Common Australian Property Investment Mistakes Buyers Make
When it comes to buying an investment property, experts agree that the key is be informed. But it’s just as important to do your own research.
If you were asked what do you feel more comfortable with, investing in shares or property?
The majority of people would say property. The reason for this is because property is something that we all have experienced in our lives, so naturally we automatically assume we understand it better than shares or managed funds.
Investing in property seems to be all the rage these days and it’s no surprise when you consider the countless benefits that come with it like capital returns and rental yields.
But just like all things in life, investing in property comes with its downfalls and if you’re not careful you could be lead down the garden path.
So before you try your hand at investing in property, watch out for these common mistakes to avoid:
Lack of solid research and due diligence
It may seem obvious, but understanding where and what you are buying will help determine your long-term profits. Conduct some research to get to know the suburb you are looking to buy in, including the demand for rentals, and the local demographic and needs of your prospective tenant. Young working professionals, for example, will be looking for a different property to rent than a growing family. Being clear on your investment strategy and then speaking with professionals in the local area (such as mortgage brokers, real estate agents and financial planners) can help you decide if a particular suburb or property is right for you.
Choosing the wrong location
We’ve all heard the saying “location, location, location”, so it shouldn’t surprise you that picking the wrong location is at the top of our mistakes list. Some of the things to avoid when hunting down an investment property include locations on main roads without infrastructure like transport, shops and parks nearby.
The reason? Well, this type of property without amenities, will not, exactly be an attractive rental to tenants. That’s why it’s always important to draw up a list of things that your ideal investment property should have to ensure you’re not only buying in the right suburb but the ideal spot within that suburb as well.
Buying with a Short Term View
Buying an investment property has some pretty steep upfront costs and they usually are around 5% of the price of the property. Then add the ongoing interest on the loan and you can start to appreciate the importance of the good returns, otherwise you are going to lose money, especially in the short term. An investment property needs time for the power of compounding value to realise its true value as an investment asset. If your situation is to change in the short term and you may be required to sell your property in 5 years or less, then generally speaking it may not be a wise investment for you now. In our business short term investing is 10 years or more, median term is 25 years or more and long term – well that’s never to sell so you can reap the full benefits of an income for life!
A long-term mindset is important, pointing out situations such as a couple buying with two incomes, but failing to plan for dropping to a single income when they started a family.
Know the purpose of buying your property. Are you after short-term or long-term gains? Are you planning to one day live in the property or is it a straight investment? What type of property will help you meet your income goals? All these questions may need to be answered before you sign on the dotted line - you don’t want to be forced to sell a property within five to seven years.
While home loan interest rates are currently at record lows, you never know when the market could shift. So make sure you can reasonably afford your ongoing repayments if your lender was to increase your rate down the track by using our rate change calculator.
Chasing the Lowest Interest Rate Option
Many people think the best deal for them is the lowest interest rate on a property loan. But it’s not always that clear cut.
Getting a loan with a low interest rate doesn’t guarantee that you’ll get the cheapest loan out there – especially if you don’t check the fine details of the loan thoroughly.
Some banks limit extra payments into your loan. Others enact a minimum loan amount for you to qualify for the cheap deals. You might face break fees if you want to get out of a fixed rate before the term ends, or you may be unable to redraw additional payments.
In any case, the interest on your loan is a deductible expense for an investment property.
Using emotions to make decisions
A common mistake is trying to buy a property for its lifestyle benefits rather than its fundamentals.
When buying a home, about 90% of your purchasing decision will be based on emotion and only 10% on logic. This is understandable, as your home is where you’ll raise a family.
It’s your sanctuary.
When it comes to investing, however, letting your heart rule your buying decision is a common trap to be avoided at all costs
Allowing your emotions to cloud your judgement means you are more likely to over-capitalise on your purchase, rather than negotiating the best possible price and outcome for your investment goals.
Using it as a holiday house and an investment property – that doesn’t work. Holiday homes often had poor yields, poor capital growth and required a lot of maintenance.
“Oh what a lovely splash back, and that garden terrace is to die for!” But wait...before you fall in love with a property that you deem as just, “so me”, remove your heart from the buying equation and ask yourself - is it really worth paying a premium for those features if you won’t be living there and will it actually increase the potential for higher rental yields?
You may be better off buying a property that is a bit more rundown but can be spruced up with a bit of DIY reno.
Liking a property isn’t necessarily a bad thing, as mainstream owner-occupier appeal will make a property easier to sell. If it’s got a lot of appeal in a desirable location – that’s great, but it’s got to be in your budget.
Beginning property investors should always buy the property based on analytical research.
Will it provide the gains and returns you require? It is in the best location to attract quality tenants? Will it appeal to the owner-occupier market that sustains property prices in the long term?
By answering these questions, rather than buying a house because you loved the curtains or thought it would make a good holiday retreat, you’re thinking based on financial gain rather than personal feelings.
And at the end of the day, investing is all about economics, not the emotions.
Failing to buy within your budget
Buying, managing and selling an investment property can be costly so considering what you can afford in terms of repayments, ongoing and hidden costs is vital. If there is no way you can afford the property and still live your life, it can get you into trouble quickly.
Some of the costs involved with property investment include: stamp duty, conveyancing fees, legal costs, search fees, and pest and building reports. Then when you own a property you will have to factor in ongoing fees such as property managers and mortgage repayments too.
Over-borrowing and safety buffers
Its not uncommon for investors to get over-confident when they had acquired multiple properties.
What happens is with the strong sense of certainty and superficial confidence, there’s a tendency to go out and buy all these properties.
But refinancing can become impossible if you borrowed to your limit, particularly considering the tightening in lending restrictions. When you’re borrowing 95 per cent – you’ve got no room to move when interest rates go up and rents don’t.
Cross-collateralisation is when you use two or more properties financed by one bank to secure loans with the same bank for further properties.
It’s a big mistake to have your own home loan and your other properties all under the same bank. Do this as you build your portfolio and the bank could end up holding all the cards, putting your own home at risk.
You can avoid cross-collateralisation by using the equity from your home to cover the deposit and costs of buying another property without putting the home at risk.
Not Realising You Have Lazy Equity
One of the most common mistakes that you can make when trying to grow your investment property portfolio is to be sitting on “lazy equity”. The problem arises because most people don’t understand what it means to have lazy equity and how they can avoid it.
Lazy Equity is the term given to equity that you have accumulated in your property portfolio but which, for some reason, you are not putting to its most appropriate use (i.e. to invest in more appreciating assets). The two main reasons why investors accumulate lazy equity are:
Not being aware of current value of property; and
Not having the most suitable loan structure.
Smart Investors should always be aware of changes in the median house value of suburbs where they hold investment property. While the median house value is not an indication of the value of their property, it can be used as a “marker” to prompt you to undertake a more detailed study of local property prices.
Lazy equity is disposable equity that’s not being used for deposits on additional investments. If you don’t stay up to date on your equity position, you could be missing out.
Make sure you know your properties’ values – and when sales results in your area are looking good, get the bank to revalue the property.
Signing a Contract without a Finance Clause
Never sign a contract without a “subject to finance” clause. A finance clause gives you the ability to pull out of the contract if you can’t obtain the necessary funding to purchase the property.
It also gives you the opportunity to think about the purchase and do your due diligence before making the investment concrete.
Other property investment mistakes include:
- Buying at auction – paying more than everyone else isn’t a good investment strategy!
- Overcapitalising – it’s important to stick to your budget.
- Selling to realise a profit – better to refinance to buy another property.
- Paying off your debt – better to create a redraw facility.
- Failing to get experts to review your contract – you’re unlikely to know everything to look out for yourself!
- Buying in regional or rural areas – plenty of land means there’s a surplus of supply, so there’s less pressure on pricing.
- Waiting for a downturn in the market – chances are the market will rise, not fall.
Lack of strategic planning - When beginning property investors fail to plan, they plan to fail
It’s an old adage but very true.
Planning is important - often people buy properties because they think that they’re a safe, solid asset class – but they don’t think about what stage of life they’re at.
Do you need to minimise your tax, will you be short for your super fund? If you don’t match the properties to your lifestyle and circumstances, it’s a ridiculous thing to do.
Its important to consider exit strategies when it came closer to retirement. Someone looking for an ongoing income from an investment property in retirement would need to pay off the property in full.
That was in contrast to a first-time buyer looking to get their foot in the door and chasing capital growth, who might negatively gear an investment property, pay down their debt and then use the property later as a primary place of residence.
What type of property do you need to buy in order to meet your income goals?
With a carefully thought through outline of your investment journey, you will end up exactly where you want to be, so plan your action and then action your plan.
If you’re a beginner looking for a time tested property investment strategy or an established investor who’s stuck or maybe you just want an objective second opinion about your situation, why not let the independent property strategists build you a personalised Strategic Property Plan.
When you have a Strategic Property Plan you’re more likely to achieve the financial freedom you desire because we’ll help you:
Define your financial goals - see whether your goals are realistic, especially for your timeline;
Measure your progress towards your goals – whether your property portfolio is working for you, or if you’re working for it;
Find ways to maximise your wealth creation through property, identify risks you hadn’t thought of.
And the real benefit is you’ll be able to grow your wealth through your property portfolio faster and more safely than the average investor.
Relying on rental incomes
A lot of investors buy with the mindset that their rental income will cover the majority of the investment property related expenses but what happens if you can’t find a tenant for an extended period and your income doesn’t cover the costs?
It’s risky, and if you can’t meet the repayments you could end up defaulting on your loan and the bank could seize your investment property. So only borrow what you can reasonably afford to repay yourself. Use our home loan repayments calculator, to get an idea of an amount that will suit your financial situation.
Speaking of rental income, make sure you keep an eye on the market and make rental increases whenever your tenant’s lease has come to an end (usually 6 or 12 months). Your tenant is likely to take increases to rent of $10 or $15 far better than if you hike up the rent by $50, because you’ve been apathetic and let too much time slip by.
Not knowing what you can claim
One of the best parts about buying an investment property is negative gearing, which ultimately means if your rent isn’t covering your home loan repayments you can claim a portion of that expense. But the interest on your loan isn’t the only thing you could claim at tax time.
So make sure you have a chat with your accountant to ensure you’re maximising your tax return with the deductions available to you. These include the costs of any repairs to your investment, council rates and strata charges (and much more!).
Taking professional advice on legally reducing your tax is very smart. You should always look to ensure you protect what’s rightfully yours. However, don’t make your property purchasing decision based on a better tax outcome. Tax benefits is one of the big selling points for any agents selling new stock (often they don’t have much else), and they package their selling angle around the idea that once the tax benefit is factored into the purchase, the property is only going to cost you ‘less than $50 per week to hold’ as an example. You should care how much it is going to cost you to hold; you should care far more about how much it is going to grow in value. If it doesn’t grow in value as well as say another property with less tax benefits does, then you are losing far more money than what a tax benefit will give you.