Beginner’s guide to buying investment properties in Australia
If you have earned and saved your way to a position where an investment property is viable, you are in a great spot. Your work is not done yet though. Now it is time to make sure you pick the right property, which can be equally difficult. This is a guide to the things you will need to consider when looking at properties for sale, and making your decision.
What is an investment property and how do they make money?
Any property that is bought for the primary purpose of generating money rather than occupancy is an investment property. It is a business venture, so you need to understand how it will generate income for you.
Cash flow
Cash flow is the difference between the rental income of an investment property and its expenses. It informs a real estate investor about how much money they are making or losing.
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, you should not buy a property without having an idea 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.
Inspecting the property is important as well, because this is usually how you find out about any big maintenance or structural repairs you will need to make.
Once you have crunched the numbers, if you are bringing in a profit (your rental income exceeds all of the above expenses), the property has a positive cash flow, or is positively geared. 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.
Negative cash flow
On the other hand, many property investors have negatively geared properties, where they make a loss each month. This is not as catastrophic as it sounds: 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 are not 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 your investment is going to be financially successful.
There are two types of rental yield: gross and net.
Calculating gross rental yield
Gross rental yield measures your annual rental income with the property value as a percentage.
To calculate:
- Add up your rental income for the year to get your total annual rent.
- Divide your annual rent by the value of your property.
- Multiply that figure by 100 to show your gross yield as a percentage.
Here is 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 is $30,000 divided by $600,000 multiplied by 100 and would equal 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:
- Add all of the expenses you incurred from owning the property.
- Add up your rental income for the year to get your total annual rent.
- Subtract the annual expenses from the annual rent.
- Divide your annual rent by the value of your property.
- 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 expend $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, this becomes realised capital gains.
You will 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.
The different types of investment properties
Domain estimates that there are over 15 million different buildings larger than nine square metres in Australia. So there is a wide selection of properties to choose from. There are three broad categories of investment properties: commercial, residential or vacant land. Note that there is not a single ‘best’ type of investment property: each of these options have benefits and drawbacks.
Residential property
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Pros |
Cons |
|---|---|
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Existing properties offer an income stream ready to go straight away. You can look for tenants as soon as you settle on the property, or there could even be pre-existing tenants already paying rent. |
Rates and fees. Landlords are responsible for paying maintenance or body corporate fees. |
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Residential properties tend to be far less expensive than commercial real estate. |
Vacant land
|
Pros |
Cons |
|---|---|
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Low upfront costs. Land with no development on it is typically far cheaper than equivalent lots with a building already on it, so investing in vacant land can be a good way to get started in property if you have a low budget. |
Lack of immediate income. Until there is a practical use for the land, it doesn’t generate income so there won’t be any way to offset expenses. |
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Potential for appreciation. Even without development, vacant land can gain value over time, especially if it’s in a desirable area or has big development potential. |
Low liquidity. Selling vacant land can be more difficult because there are fewer potential buyers. |
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Flexibility for development. Subject to zoning laws, there is a variety of ways vacant land could be developed. |
Potential zoning issues. Investors need to do their homework before buying vacant land. It’s important to ensure you will be able to use the land for it’s intended purpose, as some areas will have restrictive zoning laws. |
Commercial property
|
Pros |
Cons |
|---|---|
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Higher income. Commercial properties will typically generate much more rental income than residential properties. |
Larger investment. As you’d likely expect from the size, buying an office block or a warehouse tends to be significantly more expensive than a home. Many people choose to make these investments as part of a consortium rather than individually. |
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Long term leases. Rather than the six to twelve month leases common to residential properties, businesses often prefer to sign longer lease terms, often several years. This gives more long term security and a stable income stream. |
Vacancy risks. While tenants will normally stick around for a while, finding them can be difficult. Vacancy rates tend to be higher for commercial properties, so you could end up stuck without tenants for extended periods. |
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Low rates and ongoing fees. Unlike residential property, paying for things like council and body corporate fees is the tenants responsibility. |
How to find a good investment property
Work out what 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 could be attractive to a family, but may be too much upkeep for an elderly couple.
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.
Look closely where you are buying
Once you have got the basics down, it is 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
Consider the property’s age, features and expected maintenance
Despite the fact you would not be living in the property you need to think about the features of the property to give yourself the best chance at finding consistent tenants.
Features like a garage, additional bathrooms, or a home office space will go a long way to increasing the property’s rental value both in rental yield and tenant security.
Other things like air conditioning, natural light, outdoor entertainment areas like decks, patios or porches, windows can boost a properties value. If the property is an apartment, does it have enough parking spaces? Is it several floors up? These factors will influence the kind of tenant you may be able to get in the property.
The age of the property also will be something 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 want to avoid a property with heavy costs draining your finances
Types of investment property loans
Once you have found the investment property that ticks all your boxes, it is time to look at financing. Many of the same options are available to you for both owner occupied and investment loans, but there are a couple of differences, which we will explore.
Fixed vs Variable
Just as with owner occupied home loans, you will need to decide whether or not to fix your rate for a given amount of time. A fixed loan will suit you if you are looking for stability and predictable repayments, but you could miss out should rates go down. On the other hand, if rates go up and you’ve gone with a variable rate, you’ll end up paying more in interest. There is risk involved with both so it pays to keep up to date with forecasts and economic predictions to try and see which way the wind is blowing.
View investment property products
Buying an investment property with equity
Equity refers to how much of the property you own outright in relation to its total value. It’s a simple calculation, you simply subtract your outstanding loan amount from the value of the property at any given time to find how much equity you have. Immediately after settlement, your equity is just equal to your deposit, but you build more as you pay off the loan.
You can use your equity as security for a further loan. Useable equity is normally 80% of the property value minus the debt still remaining. Lets say your property is valued at $500,000 and you have $150,000 remaining on your mortgage. Your useable equity would be (500,000*0.8)-150,000=$250,000. If you decided to buy an investment property, you might be able to get an equity release on up to $250,000. This would mean you withdraw this amount to use as a deposit for the new property, topping up your existing loan and adding the loan for the investment property. This option is popular because with a large deposit amount, you can often avoid paying Lenders Mortgage Insurance (LMI), which typically applies to loans that are more than 80% of the property value.
You are not guaranteed to be able to do this. Lenders will still assess your application in a similar way to your initial application: considering your income, expenses and ongoing debts. They will need to be satisfied you will be able to comfortably pay off both loans simultaneously.
Interest only loans
Some lenders (including loans.com.au) allow investor loans that begin with a period of one-five years of only paying interest, not the principal amount. This can help reduce repayments and increase cash flow, but you’ll need to remember you won’t be paying off any of the principal, so when you do return to paying both, your repayments are likely to be higher.
SMSF loans
Self-managed super fund (SMSF) loans are a type of loan that lets you use your superannuation fund to invest in property. You will need to set up an SMSF and comply with the relevant regulations, but this can be a tax-effective way to invest in real estate.
loans.com.au offers all of the above, as well as a team of dedicated lending specialists who can help with any questions you might have about investing in property. Check out the range of products available or book a call today.
About the article
As Australia's leading online lender, loans.com.au has been helping people into their dream homes and cars for more than 10 years. Our content is written and reviewed by experienced financial experts. The information we provide is general in nature and does not take into account your personal objectives or needs. If you'd like to chat to one of our lending specialists about a home or car loan, contact us on Live Chat or by calling 13 10 90.
