How to choose the right investment property

If you’ve saved and earned your way to a position where an investment property is viable, you’re in a great position. Your work isn’t done though. Now you’ll need to make sure you pick the right property, which can be equally difficult. This is a guide to what you’ll need to consider when browsing the market and making your decision.

1. Understand what you are investing in

It’s important to think of an investment property in investment rather than property terms. This is essentially a business venture to generate income, so you need to make sure you understand the basics on the financial side.

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, perhaps from capital gains as the property increasing in value, or 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. You can normally deduct losses you make on your investment property from your taxable income.

Rental yield

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.

Capital gains

Capital gains are the money you make from your investment property increasing in value. It refers to the difference between the current value of your property and the price you bought it for (hopefully this is a positive number!) Once you eventually sell the investment property, these become realised capital gains.

You’ll need to take inflation into account when it comes to capital gains. Your property may have gained in nominal value (be worth a higher dollar amount than your purchase price), but due to inflation, in real terms may have actually decreased in value. Consider someone who bought a property for $400,000 in 2010, and sold it for $450,000 in 2021. This might seem like a capital gains, but according to the RBA inflation calculator, $400,000 in 2010 is actually worth $497,086 in 2021, so you have lost real value.

2. Look closely at where you are buying in

Once you’ve got the basics down, it’s time to apply them to find the right investment property. Location might be the most important aspect of how much value you can gain from a property. For higher returns on your investment, you want a property that is desirable to live in, so they are prepared to pay more in rent and thus increase your rental yield. In general, suburbs closer to the CBD are more in demand, but this can vary, so it’s important to do your research on any area you are looking at.

Proximity to any of the following could make your property more attractive to tenants:

• Schools
• Public Transport
• Shops
• Cafes and restaurants
• Parks or nature reserves

Look out for suburbs with development scheduled, as you might be able to get in before it becomes more desirable and thus see good returns. Another good strategy is to seek out emerging suburbs that might have expanding populations. These normally have the highest potential for growth.

If you would like to make your decision based on data, some good metrics to consider regarding suburbs are vacancy rates, average rental yields and average property prices. Low vacancy rates are a positive as they indicate that a suburb is in demand, which is a good indicator that property values will increase.

Take a look at some of the best suburbs for capital growth in Australia’s biggest cities:

• Top suburbs for capital growth in Sydney
• Top suburbs for capital growth in Melbourne
• Top suburbs for capital growth in Brisbane

3. Work out which type of property you are after

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 several floors up may deter older tenants, but at the same time may attract students.

If you have a suburb in mind, the demographics of that suburb will determine what sort of tenants you should try to be attracting. In a suburb surrounding a university (St Lucia in Brisbane, for example), you would expect tenants to mostly be students, so you might decide a smaller apartment would still potentially be in demand.

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

4. Consider the 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 enough parking spaces? Is it several 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. 

5. 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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