Is buying an investment property right for me?
You should consider if the main benefits of property investment align to both your financial goals and personal situation.
The 3 main benefits of property investment are capital growth, rental and investment yield and tax benefits.
Capital growth is the continued growth in the value of your property over time. This strategy generally requires you to hold onto the asset over a longer period of time.
As an example, if you purchased a property in 2010 for $300,000 and it grew in value by 5% each year it would be worth $383,000 in 2015 and you would have made a $83,000 capital gain, minus any expenses and taxes.
Rental and investment yield
Rental yield is the money you earn from rental income minus the expenses you incur owning the property. With the right structure, a property investment can generate a monthly income stream and high investment yield. Investment yield is the yearly amount of rental income you earn divided by the total loan deposit you made.
As an example, if you earned $10,000 in rental income after your expenses and deposited $100,000 on your loan your investment yield would be 10%.
There are tax advantages for all types of property investors; you can claim expenses you incur owning the property, deductions for depreciation and negative gearing. Negative gearing allows investors to offset losses they incur in their property investment against their taxable income.
Why existing home owners might choose to buy an investment property
Existing property owners who have paid off at least 10 per cent of their property value, can borrow to purchase another property without having to put down a deposit or make a large upfront financial commitment.
When you have more equity in your existing property, banks will lend you higher loan amounts so that you can potentially purchase higher value rental properties. One of the biggest advantages of having equity is that you may not have put down a deposit on the investment loan as your existing property is security for the loan.
An example of using equity to purchase an investment property:
The Smith’s bought a home in a Melbourne suburb in 2005 for $460,000. Over the next 10 years the Smith’s paid their loan balance down to $300,000. In 2015, the Smith’s decided they want to buy an investment apartment so they had a valuer come and estimate their property was now worth $750,000. This meant the Smith’s had $450,000 of equity in their property.
The Smith’s decided to buy a $500,000 apartment in a popular student area and used a mortgage broker to secure a loan for the entire amount. The mortgage broker negotiated with the lender to allow the Smith’s to use their existing property as security for the new $500,000 loan and they did not have to put a deposit down or pay Lenders Mortgage Insurance (LMI). The loan repayments were $2,500 a month (30 years, 4.75%)
The Smith’s quickly found renters who would pay $2,600 a month in rent. Without having to put down a deposit, the Smith’s were able to purchase an investment that would generate capital gains but also a monthly income stream.
Why first home buyers might choose to buy an investment property (rather than buying a home to live in)
It’s not uncommon for property investors to purchase an investment property the first time they buy a property. For some first time buyers, property investment allows them to use their existing income and savings to purchase a property they expect to grow in value over time. First time buyers can be younger and often in the earlier stages of their career and are taking on an investment with the expectation that as their salary increases, they’ll be able to quickly reduce their loan balance and increase the income stream from the property.
Many first time buyers will also see their borrowing capacity increase when they apply for a loan for investment purposes. This is because lenders will factor in the income you will generate from rent, on top of your regular income .
An example of a first home buyer investing in property.
Julie and Sam, both aged 26 have no children and earn a combined income of $160,000 and wanted to start building some equity in property but were unsure if they should buy to live in or invest. A local bank said their maximum borrowing capacity would be $1.1M and their repayments would be $6,500 per month. Repayments that high would have left Julie and Sam sacrificing more of their lifestyle than they’d like.
Sam and Julie approached a mortgage broker who talked to them about purchasing a property as an investment. They applied to a lender for a loan with the purpose of it being an investment. After they got pre-approval they found a property in a popular student location where the rental rates covered most of the loan repayments.