While it can be good in some arenas to learn from your failures, property investment is not something you can afford to make mistakes in. There are plenty of articles about what you need to know about property investment but fewer articles about what NOT to do.
Avoiding common mistakes can mean the difference between success and financial failure by investing in a bad property. Without due diligence before investing in property, your financial future could be precarious.
Here are 11 common mistakes to avoid when investing in property.
- Investing with your heart rather than head
When we buy a home that we will live in ourselves, emotions play a massive part in the decision, no matter how rational we think we are. However, when buying property solely as an investment, it is better to avoid emotional attachment to the property.
Being a successful investor means treating your property like a business.
Treating your property like a business includes:
- Avoiding renting to family & friends (who you find it harder to evict if something goes wrong),
- Raising the rent when appropriate,
- Bringing a property manager on board to help make objective decisions, and
- Not falling in love with your property.
Being objective and analytical about the pros and cons of each property you investigate will help you to make a good investment decision.
- Skimping on the research
While researching multiple properties can feel tedious, if you skimp on the research, you will only have yourself to blame when the property costs you more money than you had expected. Extensive research is essential. Property is expensive, and you will likely be paying a mortgage on your investment for some years. You do need to research such a large investment very carefully.
Here are some key things to ask before investing in property.
ARE YOU BUYING OLD OR BUYING NEW?
A new property will need less maintenance and repairs than older properties. Another bonus to a new property is that you can claim depreciation on your tax returns, giving you substantial tax benefits.
However, it can be a challenge to find higher capital for a new property, especially for first-time investors. You can also pay higher commissions and fees when you buy a new property from an agency compared with an older one.
Older properties may offer an excellent opportunity to renovate and increase the value of your property. An older property is more accessible as the price is lower, and you can make significant capital gains if it is in a growth suburb.
WHAT’S THE CONDITION OF THE PROPERTY?
Check everything when inspecting the property prior to purchase. Any damage like holes in the walls, stained carpet, or marks on the floorboards can reduce potential rent, and you will need to fix them before receiving rent.
Check the taps and lights. In fact, check every little thing. Open each cupboard and door, and investigate every space, looking for potential damage. If you find damage, you can either decide not to buy that property or negotiate to get the damages reduced from the asking price.
DOES IT HAVE ENTICING FEATURES & AMENITIES?
Tenants are your customers when your business is an investment property. Think about the property in terms of rental desirability. Is it close to shops, transport, and schools? Are there features of the property that tenants want? Every successful business creates satisfied customers. Choose the property that will satisfy potential tenants.
Like any product you sell, you need to consider your customers’ needs. What does your target market want in a rental property?
To find a checklist of questions that can help you to identify what tenants want, see the article on how to research what tenants want.
- Cutting out the experts
It is a big mistake to ignore experts. Asking for advice from everyone except the experts in the type of investment you are considering is not wise.
It is common for landlords to get advice only after there is a problem or to help solve disputes with tenants. Why not get advice before you run into problems? Your property portfolio will be the biggest investment you make.
Get advice whenever you feel like you are out of your depth or unsure.
These experts in their fields can help you in various situations:
- See your accountant if you have concerns about your taxes or cash flow.
- Your mortgage broker can assist with concerns about your mortgage or repayment of property loans.
- Before purchasing a property, it is a great idea to do a thorough property inspection. A surveyor or a real estate broker can assist you.
- Hiring a property manager is wise if you find managing your properties is taking too much time. Property managers can also help with problem tenants, rental arrears, or other issues.
- Not having a property investing strategy
Property investment is a big deal. It could be one of the biggest investments you make in life, and you want to get the best return for your investment. An investment strategy helps you to get started with property investment and allows you to build a portfolio of multiple properties.
Generally, you will have to make a trade-off when you invest in property. Cheaper properties to purchase offer lower returns but are easier to buy. Getting the capital to buy a higher-cost property is harder, but these yield larger returns. Depending on the amount of your savings for a deposit, there are different ways you can get started in the property market.
- If you have a close relative who is willing to stand as a guarantor, you could find it easier to get a loan. However, you must make the repayments on the loan because you are risking not only the property you are buying but the property which is guaranteeing your loan.
- An alternative to paying everything yourself is to consider the strategy of fractional ownership. This is where you buy shares in a single property, receiving a fair share of the rent and capital gains when the property sells. This can be a lower-risk way of entering the property market, but you will make less or make money slower as you only receive a fraction of the profits.
Whatever option you choose depends on your financial situation. However, the property is always a good investment with rental returns and a high probability of capital gains, so if you have sorted out your finances properly, it is always a good time to buy property.
Look at this article on the seven most common investment strategies for options for getting started in property.
- Not having a property financing plan
Do your research and ensure you have a solid plan on how you will finance your property investment. You need to know how you will cover the ongoing costs like loan repayments, interest rate increases, council rates, strata fees, and utility bills.
Know what your financial goals are. Consider carefully how much risk you are willing to take before you buy and what you can afford regularly. You will need to allow for vacancy times between tenants. If you lose your income or the tenants are late paying rent, will you be able to cover the mortgage?
Discuss with your accountant or financial advisor whether you should positively or negatively gear the property. This will have tax and income implications for your financial situation.
Negatively geared properties have a net loss over a financial year, with rental income and holding costs being lower than your actual costs. There are tax benefits to negatively gearing, as the rent is not counted as a taxable income. Approximately 60% of Australian properties are negatively geared.
Positively geared properties have a net gain, so your rental income is higher than all the costs of running and maintaining your property. You will receive a regular income from your property, giving you another source of income, although it is often small. Positive gearing is becoming more popular in the 2020s.
Financial decisions include choosing between a principle and interest or an interest-only loan. This decision will depend on your financial ability to repay the loans.
- Negatively gearing when you can’t afford it
Negatively gearing the property comes with a reduction in taxable income and the opportunity to have bigger capital gains. However, there is a risk of negatively gearing a property. You will be paying monthly money to cover the property’s costs above the rental income you receive.
If you cannot afford the additional costs of negatively gearing your property in the short term, it may not be your best decision. You need to be sure you will not be forced to sell the property if misfortune occurs.
- Buying the wrong property
There are so many properties to choose from, and it can be difficult for first-time investors to select the right property. Here are some things to consider when buying a rental property to avoid a dud investment.
THINK LIKE A TENANT
You will not make money if you do not know the rental market where your property is located. Pouring thousands of dollars into making a luxury property to get higher rent is useless when your property is next door to a university and will be wanted by students on a budget.
You need to know what tenants in the area want in a rental property.
THE MINOR REPAIR, THE BETTER
Do a thorough property inspection before buying. Look out for wall cracks, dampness, and signs of pests, as these will all entail extensive repairs and maintenance. Consider that you might have to pay for repairs before you can get a tenant to start paying rent, which means you will have repair costs and mortgage repayments before your property starts earning.
DON’T BE A CUSTOMER
Don’t fall for the sales pitch. Research and decide what suits your financial situation. A sales agent working for a developer may try to sell you an off-the-plan apartment, but you’ll need to wait until the condo is built before you can get tenants in. Salespeople are there to sell, not necessarily in your best interest.
- Buying for the short term
Property is not a short-term investment. Real estate appreciates over time, so it may not be the best option if you need a short-term return. Even if you have made a decision that has had negative consequences in the short term, you can recover your loss if you can hold on to the property for enough time.
The longer you have your property, the higher your capital gains will be.
Time in the market always beats ‘timing the market’. This article explains when it’s the right time to buy real estate.
- Not leaving enough to live on
Property investment may be attractive, but you need to be sure you can cover the costs in the short term. You don’t want to settle for a property that is not a good investment because you do not have the finances to buy an investment-grade property.
Ensure you have enough money to make a decent deposit on your real estate investment. You must have enough to cover the monthly loan repayments (even before you get rental income) and funds to cover unforeseen mishaps.
If you do not have enough funds available to cover the costs, you could have financial stress or difficulty. You could lose your investment or not be able to cover day-to-day expenses.
It is helpful to save between two and four months of rental income as a financial buffer to cover mishaps and tenancy vacancies before you start to avoid this common mistake.
There will always be properties for sale, so getting your finances in place first is important. Talk to a qualified financial advisor before leaping into the property market.
- Selling out of fear
You have bought your first investment property. Now, you need to keep it. Selling out of fear is one of property investors’ biggest mistakes. The property market will have downturns and will not always show positive capital gains. Selling a property in a downturn out of fear can leave you financially worse off, owing more than you sold the property for.
However, properties double in value every seven to 10 years. There will be downturns during that time, but if you can hold on to your property, you will see an upturn too. Don’t give in to fear but hold on to your property if you can.
- Not hiring a property manager
Hiring a property manager costs a small fee from your weekly rental income. Still, it gives you access to the expert who will manage the day-to-day running of the property, dealing with tenants, renewing leases, and ensuring repairs are properly completed when needed. There is a lot of work in managing the property if you choose not to hire a property manager. Most people find that the time and effort involved in self-managing the property is not worth the couple of thousand you save in management fees.
More than 80 per cent of property investors employ a property manager. Leaving paid employment to become a full-time property manager or working extra daily hours to manage your property doesn’t make financial sense. You can hire a professional to care for your property for a few hundred dollars in management fees.
9 Things To Know Before Buying an Investment Property
An investment property costs hundreds of thousands of dollars, so it’s natural to be anxious about making a mistake. Even those with plenty of experience in property investment can fear missing something crucial and investing in the wrong property, which will cost you more than you planned due to unexpected repairs. Below are some things to check, decide, and consider when selecting your investment property.
- How will you finance your property?
There are several options with finance, but it depends on your current financial situation and the savings behind you as to what option is best for you.
One of the big decisions is to choose between negative and positive gearing of your property. Positively geared properties provide additional income, while negatively geared properties have greater tax benefits. Unfortunately, you cannot have both options in one property: make an income and have the same tax benefits.
When you own a negatively geared property, you pay more in the costs of your property (mortgage, maintenance, council rates, strata fees, and utility bills) than you receive in income from rent.
This means you can use your losses in cash flow from your property to reduce your taxable income, giving you a better tax return each year. The expectation is that when you sell the property, the capital growth will cover the previous losses and will provide profit on top.
While this is a viable strategy, it has a greater risk because you need to cover the regular losses of the property. People with additional funds available to them can take this risk.
Negative gearing is a terrific choice in making the most of your property investment, only if you can afford the month-by-month losses for the annual tax benefits.
In Australia, about 60% of investment properties are negatively geared. However, the latest statistics have shown that positive gearing is becoming more popular.
A positively geared property works the opposite way. It will generate an income because the rent is higher than the running costs, but you will have to pay tax on that income.
While this is a less risky strategy and generating an additional income is attractive, especially for first-time buyers. However, you may need to buy property in regional areas to make it work.
Positive gearing is the perfect choice for first-time buyers who want an additional source of income.
Know that the passive income may be quite small, and you have less capital growth when you sell the property than the negatively geared property.
Carefully consider the pros and cons of positive and negative gearing and discuss the options with your accountant before deciding which option is best for you.
P&I OR IO?
IO and P&I are short for Interest-Only and Principal and Interest. This is how you set up your mortgage and how high the repayments will be monthly.
With interest-only loans, you only pay back the interest cost on your loan for a period (between one to ten years). After that, you start paying interest and the borrowed amount.
If you take a principal and interest loan, you will repay the loan amount and interest in your repayment each month from the start of the loan. You pay more each month, especially at the start of the mortgage, but you save money by paying off the mortgage sooner and paying less interest over the years.
- Where are you looking to buy?
Location is king when it comes to property. Where the property is situated is just as important as the type of residence it is. If the property is too far away from public transport, some people will not want to rent there. A luxury unit at a high rental rate will not be popular next door to a university where many students on a tight budget want to live.
WHERE DO TENANTS WANT TO LIVE?
Although individual tenants may want different things, the list below shows the most popular features in a location for a rental property:
- Lots of restaurants nearby,
- Public transport and train station within walking distance,
- Being close to the university (if you’re renting to students),
- school districts,
- Short distance to a supermarket,
- A nearby park.
A property with these features will be popular with tenants, allowing you to charge higher rents and reduce the property’s vacancy rate.
To get a complete checklist, see the article on what tenants want.
REGIONAL OR URBAN?
The choice between regional and urban properties could depend on your initial financial status when investing in a property.
Urban properties have lower vacancy rates and strong capital growth. However, they cost more upfront and can be difficult for some investors to afford.
It is cheaper to invest in regional areas because properties are less expensive there. However, regional areas generally have higher vacancy rates, and the property will appreciate at a slower pace, giving slower capital growth.
Regional properties do have a lot to offer, though, and recent data shows a boom in the regional property market as more people became able to work from home due to the Covid-19 pandemic. As people have realised, regional areas can offer lower infection rates for illnesses, still offer community facilities, and provide more space for children to play, especially if the parents can work remotely.
INVESTING IN PROPERTY OVERSEAS
Overseas property can be cheaper, and it could be a viable option for your investment.
You can reap real rewards from the investment strategy of buying property overseas. It can be a very low-capital investment option if you choose a location with a great exchange rate compared to the Australian dollar. You can use the property as a holiday house for yourself and rent it out to other holidaymakers the rest of the year if it is in a popular tourist location. You can also spread the risk by investing in different property markets worldwide.
See this article for more information on the pros and cons of buying an overseas investment property.
- What type of property are you interested in buying?
You can buy a range of different property types, and each has benefits or pitfalls.
HOUSE, UNIT, OR LAND?
A vacant block of land is not always a good investment unless you have the skills and in-depth knowledge of an area and the funds to wait for profit. You won’t earn rental income while building, so you need to factor the ongoing mortgage payments into the equation.
Many first-time investors choose a unit or an apartment, especially in urban areas. While the cost of a unit is usually substantially less than a house with more land around it, there can be fees that cut into cash flow. Strata and body corporate fees can be substantial, especially if the unit block has many facilities, such as a pool, a lift, and a gymnasium, as these cost a lot to maintain.
The most popular type of investment property is a house. Despite the higher purchase price, closer to 40% of new investment properties are houses.
Choosing the right investment property for you is based on the level of risk you want to take and what you can realistically afford.
NEW OR OLD?
New properties offer two main benefits: fewer maintenance issues and the ability to claim depreciation on the property when completing your tax return. Be aware, though, that buying from a property marketing company may cost you more as they add commissions to the price.
Older properties can offer excellent opportunities to add value to your investment and increase the rent return by doing a few renovations. You have to factor in the cost of renovations, including the time they take, before making a profit. Older properties are more likely to need higher maintenance and repairs, which can eat into your profits.
Unless you are experienced in property inspections, it is a good idea to hire a professional building inspector before you purchase an older property. They will be able to identify necessary repairs and upcoming maintenance issues, helping you ensure you are not purchasing a property that will cost too much to repair compared to the potential return.
RESIDENTIAL VS COMMERCIAL
Commercial properties can offer many benefits to investors. Commercial tenants are responsible for paying outgoings on a property, giving you a higher rate of return of up to 12% per annum. You will probably have positive cash flow with a commercial property.
Most businesses will accept longer lease terms than residential properties, meaning you can reduce the risk of the property being empty. However, finding tenants for commercial properties can be harder, so you can have longer vacancy times between tenants.
It could be harder to finance a commercial property, and you will need a higher deposit. Usually, you can borrow up to 80% of a residential property price but only 60% of the commercial property price.
Commercial property investors must understand the broader economic situation and know which types of businesses are likely to succeed. Some commercial properties that seem like good investments can fail due to technology changes. Video shops were very popular in the 80s and 90s but are no longer to be found, leaving some commercial premises empty for a long time.
Due to the higher financial requirements and the depth of economic knowledge needed, most investors start with residential property and only invest in commercial property once they have more experience.
- What to look for in an investment property
Completing a thorough property inspection is important, as the property’s physical attributes will change your rental yield.
When inspecting a property you are considering buying, look at:
FEATURES THAT DETERMINE THE VALUE OF THE RENTAL
- How many bedrooms separate dining room
- The size of the rooms and in-built wardrobes
- The number of bathrooms
- The size and condition of the kitchen
- If there is a separate dining room
- The number of storage spaces
- Whether the property has a garage or covered car park or other easy access to parking
- How secure the place is (which can impact your insurance premium)
- If the property needs maintenance
THE GENERAL STATE OF THE DWELLING
- Check for cracks & holes in the walls.
- Ensure the air in cabinets is not damp or mouldy.
- Check for mould and water stains on floors, walls, and ceilings.
- Shine a flashlight over the ceiling to check for sagging parts.
- Check for rust in the gutters.
- Make sure all the roof tiles are in good shape.
After purchasing the property, continue with routine inspections to maintain the property properly. After all, buyers will be looking for the same things when you are ready to sell.
- Can you cover all the costs involved in buying an investment property?
More costs are involved in purchasing property than just the advertised or final auction price. You need to be aware of these additional costs and ensure you have the finance to cover them, remembering you can only borrow 80% of the purchase price for a residential property.
Consider these costs:
- Valuation fee
- Stamp Duty
- Legal fees
- Lenders Mortgage Insurance
- Loan fee
There are also ongoing holding costs that need to be paid from the moment you have handover, whether you yet have a tenant, including rates, insurance, mortgage repayments, and utilities.
- How much can you borrow?
A standard mortgage expects you to have a 20% deposit. Although it may be possible to borrow up to 85 or 90% of the purchase price, these loans come with stricter eligibility criteria and may need the security of another property.
Lenders consider whether you are a good person to risk loaning such a large sum to, so they look at your:
- Genuine savings
- Employment status
- Credit history
Getting pre-approval for the loan is good, so you know which properties you can truly afford.
If you can show the lender that you satisfy all the lending criteria, you should be able to secure a mortgage on a property.
Most banks can provide pre-approval for the loan, which means you know you can get a mortgage up to a specified amount. This will prevent you from declining your mortgage application after you have paid the deposit.
- Should you get a property manager?
Over 80% of property investors use a property manager in this country. There are all types of reasons for bringing a professional on board to manage properties:
- Time savings. Managing your own property can be very time-consuming, so most investors realise it is worth paying a few hundred dollars for a property manager, allowing you to continue to work full-time.
- You are getting an expert to manage your properties. Property managers have local and expert market knowledge and can develop great ideas to increase your rental yield and capital growth.
- They find tenants. Property manager leasing services are a great way to find good tenants and avoid long-term vacancies.
- They handle property maintenance for you, dealing with reputable tradespeople in the area, and saving you headaches.
- They collect your rent and keep things running smoothly
Before you decide if you should hire a property manager or self-manage the property, read the article on comparing different types of property managers and the ultimate guide to property management.
- Are you prepared for the unexpected?
Buying a property is always risky, but being prepared for unexpected costs can help mitigate the risks. Can you cover vacancies, bad tenants, late rent payments, property damage, or decreased property value from a market downturn? These can have a hefty price tag and significantly impact your day-to-day finances.
It is essential to have a financial buffer, usually between two to four months of your rental income, so you have funds on hand to cover the unexpected costs.
- Do you know your legal obligations?
The landlord-tenant laws vary from state to state, but you must be aware of your legal responsibilities to your tenant. A good property manager can ensure you are fully aware of your responsibilities as a landlord. They can help you prepare legal documentation such as a tenancy agreement, an entry report for maintenance, or an eviction notice.