Key benefits of buying an investment property

Posted on: Bank West

Residential property is a popular investment choice for many Australians. So what are the benefits of buying an investment property, and is it right for you?

Investing in property is typically done for either capital growth, as the property rises in value over time, or for rental income, from leasing the property to tenants.

While some types of properties can provide a balanced mix of returns, it’s generally very rare to find a property that will provide high levels of both capital growth and rental income.

Here are some factors to help you determine which is right for your situation.

Investing for capital growth

Capital growth is when the value of a property rises over time, and therefore increases the owner’s personal wealth.

When properties grow in value, investors can utilise the equity (the difference between the value of the property and how much debt is owing on the mortgage) for personal use, such as buying another investment property, for an overseas holiday, to renovate their home or to buy a new car, for example.

Alternatively, the owner can sell the investment property and pocket the profits, or use these to help pay off the mortgage on their family home. However, it’s important to note that there will be tax to pay on the profits, as well as selling agents fees for the sale of the property. Understand why property is a long term investment.

When determining your expected profits, investors should also be mindful of any other costs they’ve incurred along the way, such as interest on their loan and stamp duty and settlement fees they paid when purchasing the property.

For more fees associated with buying property, use our simple home loan fees calculator below.

Investing for rental income

Rental income is the money you receive from leasing the property to a tenant.

If the rental income covers the expenses of holding the property (such as your loan repayments, maintenance costs and property management fees etc), the property is classified as positively geared, meaning you end up with extra money in your back pocket each week. This money is essentially an extra source of income and can be used for discretionary spending, to pay bills or help pay down debt on your family home.

If the rental income doesn’t cover all your holdings costs, you’ll have to chip in some of your own money to meet these payments – this is called a negatively geared property.

If the property is negatively geared, it’s particularly important to determine what impact extra mortgage repayments would have on your finances in the scenario that your interest rates rise.

A good way to evaluate if a property has a strong rental income is to determine its rental yield, which is a calculation of the value of the property and the annual rental income.

By determining the rental yield of a property, you can measure it against other properties at a suburb or city level to gauge how it compares. In a nutshell, rental yield is a better ‘apples-to-apples’ comparison for rental returns.

What is rental yield?

Rental yield is the cash return (i.e. rental income) you receive from leasing your investment property to a tenant. It is displayed as a percentage and can be shown as either gross yield or net yield.

Gross yield is the total cash return your property has generated before expenses, such as property management fees, loan repayments and insurance, for example. The net yield is the cash return you have left over after you’ve deducted all your expenses.

How do you calculate rental yield?

Take an investment property that is purchased for $400,000 and the tenant pays $350 per week in rent.

Gross rental yield

Find the annual rental income

$350 per week x 52 weeks = $18,200 in rental income each year.

Divide the annual rental income by the cost of the property, and multiply by 100.

$18,200/$400,000 x 100 = 4.55%

Net rental yield

Net yield provides a better indication as to whether you can afford to hold an investment property because it takes into account all the expenses associated with the property, as well as the total cost of the property, not just the purchase price.

Examples of costs and expenses that need to be used when determining net rental yield.

Property costs:

Stamp duty

Settlement fees

Building and pest inspection fees

Loan costs

Annual expenses:

Property management fees

Vacancy periods

Council rates

Insurance

Maintenance and strata fees

Loan interest repayments

The net rental yield is more difficult to determine because it includes many different costs and expenses. However, it can be calculated as follows:

[(Annual rental income – annual expenses) / total property cost] x 100.

It’s important to note that rental yields are influenced by a number of factors such as the type of property (i.e. house, apartment, villa etc), its age (newer vs older), its location (state vs state, country vs regional, inner city vs urban fringe etc) as well as the demand and supply-side drivers.

Investing for tax benefits

Some people also invest in property for the tax benefits, such as depreciation claims.

Investors who buy a brand new investment property can claim some depreciation on their taxable income, such as the depreciation of the building and items considered plant and equipment, including hot-water systems, air-conditioning units and curtains.

If the property is negatively geared, investors can also claim the losses as a tax deduction.

While these tax benefits can be favourable, they typically shouldn’t be the primary factor for buying an investment property, as you may end up with an underperforming property. Investors, or those considering investing, should check the latest tax laws as these can change.

Determining what’s right for you

It’s important to understand what you want from an investment property and identify the types of properties that will help you meet your investment goals.

Some properties may offer higher rental income and some may offer better potential for capital growth, but rarely does an individual property provide both.

It can also be helpful to speak to industry professionals, such as an accountant, financial planner, Mobile Lending Manager or buyer’s agent, for relevant advice.

Original Article: https://www.bankwest.com.au/personal/home-buying/guides/benefits-of-property-investment