Finance Basics

Questions about finance answered

Property - What do I need to know about buying an investment property?

Buying a property to rent out is a popular form of investment. Houses and units are easier to understand than many other types of investments, yet they do have some issues you need to be aware of.

Before you enter the property market, check if this type of long-term investment suits you

Where and what you buy will affect your return on investment. The following tips will help you develop your own criteria for a good property investment.

Where to buy

  • Think twice about investing in property markets you are not familiar with
  • Look for areas where high growth is expected, in other words where there is potential for capital gains. Property experts regularly provide tips on up and coming suburbs, just make sure you are aware of any biases they may have
  • Look for areas where rental income is high compared to the property value
  • Research recent sale prices to give you an idea of what you can expect to pay for property in the same area
  • Find out about the vacancy rates in the neighbourhood. A high vacancy rate may indicate a less desirable area. This may make it harder to rent the property and may make it difficult to sell in the future
  • Research proposed changes in the suburb that may affect future prices. Things like planned developments or zoning changes can affect the future value of a property. Don't assume that last year's boom will continue this year.

What to buy

  • Look for properties with features that will appeal to as many people as possible, such as a second bathroom, lock up garage or somewhere close to shops, schools and transport
  • Look for a property that will attract more than one segment of the rental market such as singles, couples, young families or retirees
  • Low maintenance costs are important
  • Units can be easier to maintain than houses, although you will have to pay body corporate fee

Pros and cons of property investment

The benefits

  • Property can be less volatile than shares or other investments
  • You can earn rental income and benefit from capital growth (if your property increases in value over time)
  • If you take out a loan to purchase an investment property, interest on the loan and most property expenses can be offset against rental income, for tax purposes
  • You are investing in something you can see and touch

 

The pitfalls

  • Rental income may not cover your mortgage payments or other expenses so you may have to use other money to cover these costs
  • An increase in interest rates will increase your repayments and decrease your disposable income
  • There may be periods of time where you don't have a tenant and will have to cover all costs yourself
  • You can't sell off a bedroom if you need to access some cash in a hurry
  • If property investment is your major investment you may have little or no diversification
  • If the value of the property goes down you could end up owing more than the property is worth, this is known as negative equity
  • There are very high entry and exit costs such as stamp duty, legal fees and real estate agent's fee

Positive or negative gearing

Most people will borrow to invest in property. This is called 'gearing'. The more you borrow, the more you will pay in interest

Negative gearing

  • Negative gearing is when your income from an investment is less than your expenses. In the case of property this means the rental income you receive is less than the interest and other expenses you pay. Your investment is making a loss which most investors hope they will make up with a capital gain when the value of the property increases.
  • A loss can be used to reduce your taxable income which will reduce the amount of tax you pay. See the Australian Taxation Office's section on residential rental properties for details of income you must declare and expenses you can claim.
  • Remember, you are only reducing your tax payable because the income from your investment isn't covering your expenses.

Positive gearing

  • Positive gearing is where your income from an investment is higher than your interest and/or other expenses. This means you will have extra money in your budget but you will have to pay tax on the additional net income.

Positive vs negative gearing

Many investors focus on the tax benefits of negative gearing without considering the loss in after tax income.

 

← Back