Are you ready to buy an investment property?

How do you know when you’re ready to take the leap and buy an investment property? This month Damien outlines some key factors you need to consider when looking at investing for the first time to determine whether now is the right time.

Disclaimer alert!!! Before buying an investment property, make sure you seek some expert advice from your advisory team.  If you don’t have one, go get one – everyone needs an Entourage.

The property investment market has slowed in recent times due to APRA’s changes to lending. After a surge in 2014, the market has been pretty bumpy and not likely to change anytime soon – although you might find this is a good thing for you!

Despite regulatory changes, Australian’s still love property and will always see it as a great way to build their wealth, if done correctly.  The other thing to note, is with less investors in the market right now there’s less competition for the properties you will be wanting to buy.

In this article, we will ask a few questions to help you decide whether you are ready to purchase an investment property.

As we see it, there are a three key questions to ask yourself before you decide to buy an investment property. For this example, we are going to use an investment purchase price of $500,000.

Question 1 – Do you own a property already and have at least $200,000 of equity in it, or have cash for a deposit?

Question 2 – Have you got surplus income of approx. $1,500 per month after all bills, mortgage repayments/rent and living expenses?

Question 3 – Are your finances stable, particularly regarding your employment, and will they be into the immediate future?  By this I mean you are not looking to leave full time work to start a business or looking to have a baby and lose one partners income.

If you have answered yes to all 3 of these questions and think you want to take the next step in buying an investment property, I’d be making a time with an expert to run through if it’s right for you.  Investment properties aren’t for everyone so you need to make sure it’s right for you from a time, cash flow and risk perspective.

Let’s explore these questions in a little more depth now.

Question One: Equity or Cash

To buy an investment property, you will need to have funds. This can be in the form of cash that you have saved or it can be equity in your property (not sure what equity is – read our article here).

I’m basing this scenario on a mortgage insurance free scenario which means an LVR of 80%:

• Your current home value – $1,000,000
• LVR @ 80% – $800,000
• Current debt – $600,000
• Equity to 80% LVR – $200,000

With the above example, you are able to leverage your home’s equity to 80% of its value which can form 20% plus costs for your new investment property.  The new investment loan if you purchased for $500K would look something like this:

New investment loan – $530K

With this purchase price, it hasn’t utilised all the $200K of equity in your home either.  There would still be approx. $70K remaining.  If you were to purchase a higher priced investment property, you could do that as well.  The reason we want to borrow the full amount for this investment property is because it’s tax deductible and you still have home loan debt which is not tax deductible.  In regard to what type of repayments you make on the investment purchase, it is OK for this to be interest only as you are probably focusing on paying down your home loan not the investment loan.

Question Two: Cash flow

Just because you think you can afford an investment property, doesn’t mean a lender will agree with you.  An investment property can be cheap to hold if the rental income is high and consistent month to month.  If you also have a low interest rate and own a half a million dollar property then cash flow can be quite easy.

But bring in the tight lending restrictions and how lenders actually assess new and existing debt (link to other article).  For this new debt and your existing debt, you need to be able to service everything at a rate in the mid 7%’s and paying principal and interest even if you are looking to pay interest only on your investment loan.

Let’s break it down using the previous scenario and assume an assessment interest rate of 7.5%:

It can start looking a little bit overwhelming when we consider it like that. Bear in mind with rental income and tax deductions the reality of your investment loan is that your out of pocket isn’t going to look like this. But you do need to be able to show you can service your debt should you have no tenants for a period of time or if happen to interest rates increase (and let’s be frank, they always do!).

When purchasing any property, there are always risks attached as life can throw unexpected things at us.  There are always ways to minimise these risks and protect yourself such as income insurance, landlord insurance, etc.

Question Three: Stability and Timing

If the other two questions are aligned and you are don’t have any major changes coming up that are likely to affect your ability to repay the loan, then you should consider purchasing an investment property.

If you are looking at making some lifestyle changes like a new job or having a baby, then we’d probably recommend you wait – even if it is a yes to the first two questions. If you have a property already that is continuing to appreciate, then you’ll probably be in an even better position when you look to invest down the track.

We at Entourage have helped hundreds of investors, young and old, buy well and grow their wealth through the property market. Despite recent regulatory changes, nationally capital growth is sitting at 8.9% year on year, indicating property is still a great investment in Australia and one that we advocate. If you want to chat about investing, give us a call on 03 9421 1651 and we can help guide you through what your investment position could look like.

By Damien Roylance.