If you decide to buy an investment property the first question you should ask yourself is how much can you afford to contribute towards the purchase each week. The answer affects what type of property you should look for and the location.
There are two types of property investment:
(a) cash flow positive property which often has little potential for capital growth; and
(b) cash flow negative property which often has potential for capital growth and often provides negative gearing opportunities which minimizes the amount of personal tax you pay.
Negative gearing is the situation where the total costs of owning the property (eg. interest payments, council rates, water rates, strata levies, insurance premiums, depreciation and the like) are higher than the income (rent) you receive in relation to the property each year. Assuming the title of the property is in your name any loss can be deducted from your personal income which can reduce the tax that you have to pay.
With this type of purchase the buyer banks on the capital value of the property appreciating over time so that when it is sold the sale price covers all the costs and still gives a profit. Capital gains tax is then paid on the profit at your marginal tax rate.
Cash Flow Positive Property
A cash flow positive property is a property where the income from the property (ie. the rent) exceeds the costs associated with owning the property leaving a profit. Assuming the title of the property is in your name the profit must be shown in your personal income tax return and you will pay tax on it at your marginal rate.
Often properties that achieve high rental returns are in areas where the property prices are already very high (eg. mining regions) and there is little opportunity for capital growth. The strategy here is to hope that the high rents cover the purchase and holding costs of the property in ashort period so that the rent becomes profit.
Buying a home now with the idea of selling it a few years or profiting from the purchase of a fixer-upper that can be resold at a much higher price, here’s what to look for when considering real estate as an investment :
Plan on a big down payment. Mortgage insurance isn’t available for investment properties, so a 20 percent down payment is required to get traditional financing. And putting even more down can result in a better rate. Also, loan costs are generally higher for investment properties.
Beware of fixer-uppers. If you’re new to investing in real estate, beware of taking on a bigger challenge than you can handle. Unless you have the skills for large-scale improvement – or know someone who does quality work at bargain prices – you’ll likely pay too much to rehabilitate the property and still make a profit on its sale. A better option is to look for properties that need modest repairs that are priced at below-market rates.
Enjoy being handy and fixing things. Opting for the landlord route brings with it lots of challenges, including making repairs. Be sure to have enough savings on hand to handle any unexpected repairs in the short term – before the rent checks start rolling in.
Income varies. Tenants come and go, and it may take a while to rent out a just-vacated unit – especially if it needs substantial repairs or rehabbing, reducing your income. But you’ll still have to pay the bills, including mortgage, property taxes and insurance.
Start small. While repairs present a challenge, so can buying a larger property than you’re ready to handle. Starting small – purchasing a single apartment, condo or duplex, for example – can help you get grounded in the idea of investing in real estate and decide whether it’s really the right step for you.
Property taxes. Depending on the type of rental property purchased and how long it is kept, investors could discover a big increase in property taxes, if a homestead exemption had been in place for the previous owners.