How to Start Investing
A beginner's guide to property investing
Source: By Eynas Brodie | Property Basics |
Given the increasing emphasis on personal retirement planning and the countless money-making stories to come out of the recent boom, it's hardly surprising that more and more people are hankering to get into the property game.
But for many would-be investors, although the spirit is willing, the same can't be said for the flesh. Something holds them back from taking the plunge.
It could be that they don't know the first thing about property investing and find the process daunting. Or perhaps they don't think they earn enough money to do it.
Should either of those possibilities throw a roadblock or a stop sign on their path to property investment? Or is commonsense, combined with a dose of courage, enough to clear them over the first hurdle?
We look at what 'First-time' property investors need to know - both before and after they've signed the dotted line on a sales contract.
We'll also look at sealing the deal; the legal aspect of a purchase; common mistakes; costs associated with buying; property management; and taxation.
SEEK ADVICE
STRATEGY
FINANCE
RESEARCH
WHAT TO BUY?
USING AGENTS
READY TO BUY
BEWARE THE HIDDEN COSTS
BUILDING AND PEST INSPECTIONS
LEGAL MATTERS
PROPERTY MANAGEMENT
COMMON PITFALLS
TAXATION
DEPRECIATION
TEN TIPS
SEEK ADVICE
For every happy property investment tale, there is likely to be a horror story about an investment gone wrong, so getting advice before getting a property is wise.
Initial findings by the Parliamentary Joint Committee on Corporations and Financial Services into the regulation of property investment advice explains why reliable advice is vital in safeguarding your interests.
"Unfortunately many consumers have learnt, to their cost, that investment in property can be a complex matter, with considerable risks for the uninitiated," it says.
"The amounts involved are usually relatively large, with significant entry and exit costs, and the risks involved in using some of the new financing options, such as utilising the equity in the family home, need to be well understood."
Queensland's Fair Trading Minister Margaret Keech says potential property investors encouraged by increases in rental yields should exercise caution when turning their investment dreams into reality.
"Buying an investment property can be an expensive and complex purchase and, with prices in residential and commercial markets surging in recent years, it can also be an expensive mistake," she says. "Property requires maintenance and running costs, and involves more financial commitment and supervision than other 'passive' forms of investment, so it is important to do your research carefully before you buy."
So while property investment may be a popular vehicle for wealth creation, the warning to potential buyers is not to enter into it too lightly.
Investors should use every opportunity to pick the brains of the professions and experts they encounter.
And there are plenty of those, because behind every property transaction is a small army of people working on behalf of the buyer and the seller. They can (but don't always) include the agent marketing the property, mortgage and insurance brokers, solicitors and conveyancers, lending institutions, building and pest inspectors, and financial advisers or accountants.
Make sure you get your money's worth from each one and don't be afraid to ask lots of questions.
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STRATEGY
Having decided you want to invest in property, the next question you need to answer is why? What do you hope to achieve from it?
Your answer will form the basis of your strategy, and your strategy will play a key role in steering your investment decision.
Once you've identified what you want to get out of your investment, it will be easier to determine what type of property you should buy, and subsequently, where to go looking for it.
For example, if your strategy is to buy and hold a property so you can build equity for a capital gain later down the track, you will need to find a property where price growth looks assured.
Jack Henderson, a buyers agent, emphasises the importance of having a clear strategy to begin with. "The investment strategy might revolve around cash flow, it might revolve around capital growth or some combination of either, and having that strategy together to start with is critical," he says.
His tip for newcomers is to rank capital growth above cash flow when formulating a strategy.
"Equity lasts forever," he explains, "(whereas) cash flow is spent and disappears. Of course, the reason you are building this equity is because someday, you'll want to get off that treadmill and relax and enjoy life, or the time may come when you are no longer able to work. You need to be in a position where your money and your investments never retire. "Twenty-four hours a day, seven days a week, 365 days a year, they should continue earning money for you," he says.
Stuart Wemyss, chartered accountant and director of mortgage broking firm ProSolution, agrees that determining your investing objectives should be your first move.
"Before making any investment, a person should consider a number of factors including their aims, timeline, how to do it (i.e. buy and hold, renovate and sell etc.) he says. "This will also have a bearing on the type of loan that they need to choose."
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FINANCE
Wemyss suggests new investors begin by preparing a budget to determine their maximum monthly commitment.
"Most investment property purchases will be cash flow negative. That is, the rental income will not be enough to pay for the loan repayments and expenses," he says.
"Therefore, investors will need to commit to contributing some cash towards paying for the remaining property/loan expenses. Investors should determine how much they can comfortably afford to contribute.
"From this they should be able to determine the maximum loan amount they are comfortable with and therefore the maximum purchase price."
The next step, says Wemyss, is to consider the deposit requirements.
"The amount of deposit or equity that investors have will determine the lenders that they can choose from," he says.
The options he lists are:
§ Borrow up to 105% of the property's value - therefore no deposit is required.
§ Borrow up to 100% of the property's value - therefore you will have to pay for stamp duties and legal costs.
§ Borrow up to 95% of the property's value - therefore you will only have to pay for a 5% deposit, stamp duties and legal costs.
§ Borrow up to 90% of the property's value - therefore you will have to pay for a 10%, stamp duties and legal costs. Most lenders in Australia will at least lend 90% of an investment property's value.
"Of course, if investors borrow more than 80% of a property's value, the investor will have to pay for lenders mortgage insurance," Wemyss says. "This is a tax-deductible cost claimed over the first five years of the loan term."
Mortgage insurance is a once-only premium that protects the lender if the borrower defaults.
According to Henderson, there are investment strategists who promote the use of mortgage insurances.
"Mortgage insurance does in fact help reduce the deposit required to purchase the property," Henderson says. "...it's a way that people can invest in property at a lower deposit. In fact, with the use of mortgage insurance one can buy property with as little as 5 per cent deposit in some areas."
Wemyss warns new investors not to over commit themselves and to make sure their borrowing capacity is in line with their monthly commitment.
"Speak with a lender or mortgage broker to ensure you have sufficient borrowing capacity and deposit to be able to afford the investment that you have in mind," he says.
"The investor should then seek a loan pre-approval in writing from their chosen lender. Pre-approvals do not cost anything and does not commit the investor to using that lender - so there's no reason not to get one.
"They provide the investor with some comfort that the lender will approve the loan once they purchase a property. Also having a pre-approval minimises delays in the future,” says Wemyss.
This appears to be a trend more people are following, with a recent survey of Mortgage Choice franchisees showing that 69.2% of respondents found buyers organised their loan before purchasing a property.
Still on the subject of finance, it is worth noting that the First Home Owner's Grant is only for first homebuyers who intend to use their first purchase as their principal place of residence for at least 12 months. The grant is not designed to help investors. For more information, visit www.firsthome.gov.au
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RESEARCH
Now comes the hard part - finding the property! This is where the phrase "knowledge is power" really rings true.
"Research is critical as far as the first investor is concerned, however most first investors don't know where to start," says Henderson.
"There are a whole range of different drivers as far as investment properties are concerned and getting good advice is critical to the process. In the old days, you could buy any property and it just went up in value. Today, to buy a top performing investment property, you've got to do the research.
The research ranges from understanding what drives investment property values. It includes research into areas that have had historical capital growth and why it has occurred. I would look into the supply and demand ratios, looking for areas of strong owner-occupier demand which drives up property prices and tenant demand which strengthens rental returns.
"I look for areas going through transition, going through gentrification. I look for areas where old houses are being refurbished or pulled down and replaced with new townhouses or apartments, where lifestyle shopping strips are emerging.
"There's lots of data available from various sources, so trying to access and interpret the data is important," he says.
While this is often the most time consuming part of the process, it is usually the one that pays off the most. If you have research to support your investment decision, then you've effectively stacked the odds in your favour in terms of how it will perform for you
There are plenty of resources available when it comes to researching investment properties. Some of them come at a cost, while others are free.
Some possible resources: Real Estate Institute of Australia - www.reia.com.au ; Property Council of Australia - www.propertyoz.com.au ; Australian Bureau of Statistics - www.abs.gov.au
Not only is it wise to thoroughly research the area you wish to invest in, but you will also need to research the financial capability of the investment.
This includes assessing the capital growth history, potential rental income and ongoing expenses, such as land tax, insurance and (if you are buying into a complex) body corporate fees.
"Potential property investors should shop around first, seek independent valuations, financial and legal advice before buying, and in the case of residential property - unless it was bought at auction - take advantage of the five-day cooling-off period if they need to," says Keech.
"It's also important to consider the likely returns on the property before making a commitment to buy, and be wary of promises of high rates of return. If returns seem too good to be true, they probably are."
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WHAT TO BUY?
Should you buy a house or a block of land? What about a duplex or a unit? Do you want a property with a view or is multi-zoning your preference?
The questions are endless, and while it is easy to get caught up in all the different possibilities, try not to lose focus. The growth, returns and expenses for each property type varies, so again it comes down to research and working out which property will best meet your needs.
For example, well-located land may give you a good capital gain long-term but it won't deliver the weekly rental return that only a physical structure can.
Henderson suggests first-timers start with residential real estate, pointing to established townhouses or apartments as a great first-time investment.
"If you have the time and experience, renovating established properties or developing new properties greatly boosts your returns from real estate investing," he says.
"I would look for a property with a 'twist' where there is a hidden opportunity to add value that others don't see.
"As you become more experienced you may want to consider industrial, commercial or retail properties. Generally, we don't promote buying off the plan for investors because it is hard to find value in these properties because of the high fees, marketing costs and profit margins incorporated in the pricing."
Consideration should also be given to additional features of a property which will make it attractive to future buyers and tenants. If the property is tenanted, find out about its rental history so that you are informed about what you are inheriting.
You can revisit your strategy for guidance and discuss your options with your financial adviser.
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USING AGENTS
When you are looking at properties, you will often come into contact with real estate agents or sales representatives.
A Homebuyers' Survival Guide produced by the Western Australian Government's Department of Consumer and Employment Protection reminds buyers that these agents or sales representatives have been hired by the seller.
"The real estate agent's job is not to get you the 'best deal' as a buyer, as they are employed by the seller to get the best price and conditions for the sellers," it says.
Nevertheless, Real Estate Institute of Australia president Ian Wells says it's important the agent you are dealing with is knowledgeable on investment-type properties and what is required to make a property a good investment proposition - for example, their popularity as far as rental demand goes.
"Some areas are far more in demand than others," Wells says.
"They might be close to educational facilities or hospitals or CBD locations, and consequently they have good demand for tenants, whereas other locations are not popular for tenants and are more difficult to rent and consequently, vacancy factors would be higher."
Wells also advises buyers to check that the agent is a member of the Real Estate Institute.
"The benefits are that they have a Code of Conduct, they are generally well trained and are continually being advised by their institute of latest statutory local government requirements and licensing provisions," he explains.
This applies to buyers agents, as well as real estate agents.
Buyers agents, as their name suggests, represent the buyer only and can be hired to do the legwork of finding a property for you. Wells says about 75 per cent of all real estate industry businesses are members of the Real Estate Institute.
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READY TO BUY
Okay, so you've found a property that's ripe for the picking. You've done your homework on the area and you've come to the conclusion that this is 'the one'. Now it's crunch time!
Presuming the property you want to buy is being sold through an agent or directly with the seller (private treaty), this is the point you would begin negotiating a sale. You should always try to negotiate, rather than accept the price.
If, however, the property is being sold at auction, you will need to consider a number of things, such as whether you want to put in an offer prior to auction, what your limit is if you intend to bid, and whether you can meet the terms and conditions of the auction (for example, the seller may require a 10 per cent deposit on the fall of the hammer and a 30-day settlement).
Remember, if you are the successful bidder at auction, the sale is unconditional. There is no cooling-off period and you don't have the luxury of contract conditions (eg. subject to finance approval). With that in mind, it might pay to attend a few auctions beforehand so you can see what happens.
Other methods of sale include expressions of interest and sale by tender.
Before endeavouring to seal the deal, try to ascertain how long the property has been for sale, why the vendor is selling, what offers they've had on the property, what will be included in the sale and how flexible the seller is with contract conditions.
This information, along with research on what similar properties in the area have sold for, will put you in a strong position to negotiate. Even if this is your first time, knowing your stuff will give you the edge you need.
The Queensland Office of Fair Trading's consumer real estate guide, Real Estate Realities, gives the following tips:
§ be wary of accepting advice from professional experts closely associated with the seller;
§ seek independent legal advice and an independent valuation before you sign the contract; and
§ check the sales contract is accurate and you agree with its contents including conditions that give you adequate avenues to cancel. If you are unsure, check with your solicitor before you sign the contract.
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BEWARE THE HIDDEN COSTS
New property investors don't always realise that the final bill for their acquisition will be for more than just the purchase price - in fact quite a lot more! The different fees that surface when acquiring a property can come as a rude shock, which is why it pays to know what you'll be up for beforehand.
When you purchase a property you are required to pay stamp duty. The amount of stamp duty varies from State to State, so this is something you'll need to check with the Office of State Revenue. Alternatively, the conveyancer or solicitor handling your transaction will let you know how much you have to pay.
You also have to pay stamp duty on the amount you are borrowing to buy the property. You can obtain this figure from your lending institution.
But there's more! In every State (except the Northern Territory), there's an annual charge applied by the Government to the total unimproved value of land owned in that State called land tax. Again, this tax rate varies from State to State but tends to apply to most investment properties. Your principal place of residence is exempt, subject to certain criteria being met. The details of the land tax scale that applies in your State can be obtained from the Office of State Revenue.
Other costs associated with buying can (but don't always) include mortgage insurance, building and pest inspections, conveyancing and valuation reports. Then, of course, there are the ongoing costs once the property becomes yours, such as property management fees, maintenance and repairs, council rates and insurance.
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BUILDING AND PEST INSPECTIONS
When making an offer on a property, you should consider adding a clause to the contract making the sale subject to satisfactory building and pest reports. This allows you to enlist the services of building and pest inspectors to assess the condition of the property and inform you of any structural defects or termite damage.
Depending on what the inspectors find, you may be able to use their reports to negotiate contract conditions as well as the price.
Although these reports generally cost a few hundred dollars, they can potentially save you thousands on unforeseen repairs.
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LEGAL MATTERS
You will need to enlist the services of a conveyancer or solicitor to manage the conveyance of the property. Make sure they are appropriately qualified to deal with property transactions because their knowledge and expertise will fill in the gaps of your own inexperience.
If you haven't already done so, you should provide your conveyancer or solicitor with a copy of the contract and associated forms. Not only will they make sure your interests are protected, they will also proceed with the necessary searches of the property on your behalf, the cost of which is usually factored into your total bill.
You can also ask them to prepare an estimate of the costs required for settlement so you have an idea of how much money you will need all up. You are normally required to insure the property as soon as you have signed the contract of sale - not after settlement. Your conveyancer or solicitor can explain more about this to you if you are unsure.
It is the job of your legal professional to manage any issues that may arise between signing the contract and settlement date and to ensure, in conjunction with your lender, that settlement proceeds smoothly.
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PROPERTY MANAGEMENT
Congratulations! Assuming the sale has settled and you have been given the keys to your new property, you are now officially a landlord.
But the decisions aren't over just yet. You now have to decide whether you want to be "hands-on" and manage your investment property yourself or hand over the reins to a qualified property manager.
The benefit of using professional property management is that it frees you from dealing with tenant issues. Furthermore, a property manager is required to keep abreast of changes to the Residential Tenancies Act and is in a position to run checks on potential tenants.
For a percentage of the gross income you earn from your tenants, a property manager will look after the responsibilities of screening potential tenants, handling documentation, and overseeing maintenance and repairs.
Often property agreements last for long periods of time, so make sure you know what you're agreeing to and the services you will receive under the appointment.
If, on the other hand, you choose to do it yourself, you will need to familiarise yourself with the relevant laws and procedures. You can contact your local residential tenancies authority for further information.
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COMMON PITFALLS
Real Estate Institute of Australia president Ian Wells believes making an ill-informed decision to acquire an investment property is the most common mistake new investors make. He says this includes not carrying out sufficient research, not using professionals who have knowledge of investment properties and not fully understanding the ramifications of property ownership.
"If it's residential property, they should have a good understanding of the Residential Tenancy Act in the various States," he says.
"They should be fully aware of the responsibilities of a landlord and a property owner, particularly in regard to their outgoings which are rates, land tax, insurance, maintenance, management, vacancies and things of that nature so that they can truly determine a net return on their property."
Jack Henderson, manager of Metropole Buyers Agency, shares Wells' sentiments, saying novice investors make the mistake of underestimating the acquisition and running costs of an investment property.
"They commit themselves a little bit too high and then are very concerned if it's vacant for a week or can't cash flow minor repairs or refurbishments.
"It also is our habit as beginner property investors, unless we are informed and helped, to buy as close as possible to where we live because we like to live there. That can be a very dangerous trap because where we live may not be such a good investment area with good growth potential and strong rental income," he says.
Stuart Wemyss, chartered accountant and director of mortgage broking firm ProSolution, says often times novice investors don't look far enough ahead.
"Many problems arise for investors when they don't consider how their loan product or structure may affect them in the future," he says. "They don't consider the effects or cost of changing the loan in the future because they are in the mindset of: 'I'll own this property for the next 10 years.' They might sell it because it turns out to be a dud. They might renovate, increase the loan to access equity, etc."
Taking loan advice from inexperienced people is another common faux pas.
"Poor product selection or loan structure often arises out of following advice from people that don't know about property investing and/or aren't investors themselves," says Wemyss. "A good example is people taking advice from inexperienced bank staff. When setting up your loan structure and choosing a lender and product, speak with a knowledgeable professional or other investors."
Wemyss says another common slip-up is when new investors fail to arrange a pre-approval on their finance.
"There is no excuse. All investors should seek a pre-approval before every purchase. This avoids delays and complications," he explains.
A lot of the time when contracts collapse, it is for reasons to do with finance which is why having an inadequate finance clause, or having no finance clause at all, can be a fatal error.
"In most States you can submit offers and sign contracts of sale with 'subject to finance' clauses," says Wemyss. "This allows you to organise finance within a specific period of time. If you cannot organise finance then you can cancel the contract and recover your deposit.
"If possible, always purchase 'subject to finance' and give yourself approximately 14 days from contract date to arrange unconditional finance approval.
"You may not be able to do this in NSW because it is uncommon to include 'subject to' clauses. However you can provide a lender with a draft contract signed by you (the purchaser) and most lenders will then approve finance unconditionally after the valuation has been completed. You can then exchange contracts once this has been approved," he says.
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TAXATION
Australian Taxation Office marketing and education assistant commissioner, Kathy Dennis-Carter, says recent audits have highlighted poor record-keeping as one of the most frequent blunders made by property investors.
"People don't keep complete and keep accurate records," she says. "That's particularly the case when their circumstances change. For example, where they convert what was once their main residence into a rental property and they don't have the records for the time when their property was their main residence."
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DEPRECIATION
Independent valuer Herron Todd White estimates that up to 70 per cent of property investors don't know about the benefits available to them in getting a tax depreciation schedule for their investment property - whether it be residential or commercial.
HTW project director Phil Grahame says failure to obtain a tax depreciation schedule results in reduced cash flow and real loss of income from your investments to which you are entitled.
"A quantity surveyor can prepare a schedule with current depreciation information for your accountant to ensure you receive the maximum depreciation allowable through your tax return," Grahame says.
"The cost of having a depreciation schedule prepared is in itself tax deductible and is usually recouped in the first year's tax return, allowing you to pay less tax from year one.
"A common misconception held by many potential investors is that only new buildings attract depreciation. However, and this is the key, each investment property contains a number of depreciable assets such as removable floor coverings, stoves and cooktops, air conditioning units, hot water systems, curtains and blinds, dishwashers, and swimming pool filtration and cleaning systems."
Grahame says any building built after July 18, 1985 qualifies for the 'special building write-off' which means investors can claim depreciation on the original construction cost of the building.
"A schedule can be prepared that is backdated by up to five years," he says. "Amendments to your previous tax returns can be made, allowing you to access five years of depreciation in one year."
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TEN TIPS
1. Think twice before crossing the border
Wells has a warning for investors who are considering venturing interstate.
"They're probably out of their knowledgeable area and they should certainly do their research and get to know the local marketplace before making a decision on acquiring," he advises.
2. Be prepared
Keep proof of all you spend to ensure you don't pay more tax than you need to over the years. The ATO says you need to separately identify the cost of the building and any depreciating assets so you can claim all the deductions you are entitled to and work out your capital gain correctly when you sell.
3. Surf the web
Henderson suggests using the internet to communicate with like-minded investors. "That's a place where they can get free homework and free research." He names the Somersoft forum (www.somersoft.com.au/forum.htm) as a useful online resource. 'They're a little self-help groups,' he says.
4. Seek independent financial and legal advice
There are a number of tax and legal ramifications associated with property investment and it's vitally important for potential investors to seek professional advice from their financial planner, accountant or solicitor before deciding on a strategy.
5. Use the equity in your home
With the recent housing boom and increase in property prices, many homeowners will have a significant amount of equity in their homes that they can tap into to purchase an investment property.
6. Consider borrowing 110 per cent to cover purchase price and costs
If you have enough equity in your home, you may want to consider borrowing the full purchase price of the property and associated costs - you won't have to save for a deposit and you can claim any rental shortfall on a negative-gearing basis.
7. Carefully consider the options of positive vs negative gearing
Consult with your financial adviser before purchasing an investment property as to whether positively or negatively gearing a property is of greater benefit to your financial needs.
8. Choose the most suitable loan
There are a number of different types of loan available to residential property investors, and the most suitable loan will depend on your investment strategy.
9. Consider interest-only vs principal and interest loans
Think carefully about interest-only vs principal and interest options. Although interest-only loans will not reduce the loan amount, they will result in less monthly repayments and allow you to make greater contributions to your principal place of residence, allowing the investment property to grow in value through capital gains.
10. Take a long-term approach
As with all investment strategies, a long-term approach should be taken when purchasing an investment property. Unlike the gains achieved on investment properties in the recent boom, borrowers can still expect good returns per year, and depending on market conditions and personal circumstances, may look at holding on to the property for seven to ten years.
© Australian Property Investor magazine - www.apimagazine.com.au. Reproduced with permission.
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