Approximately 20% of the population owns an investment property. Of those investors, 50% will sell within the next five years. Many first time investors don’t buy an “investment grade” quality property and make mistakes when buying. So what are some of the common pitfalls to avoid when searching for the ideal investment?
Choosing a property that the banks don’t like
Banks consider several investment property types as risky. These often include serviced apartments, student accommodation, defence housing, small apartments, commercial properties and properties in a business or mixed zoning or in country or outer coastal areas.
Major banks occasionally don’t want to lend against certain properties or restrict loan to value ratios (LVR’s). Purchase these types of properties with caution. If it’s not good enough for the bank’s money, it shouldn’t be good enough for yours.
In addition, you should watch out for properties that come with rental guarantees for a year or two. The only guarantee is that the developer has loaded the rental amount into the inflated purchase price.
Properties in certain postcodes or suburbs also have finance restrictions. Southbank, Queens Road and St Kilda Road, Docklands, Port Melbourne, South Melbourne and Carlton are generally seen as riskier properties for the banks and will have finance restrictions.
Banks may also have finance restrictions for NRAS properties and those with stratum title or company share ownership. These restrictions will impact your capital growth potential and resale value. Fewer buyers, in particular first home buyers, will be able to buy these properties in the future.
Know the risks of buying “Off the Plan” or brand new properties
Be wary of developer incentives; they can seem almost too good to be true. Be wary of “free cars” or “free holidays” as the purchase price will usually account for this. Many buyers purchase “off the plan” due to the significant stamp duty savings. Yet they fail to realise that this is usually offset by the GST they indirectly pay, as a developer pays 10% GST on the building costs component.
For example, if a $500,000 apartment costs a developer $250,000 to build, they will be charged $25,000 GST which will be passed on in the purchase price. You should also be wary of high Owner’s Corporation/Body Corporate fees which will ultimately affect your cash flow and rental return. Buildings with lifts, communal gymnasiums and pools usually come at the cost of higher fees.
Many investors are attracted to the significant building and chattel depreciation that new properties offer which enhances cash flow; though some new properties don’t seem to achieve the same capital growth as older existing properties that have a proven track record. This may be partly due to the increasing supply of these properties every year. Around 25,000 new apartments will be hitting the market within the next 12 months that will be in direct competition to your new apartment.
Not being able to afford the investment property
Many investors don’t do their research on investment property prices. This often means they overpay, which ultimately affects their cash flow and out of pocket expenses. They also don’t properly research rental returns in the area, often based on the agent’s over estimated rental valuation.
A simple solution is to prepare a detailed cash flow analysis before you buy, which many investors overlook. Don’t forget to include expense items such as bank interest, lender’s mortgage insurance, stamp duty, council and water rates, property management and leasing fees and Owner’s Corporation fees. There are computer programs readily available that can calculate before and after tax cash flows. Ensure that you have income protection insurance which is tax deductable and will protect and cover your personal income in certain scenarios. Always have money set aside in a bank account for any emergencies or maintenance items that may arise.
Purchasing the property in the wrong entity
Many investors sign a contract first before speaking to their accountant about their ownership structure options. This is often too late. Should you buy the investment property in your name, family trust or a Self-Managed Super Fund?
Setting up a SMSF or family trust takes a lot of time. You need to establish this before signing any contracts, as it is too late afterwards, even if you sign the contract “And /Or Nominee” so you can nominate a related entity.
There are pros and cons to different ownership structures and many investors buy property in the wrong ownership structure for their situation. Investors should discuss the pros and cons of the different structures with their accountant before signing on the dotted line.
Focusing on tax benefits or high yields and not on capital growth
Be wary of buying property that gives you good rental yields or good tax deductions or depreciation, but very limited prospects for creating wealth and equity. Capital growth should be the most important consideration as this equity will accelerate your wealth creation strategies and allow you to create equity and use this to build your portfolio further.
This article has been supplied courtesy of Frank Valentic, Director at Advantage Property Consulting.