricious and always strive to find the balance between financial stability and the capacity to enjoy life.

 

Resources

  1. Glen Spratt, Mortgage Port, “Our Top 10 Tips for Buying an Investment Property”: http://www.mortgageport.com.au/information-and-tips/our-top-10-tips-for-buying-an-investment-property/
  2. Nila Sweeney, “10 Questions You Must Ask Before You Invest In A Rental Property”: https://www.yourmortgage.com.au/article/10-questions-you-must-ask-before-you-invest-in-a-rental-property-144773.aspx
  3. Dana Anspach, 6 August 2016, “Things You Must Know Before You Buy Rental Property”: https://www.thebalance.com/before-buying-rental-property-2388762
  4. Sue Williams, Domain.com, 9 August 2016, “10 things to look for in an investment property”: https://www.domain.com.au/news/10-things-to-look-for-in-an-investment-property-20160804-gqkors/
  5. Jay Jenkins, The Motley Fool, 2 August 2014, “4 Things to Know Before Buying a Rental Property”: https://www.fool.com/investing/general/2014/08/02/4-things-to-know-before-buying-a-rental-property.aspx
  6. Moira Lawler, LearnVest, 13 May 2016, “6 Important Things You Should Consider Before Buying An Income Property”: https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/learnvest/2016/05/13/6-important-things-you-should-consider-before-buying-an-income-property

 

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