Investment properties pros & cons - a Money Buddy guide
Property has proved a relatively secure investment over the past quarter decade in Australia, with returns above 8 per cent in some metropolitan markets, but what should you consider before directing your savings to an investment property?
Pros: advantages of investment properties
In general, property is considered a fairly low-risk investment, and can be less volatile than shares (although, this is not always the case). Some of the advantages of investing in property include:
- Tax benefits – a number of deductions can be claimed on your tax return, such as interest paid on the loan, repairs and maintenance, rates and taxes, insurance, agent's fees, travel to and from the property to facilitate repairs, and buildings depreciation.
- Negative gearing – tax deductions can also be claimed as a result of negative gearing, where the costs of keeping the investment property exceed the income gained from it.
- Long-term investment – many people like the idea of an investment that can fund them in their retirement. Rental housing is one sector that rarely decreases in price, making it a good potential option for long-term investments .
- Positive asset base – there are many benefits from having an investment property when deciding to take out another loan or invest in something else. Showing your potential lender that you have the ability to maintain a loan without defaulting will be highly regarded. The property can also be useful as security when taking out another home, car or personal loan.
- Safety aspect – low-risk investments are always popular with untrained "mum and dad" investors. Property fits this criteria with returns in some country areas reaching 10% per year. Housing in metropolitan areas is constantly in demand with the high purchase price being offset by substantial rental income and a yearly return of between 4% and 8%.
- High leverage possibilities – investment properties can be purchased at 80% LVR (loan to valuation ratio), or up to 90% LVR with mortgage insurance. The LVR is calculated by taking the amount of the loan and dividing it by the value of the property, as determined by the lender. This high leverage capacity results in a higher return for the investor at a lower risk due to having less personal finances ties up in the property (80% of the purchase price was provided by the mortgagee).
By choosing a property intelligently, investors can make this form of investment work for them. However, as with all investments there are some disadvantages to be aware of.
Cons: disadvantages of investment properties
Some potential problems to consider :
- Liquidity – it's true, you can sell the property if things go bad. However this can take many months unless you're willing to accept a price less than the property is worth. Unlike the stock market, you will have to wait for any financial rewards.
- Vacancies – there will be times when mortgage payments will need to be covered out of your own pocket due to your property being untenanted. This could just be a result of a gap between tenants or because of maintenance issues.
- Bad tenants – it's every investment property owner's worst nightmare: problem tenants. They can significantly damage your property, refuse to pay rent and refuse to leave. Disputes can sometimes take months to resolve.
- Rising interest rates – if your investment loan has a variable interest rate, there is always the risk of economic conditions causing interest rates to rise. If not properly budgeted for, rising interest rates could cause an investor financial stress where concerns of liquidity and quickly selling the property become a reality. When interested rates are on the up, liquidity in property markets starts to dry up.
- Property oversupply – in recent years, inner-city builders have created a glut of high-rise apartment blocks, resulting in fierce competition and many units being increasingly difficult to rent out.
- Ongoing costs – in addition to the standard costs associated with a property, ongoing maintenance costs, especially with an older building, can be substantial.
- Putting all your eggs in one basket – if you have all your money tied up in property, overexposure to one particular type of investment can be a dangerous thing. If the property market crashes you can stand to lose significantly.
- Capital Gains Tax – imposed by the Federal Government on the appreciation of investments and payable on disposal.
- Other costs – negative gearing may offer tax deductions each financial year, however ongoing payments to cover the shortfall need to be budgeted for every month. Also, costs involved in purchasing and disposing of the property can be substantial.
Investment property recent growth areas
When purchasing an investment property it is worth looking at which suburbs have recently had a boom in property values, below are the top eight most recent examples of growth suburbs in each state.
- 2.Harris Park
- 3.Hamilton East
- 4.Lake Cargelligo
- 5.Grose Wold
- 2.Surfers Paradise
- 4.Kings Beach
- 7.Mount Lofty
- 1.Coconut Grove
- 2.The Gardens
- 3.Dundee Beach
- 8.Fannie Bay
- 8.Upper Sturt
- 2.North Dandalup
- 3.Peppermint Grove
- 1.West Moonah
- 4.Port Sorell
- 6.Eggs And Bacon Bay
Just like any other investment decision, you need to make an informed choice that’s right for you. Make sure you get good investment advice and are aware of all the pros and cons before committing yourself - and always read the fine print.