What to look for in an investment property

How to choose the right investment property for you

The main goal of an investment property is to grow wealth, by cashing in on capital growth and passive income. This means what you are looking for may be different to a home you may buy with the intention of living in.

If you are in a position to apply for an investment loan to buy a rental property, great work. But before you do, here’s a helpful guide into what factors to consider before you buy.

1. Have a strategy

When planning for any big purchase, whether it be a car, a home, or an investment property, you need to have a strategy for how you are going to save, buy and maintain your investment.

Buying an investment property needs to be driven by a strategy. Ask yourself, are you focusing on capital growth, rental yield, or negative gearing? (just to name a few).

Researching these strategies, and coupling it with your own goals will help the research and buying process.

Helpful guide: Investment Property Checklist

2. Understand cash flow

Cash flow is the difference between the rental income of an investment property and its expenses. It basically tells a real estate investor if they are making money and how much of it is made.

Understanding cash flow can be the difference between a solid long-term investment and a stressful and expensive situation.

Positive cash flow

Whether you crunch the numbers yourself or trust an accountant to do this for you, the number one rule is: ‘Don’t buy a property without knowing what the cash flow is’.

Firstly, ensure you understand all the costs of holding the property, including rates, body corporate fees, insurance and property management fees. This will allow you to calculate the interest, estimate depreciation and give you an idea of the cash flow for the property.

It is important to make sure you have inspected the property, as this could help you find out about any big maintenance or structural repairs needed.

If you are stretching your savings to buy an investment property, getting a property you can positively gear is going to be better for your situation.

Often the sellers will have made cash flow predictions, make sure you check these and do your own calculations before buying.

Negative cash flow

Oftentimes investment properties generate negative cash flow. When this happens, you need to put in additional money from your own pocket to cover the difference between the total cost of the property (interest repayments, rates, insurance, maintenance, etc.) and the total income (rent and tax breaks).

Some investors are happy to do this because they expect a long-term profit. These investors expect these ‘top-ups’ to go down over time as the rent increases with inflation.

It is important to factor into this net loss the possibility of not having tenants in your investment property 52 weeks of the year, management costs if you aren’t managing the property yourself, and any repairs or maintenance costs.

Negatively geared properties come with tax benefits, so be sure to learn about these before you buy.

3. Look closely at the suburbs you’re buying in

Location will always be the driving force determining whether people would love to buy or rent a property. It’s important for them to be close to their work, to the CBD, to public transport, good schools, hospitals, shopping hubs, and parks.

If your property is close to a good school it’s likely that you will have a young family as your tenants. If your property is near lifestyle amenities it’s likely that you’re going to have a young professional as your tenant.

Make sure to factor in the location and amenities that are important to the demographic you would ideally like for your tenants.

Review capital growth

Capital growth is the increase in the value of the property over time.

One helpful growth trend indicator is the median sale price for the suburb and seeing if it has increased over the past few years.

Median means the average house price, and tracking it over recent years helps indicate if the suburb is growing.

It is also important to factor in what is influencing this growth, such as demographic information, nearby schools, shops, facilities etc.

Location of a property will often influence an investor more than the quality of the dwelling itself.

• Jobs. What’s the employment situation like in the area?

• Schools

• Shops

• Transport, both public and access to freeways.

• Recreational activities like parks, sporting facilities etc.

This information could help you build a picture of what your capital gains (ie: how much you gain financially based on the capital growth of the property) may look like over time.

Take a look at some of the best suburbs for capital growth in each major city:

• Top suburbs for capital growth in Sydney

• Top suburbs for capital growth in Melbourne

• Top suburbs for capital growth in Brisbane

Rental yields

If you're a property investor, you're going to want to make a return. That's where understanding rental income and yields can be helpful. But what is it? And, how is it calculated?

Rental yield is the profit margin you make each year from your investment property. It measures the gap between your costs, like repairs, maintenance, and depreciation, and the income you receive over the year from your tenants.

It allows you to review how your current investment property is performing and whether buying an investment property in a certain suburb is going to be a good investment.

Whether you have an investment property already or are looking to buy one, understanding potential income returns is a crucial part of assessing whether you're investment is going to be financially successful.

There are two types of rental yield: gross and net. You can find out how to calculate each below:

Calculating gross rental yield

Gross rental yield measures your annual rental income with the property value as a percentage.

To calculate:

1. Add up your rental income for the year to get your total annual rent.

2. Divide your annual rent by the value of your property.

3. Multiply that figure by 100 to show your gross yield as a percentage.

Here's the calculation in action. Let's say you made $30,000 in rental income and your property is worth $600,000. Using the calculation that's $30,000 divided by $600,000 multiplied by 100 equals a 5% gross rental yield.

Calculating net rental yield

Net rental yield is similar but takes into account all the expenses you incurred in the year. It's considered a more accurate representation of your investment return.

To calculate:

1. Add all of the expenses you incurred from owning the property.

2. Add up your rental income for the year to get your total annual rent.

3. Subtract the annual expenses from the annual rent.

4. Divide your annual rent by the value of your property.

5. Multiply that figure by 100 to show your net yield as a percentage.

Rental expenses you may have incurred include depreciation, insurance, repairs and maintenance, body corporate fees, property manager fees, and council rates.

Let's say you made $30,000 in rental income and your property is worth $600,000. But you also had to fork out $2,000 for repairs, $3,000 for insurance, and $1,000 in body corporate fees, so your expenses total $6,000.

So $30,000 (income) minus $6,000 (expenses) divided by $600,000 (property value) multiplied by 100 equals a 4% rental yield.

What is a good rental yield for an investment property?

There's no blanket rule on what is a good rental yield as expected returns differ on where your investment property is located. Obviously, you always want to have a positive return on your investment otherwise you'd be losing money.

Typically, if you buy in a metropolitan area like a capital city, yields above 3% are considered a good return. If your property is in a regional area, a rental yield above 5% is a well-performing investment.

Vacancy rates

Investment properties are assets, and assets should produce a regular income stream. Investment grade properties offer a steady cash flow by having consistent strong demand and low vacancy rate.

Your real estate agent can provide insight into the rental demand in general and what tenants are looking for.

Investors should also look at the vacancy rate of the suburb they are targeting. Generally, the lower the vacancy rate is, the better for investors as it can be an early indicator of the potential for future capital growth.

On the other hand, a high vacancy rate can be an indication of oversupply (like a bunch of new high rises) which means investors will struggle to get their property rented out because they will all be competing for the same pool of tenants.

It’s widely known that the industry standard of a market imbalance is a vacancy rate of around 3%, so investors should aim for suburbs with a vacancy rate below that.

4. Type of property - apartment, townhouse, house

The type of property will be a key to your success renting it out. For example, a house with a large yard may be attractive to a family renting, however may be too much upkeep for an elderly couple.

Similarly, an apartment may be several floors up, if it doesn’t have elevator access it may deter older tenants, but at the same time may attract students.

The type of property goes a long way to securing tenants to pay rent, and these factors all need to be considered before you buy. You need to include in your strategy who you want to rent out your property, whilst also evaluating your own personal goals.

Do you want to live in the property one day? Or is it purely for capital investment?

Your investment strategy needs to drive these decisions, so that your investment provides you with long term gains.

Need a bit more help? Read our guide to investing in a house vs apartment.

5. Age of the property, property features, expected maintenance

Despite the fact you won’t be living in the property, to give yourself the best chance of finding consistent tenants, you need to consider the features of the property.

Features like a garage, additional bathrooms, or a home office space will go a long way in increasing the property’s rental value both in rental yield and tenant security.

Other factors include things like air conditioning, natural light, outdoor entertainment areas like decks, patios or porches, windows. If it’s an apartment does it have parking? Is it multiple floors up? These factors will influence the sort of tenant you may be able to get in the property.

The age of the property also will be a factor for you to consider. Older properties may need more regular maintenance, repairs, upgrades etc.

Investment properties typically involve ongoing expenses, and it’s good to plan for that, but you don’t want to buy a property that is a drain on your finances through maintenance costs. 

6. Does it suit your investment strategy?

It’s important to make a smart decision when choosing an investment grade property. It also pays to have a good investment property loan that is suitable to your needs and financial status.

If you are ready to get started on your investment journey, call us to chat to a friendly lending specialist or chat to us online or check out our competitive low-interest investment home loans.

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