What are the benefits of investing in property?
Property prices are booming across Australia, and more and more Aussie investors are hoping to sink their teeth into the market and secure a potentially high return.
The latest Australian Bureau of Statistics Lending Indicators show that for January 2021, investors made up $6.64 billion worth of new loan commitments (seasonally adjusted). This was an increase of 9.4 per cent over the month – the largest rise since September 2016 – and a 22.7 per cent increase year-on-year.
But what is it about investing in property that’s drawing so many more Aussies? Let’s explore some of the biggest advantages of investing in property in 2021.
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1. Passive income
Passive income often refers to a type of income you earn that does not require a lot of effort to earn, unlike a traditional income at a 9-5 job for example.
Investing in property can be one way to earn a passive income, as it comes when rental payments paid to you by your tenants are greater than your expenses (positively geared property).
A positively geared property earns you a passive income. For example, when you receive $3,000 a month in rental income but only pay $2,300 in its expenses (mortgage repayments including interest). The difference of $700 in this example would be your passive income.
It is possible to earn a passive income from your investment property. You can also access equity if its value grows over time. This is done by either selling the property, accessing the equity via a redraw facility or refinancing your mortgage to a higher loan amount. Keep in mind that with the latter, you will potentially pay more over time through higher interest repayments on a bigger principal.
2. Negative gearing
It’s worth noting that in Australia, if you invest in property and you’re losing money, there may actually be tax advantages. If your rental return is less than your expenses, you may be able to offset any net rental loss in a financial year against your income (your salary or other assets). This may reduce the amount of taxable income you have to pay come tax time.
3. Increase your assets
If you have existing assets, such as stocks, crypto currency, bonds, art or existing property, by investing in property you’re adding to your list of assets. Across your entire investment portfolio, if the property is positively geared, or you sell it at a profit, this may increase your overall return.
Generally speaking, the more you invest and diversify your portfolio, the higher chance you have of growing your money. And if you choose an investment property carefully while assessing the market, the rate of return may be significant.
What are the risks of investing in property?
Just like with any investment type, there is a level of risk involved with investing in property. This may include:
1. Market fluctuations
Just because a housing market may be in a period of upward growth does not mean that this is guaranteed to continue at the same rate or at all. While property investment in Australia is considered a relatively safe investment historically, the market may still fluctuate and your property is not guaranteed a return when it comes to sale time. This is also true of short-term rentals, such as AirBnb, with seasonal fluctuations and economic influences impacting its profitability.
2. Rate fluctuations
Home loan interest rates are influenced by the Reserve Bank of Australia (RBA)’s cash rate as well as the lender’s decision making. If the cash rate were to rise and your investor home loan was paying a variable rate, your interest rate would increase too. This may see investors paying hundreds of dollars more a month in repayments, and tens of thousands over the life of their loan.
Although the RBA has indicated it does not intend to lift rates for years until inflation targets are met, it’s safe to assume that in the future this day will come.
A property may not always be consistently tenable. Whether it’s due to lulls in the market or unexpected tenant activity, you may find your property will have weeks or even months without generating rental income. Further, issues with tenants may arise and properties can face damage that can cost owners considerable amounts in repairs. Do your research around vacancy rates in your property’s suburb before buying.
It’s not just the rare bad tenant you need to keep in mind, but general upkeep, maintenance and repairs. This can be particularly prevalent in older buildings. While tenants are legally required to maintain a level of cleanliness, it is the landlord’s responsibility to fix and repair major issues, such as broken property appliances and damages from wear and tear and/or natural disaster. All of these expenses can add up and decrease the overall profit you earn from a property.
5. Ongoing costs
It’s worth keeping in mind that there are ongoing costs associated with an investment property that may reduce your overall rate of return. This may include:
- Council rates
- Water rates
- Building insurance
- Body corporate fees
- Land tax
- Property management fees
Speaking of taxes, while you may be able to claim tax deductions on expenses, property owners will still have to bear these upfront costs. Further, if the property is positively geared, you’ll need to pay tax on your rental income.
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How do I choose the right investment property?
There is a lot to consider when it comes time to choosing your ideal investment property. Unlike choosing a home to live in, you’re less focused on the “feeling” of the home and more priority should be given to practical factors, such as location and potential growth. Here are some tips when looking for an investment property:
1. Areas of growth
When real estate agencies talk about “up and coming suburbs” they’re usually talking about properties in areas where you may expect capital growth. This can be because of a growing population, a booming local economy, distance to public transport or other infrastructure. You’ll also want to take stock of rental yield trends in a variety of suburbs to identify exactly how these areas are growing.
2. Vacancy rates
To help narrow down your search, keep on top of the latest vacancy rate data in your ideal suburbs. Generally speaking, you’ll want to aim for a suburb with low vacancy rates and a tight rental market, as areas with high vacancy rates may signify not only issues with the suburb, but may result in a greater chance of large gaps between tenants.
3. Low maintenance
As mentioned earlier, there are risks involved with choosing an investment property that requires a lot of ongoing maintenance and upkeep. Unless you plan to add value to the property by renovating, it may be worth considering a turnkey property. Properties with large green spaces or pools also involve a lot of added costs and upkeep, all of which may increase your expenses as a landlord.
4. Speak to the locals
If you think you know where you want to buy, consider reaching out to locals and real estate agents for more detailed information. There are some things that only locals, like a barista at the corner cafe, may know, such as which houses you may not want to buy next to. Then, get in contact with competing real estate agents, let them know you’re looking at similar properties, and see what secrets they’ll let you in on once they know they’re fighting for your business.
5. Plan for the future
It’s not just about past rental yield trends and current vacancy rates, you’ll also need to take stock of potential developments in an area to determine if this may impact your property’s value. Look on government and council websites for detailed information on infrastructure proposals. Tenants can tolerate renovations to other properties on their street, but may be less inclined to live in a house when a new shopping centre is going to be built next to it.
Reduce Home Loans General Manager, Josh Beitz, says “In a competitive market, consider using a buyers’ agent as a way to find and access properties off-market”
What to look for in an investor home loan
When choosing an investor home loan there are several factors to keep in mind that impact the overall cost of the mortgage and therefore return on investment.
For leading investment rates visit Reduce – https://www.reduceloans.com.au/investment-loans/
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Should I aim to pay down my mortgage quickly?
Home loan lenders need borrowers to meet eligibility criteria before they can be approved for a home loan. This helps lower the level of risk that a first home buyer may default on the home loan.
The common advice experts will tell everyday Aussies is to get on top of their debt as quickly as possible. However, when it comes to an investment property mortgage, the advice starts to differ.
On one hand, why would an investor want to worry about making extra repayments on a mortgage for an investment their rental income may cover.
First and foremost, it’s important to decide your intentions with the investment property. If you’re planning on flipping it and selling it in a matter of months or years, then a mortgage is the least of your worries. But if it’s a long term investment designed to be an income-earning asset well into your retirement years, then a home loan becomes more relevant.
Let’s explore the pros and cons of whether an investor should aim to pay down their mortgage quickly, or to take a more relaxed approach.
Benefits of paying off your mortgage quickly
If you’re planning on keeping your investment property for the foreseeable future, then the mortgage attached to it will become a priority. And there are a few key benefits to paying off a mortgage as quickly as possible when you’re an investor with long-term goals.
For example, a hypothetical investor with a $400,000 mortgage at an interest rate of 2.8 per cent (excluding fees) would make repayments of $1,644 a month. But by increasing those repayments by just $150, they could save $26,507 in interest repayments over the life of the loan and shave 4 years, 1 month off of their mortgage.
Further, the longer you pay a mortgage, the more mortgage rate fluctuations you may be subject to. As it stands, interest rates are historically low, but it’s not unreasonable to expect them to rise again in the next 25-30 years of an average mortgage. By aiming to pay off your mortgage as quickly as possible, you’re reducing the amount of interest rate hikes you may be subjected to.
And once your mortgage is paid off in full, you should start earning a significantly higher passive income from rental payments.
Benefits of not rushing to pay mortgage
If you’re planning on flipping a property, then you’re looking to extract the most value from the property as possible. Adding to your expenses by worrying about extra mortgage repayments may not be a priority. In this scenario it’s not uncommon for investors to opt for interest-only repayments on their mortgage as well, as this reduces their expenses considerably.
But if you’re not planning on selling the property right away, there are still advantages to a set and forget approach to mortgage repayments. If your property is positively geared, then the rental income you’re bringing in should be covering these repayments for you and then some. You may then take that extra cash and consider investing it in other avenues.
This may involve something as simple as putting it in a high interest savings account or a term deposit, or you may want to consider investing this money back into the property through renovations. By renovating you may be able to add additional value to the property and boost your capital gain. You may even want to invest that money into other assets, such as stocks and bonds, or even another investment property.
Whichever option you decide, it’s important that you do your research and even consider speaking to a broker about the best approach for your specific financial situation.
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Should I consider short-term or long-term leasing?
Home loan lenders need borrowers to meet eligibility criteria before they can be approved for a home loan. This helps lower the level of risk that a first home buyer may default on the home loan.
Choosing between short-term or long-term rental can be a tricky decision for even the most season of investors.
With the recent increase in short-term rentals, particularly in regional areas due to Covid-19’s impact on overseas and interstate travel, it may be a tempting option for some property owners. But the added security of 6, 12 and even 24 month leases can bring much-needed stability to a property investors’ finances.
Let’s explore some of the benefits of both types of leasing arrangements:
Pros of short-term leasing
- Greater flexibility. One of the major advantages to short-term rentals is the added flexibility it affords property owners. If you want to reserve time for personal use of the property for yourself, family or friends, you’re easily able to.
- Less tenant stress. If you end up in the unfortunate situation of having problem tenants, you’re not tied down to them as you would be with a 6 or 12 month lease. Plus, as you’ll be cleaning and maintaining the property after every stay, you may be more likely to avoid urgent repairs or avoid problems from prolonged damage.
- Secure payment. Some short-term leasing platforms, like AirBnB, ensure owners are paid ahead of the stay. For those who’ve struggled with tenants not paying rent on time, this can be a considerable benefit.
- Greater profit. In some instances, short-term rentals can earn owners a greater profit than long term. Short-term rental website, Guesty, reported that this rental type may bring in around “30 per cent higher profits” than long-term rentals.
Pros of long-term leasing
- Security. The biggest advantage to long-term rentals is the greater stability and security it affords. You can rely on the income you earn from tenants for an ongoing period of time and unlike short-term rentals, you won’t have to worry about seasonal fluctuations with travelers.
- Simplicity. Having a successful short-term rental involves a level of hospitality and upkeep that some property owners may want to avoid. There is simplicity in long-term rental as there is less constant management involved.
- Less upkeep. Tenants are legally required to maintain a level of cleanliness equal to the condition of the property at the start of the tenancy. Unlike short-term rental, you won’t need to come in and clean and perform basic maintenance on the property yourself.
- Pay fewer bills. Long-term tenants are responsible for utility payments, such as gas, water and electricity bills. Unlike a short-term rental, you can avoid this costly ongoing expense.
What is Negative Gearing and how does it affect me?
When it comes to property investment in Australia, a term that you may have come across a lot is negative gearing.
Put simply, negative gearing describes a situation in which an investors rental income does not cover the cost of its expenses, including interest payments.
The reason this topic is so prevalent in Australia, is that investors are able to offset the net rental loss against their income (salary or other assets). An investor may be able to reduce their taxable income for the financial year(s) they experienced a net rental loss thanks to their negatively geared property.
No investor sets out to lose money on their property. Perhaps they’ve found themselves in an unexpected loss position due to emergency repairs, gaps in tenancy or higher expenses than usual.
However, investors are willing to negatively gear a property when this happens for the aforementioned tax benefits, as well as the expectation that the capital gain (profit earned on sale of asset minus cost of asset) will offset this loss.
While capital gain is not guaranteed (as with any investment) the current housing market conditions mean that more property investors may expect a lower risk of a loss when investing in property.
CoreLogic figures for 2020 found that even with the impacts of Covid-19, capital city dwelling values ended the year on an upward trajectory. So, depending on a range of factors including location and market fluctuations, property investors in Australia may feel less uncertainty about whether their investment may increase in value compared to other investment options.
For more information on how tax works for investment properties, please visit the Australian Taxation Office (ATO).
Mark Chapman – Director of Tax Communications at HRBlock “The tax deductibility of interest is what makes property such an attractive investment for many because it is a key component in ‘negative gearing’ – the ability to offset losses against other income. Many properties are negatively geared. Really, negative gearing is a “win:win” situation – rents are low enough for renters to afford while the investor makes a tax loss which can be offset against other income. In addition to interest relating to the property acquisition, you can also claim a deduction for interest on loans taken out to carry out renovations, purchase depreciating assets (for example, furniture), or make repairs or carry out maintenance.”
How can I avoid choosing a “lemon” as an investment?
There are a few important factors to keep in mind before you apply for your first home loan or make an offer on a property. Here are some of the most common mistakes first home buyers make and how to avoid them:
As with any asset, there’s a risk that fraud, scamming or negligence may occur from developers of off-the-plan properties or new buildings. And there’s been a growing list of developers ordered to fix serious construction faults and damages over the last few years, such as Sydney’s Opal and Mascot towers.
Unfortunately, it’s challenging for buyers to ascertain whether a new apartment block, for example, has serious issues before you’ve made an offer. In fact, many major defects may only surface a few years down the track. You’re put in a position of needing to trust the professionalism of the builders, engineers and certifiers, and this will always incur a level of risk.
With this in mind, before you consider purchasing a property for investment you’ll want to ensure you’ve done your due diligence. The difficult part is that unless you’re purchasing an existing dwelling, this is difficult to do so.
For New South Wales specifically, the recent increase in these events has led to a new Building Commissioner being appointed to raise standards in the states’ construction industry, according to Domain. Thankfully, they’ve already had a “major impact” on the standard of projects across New South Wales. Hopefully moving forward, those interested in investing in off-the-plan properties or new buildings will see a much more reliable environment with reduced risk of negligence.
If you’re considering investing in an existing dwelling, there is something you can do to reduce this potential risk: order your own inspections.
Even if the current owner of a dwelling has paid for a professional inspection, this doesn’t mean you shouldn’t get an independent opinion. Seek out your own professional to inspect the property for damages and faults as well as pests and ensure you choose someone not just recommended by the current owner.
An independent investigation can provide you with a thorough inspection and assessment of the existing issues with a property. Minor faults may be fixable, but major ones may not only influence the value of the property but whether you choose to purchase it. No investor wants to sink tens of thousands of dollars, or run into unexpected problems with a property.
Why should I invest in property?
There’s a reason the safe opinion in life is colloquially called “safe as houses”. In terms of investment options, property is considered a less volatile option than other high risk investments, like stocks, bonds and even crypto currency.
How much deposit do I need for an investment property in Australia?
As a general rule of thumb, it is recommended that you save a deposit of at least 20 per cent before applying for any home loan. This allows you to avoid paying costly lender’s mortgage insurance. Deposits of 10% can be accepted but additional costs may apply.
What type of investment property should I buy?
Making a choice about your first investment property is highly personal, will differ for every Australian and should not be taken lightly. Weigh up all your options, including the affordability of apartments over houses and strata fees versus council rates. Do your research into the suburb, neighbourhood, vacancy rates and rental yield growth before making a decision.
Can I get a mortgage based on rental income?
Generally speaking, lenders will take 80% of your rental income into consideration, as well as other income sources like your salary and other assets, to determine your borrowing power.
I’m from overseas, can invest property in Australia?
There are rules and regulations around foreign buyers investing in Australian property. Foreign buyers are limited to investing in new dwellings, off-the-plan properties under construction, or vacant land with a view to development.
They must also apply to the Foreign Investment Review Board (FIRB) for approval for their investment. There are also fees owed to the FIRB on top of your purchase, but are dependent on the property’s value.
Do I need a larger deposit for an investment property?
Generally speaking, no. But as investors may have stricter eligibility requirements to meet, it does not hurt to have a larger deposit or show a greater level of savings when applying for an investment loan.
Are there extra fees involved with investing?
There may be some additional costs involved with investing in property, such as property management fees, landlord’s insurance, accountant fees and paying for a depreciation schedule to see where you may claim tax deductions from your investment.
What are the tax benefits for property investing in Australia?
The major tax benefits for property investing include negative gearing, depreciation, capital gains tax exemptions, claiming mortgage interest as a tax deductible expense and avoiding paying tax on funds withdrawn through an equity loan.
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