Just like anything new, kicking off an investment portfolio can be scary. However, with the right strategy and diligent research comes confidence; and with confidence anything is possible. But where does a first-time property investor start?
Why do today what you can put off until tomorrow — if every residential property investor lived by this mantra they would likely still be enviously looking on from the sidelines as their contemporaries jumped on the investment bandwagon. Perhaps that’s what you’re doing right now – because there’s always something else to save for, a better-paid job to land, and of course, interest rates could always be more favourable.
Early lessons for investors
If you are thinking of breaking into the property investment segment, you must remember these two lessons as you shape your strategies.
First, you must realise that investing in property is a long-term strategy — when you take into consideration the high purchase costs such as stamp duty, legal and loan costs, then you really need to be holding for over five years, depending on where we are in the property cycle.
For some, the strategy is to hold property long-term, or at least 10 years to benefit from a complete property cycle.
The second lesson is to always be thirsty for knowledge — you can read magazines, watch the news, listen to experts, and even enrol in short courses that will widen your grasp of the property market.
Educate yourself to become more financially literate and understand all the strategies that can be used when investing in property.
Part of this education is being clear on what you are trying to achieve. Without a plan, it’s almost impossible to get to the goals you are trying to achieve.
While different investors have different goals and different constraints, having a plan will govern what sort of structures you put in place, or finance strategies you may employ. Once you put your plan together you should be able to see yourself reaching your short, medium, and long-term goals.
Develop an initial strategy
An initial strategy should be treated like a blueprint for all future investments. It can also provide certain steps that must be considered for each investment. Here are some key questions to ask:
How do I structure my investment?
Do I buy in my own name?
Do I buy in a trust?
Do I use my super or ask parents to help with a deposit?
Which financial products do I use and from which banks
Before I buy, if renovating is part of my strategy, what are the costs in doing so?
Taking into consideration the goals and constraints of the investor, a risk profile should also be developed. This will weigh the pros and cons of various ways of investing.
Some people buy and hold; some people buy, renovate and hold; some buy, renovate and sell. That could be for existing stock out in the market, or it could be for new stock just built, or possibly even off the plan. Different strategies have different risks. That’s why it’s very important in your initial strategy to review your risk profile. Find out which is the most appropriate approach for you.
Establish a structure
There are countless structures available to investors when buying a property. These can include trusts, such as a unit trust, discretionary trust, family trust or hybrid trust. In recent years investors have set up self-managed super funds and they may use instruments like property warrants to try to leverage further into property.
The type of structure chosen will depend on the investors’ risk profile, what they’re trying to achieve, whether they’re buying solely for themselves or with family, or buying with unrelated parties.
Assemble your team
No man is an island, and no investor knows everything. To create action plans to move the strategy into reality, it is recommended that you reach out to experienced investors and create an investment team.
You can start by finding a good property-specific accountant who will be able to advise you on the best structure for purchasing with, look at your financial situation, and help you analyse potential property purchases. You will need this advice before you exchange on a property.
A good solicitor is also crucial — choose someone who has invested in property themselves. Interview them if you must. This is important for all the people you surround yourself with as the more property transactions they have handled the more experienced they’ll be.
You will also need a good broker with strong, established relationships within the banks. Once you give your broker information such as what you are earning and what other debts you have, they will be able to tell you what size loan you can service and how much deposit you will need.
Check your finances
Once you are all set, you must get a copy of their credit file so you can check your records and correct any mistakes. Requesting a credit report is affordable and sometimes free if you are prepared to wait a few days to obtain it, but it can be an important document to hand to a broker.
Undertaking this step will help you see where you stand. You’ll be able to look at your bank statements and say, “I have this much cash”. From there you can get an idea of cash flow and budgeting. How much can you afford or are you willing to invest on a monthly basis in your investing plans?
Your credit report gives you and the broker confidence that your records are clear — even a mobile phone debt that you forgot about three years ago can cause problems if it is not declared upfront.
It is crucial that borrowers get their own financial situation under control and understood. Having credit card statements, any additional loan information, the last couple of payslips, PAYG group certificates, and other documents close to hand will assist the process.
For many brokers, clients who are ready with all the information sorted indicate how good one would be as an investor. After all, investing is a business, it is not a game or a hobby — you’re in it to make money.
Although almost anyone can get into property investing, it does require that you at least have some money or assets to get you enough credit with a lender.
For some people, like middle-aged or elderly couples, this can be easier as they probably own their own home. That equity can be used towards borrowing for a purchase, as can any savings they’ve accumulated.
For buyers starting out without any property already in their name, and limited savings, it is a little trickier, but far from impossible.
The banks have been reducing the LVRs pretty steadily over the past few years, and 100% loans and even 95% loans are hard to find. For first-time investors, they would need a minimum 10% deposit.
A lot depends on the bank, the timing, and who you talk to, but in most cases, it comes back to how your case is presented. They are after very strong applications so ensure you have everything ready to go.
Most investment experts agree there is little point in even looking for a property without knowing what your borrowing capabilities are or getting some assurances from a lender.
As mentioned earlier, it pays to have a finance strategy in place before looking to buy property. There are many cases wherein potential buyers win a bid at auction but are unable to get financing from the bank, resulting in them backing out. This could put a substantial dent in your finances, as the costs could be quite high. You could be up for the 10% deposit and the agency fees, which could be 2% to 3% of the property purchase price. Plus, there are legal fees.
All in all, there is some limited preparation that investors can do prior to approaching a broker. Online calculators can provide clues as to borrowing capabilities, but these should be used as simple guides only.
For some people they are extremely misleading, in both directions – they can be too conservative or they can be far too generous. That’s because people are not all the same. The bank’s primary market is for the very conservative, standard PAYG earner. There are many people who do not fall into that basket. For example, what you consider to be income and actually is cash in your pocket, such as commission or overtime payments, aren’t always acceptable as income to a bank for their servicing models.
Pre-approval from a bank must also be taken with a pinch of salt as it is no guarantee you’ll get the loan. Different lenders will undertake different amounts of scrutiny on the documentation.
If you’re dealing with a lender who will give the approval in principle, which means the assessor has actually looked at the file and checked the documentation, then that’s worth a little bit more in the sense that it’s actually been looked at. They’ve not just looked at the electronic loan application.
Regardless, it can be a useful step to take, if only to get the borrower organised with the right documentation.
It’s also important to note that the total transaction costs can add an additional 11% to the purchase cost. Make sure you include those added extras when buying a property – like legal fees, research, and mortgage insurance. Stamp duty, while not strictly speaking a ‘finance cost’, is a property transaction cost regardless of whether you borrow or not.
Additionally, find out about ongoing costs such as council fees, strata fees, body corporate expenses and property management fees. An accountant can help you determine negative gearing and capital gains tax.
From there, you should consider how you want to structure your mortgage.
The type of finance product you choose may depend on your strategy — for instance, if you were to buy, renovate and try to add value and increase your equity component in that property, then look to refinance, extract the equity, and move on to the next one.
To increase your buffer position for holding costs moving forward, certain financial products may suit you better than others. Others may have break costs or refinancing costs, or hefty legal fees moving forward. So, seek finance that meets your initial objectives.
One option is an interest-only loan, to maximise available cash. Interest-only loans can maximise cash flow and represent the lowest ‘personal commitment’ a borrower has with the lender.
This, however, does not stop you from making extra repayments – and that’s important – but it means that contractually your obligations are as low as they can possibly be.
Offset accounts are also a great addition. They keep your money separate from the loan so you are never affecting the tax status of the loan.
For example, people buying their first investment property will likely want to buy something down the track for themselves, so they should be saving money in their offset account which gives them the benefit of reducing the interest cost of the investment and improving cash flow during that time, which then gives the investor more money to put into the offset. They can invest and at the same time they are saving for their own home.
Finally, the question of whether to fix or go variable will need to be considered. The decision should be based on individual circumstances, your portfolio, costs, risk profile and what you’re trying to achieve.
As long as you factor in the end period of a fixed rate, and what it may fluctuate up or down to, then you can risk manage yourself moving forward. If it’s variable upfront, you should try to keep a 2% to 3% buffer either side of that variable rate. If you’re risk averse you may want to put 5% to 6% on top.Advertisement
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For young investors without reserves of savings, sometimes it is up to their parents to help out. This might entail lending a deposit or using the equity in their home to secure a loan.
The advantage of tapping into parents’ equity is usually that it minimises the need for expensive mortgage insurance – and that’s a great idea. However, parents do need to be a little bit careful, particularly older parents who may be thinking about selling their house to move to a retirement village.
The bank will want cash when they sell to cover that loan, unless the first property has gone up a sufficient amount to cover that loan. And there’s a certain amount of trust in the children to pay down the loan. In that situation, if it’s an investment property, the child has an obligation to their parents to reduce the loan to release the parents’ property as soon as possible.
Parents, other relatives, and friends might be able to assist by offering free accommodation or cheap rent as a temporary place of residence.
Understanding tax and capital growth
Tax should rarely be a major consideration for investors; in fact it is “the icing on the cake”.
Still, you should never invest in something purely for tax reasons. Tax benefits on a property can be beneficial and can certainly make the returns better but doing research and due diligence upfront is crucial. Capital gains, land tax and possibly GST are all factors that need to be understood.
An important point to remember is you are only taxed on capital gains if you sell your property. Many high-profile investors have achieved significant returns over the long term because they bought capital growth assets and held them for extended periods.
If you purchase high rental yield properties, however, you will be taxed on the rent. This option might depend on what your financial situation is. Those with a low wage and limited savings may need to sacrifice growth and go for yield, but the opposite is true for those with a high paying job.
These are just some of the things than can help you get a leg up as you start your journey in the property investment space.
This article was first published in May 2010.
Photo by Pexels--2286921 from Pixabay.