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SUCCESSFUL FUNDAMENTALS
A big concern for first time property investors is, what if I don’t have a tenant? This fear has caused some would be investors to back right out of a deal.
To resolve this concern it’s important to come to terms with the fundamentals of a successful investment property strategy; which are:
1. Property location and real asset value
A sound strategy to achieve capital growth is to locate and purchase property in areas that have economic and population growth that are producing steady capital gains. As opposed to property that only produces capital gains in a boom period and then lies dormant afterward. These types of areas should already be demonstrating good economic activity and growth which in turn is producing a steady influx of people.
A good barometer of potential growth is government population growth figures that show steady or above normal growth for the short, medium and long term cycles.
In regard to real asset value, you should do your homework and re-assure yourself the purchase price you’re considering is real market value or better. With a little bit of practice the internet can be useful for this purpose.
2. The demand for tenancy throughout the lifespan of the property
Regardless of the type of the property you purchase it needs to be in an area where people want to live. It should be in an area where the tenants have good access to amenities and services. For example with new house and land packages (which families with children favour) there should be easy access to schools and shopping. For apartments it’s important to have easy access to public transport and shopping.
Taking these and other factors into consideration along with the long term outlook for the quality of the neighbourhood should ensure a steady supply of tenants.
3. Good rental yield
Having and holding a rental property over the long term that’s located in a good growth area, will potentially produce good capital gains. Along with that you’ll also potentially get rental increases. 5-10 years down the track you’ll probably find your investment is performing well for you and will eventually be positively cash flowed. However, when first purchased the property normally costs some money out of pocket each week.
The key to success then, is to keep this weekly cost to a minimum. Achieving a good rental yield of at least 4.5% gross plus will go a long way towards that goal. Be careful though, it should be noted that you can find a good growth area with low rental vacancy but because of the socio-economic heritage of the area it is still attracting low rental yields.
We suggest these areas are not good for investment because it will probably take an extended period of time before the rental yield will justify the amount you’ve invested. We suggest you move on, as there will be better opportunities elsewhere.
4. The Correct Tax Structure
Tax laws in Australia allow the individual to take advantage of the depreciation schedules on new buildings built after 1987. This can allow the individual to further enhance their position by utilizing the resources of the income tax they now pay and channeling these resources to their own benefit.
Well chosen new investment properties can provide a strong tax structure because of the allowable depreciation schedules on fixtures and fittings and the cost of the building. These types of properties can be desirable because they can provide a cushion or a safety net in the event of tenant vacancies or in the event you have to reduce the rent to attract a tenant. In brief, you receive a benefit because with any type of rental shortfall your taxable income will decrease and your tax credit or refund will increase, therefore supplementing your cash flow.
It won’t cover all the shortfall, but depending on your individual tax bracket it should make the shortfall manageable.
5. Affordability
Generally renters have tolerance levels of how much they will pay in rent. This tolerance can be dependent on varying factors but the two main factors are the socio economic profile of the renter and the geographical location. In other words, someone earning $30-40,000 per year is probably not going to be in the market for a $500 per week rental property.
Not always, but generally you’ll find that once the purchase price of the property starts to go over $450,000 the rental yield will start to drop off (there are exceptions to this, but they are rare).
Another important factor you should consider is your bottom line weekly holding cost. Now, this can be affected by a number of factors and they are your tax bracket, tax structure of the property, out going expenses and the rental yield you achieve. Buying an investment property by using your head as opposed to following your heart is a good maxim to follow. Even if you could afford to buy a $500,000 investment property there’s a lot of good reasons to considering buying 2 $250,000 properties instead of the one.
6. Professional Rental Management
Most real estate agencies have a property management division but this does not necessarily make them professional property managers. A good property manager will be exceptionally professional in their approach. It may take you doing some homework or receiving a referral to find this entity.
You want a manager who will carefully screen your potential tenants by checking their references and information supplied. You want one that will strive to get reasonable rental returns for you and follow up diligently in the event of rental arrears. It’s also important that they conscientiously follow up on maintenance checks throughout the term of the lease and not just one now and then.
In some areas of Australia a growing trend is to have an on-site manager in some complexes. These managers typically buy their residence in the complex and pay an additional fee for the management rights. The benefit to the investor is that these managers have a vested interest ongoing in maintaining the quality and the value of the complex.
7. The Correct Financial Strategy
It’s universally accepted that you buy an investment property and you finance it with an interest only loan. That’s okay, if you’re also paying off a home loan. If you’ve already paid off the home loan then we’re going to suggest that interest only is not necessarily the only consideration. Many investment property gurus would have you buying property after property on interest only loans.
The problem with that strategy is you’re never going to pay off the properties. I know, you’re saying, if I pay the loans off, I’m reducing the tax deductions. This is marginally correct because you will be reducing the interest factor. But if you’ve bought new properties with healthy depreciation schedules combined with your property expenses, you’ll find the loss in interest deductions to be negligible compared to the deductions you still have left.
The benefit of this strategy is that ongoing you’ll be able to buy more property because the bank will lend you more money for additional purchases as you reduce the debt on the previous purchases. Additionally you will be less vulnerable to any market place uncertainties and you will also achieve financial independence sooner because you’ll be carrying less debt and retaining more of the returns for yourself.
Another important aspect of purchasing an investment property is to have a predetermined financial plan that takes into consideration your income and expenses on an ongoing bases so you can feel comfortable with the affordability of your project.
Property markets are not always going to go up and interest rates are not always going to be friendly. With a pre-determined financial strategy in place that has the right loan structure, cash flow analysis and capable ongoing management, for both the property and your finances, this may at the end of the day see you on top of the pile.
