Pros and cons of building an investment property

Pros and cons of building an investment property
We'll go over the pros and cons of buying vs building an investment property and how you can get the right loan when you're ready to begin construction.
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If you decide to go down the investment property route, you've got two options: you can either buy an existing investment property (which is the more common option) or you can construct a new one. 

If you choose to build an investment property - either on vacant land or by knocking down an existing building - then you should be aware of the pros and cons of doing so. 

Advantages of building over buying 

They're customisable 

If you've got a flair for design, or just liked playing computer game The Sims, building a new investment property can let you tailor the new home to the market and to your own preferences, unlike an existing property where you're limited to what's already there (unless you decide to knock it down and rebuild).

Doing your research and talking to real estate agents and architects can help you gain a thorough understanding of what kind of property the market is clamouring for right now, which can boost the home's value and rental yield. 

Depreciation is tax-deductible 

There's a number of deductions you can claim for investment properties, but newly built properties also let you claim the depreciation on internal fixtures and fittings (such as blinds), which can reduce your taxable income. See a professional accountant for anything tax-related. 

Building an investment property can be cheaper buying an existing property 

Although not always the case, getting a good land and building deal could result in the overall price being cheaper than buying an existing property.

There are a number of reasons why this is the case, but one reason is a lot of people aren't willing to go through the task of getting the house designed and built - they'd rather get straight into it. This is only the case for the right property, so don't assume you'll automatically pay less. 

You can build equity instantly 

Depending on how good of a job you've done purchasing the right land and building an attractive property, you can go back to your lender after everything is done and get the property re-valued. If the home is re-valued to a price that's higher than the initial value during your application (more on this later), you have instantly added some equity to the property.

Related: Understanding equity in your home

Disadvantages of building over buying

Locations are limited

This goes without saying, but how many empty blocks of land do you drive past in any suburb in major cities? This might not be as much of an issue in rural areas, but land is pretty limited in most established areas, so you might have to take what you can get. 

The alternative is to knock down an existing property or look further out if you can't find one in a good area, but neither of these might be preferable to you. So you have to look hard to find a vacant block in a desirable area. 

Other developments can harm your property's value 

In newly-established areas, there's always the chance a big apartment block could go up in front of yours, blocking its view and lowering its price. Or maybe some undesirable businesses open nearby, or a bunch of the new neighbours start defaulting on their mortgages. 

In addition, too much supply in the area (lots of new houses) can also lower the value of your house since price tends to be inversely related to supply. None of this is guaranteed, but it's worth thinking about. 

Your budget could blow out 

As Murphy's Law says, "anything that can go wrong, will go wrong". You might have a set budget for constructing your home, but how often does everything go 100% to plan?

You might be able to get a fixed contract from your builders so you pay a fixed amount of money for construction, but there are still other costs that can be added on, not to mention the initial time frame can be extended too. You never know when it might rain (spoiler alert: often). 

It can involve a lot of work

Obviously, there's more work involved in building a house from scratch than just buying an existing one: you have to speak to architects, builders, electricians, plumbers, painters...the list goes in. 

Most of this should already be taken care of when you buy an already-built house.

You get no rental income until it's done 

Houses take a while to get built - a minimum of a few months, usually more than six months or even a year. This is all time you're making loan repayments without earning a rental income when you otherwise could be if the house already existed. 

To get a loan for building a new property you usually don't get a regular home loan - you can get what's called a construction loan, which is slightly different.

What is a construction home loan? 

A construction loan is a type of short-term home loan used to fund the cost of building a new property. They usually last for about as long as it takes for the home to be completely constructed, and when the loan term is up, you convert to an "end loan", which is a regular mortgage.

You might be able to use a standard home loan for building a new house if you have enough equity in an existing property, but you probably won't have any if this is your first property. 

How do construction loans work?  

Repayments on a construction loan are interest-only, before reverting to principal-and-interest upon completion, unless otherwise agreed.

Unlike a home loan, construction loans cover the expenses you incur as they occur. uses a six-stage process: 

Stage Typical Components
Deposit Paid to the builder to commence work
Base Concrete slab complete or footings and base brickwork complete
Frame House frame complete and approved by inspector
Lockup Windows/doors, roofing, brickwork, insulation
Fixing Plaster, kitchen cupboards, appliances, bathroom, toilet, laundry fittings/tiling, heating, fixing/internal doors, etc., plumbing, electrical, painting
Practical Completion Fencing, site clean-up, final payment to builder

These stages are called the "progressive draw-down", and you're only charged interest on the portion of the loan that's been borrowed.

If you've been approved for a $500,000 construction loan, but that first 'base' stage costs $100,000, the lender will only charge you interest on that $100,000. 

How to apply for a construction loan 

You'll need all the usual stuff required for any home loan application, like:

  • Identification 
  • Employment information 
  • Payslips and pay summaries
  • Lists of assets and liabilities 
  • A savings history 

But in addition to all of this, you'll need to present professional plans for the property, including an expected valuation. Having a larger deposit can help too. 

Tags: building an investment property | construction loan

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