You’ve been daydreaming about financial freedom, searching for ways to build wealth and live comfortably. Investment property could be the answer. Steady income, long-term growth, and the possibility of sitting back while your money works for you. It sounds like a dream come true.
But how does it all work? Is it as easy as it seems? What are the risks?
Having worked in the property industry for over 10 years, I’ve helped thousands of people grow their wealth through smart investments. Understanding your financing options and strategies is crucial whether you’re new to real estate or a seasoned investor.
In this guide, I’ll break down how investment properties work, the benefits, and a step-by-step approach to buying one. I’ll also explore financing options, tax deductions, and common pitfalls to avoid.
What Is An Investment Property?
An investment property is one that you buy with the intent of making a profit, either through renting it out or by selling it at a higher price than what it was bought for. These properties can be owned by an individual or a group of investors.
The key difference between an investment property and a primary residence is where your home is. It’s where you rest, sleep, enjoy leisure time, and live. While you might still own an investment property, this asset is not used for residence. There are multiple types of investment properties, such as:
- Rental properties: Residential assets rented out to tenants for a monthly income.
- Holiday homes: Residential assets primarily located in tourist or exotic locations rented out to travellers or individuals on vacation.
- Commercial properties: Commercial properties are rented out to other businesses for a fixed amount to be received monthly, quarterly, or yearly.
Related: 5 Different Considerations For Investment Property Loans
How Does An Investment Property Work?
At its core, property investment generates income in two ways: rental income and capital appreciation. Rental income is the money tenants pay you, providing a steady cash flow.
Meanwhile, capital appreciation refers to increased property value over time, which can result in significant profit when sold. Both these can happen simultaneously. However, owning an investment property isn’t just about pocketing cash.
Costs include mortgage payments, property taxes, insurance, and regular maintenance. Balancing these expenses with the rental income is key to achieving positive cash flow.
Additionally, property values can fluctuate, so it’s essential to have a long-term view and not solely rely on short-term gains.
Related: How Rentvesting Gets You Into The Property Investing Game?
What Are The Benefits Of Property Investment?
There are many more benefits than investment properties. Some of these benefits include:
1. Diversification
Real estate helps diversify your investment portfolio, spreading your risk across different assets and minimising the impact of economic volatility.
2. Inflation Hedge
As inflation rises, so do property values and rental income. This helps protect your purchasing power over time, making you somewhat immune to crises.
3. Leverage
You can use borrowed money to buy property, amplifying your returns without putting down the full amount.
4. Potential For Improving Assets
You can boost its value and income using smart renovations and upgrades. If you’re handy with home design or construction, you could save on labour and add value to the property.
5. Potential For Appreciation
Property values in Australia have been increasing in recent years, and with this expected to continue, there’s a good chance you’ll walk away with a nice profit when you decide to sell.
6. Tangibility
Real estate is a physical asset, something you can see and touch. It’s also an asset that can be passed down as a legacy, unlike stocks that can just vanish in a market crash.
7. Tax Benefits
There are plenty of tax perks for property investors. For instance, you can claim deductions for expenses like interest on your loan and property management fees.
Related: The Key Traits of SMART Property Investment
How To Buy An Investment Property?
Getting into property investment might seem overwhelming, but if you break it down step by step, the process becomes much more manageable. If you want to acquire investment properties for profit, you need to:
Step 1: Research Market Trends
The first step in making any sort of investment is to do market research. Why? Though real estate promises positive returns, only some locations are worth your hard-earned money.
Look for locations with growing populations, upcoming infrastructure, and job opportunities, as these factors drive demand for rental properties.
Step 2: Identify Suitable Property Types
Based on your investment goals and budget, decide whether to invest in residential or commercial properties. Residential properties tend to be more stable, while commercial properties can offer higher returns but come with more risk.
Try to assess every option before making the final decision.
Step 3: Inspect Properties Thoroughly
Once you’ve identified a potential property, conduct a thorough inspection. For that, you need to hire a professional to provide detailed reports on the property’s condition — for instance, structural issues, maintenance requirements, and potential hidden costs.
With a professional, you will be able to understand terms and procedures.
Step 4: Negotiate the Price
Of course, negotiation is a must-have. Don’t be afraid to negotiate with the seller, but not without researching comparable properties in the area. Only then can you secure a favourable deal.
Step 5: Complete the Settlement Process
Finally, complete the settlement with the help of legal and financial professionals. You’ll only have to finalise the mortgage, sign the contracts, and pay the agreed price.
Related: Is Investing In A Duplex The Right Move For You?
Financing Your Investment
The benefits and the process of acquiring investment properties make it worth pursuing, but all things that generate profits require some initial capital.
In the case of investment properties, that capital can come from different financing options, but to avail yourself of these options, you must first know how much you can borrow.
How Much Can I Borrow For An Investment Property?
When it comes to borrowing money for investment properties, it’s important to understand the difference between investor loans and buyer loans. A buyer purchases a home to live in, so there are no tax benefits.
However, the mortgage interest and loan fees are tax deductible for an investor since they come under business expenses. But, these tax deductibles increase the risk profile of an investor. This added risk is what causes the interest rates to go up.
Now that you know the difference between these loans, the next step in determining how much you can borrow for your investment property is assessing your borrowing power.
Doing so is essential as it will help you determine exactly how much you need to pay back each month. When you’re calculating your borrowing capacity, the different factors that you need to consider include:
- Your income.
- Monthly expenses.
- Current interest rate.
- Loan type and duration.
Other factors to consider include credit cards, lease agreements, and any other existing debts. There are many online borrowing power calculators available to help you estimate how much you can borrow for an investment property.
Apart from this, you also need to remember that when you own an investment property, you’re responsible for its repair, maintenance, and any other associated charges. So, don’t forget to factor this into your expenses.
Related: The Ideal Loan Structure For Investment Property
What Are The Different Types Of Investment Property Loans?
When you have determined how much borrowing power you have, you can’t just go out and get the first loan that’s offered to you. Different types of investment property loans are available, each with various features and home loan repayment options.
You’ll need to consider all of this to determine which suits you. Some of these loan types are:
1. Fixed-Rate Loans
A fixed-rate home loan is all about predictability. From the day you sign, the interest rate remains constant. That means there will be no surprises. Your repayments will stay the same with this loan, and budgeting and planning will be easier. But, with these loans, you don’t have any additional features.
2. Interest-Only Loans
An interest-only loan lets you pay only the interest on the mortgage for a set period, usually between 3 to 5 years. During this time, you’re not paying down the loan principal itself.
This type of loan is particularly attractive to property investors because the repayments are lower during the interest-only phase. However, once that period ends, the repayments will increase.
3. Variable Interest Rate Loans
A variable interest rate with these loans fluctuates based on the cash rate, which means your repayments could go up or down over time. A standard standard variable rate offers additional features, like making extra repayments, redrawing funds, or linking to an offset account.
4. Offset Accounts
You can think of this as your secret weapon. It’s a separate savings or transaction account linked to your loan, reducing your loan balance.
For example, if you have a loan of $100,000 and a $20,000 deposit in the offset account, you’ll be charged interest based on $80,000. These accounts increase interest and give you easy access to your funds.
Related: How To Buy Your Investment Property Using Equity As A Deposit
How Much Deposit Do I Need For An Investment Property?
Now that you know the different types of investor loans, the next thing you need to consider is how much your deposit will be. Regardless of the loan you choose to take, you’ll have to make an initial deposit.
This amount depends on several different factors, including:
- Property type.
- Your financial or borrower profile.
- Who the lender is.
It’s important to remember that the initial deposit requirements may vary from one lender to another. However, as a general rule of thumb, making a 20% deposit is best. For example, if you’re taking out an investor loan for $380,000, the initial deposit should be $76,000.
If you choose not to pay the 20% deposit, you may have to get Lender’s Mortgage Insurance (LMI). The LMI is an insurance premium that buyers with smaller deposits need to pay. The insurance protects the lender if the borrower cannot repay the loan.
When making an initial deposit, the key factors to consider are the interest rate, fees, and the terms and conditions offered by different lenders.
Additional Considerations
When diving into property investment, thinking beyond the loan itself is essential. First, consider working with a mortgage broker who can help you navigate the loan market and secure the best deal for your needs. They’ll have access to multiple lenders and may find options you wouldn’t come across on your own.
Also, calculate the total cost of ownership. This means looking beyond the interest rate and factoring in loan fees, ongoing maintenance costs, potential repairs, home insurance, strata, and real estate management fees. This comprehensive view helps you avoid surprises and plan your budget effectively.
Related: 3 Tips For Saving For A Home Loan Deposit
Using Super To Buy An Investment Property
Thinking about using your super to buy an investment property? It can be a smart move, but there are a few things you need to consider first. You’ll need to set up a self-managed super fund (SMSF), as regular super accounts don’t allow for this kind of investment. While this strategy has its perks, like lower tax rates on rental income, there are also strict rules to follow.
For example, you can’t live on the property or let family members move in. SMSFs come with borrowing limitations, so it’s not as simple as taking out a regular home loan. The costs of managing the property and market fluctuations can also impact your returns, so it’s important to keep the long game in mind.
The upside? You could enjoy some solid tax benefits while growing your retirement savings. Ensure you know the risks and stay compliant with SMSF regulations, or you could face hefty penalties. In addition, it’s worth consulting a financial advisor to see if this strategy fits your investment goals.
Related: How To Use Super To Buy Property?
How to Use Equity To Buy An Investment Property?
When it comes to equity, you need to know that the term refers to the difference between the current market value of your property and the outstanding balance on your mortgage. Equity increases as you pay off the loan.
This is often referred to as positive equity. Negative equity, on the other hand, occurs when the value of your house decreases and is below the loaned amount. This can make it difficult for you to secure a loan or avail of refinancing.
The great thing about having equity is that you can use it for refinancing. There are multiple stages to this process. Some of the things you need to do when using equity for refinancing include:
| Stage | What To Do … |
| Assessing Your Current Equity | ● Determine the current market value of your property through a professional appraisal or comparative market analysis.
● Calculate your equity by subtracting the remaining mortgage balance from the property’s value. |
| Finding A Suitable Lender | ● Research various lenders to compare interest rates, fees, and loan features.
● Consider traditional and non-bank lenders to find the best fit for your needs. |
| Applying For A Refinancing Loan | ● Gather necessary documents, including proof of income, credit history, and mortgage details.
● Submit your application to the chosen lender and provide any requested documentation. |
| Closing The Loan | ● If approved, review the new loan terms carefully before signing.
● Pay any associated fees, such as application, property appraisals, or closing costs. |
When you pursue refinancing, remember that addressing potential risks and challenges like negative equity, increased debt, and financial flexibility is important.
Related: Using Home Loan Redraw And Cash Out Features
What Tax Deductions Can You Claim On An Investment Property?
Understanding your tax deductions can significantly enhance your cash flow when it comes to property investment. Here are the key deductions to keep in mind:
- Interest on the loan: The interest paid on your mortgage is typically deductible, which can reduce your taxable income.
- Property expenses: Property management, repairs, and maintenance costs can often be claimed, helping you recover some of your investment costs.
- Rental-related expenses: Expenses incurred while renting out your property, such as advertising for tenants and lease preparation fees, are usually deductible.
- Depreciation: This is the wear and tear on your property over time. You can claim depreciation on the building and certain assets within it, adding another layer of tax relief to your investment.
Related: How To Master Tax On Investment Property Obligations
How To Avoid Capital Gains Tax On An Investment Property?
Understanding Capital Gains Tax (CGT) is crucial when selling an investment property. CGT applies to the profit made from the sale, calculated as the difference between the selling and purchase prices. To minimise CGT, you need to explore potential exemptions and discounts.
For instance, owning the property for over 12 months may qualify you for a 50% discount on the capital gain. If the property is your primary residence or meets specific criteria, it might be entirely exempt from CGT.
Before selling, you should consider the CGT implications to strategise timing and explore options to mitigate the tax impact.
Related: All The Investment Property Tax Deductions You Can Claim
Avoiding Common Pitfalls
Investing in property can be rewarding, but navigating potential pitfalls is essential to protect your investment.
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- Overextending yourself: Avoid taking on more debt than you can comfortably manage; it can lead to financial strain.
- Neglecting due diligence: Conduct thorough research on the property and its location to avoid costly surprises.
- Failing to plan for vacancies: Budget for potential vacancies to cover expenses even when the property isn’t rented.
- Overestimating rental income: Be realistic about potential rental income to avoid financial shortfalls.
- Ignoring property management: Proper management is key to maintaining your investment and maximising returns; don’t overlook this vital aspect.
- Failing to diversify: Diversifying your investment portfolio can reduce risk and enhance financial stability in uncertain markets.
- Comparison rates: Choosing the wrong comparison rate structure, for example, a variable rate when a fixed rate might be more suitable, can lead to unexpected costs. Variable rates can fluctuate, resulting in higher repayments if interest rates rise.
Related: How Many Investment Properties To Retire On: An In-Depth Guide
7 Popular Property Investment Strategies
The following strategies can help you build wealth and achieve your financial goals.
1. Buy And Hold
A classic approach, this strategy focuses on purchasing a property and holding onto it long-term to benefit from appreciation and rental income. Consider using a loan repayment calculator to forecast your financial commitment and potential gains.
2. Negative Gearing
This strategy involves buying a property where expenses exceed rental income, allowing investors to offset losses against their taxable income for potential tax benefits. To maximise benefits, consult with mortgage brokers to explore suitable loan products and home loan product options.
4. Positive Gearing
Here, the rental income surpasses the property’s expenses, providing immediate cash flow for investors who prefer consistent income. Evaluating variable home loans and fixed-rate home loan options can help tailor your investment to your cash flow preferences.
5. Using Equity
By taking advantage of the increased value of existing properties, investors can tap into their equity to finance new purchases and accelerate wealth creation. Utilise a borrowing power calculator to understand your financing capabilities and explore lenders’ mortgage insurance for better loan terms.
6. House Flipping
A high-risk, high-reward tactic, house flipping, involves buying, renovating, and quickly selling properties for a profit. Consider the upfront cost and plan for any stamp duty and potential fees and charges involved in the process.
7. Dual Key Duplex Investments
Investing in properties with separate living spaces allows for multiple rental incomes, catering to the demand for affordable housing while maximising cash flow. Compare home loans to find the best investment home loan rates and consult with lending specialists to structure your split loans effectively.
Related: Thinking Of Investing? Here Are Australia’s 7 Most Popular Investment Property Strategies
Summing Up
Property investment might be your answer to wealth since it promises steady income and long-term growth.
Buying an investment property requires a lot of planning, particularly in the lead-up to an investment loan. It’s also important to evaluate both fixed-rate loan and variable-rate loan options to suit your investment strategy.
Are you ready to buy an investment property? Get in touch with us today or book an appointment with our home loan experts. Our loan specialists can help you with your investment loan and help you navigate the process.
Frequently Asked Questions
Can I afford an investment property?
Use home loan calculators to assess your financial situation, including income, expenses, existing debts, and potential loan interest rates. Consult with loan experts to compare investment home loans and understand the comparison rates.
Can I turn my home into an investment property?
Yes. You can convert your home into an investment property by renting it out. Before doing so, evaluate your current home loan product and consider loan structuring options that may impact your mortgage terms. Be mindful of how this change affects your taxes and internet banking arrangements.
How many investment properties do you need to retire?
The number of investment properties needed to retire varies based on your financial goals, desired income, and lifestyle, but generally, multiple properties can provide a more stable cash flow. Evaluating your equity to invest and using a borrowing calculator can help determine how many properties provide a stable cash flow.
Can you live in your investment property?
Yes, you can live in your investment property. However, doing so may have implications for your tax deductions and rental income potential and may require adjustments to your loan-to-value ratio.
When should I sell my investment property?
Consider selling your investment property when market conditions are favourable, your financial goals change, or the property no longer aligns with your investment strategy.
Consult with a loans specialist to understand fees and charges associated with selling and how this decision aligns with your investment strategy and the current estimated property value.
