There are several considerations that one should contemplate before purchasing an investment property.
The broad overarching ‘rule of thumb’ is that finding and buying the right investment property differs greatly from finding and buying your own home.
When buying an investment property, the key driver is to make a ‘reasonable’ financial return, whether through capital growth or rental income. That’s why being smart about what and where you buy is essential.
Key factors to look for in an investment property:
- The right type of property
The type of property you buy will essentially depend on your budget, but nonetheless, think about what would appeal to a person or family looking for a place to call home.
For example, an apartment/unit may work very well if there are many singles, professional couples, or university students in the area. Alternatively, a house with a backyard will more likely appeal to tenants in a family-friendly suburb rather than a smaller apartment.
Additionally, consider the amount of maintenance involved. A newer house or apartment will generally require less maintenance than an older property, which will mean less cost outlay for you as a property owner/landlord.
- Property Features
Ask yourself what features a prospective tenant or tenants would be looking for. Will they need plenty of storage space? Will they require a garage or car space? Maybe they want more than one bathroom and an office space to work from home. Desirable features like these can assist with charging more rent and, therefore, push up your rental return and any potential longer-term capital growth. It is essential to remember these things when looking for the ideal investment property.
- The right location
Location, location, location, is an often used catchphrase when talking about property and its ultimate value. Before buying an investment property, there is some value in ‘putting yourself in the tenant’s shoes’ and asking yourself what living in the suburb yourself would be like. What is appealing about the area and the lifestyle offered? Are there worthwhile amenities nearby – parks, schools, entertainment and eateries? Find out if any development plans or significant infrastructure projects are planned or underway for the area, like new hospitals or transport links, which can all add to a property value in the long run.
- The Potential for Capital Growth
Capital growth is the increase in property value over time. Supply and demand are the key factors in determining capital growth, as property prices will increase when demand is high relative to the supply of properties in that area.
- Rental Yield
Rental yield is another important consideration, as it provides insight into how profitable an investment property will likely be. This crucial metric identifies the rent the property generates relative to its purchase price. It is expressed as a percentage and calculated by dividing rental income by the property’s purchase cost.
For example, an investment property costs $600,000 to buy and is currently rented out at $550 per week (which equals $28,600 per year). The rental yield of $28,600 divided by $600,000 equals 0.0476, or 4.76%.
While a higher rental yield translates into more immediate income, it can often come with a trade-off. Properties with higher rental yields may have a lower potential for capital growth (increase in value) over time, so it is essential to strike the right balance between them.
If you need a higher and consistent income stream to help cover your loan repayments, prioritising a property with strong rental yields may be more prudent. However, this might mean sacrificing some potential long-term capital gains.
Of course, there may be other considerations, such as demographics/population growth, vacancy rates, number of days on the market (DOM), and auction clearance rates; however, the five factors that I have highlighted are, to my way of thinking, the essential considerations for an investment property purchase.
Tax Implications
While buying an investment property may be popular for someone like yourself who wants to grow their wealth and secure some financial stability, you need to be aware of various tax considerations.
These may include:
- Tax deductions – which can help offset rental income and reduce taxable liabilities. Common deductible expenses include mortgage interest, property management fees, insurance premiums, repairs and maintenance, council rates and land tax, and depreciation of capital works and plant and equipment. By keeping track of these expenses, a property investor can significantly lower their taxable income, maximising cash flow and their overall returns on investment.
- Depreciation and Capital Works Deductions – depreciation can allow a property owner to claim deductions for any ‘wear and tear’ on their investment property’s structure and fittings. Capital works deductions can cover the depreciation of the building’s structure over its lifetime, while plant and equipment deductions apply to assets within the property, such as furnishings and appliances. You will need to engage a quantity surveyor to prepare a depreciation schedule that can assist you with maximising your depreciation claims and optimising your tax outcomes.
- Capital Gains Tax (CGT) – when selling an investment property, you may be subject to CGT on any profit made from the sale. This CGT liability can be reduced by holding the property for extended periods, qualifying for the CGT discount or offsetting capital losses against capital gains.
- Negative Gearing / Rental Property Losses: This allows investors to reduce their taxable income and receive tax benefits when the rental expenses exceed the rental income received.
- State / Territory Specific Taxes—In addition to any federal taxes that may apply, property investors must also be mindful of any state / territory-specific taxes, such as stamp duty and land tax. Such taxes can be pretty significant and may vary depending on the jurisdiction of the investment property.
With any of the tax implications noted above, when it comes to property investing, you must seek professional advice from a knowledgeable tax adviser or accountant to assist with leveraging available deductions, depreciation strategies, and CGT concessions so that you can minimise any tax liabilities and maximise your after-tax returns.
Overlaying all this as part of a broader financial strategy with a Vogue Advisory Group financial adviser can also potentially provide you with the best possible economic outcomes as you navigate your financial journey.
