All Your Questions About Buying An Investment Property Answered
Hot on the heels of my last post about mental tunneling, my focus has well and truly shifted to investing. As my boss would say, the Eye of Mordor has turned to buying an investment property in Australia.
If you’re wondering what the eye of Mordor is, I’ve just realised it should be the Eye of Sauron which shows how well I know my Lord of the Rings seeing as it took me 5 years and a Google search to pick up his error. Anyway….
We’ve been property investors for several years now and are looking to expand our portfolio. So with our investment loan pre-approval in hand, we used yesterday’s public holiday to do on-the-ground research into our next investment property purchase. Because there is nothing better than spending a glorious summer’s day (in the middle of winter, hello climate change) talking to real estate agents and looking at empty houses.
Actually, it was fun. Part of the research involved finding the best coffee in town, followed by the best brunch – smashed avo included – and of course checking out the local playgrounds. And it was 30 degrees C when it should have been 15 degrees C. I actually enjoy the problem solving part of finding where to invest in property, so finding answers to my million and one questions rated highly as well.
But, first time around, buying an investment property seemed daunting. Where do you even begin? Here are the answers to many of these questions I had when we first started out with purchasing a property investment.
Why would I want to invest in property and risk losing my money when I can keep my cash in a high interest account or term deposit?
Because your money isn’t working for you. Saving is awesome, but unless you get a reasonable rate of return on it you’ll never get wealthy. Compounding is essential to wealth creation and right now interest rates are so low that cash is barely keeping up with inflation.
Aren’t shares better than investing in real estate?
Depends who you ask and how long you’ve got to debate the answer. We’re opting for both. What I like about real estate investing is that you can leverage. That is, you can borrow money from the bank (leveraging) so you can grow your net worth using money you don’t currently have on the premise of future returns.
I also have a background in architecture so there is that bias as well. Po
Is real estate investing really ‘safe as houses’?
No. Real estate investing carries the same risks as share investing. Additionally, if you need to sell, it can take a long time depending on the market and because you’ve borrowed money instead of saved it, you have to pay it back.
That said, people like to live in houses, so there’s always an investment property market and you have a physical asset.
What’s better cash flow negative or cash flow positive investments?
Cash flow negative investments are those when the rent you get doesn’t cover the cost of the loan. It costs you money to keep the investment property, but you can claim this back on your tax return, AKA negative gearing.
Back in the early 2000s I came across two schools of thought on the cash flow dilemma. One strategy was to invest in the capital cities in Australia, cop the cash loss for a few years but bank on the inevitable capital gains. Property in Australia up to that time was supposed to double in value every 7-10 years.
The alternative was to invest in regional areas and start getting a rental income right from the word go (cash flow positive), albeit at the cost of significantly lower capital gains.
Then the boom happened. Property prices in Australia quadrupled in 10 years and even in the regional areas it’s now hard or maybe impossible to find a property that is cash flow positive. Certainly in the regional centre we are looking to buy in, they don’t exist.
Aren’t all the investors driving up house prices so Generation Y can’t get a foot in the market? I feel guilty being responsible for a whole generation being locked out of the Great Australia Dream.
Yes, property investors are partly to blame for driving up house prices, but that’s not the full story.
What happens if the pollies finally grow a pair and cut negative gearing like they keep threatening to?
My wise investment mentor takes a very matter-of-fact approach with all things policy related and market related. His view is that negative gearing should be considered as icing on the cake, not the reason for investing in the first place.
So it doesn’t matter what Canberra does, or talks about doing at any rate.
Where can I invest in property so I can be in the next ‘hot’ suburb?
First step, find a fortune teller.
Ok, seriously, I don’t think anyone really knows. Anecdotally though, we bought in what is now a ‘hot’ suburb back when there were still junkies walking to the local rehab clinic. Sounds delightful hey! Unsurprisingly it was affordable at the time and undervalued compared to surrounding suburb.
I’d also read that it helps to find suburbs full of grandparents, because these are the most likely to undergo a cyclical rejuvenation.
They also tend to make for terrific neighbours – very quite, friendly and always up for biscuits and tea.
Now just as that book predicted, our once grey haired suburb is filling up with young families doing what young families do – extending!
The other observation I would make is to follow the artists and musicians. They make an area cool and then get priced out of it.
I hear there’s a property bubble in Australia. Aren’t I better off waiting to buy until after it bursts?
I’ve wondered this myself, as loss aversion rates pretty highly with me. The trouble is, you could be waiting a long time, in which case you miss out on all the gains as well. Not that your brain cares.
Barefoot Investor reckons that news stories about the bubble bursting are primarily designed as clickbait for a generation locked out of the market. His advice is to make your own plans and go for it rather than waiting for something you can’t control.
Similarly, Alan Kohler in his podcast recommends against trying to short the market. He also answers the question of whether sausages can save Bunnings from Amazon. The discussion is only limited by the fact he doesn’t take into consideration the appeal of Bunnings to small children.
How much cash do I need to start a property investment portfolio?
If you’ve already got equity in property and are willing to borrow against it, then all you need is a cash deposit to secure the contract and money for administration such as conveyancing, building inspections etc. We’ve put down a $1,000 deposit previously and the bank was even willing to roll our stamp duty into the mortgage. Yup, the rich get richer.
That was a few years ago and banks are now getting pretty strong incentives to reduce lending to investors.
In just the 6 months, our bank has reduced what they were willing to lend us by $100,000. So we’ll see what happens this time around.
If you don’t have equity already built up, you will need a deposit.
Should I opt for an interest only loan or pay down the principle as well?
An interest only loan is cheaper and means you’ll be putting less of your own money into your investment initially. Also, if you have personal debt it’s worth paying that off first.
Currently, interest rates on interest only loans are higher than on principle and interest ones, which I believe is part of the government incentives to reduce the heat in the investment market.
It’s the more aggressive strategy and not the one we’ve taken.
Our first investment loan is structured as principle and interest meaning we’ve built up some equity and pay lower interest rates. Of course the downside of this is we have less to negatively gear. We are not very good risk takers.
But at the end of the day, you have to do what you’re comfortable with. You want to invest and still be able to sleep at night.
What’s the point? Don’t you know it’s the end of capitalism as we know it?
Whatever. I’m going to wait until the market crashes, when you investors go running for the exit and then I’ll pick up a nice bargain.
How do you pick a good property to buy?
The rule of thumb I was told is to buy something you could imagine yourself living in. Renters are people too. If you want your property to rent well, look for a home. It also helps to buy in an area you know.
We’re on the lookout for something that has a good feel, is in good condition without needing a heap of urgent repairs and that’s close to amenities like public transport, shops, schools etc.
I can’t afford to buy in an area I know. How do I find another good market?
Same here. Capital city prices are too high for us at the moment, so we are looking to invest regionally. We’ve kept an eye on newspaper reports regarding development plans and government spending.
We found a gem in the federal budget about a major infrastructure project that just got the go ahead in a regional town near us.
I also encouraged my husband to read the state government development plan for the region to determine which areas were getting development priority in the coming years and to help answer the question why subdivisions happen in the places that they do.
Finally, we visited the area and asked the agents a ton of questions. As far as I’m concerned, you don’t know what you don’t know. Many of the real estate agents were very generous with their time and really helped explain some of the trends we were seeing in their market.
Also, I feel it’s worth checking out the general vibe of a place. Find the best coffee place and restaurant. Check out local festivals. A good scene that appeals to you is likely to be a good sign of a vibrant area.
If you’re really an architect, then why aren’t you trying to subdivide, renovate or do stuff like on The Block?
Because I’m lazy. My idea of a good investment is one that I can buy and then forget about for the next 30 years except for at tax time or when something breaks.
Plus it’s riskier and as mentioned above, I don’t like risk.
Are you aspiring to be a property tycoon?
Yes, but with a good haircut.
Got a question I haven’t covered? Feel free to leave a comment or shoot me an email.
How do you feel about real estate investing in Australia or your part of the world? Are you an aspiring property investor?