Property investing checklist

Investing in property, such as residential real estate, is likely to be a lengthy process and one that usually involves a long-term plan. To ensure you have considered what is required before making the big purchase, we’ve outlined steps you need to take in that process.

1.   Do the numbers

A property investment must be a long-term commitment in order for it to be worthwhile, so the very first step is to ‘do the numbers’ to evaluate your budget, potential constraints and future financial and personal obligations, including the potential impact on family members.

Consider your future as far ahead as you can – remember that you should be expecting to hold the property for a minimum of five to ten years. You need to assess your ability to maintain, or increase, personal income, as well as your commitment and ongoing financial capability to continue to service the investment which will incur other costs in addition to loan repayments.

2.   Obtain professional advice

Once you’ve run the number, you’ll need to obtain professional advice. An investment in real estate is likely to be significant in relation to your current financial position.

Discuss the investment with a licensed financial planner or investment adviser to check if residential real estate is appropriate in your current circumstances. Consider aspects including rental return, maximum capital growth and/or tax effectiveness.

Following that, unless you have cash or other investments that can be converted to cash to make your property investment, the next step is to contact a mortgage broker to help you to secure finance to enable the purchase.

This will give you the opportunity to ask the broker as many questions as needed to alleviate any uncertainty you may have about securing that finance.

Brokers who assist consumers to secure finance for residential property are heavily regulated and must be licensed. They must also hold membership of the external dispute resolution scheme and hold appropriate qualifications, including maintaining continuing professional development. The broker should also hold membership of an industry body, like the MFAA, which triggers a requirement of an additional layer of obligations through compliance with its code of practice.

Next, you need to locate a suitable property. You may want to consider using a buyer’s agent who can assist you in this process – potentially saving you money by disregarding inappropriate properties and concentrating on those that are more likely to deliver the highest return and capital increase to you over time.

3.   Talk to relatives and friends

Talking to friends, family and acquaintances who have already made such an investment, or are currently considering one, can help your awareness of stumbling blocks and potential issues that you might otherwise miss. While any issues you face may seem new, it can help to bounce these off a trusted friend or relative who has been there before.

4.   Collate your information and seek pre-approval

To apply for finance, you will need proof of your current income, employment, and your assets; as well as all liabilities, including debts, loans, rental payment, outstanding credit card obligations and any other payments including buy now pay later commitments.

Collate these and any paperwork that helps support your personal position. For example, if you have been a long-term tenant, get a 12-month tenancy statement that proves your capacity to make regular repayments.

Before applying for a loan, minimise your current debt load, and if possible, reduce the limit on, or cancel, any credit cards you have, as this is perceived by lenders as potential for debt.

It is strongly recommended that you have a fully assessed pre-approval before you start your search. This will allow you to know what your financial limits are so that you can make an offer when you’ve found a property you like.

5.   Treat the purchase as a business decision and commit

While an investment property purchase should be a business decision, not an emotional decision, it is wise to consider choosing a property based on whether you feel like you could live in it.

Also consider what type of properties appeal to the people living in the area – your tenants (or perhaps an owner/occupier you might sell to down the track) are making an emotional decision when they decide where to live.

You also need to make the commitment to ‘manage’ the investment – even if you outsource the day-to-day tasks involved, including locating suitable tenants, collecting rents, paying relevant costs in rates and taxes, and ensuring that the property’s repairs and maintenance are kept up to date.

Why property investors need savings

Urgent maintenance is an unavoidable aspect of being a landlord, so having a cash buffer set aside will help you deal with any unexpected problems.

When renting out an investment property, having access to extra cash is vital for two reasons:

●      To cover the costs of repairing maintaining the property, giving it the best chance of remaining tenanted.

●      To cover the cost of the mortgage should you lose your employment or rental income.

A buffer ensures that you are not stretched to your financial limits, but rather comfortable while on your investment journey.

Ideally, your buffer would sit in an offset account against your mortgage, so that you have immediate access to the money, while at the same time reducing the principal and therefore the total interest payable on, your loan.

Before calculating a buffer, make sure you have a budget and savings plan in place that identifies your living expenses and ability to save accurately. Aim to have a buffer of three to six month in loan repayments and living expenses.

For investors without a buffer who need to make repairs to a property, there are short-term options available. Personal loans and credit cards may cater to urgent funding, but they do attract higher interest rates and fees.

If you do need to access this type of credit, make it a priority to put a strategy in place to pay back this debt as soon as possible.

Rental yields – what you need to know

Rental yield, –the rate of rental income returned against the costs of an investment property, is a great indicator of a property’s investment potential. However, you need to keep things in perspective when you factor it into your decision to purchase property.

Calculating rental yield

A good first step in examining the impact of the rental yield on the investment potential of a property is to recognise that there are two types of rental yields – gross and net – and they are calculated differently.

For property, gross rental yield is calculated by dividing the annual rental income you receive by the property value, and then multiplying this figure by 100.

For example, if you collect $20,800 rent annually ($400 per week) and your property value is $450,000, it will look like this:

·         $20,800 (annual rent) / $450,000 (property value) = 0.0462

·         0.0462 x 100 = 4.622

·         The gross rental yield is therefore expressed as 4.622%

Knowing a property’s gross rental yield is a quick way to make a rough comparison of how its rental returns fare with others in an area, but it does not give a full picture of the investment potential a property offers.

Net rental yield, on the other hand, offers a more detailed picture of a property’s rental return. To calculate net rental yield, you also factor in the costs and expenses you incur in addition to your property’s value.

The list of costs and expenses is extensive and can include stamp duty, legal costs, building inspections and recurring expenses such as maintenance and repair work, council rates, and loan interest repayments.

If you deduct $5,000 for annual costs and expenses from the annual rental income in the gross rental yield scenario in the example above, the net rental yield is 3.5%.

Of course, the credibility of net rental yield is dependent on the accuracy of assumptions you make about the cost of repairs, the property’s market value, and the property’s occupancy rate.

A building inspection might reveal dormant issues that will drastically increase future repairs and maintenance expenses. Rental yield might be high for those properties occupied in the neighbourhood, but that doesn’t mean the property you have in mind will be occupied all year, as vacancies in one street can vary from the next, too.

Rental yield is only one factor to consider

Calculating rental yield should only be part of your assessment of a property’s investment potential.

To do due-diligence and ensure you're making the right investment, it’s also important to consider the resale value, investigate market reports, demographics, sales and rentals history in an area, planning and infrastructure, and the story of the building.

Loan to value ratios

The mortgage industry is a wide, wondrous world with a language all of its own. One of the many acronyms bandied about is ‘LVR’, which stands for ‘Loan to Value Ratio’. Here’s what it means.

When you are working out what amount you can borrow to purchase a property, the size of deposit you need to save, and whether you are eligible for a particular mortgage product, the LVR is one of the most important considerations.

In the simplest terms, the LVR is the percentage of the property’s value, as assessed by the lender that your loan equates to.

So, if the property you want to purchase is valued at $500,000, and you need to borrow $400,000 to pay for it, the loan is 80% of the property value, making your LVR 80%.

LVR is important because different lenders and loan types have different maximum LVRs and some lenders will only lend up to a certain LVR for small properties or properties in certain areas.

Most lenders will finance 80% LVR, or higher with Lenders Mortgage Insurance (LMI), while low documentation loans may be limited to 60% LVR without LMI.

Fixed rate versus variable loans

Fixed rate loans

A fixed rate loan is one that maintain the same interest rate over a set period of time regardless of market fluctuations in interest rates.

A fixed rate home loan can offer stability for those conscious of a budget and who want to take a medium-to-long term position on a fixed rate. It can also protect borrowers from the volatility of potential rate movements.

Fixed rates are locked in for an amount of time that is prearranged between you and your lender – this could be a term of one to ten years depending on the lender. Three and five-year terms are generally the most popular for borrowers because a lot can change in that time.

However, fixed rate loans usually come with a few provisos. Borrowers may be restricted to maximum payments during the fixed term and can face hefty break fees for paying off the loan early, selling the property or switching to variable interest during the fixed rate period. Also, you may not be able to leverage an offset account against a fixed rate loan.

Borrowers should consider, and be aware, that at the end of the fixed-rate term the loan will usually ‘revert’ to a variable rate.

Borrowers should talk to their mortgage broker when the end of fixed rate term is approaching as lender offers may not apply the lowest interest rate they offer when a loan reverts to a variable rate.

Variable rate loans

The interest rate on a variable rate loan can change throughout the term of the loan in reaction to market fluctuations in interest rates. The interest rate on a variable rate loan can go up or down.

A variable rate loan may come with features such as an offset account (which can reduce the amount of interest you pay), a redraw facility and the ability to make additional repayments either regularly or in a lump sum.

A variable rate loan can offer flexibility, however, borrowers should consider the capacity to service the loan if the interest rate increased.

A split loan – the best of both worlds

A loan can also be split  – this option allows you to have some of your loan at a fixed rate and some at a variable rate. You can split your loan 50/50 or at a ratio that meets your needs.

Capital gains tax

If you sell an investment property, you may be required to pay capital gains tax (CGT) on that sale.

What is CGT?

CGT is a tax that you’re required to pay on any capital gain earned on the sale of an asset, such as a property.

CGT applies to any asset obtained after 19 August 1985.

What is a capital gain?

Put simply, a capital gain is made when a profit is made from the sale of an investment, so when the sale price exceeds the original purchase price.

If you sell an investment property for less money than the purchase price, you will have made a capital loss. An industry expert can help you work out your net capital gain or loss.

Calculating CGT

For the sale of a single investment, take the selling price of the property then subtract the amount you originally paid for it, along with any associated costs such as stamp duty and legal fees. The amount remaining will be your capital gain. If you make a loss rather than a gain, you will not be taxed.

You may be eligible for a 50 per cent reduction of the CGT payable if you purchased the property after 21 September 1999, owned it for at least one year before selling, and the property was purchased by an individual, trust or complying superannuation entity.

Exemptions

While any investment properties sold will be subject to CGT, you do not have to pay this tax on every property you buy and sell. Your main place of residence is exempt, as long as you have never rented it out.

You are not required to pay this tax at the highest marginal tax rate – any capital gain obtained will be added to your taxable income and then taxed at the relative margin.

This article is for information only; please seek advice from a tax adviser before making any decisions.

Top tips for negotiating a property price

Here are our top tips to tactfully negotiate the price without ruining your chances of securing the property.

Tip #1: Never enter a negotiation empty-handed

Whether it’s hiring inspectors for a building and pest report, or obtaining quotes from tradespeople, obtaining facts and figures will give you ammunition when requesting a price reduction. 

Tip #2: Separate your emotions

The most tactful way to negotiate is to eliminate all emotions. Try to separate yourself from the outcome and present your side logically. The owner is under no obligation to accept what you offer, no matter how well you present your points. So, if things don’t go your way, being negative won’t help the negotiation.

Tip #3: Remember this is someone else’s house

Negotiation is a two-way street, to come to an agreement, concessions will have to be made on both sides.

Try to understand what is important to the owner. Think about what you can offer to counteract the price reduction you’re after. Perhaps a longer settlement period so they can find a new home, it’s little enticements like this that can often be much more valuable than a couple of extra dollars.

Tip #4: If you don’t ask, the answer is always going to be no

From wanting certain fixtures included in the sale price, to extra inspection requests, you won’t know what the owners are happy to give if you don’t voice your desires.

A house that requires a bit of repair work, for example, is a great bargaining tool and generally an opportunity to secure a good price. However, before you go wild with requests, think about what is most important to you, as realistically the owners aren’t likely to budge on everything.

For example, in theory, you can inspect a property as many times as you like. In practice though, it will depend on your agent’s availability and whether the owner is currently living in the property – you might put off the owner if you are constantly disrupting their day. An alternative might be visiting the street at different times during the week. You don’t have to enter the actual home to get a vibe of what the neighbourhood is like.

Investing in a holiday house? Location is everything

Before you take the leap into a holiday-home investment, it’s essential that you consider all angles. This means taking your heart out of the equation and giving thought to rental returns.

In fact, location has a great deal to do with the success of your investment property if you will be renting it as a holiday destination.

While it would be great to have a holiday-home investment where you would prefer to travel to, when investing it’s important to also consider what locations and niche markets have good rental returns.

You need to make sure that your property location matches up with market demand. Things to consider are travel time and expense, rent rates, local attractions and activities – particularly those available year-round, not just in peak times.

For example, busier coastal suburbs may offer more consistent rental returns than quieter peripheral suburbs that may be popular only in peak holiday seasons.

Deciding whether the investment holiday property you want will be as lucrative as you think often requires the advice of an expert, particularly for investors who aren’t as familiar with the area as residents may be, so investors would be well served to seek advice instead of taking a gamble.

Construction loans

If you’re thinking of building your own home, you’ll need to be familiar with the ins-and-outs of construction loans.

Construction loans are not as straightforward as standard home loans. There are additional decisions to be made about the structure of the loan, additional documentation is required, and the funding is released in an entirely different way.

Documentation

In addition to documentation about your finances, income and identity, your application for a construction loan needs to include contracts or tenders for the construction, as well as the plans so that a valuation can be performed.

Further documentation will also be required before the first payment is made from the lender to the builder, including a schedule of the payments to be made (called drawdowns), the builders’ insurance details, and the final plans that have been approved by the local council.

Structure

To avoid having to contribute your full deposit and being charged interest on the entire loan amount from the moment the land purchase settles, you can split your mortgage into a land loan and a construction loan.

At settlement of the land purchase you start being charged interest and making repayments on the balance of the land loan – you may also be required to pay lenders mortgage insurance (LMI) depending on your deposit size.

The interest and repayments on the construction portion then kick in only as each drawdown is processed.

Funding

The drawdown schedule is very important; as you don’t start paying interest on each portion of the loan until it is paid to the builder, you, the lender, and the builder, need to be satisfied with the schedule.

For the lender to make each payment to the builder, you will need to fill out a drawdown request form from your lender, and submit it to your builder. The builder can then send the lender your form with an invoice for that part of the payment and, after the lender is satisfied that the work has been completed and is up to the standard expected in the valuation, the drawdown can be completed with a payment to the builder.

Any changes to the contract and plans can trigger a reassessment of the loan, so be as sure as you can that the plans and contracts the lender sees are final. It’s also worth trying to pay for any small amendments from your own pocket, rather than changing the loan and risking a reassessment.

Problems can also arise when other work on the site that isn't completed by the builder needs to be paid for, as some lenders only make the remaining funds of the mortgage available after the completion of construction.

While some builders will include subcontractors as part of the main contract, meaning that they can be paid by the builder as stages of work are complete throughout the drawdown schedule, others will not do this. Again, this may make it necessary to pay from your own pocket.

Who is involved in a property purchase?

Buying a property is more complex than most other purchases you’ll ever make. Here are the different parties who may be involved in your home-buying process and how you can leverage their valuable experience and knowledge..

Finance broker

Brokers act as a liaison between you and the lender. They will find out about your finances and your property goals, and search for and negotiate a loan product that matches your needs. Not only will they do the legwork and ensure your loan is processed as smoothly as possible, but they are there to guide you throughout the entire process.

Real estate agent

Unless you’re working with a private vendor, meeting a real estate agent is inevitable when it comes to purchasing a property.

Hired by the vendor, or seller, the real estate agent’s role is to advise the vendor on preparing the property for sale, market and communicate about the property, and negotiate with potential buyers.

Insurance companies

A property purchase is a high-value purchase and long-term financial commitment making risk management vital. Insurance, including mortgage protection and property insurance, will help you avoid being hit with a major financial burden should anything not go according to plan. Many finance brokers can deal with insurance as well or will recommend an insurance broker who can.

Conveyancer

The legal aspect of a property purchase is taken care of by a licensed and qualified conveyancer. If they are a solicitor, they can also provide legal advice.

Their role is to prepare the documents to ensure that transfer of ownership of the property has met the legal requirements in your state or territory.

Property valuer

Knowing the value of a property is essential in a loan application, so a valuer can play a huge role in the property buying process. A lender will often engage an impartial valuer to ensure that the buyer and the lender will know what loan amount may be warranted. The value is based on the property and location, as well as the current market.

Pest and building inspectors

Without the services of pest and building inspectors, a homebuyer’s worst nightmare – finding out the property they have bought requires costly renovations or pest treatment – may come true. Organising a pre-purchase inspection is essential.

If the property requires structural, wiring or repair work, these inspections can stop you from making a costly mistake or, if the property is still your dream home but just needs a little work, can provide a valuable bargaining chip.

Lenders

If you need to borrow money to make your purchase, you will need a lender, whether it’s a major bank, a second-tier or non-major, or a specialist lender for more difficult funding proposals.

Solicitors and conveyancers – what’s the difference?

Solicitors and conveyancers are different, and it’s important to have the right one on your team, to avoid paying too much while still getting the advice you need.

Buying property is one of the biggest financial decisions most of us will make in our lifetime – it’s something you want to get right.

Every Australian state and territory has different laws, forms, regulations, and taxes associated with purchasing property, so having either a solicitor or a conveyancer will help the whole process run smoothly.

Conveyancers

Although there is a licensing process for conveyancers, they do not have to be legal professionals so are cheaper to hire. However, they can only provide information relating to property, so if you have additional legal questions, you might have to search elsewhere.

For a straightforward property purchase, a conveyancer can do the job. Their main responsibilities include giving advice and information about the sale of property, preparing documentation and conducting any settlement processes.

Conveyancers must cease to act for a person as soon as the matter moves beyond conveyancing, when this happens, they must refer you to a solicitor for advice.

Solicitors

While conveyancers are limited to advising on your property purchase, solicitors can provide you with a wide range of legal advice in addition to your conveyancing needs, and may be necessary if your property transaction isn’t straightforward.

If there are other matters that affect the transaction like family law, asset protection, asset structuring, tax law or estate planning, you will need a solicitor’s advice.

Solicitors are more expensive, but the investment may be worthwhile if you anticipate any legal issues – having this established relationship with a solicitor means you won’t have to scramble for one later.

Stamp duty

Stamp duty, also referred to as ‘transfer duty’, is revenue levied by states on transactions relating to the transfer of land or property. It is paid upfront and needs to be budgeted for, in addition to your loan deposit.

The amount of stamp duty you are required to pay differs in each state, however there are three universal factors, along with the value of the property, that determine how much stamp duty you will pay. Contributing factors include:

1.             Whether or not the property is a primary residence or investment property.

2.             Whether or not you’re a first home buyer.

3.             If you are purchasing an established home, a new home or vacant land.

There are several stamp duty calculators available online that take the guesswork out of budgeting for a property. Factoring in this additional cost can’t be overlooked when you’re considering your capacity to repay a loan.

However, in a bid by state governments to stimulate home ownership and growth, there are a range of tax concessions available to reduce stamp duty.

Again, exact amounts differ across each state, but those likely to benefit the most are first home buyers and those opting to buy a new home.

Lenders mortgage insurance (LMI)

Lenders mortgage insurance (LMI) is required when the value of a loan is more than 80% of a property’s purchase price, or property valuation if refinancing. In very basic terms, a lender considers a loan to carry a higher risk if the Loan to Value Ratio (LVR) is above 80%, in which case LMI is payable.

Not to be confused with mortgage protection insurance, which is designed to protect the borrower, LMI covers the lender’s risk within a residential mortgage transaction in case the borrower fails to make loan repayments. LMI is a fairly common practice within the industry, particularly for first home buyers who may struggle to save a 20% deposit.

Even though the actual property acts as security for the mortgage, the nature of the property market, like any investment class, means there is a chance that its value declines. This could result in a financial loss for the lender if the borrower is unable to repay the loan and the property is sold at a price below the value of the loan.

The cost of the LMI premium is dependent on several factors, such as the loan size and property value. Most insurers are flexible when it comes to the method of payment of LMI, it can either be a one-off upfront premium payment, or a premium could be included in the overall cost of the loan and included in the regular repayments.

It is not transferable, which means a new loan, for example if the borrower refinances the loan, may require a new LMI premium depending on how much equity the borrower has in the property.

What’s in it for me?

While LMI protects the interests of the lender, there is value to borrowers in paying the LMI premium.

Opting for LMI means it allows a borrower to independently purchase a property sooner than they otherwise might. LMI is the alternative to using a guarantor or having to save for a bigger deposit, both of which are not feasible options for many first home buyers.

A deposit of at least 20% of the desired loan amount is required for a borrower to not be deemed ‘high-risk’. For many buyers it is difficult to save this amount, LMI allows those borrowers with smaller deposits to enter the market sooner rather than later.

The major benefit of LMI is that it can allow the dream of homeownership to become a reality for a lot of first home buyers.

How can I avoid paying LMI?

Depending on your circumstances, you could save for a higher deposit – a higher deposit means a smaller loan amount and therefore a lower LVR thereby reducing the lender’s risk. A loan of 80% or less of the property’s value is the key to avoiding paying LMI.

If you don’t have the financial capacity to meet a 20% deposit but still want to avoid LMI, you do have the option of getting a guarantor for your loan. A close relative, such as a parent, sibling or perhaps a grandparent, may be eligible to act as a guarantor, and they use the equity in their property to help you secure yours and keep your total loan below 80%. However, it’s important to remember that acting as a guarantor does come with some risks too.

Should you manage your investment property?

While managing your own investment property can seem like a simple way to keep more of the rent flowing towards the mortgage, there’s a little more to it than making sure the house is standing and collecting the money.

Managing your investment property appears straightforward – you find a tenant, they pay rent, and you keep a close eye on your asset. It’s cheaper and may suit people with the know-how and available time necessary to sustain a financially viable real estate asset.

If you have a reliable tenant willing to pay market rates and you know how to protect your rights and your tenant’s rights in the event of a mishap, chances are your investment will run smoothly. But there are some very important factors to consider before donning the managerial hat.

Firstly, there’s a lot of legislation in place to protect tenants and landlords. If you don’t have the means to become familiar with the law, running the books on your own might not turn out well.

Do it yourself property managers also need to manage lease agreements, rental payment authority, bond lodgement forms and property inspection reports. In the case that something goes wrong, the correct implementation of these documents could be the difference between a win or loss at the relevant tenancy tribunal.

Property managers also market the premises in order to ensure that you get a good price, and the property may be more appealing simply because renters know they will be dealing with a professional rather than an owner.

While self-managing is right for some, having a professional, trustworthy property manager available to handle inquiries, damage or a broken lease can pay off for other owners. It all comes down to whether you can commit the time and effort needed to ensure your investment needs are met, as well as the rights of your leasing tenant.