Tips & Common Mistakes First Time Investors Make
Property investment is a favorite national pastime, with some 2 million Aussies calling themselves landlords and residential real estate accounting for more than half of all household wealth.
"Did you know: As an asset class, the Australian real estate market is worth over $6.5 trillion? That’s three times more than all of the superannuation funds across the country combined, and more than four times the value of all Australian listed stocks" (Source: CoreLogic, 2016)”
It’s easy to see why. Unlike other investments - like shares or more complex ‘instruments’ such as derivatives - real estate is relatively simple to understand. It is also tangible - you can look at it, touch it and even live in it. As long as there is demand for property, you have a good chance of realizing robust growth from your investment.
Contrast this with the stock market, which tends to be more volatile and complex. Against investment instruments such as this, investing in real estate outperforms many other asset classes.
That is not to say property investing is a comfortable ride - many novice investors have failed and had their dreams dashed. You need to thoroughly do your homework if you want any chance of being successful - so consider this guide as your first assignment.
First-time investors are merely everyday people striving to create a better future for themselves and their families. They aim to buy property, rent it out in the hope that one day, with smart management and capital appreciation, they can use the value in that property to help maintain their living standards into retirement without relying totally on government assistance.
You can invest in property even if you do not currently own a home. In fact, it can be a great way of building equity to become a homeowner down the track. This First-Time Real Estate Investor Guide will help demystify the property market and assist you in making educated decisions early and gaining solid returns over time.
Australia has one of the most robust real estate markets in the world.
The political and economic stability Australia enjoys, along with historically consistent capital growth and the tax benefits associated with owning an investment property, all make investing in real estate a famous investment avenue.
“We have a powerful culture of property investment in this country, and of course one of the reasons for that is the robust and resilient nature of returns over the longer term and the fact it is considered a positive risk asset by lenders,” says Dr. Andrew Wilson, senior economist for the Domain Group.
Making well-researched decisions about the price you pay and the type of real estate you choose will have the most significant impact on your investment’s return. You also need to consider your personal budget, ongoing ability to manage cash flow and the cost of maintaining the property.
1. Determine your structure
Start by finding the taxation implications. Each structure such as trusts, superannuation funds, companies or personal names has tax advantages and disadvantages. Before purchasing, consult a good property accountant for structural advice suitable for your circumstances. It can be expensive to change names later.
2. Know your purpose
Some invest with a long-term view of security and wealth creation, while others are looking for a short turnaround and a quick profit.
Inexperienced investors who attempt a quick turnaround frequently fail. They often buy without enough research or experience, find the costs are higher and the return lower than expected, leading to rapid losses rather than gains.
The losses in this sort of venture can come hard, fast and plentiful. In a booming market, many people move into the business of flipping, only to see their profits evaporate when the market turns. If you’re a short-term investor, be careful, do comprehensive research and start small.
Looking for short-term capital gains is more speculation than investment. Good long-term property investment is just that — an investment.
3. Horses for courses
Despite much of what you read and hear, no two properties work the same way. Commercial property is primarily income-producing, while residential property primarily generates capital growth.
Some features need substantial renovation to improve their resale value, while others have inherently high land values that do the job for you. Some properties (like B&Bs) demand a lot of time and hands-on involvement, while others can be managed by a third party, enabling you to ‘set-and-forget.’
All these differences mean that the property which is right for you may not be the property which is right for someone else. Before you enter the market, it’s essential to consider your personal and financial circumstances and goals, your stage of life and the level of involvement you’re prepared to have.
4. Strategize first, buy later
Decide what type of property is appropriate for your situation. Do you have a significant enough working income to support the costs of owning an investment property? If so, a residential property that can provide capital growth may be the best bet. Do you need income to replace your wage or salary? In this case, commercial property or commercial property trust may be more suitable.
Next, determine which entity is going to own it. There are several forms of ownership: individual, partnership, company, trust or self-managed superannuation fund. The tax office treats each type of property differently, so seek advice from your solicitor or accountant before you buy. If you have to change the form of ownership down the track, you could be up for thousands in additional stamp duty and/or capital gains tax.
5. Growth and return
Two factors often mentioned in property investment are capital growth and rental yield.
One myth of capital growth is that property prices double every seven years. For example, in 1973 the average house price in Brisbane was $17,500. If house prices had doubled every seven years in 2014, the average price would have been $1,120,000. In fact, it was about half of that.
Many property investment gurus make money from seminars rather than property. If a deal sounds too good to be true, then it probably is. However, when looking for growth, two genuine property investment experts first time-investors should be familiar with are Margaret Lomas, who wrote 20 Must-Ask Questions for Every Property Investor and Terry Ryder, who runs hotspotting.com.au.
When looking at income, the figure most quoted is the gross return—that is, the total rent for the year divided by the purchase price, multiplied by 100 to give a percentage figure.
A property purchased for $500,000 and renting for $500 a week has a return of 5.2 per cent. That is $500 x 52 = $26,000 / $500,000 = .052x 100 = 5.2%.
In 2018, interest rates were at record lows, so the 5.2 percent return looked attractive.
However, when doing the calculation on an investment purchase, you should underestimate income and overestimate expenses. That way, there won’t be any nasty surprises.
Rather than making your purchasing decision on the gross return, calculate the net profit — which takes into account your expenses. For example, if you allow two weeks a year for vacancies, add council rates, corporate body costs, agents’ costs, maintenance, and insurance. A 5.2 percent gross return quickly drops to a less than 4 percent net return. This doesn’t necessarily make it a bad investment, but at least you’re making your decision on a more realistic number.
6. Get your finances in order
No matter which type of property you buy, the strong entry and exit costs mean you must consider it a long-term proposition. It’s not just a case of having the funds to buy the property, but being able to fund the holding costs for at least seven to 10 years. Think ahead to possible changes in your circumstances (such as starting a family, becoming self-employed or retiring) that could affect your ability to hold the asset for the long term.
If you’re buying a new or near-new property and relying on claiming depreciation benefits to maximize your cash flow, remember that most depreciation occurs in the first five years. Once you’ve used up your depreciation allowance, you could be out of pocket unless you can find another source of income to fund the holding costs.
7. Don’t underestimate ongoing costs
Make sure you budget enough for rates, insurance, and general repairs. And when you have purchased your ideal investment property do what you can to prevent costly maintenance issues arising, such as replace aging taps.
8. Know your limit
Before investing in property, it’s vital to have a thorough understanding of your cash flow. Also, ask your bank for a pre-approval of your investment loan, so you know how much you’re able to borrow before you start hunting for properties.
You’re buying an investment property, not a home to live in. You don’t have to love it – or even like it. Leave your emotions at the front gate, set a limit based on your research and stick to it. If the bidding goes over your limit, drop out of the race. It’s one thing to buy well, but buying at all costs is merely smart investing.
9. BYO research
When you’re researching the local market, be wary of free advice. If someone is purporting to ‘advise’ you but being paid by the vendor, they’ll be accountable to the vendor, not to you.
Instead, do your own research by looking at vital statistics from objective agencies, attending auctions in person and tracking auction results through The Age. If you need back-up, seek advice from professionals who don’t have a vested financial interest in steering you towards a particular course of action.
10. Buy in a growth area
Try to choose an investment property in an area where there is a strong demand for rental accommodation. Buying a property close to transport, universities, and schools will make it more attractive to renters.
11. Don’t buy on trend
First-time investors should be very wary of buying on an economic trend. For example, the mining boom of the 1990s and early 2000s led many property investors into country towns and regions. While returns and growth were — and there is no other word for it — spectacular, the end of the mining boom saw a significant downturn for residential investments in these areas. The supply of tenants diminished, leading to reduced rental returns; buyers deserted the market, and therefore prices fell significantly.
For first time investors buying a property is an exciting and worthwhile venture. Something is comforting about having an investment in bricks-and-mortar. Just remember, property investment is like all profitable investments, it takes to research, strategy, and planning.
12. Be realistic about your investment goals
Are you looking for fast capital growth or wanting to hold the property long-term? During boom periods, it’s much easier to renovate properties and turn them over for a quick profit. In slower economic times, it may take many years to achieve the same growth.
While home on a steep block may have a stunning view, it could be a nightmare to renovate due to retaining or excavation costs
13. Regular reviews
Cast a critical eye over your financing arrangements and property portfolio once a year to decide whether they’re still doing the required job. The finance market changes constantly, so you may be able to get a better deal with a different product, package or lender. Are your properties generating rental income and/or capital growth higher than the broader market? If they’re lagging behind Melbourne-wide or local median rental and property values, it may be time to consider selling.
Common mistakes to avoid when investing for the first time
Everyone wants to be a property investor, but the reality is you need to be informed, crunch the numbers and stay calm before taking the leap.
Here are some critical mistakes people make when investing in property for the first time:
• jump right in, before doing thorough due diligence
• make decisions based on emotions not facts
• borrow to their limit and don’t consider future changes in the lending market
• take too much risk; for example, they take out interest-only loans with no safety buffer
• choose the wrong location or asset
• rely on rental income to pay expenses
• don’t all the possible tax deductions
• don’t think about the long-term strategy.
• No two properties are the same
• Buy a property to suit your circumstances and goals
• Decide on the form of ownership
• Make sure you can afford to hold the property long-term
• Be wary of free ‘advice.’
• Set a price limit and stick to it
• Review your financial arrangements and property portfolio annually.
Speak to a Melbourne property investment advisor today.