Property is a very popular asset class in Australia, but that doesn’t automatically make it the best investment option for everyone. Before you invest in property, make sure you consider these six things.
Property investment is a popular path many people travel when looking at strategies to grow their wealth, and it’s easy to see why. An investment property is a tangible, physical asset, which makes it feel more familiar to would-be investors who already own a home.
“People invest in property for different reasons, but mainly it's because they want to focus on creating wealth,” says Peter van der Westhuyzen, an executive director in Macquarie’s personal banking business.
“That could be through capital gains; it could be enjoying an income stream from rent, and there could be some potential tax benefits there as well. It can be a good asset class to help you create wealth over time.”
Of course, there are some cons to consider about property investment too.
“Typically, if you want to rent it out, you have the associated issues of dealing with tenants. Also, it’s not a liquid or divisible asset – you can’t just sell off one bedroom if you need access to funds.
“Another thing to consider is, if you own your home and invest in property, you’re not getting the diversification benefits of investing in other asset classes that may also suit your needs and risk profile.”
If you decide property is the right investment for you, here are six things to consider before sealing any deal.
1. Understand your risk profile
Your risk profile is essentially your willingness or appetite to take risks with your investible funds. It’s important to understand your risk profile before making investments of any sort.
“You especially need to understand your own level of comfort in borrowing to invest, and in how much additional debt you are comfortable taking on,” says van der Westhuyzen.
“What happens if interest rates rise? What happens if the property market falls by, say, 20% in your area?
“For instance, what if you’ve borrowed 80% to buy a unit, and then the value of that unit falls by 20%? You could then be in a position where you actually don't have any equity left in that property.
“Depending on your risk profile you might say, ‘That's okay – it’s a long-term investment, I'm enjoying an income stream and some potential tax benefits,’ or you could be really concerned.
“A lot of it comes down to whether you're a conservative investor, an aggressive investor, or somewhere in between. If you talk to a professional financial adviser, they can help you understand whether property investment matches your risk profile and whether it suits your broader investment and lifestyle goals.”
2. Plan your cash flow management
Many people invest in property to rent it out and enjoy a passive income stream. Of course, things may not always go as planned. Tenants may leave, for example.
“Managing cash flow is one of the most important elements of owning an investment property because some investors rely on rent to help pay the interest costs associated with that property,” says van der Westhuyzen.
“When you're doing your financial modelling, you must model the worst case. For example, what happens if interest rates go up? What happens if they're one or two percentage points higher? What happens if the property is untenanted for an extended period? What happens if the maintenance costs that you expect to have to pay every year are higher than you had assumed? What happens if your tax rate changes? What happens if there are changes to lending practices?
“You have to think about what would happen if the amount of money you have to pay increases and the amount of money that you receive decreases.
“What you don't want to do is buy an investment property that then puts a lot of stress on your household, because that obviously could cause significant financial and emotional stress.”
3. Develop a life plan
As well as modelling the potential changes regarding the finances of your property, it’s wise to model the next few years out. Whether you plan to have children, travel, study or change jobs, you need to forecast the impact of these events in a clear, documented way.
“Buying any property is a big decision,” says van der Westhuyzen, “whether it's your own property or an investment property.
“It really does pay to seek some professional financial advice up front, because you could be saving yourself a lot of time, cost, energy, and headaches down the track. You need to make sure it fits into your medium to long term plans in reality, not just in theory.”
4. Assess the investment on its own merits and risks
Of course, expected returns on any investment – income plus capital gain – should exceed the borrowing costs over the long term.
Ultimately, according to van der Westhuyzen, any investment comes down to your personal financial objectives.
“We see some people who will take out the largest loan they possibly can on an interest-only basis because it works for their cash flow, the potential tax benefits suit them, and it also matches their risk profile.
“We also see people who like to gear their properties 50/50, so what they're trying to do is to get the basic level of rent to equal the basic cost of the interest rate, plus or minus. They don't want the investment property to be too much of a cash drain on the rest of their life.
“Others will gear it very heavily because they're expecting large amounts of capital growth. Some may gear it to different levels because they're looking at a total return – a combination of capital growth and income. Others just want to enjoy a very good, stable income stream.
“There’s no real right or wrong answer, but you have to be comfortable with whatever you do – a lot of it comes back to your risk profile.”
5. Which suburb should you buy your investment property
If you own property in one suburb, it’s logical to purchase an investment property there too. After all, you know the market, and you are close by if you want to manage it yourself.
“Some people will invest in the same suburb. They know the area, and they will have a strong sense of what's fair value and what's not.
“Other people might see better growth opportunities interstate or in another part of the city because of a new suburb that's just forming.
“It comes down to your objectives. Some suburbs may give you more capital growth, others may have more subdued capital growth but might have more stable tenancies that provides a more predictable income stream, for example.
“Investing in a different location may also limit your exposure to a market downturn.
“It does come down to research, and gathering as much information as you can to make a well-informed decision, based on your objectives.”
6. Do a final sense check on whether property investment is right for you
As well as exploring your risk profile with your financial adviser, it’s good to understand why property is your preferred investment.
“When it comes to investing, diversification is important,” says van der Westhuyzen. “It could be diversification across asset classes – such as shares, property or bonds. It could also be diversification across regions, so some exposure to Australian assets and also international assets as well.
“There's a world of investing out there. It's just a question of what's right for you.”
Key takeaways
- Before investing in property, explore your risk profile to ascertain whether property is a suitable investment class.
- Do financial modelling to ensure your cash flow can cover events like interest rate rises or untenanted periods, as well as any life changes that may be on the horizon.
- Assess the investment class on its own merits – is property the best source of potential returns? Does it help you diversify?
- Your own suburb may be a good place to start, however you may then have a lack of investment diversification.
Ready to talk about financing your investment property? Call one of our friendly home loan specialists today on 13 62 27.
