Before you invest in property make sure you have considered the investment suitability, risk profile and cashflow requirements.
Property is a very popular investment around the world. Property provides both rental income and potential capital gains, but it has a high entry cost. You need to invest hundreds of thousands of dollars into one property.
Rather than placing your money in a bank deposit or stocks you can invest your money in tangible real estate. Being able to physically view your investment is very appealing to many people. However, property is not a divisible asset. If you want to get your money out, you need to sell the property or borrow more money against it.
Generally, people are comfortable purchasing real estate for investing as it’s like purchasing a home to live in.
However, before you invest in property, make sure you consider these things.
Invest in Property Risk Profile
An investment property is a tangible, physical asset, which makes it feel more familiar to potential investors who already own their home. However, it is important to understand your risk profile before making any investments.
Are you willing to take some risk with your investment funds?
If so, how much risk?
If can be difficult to know whether you are comfortable in borrowing to invest until you make the investment. There are many factors to consider when taking on extra debt.
What happens if the loan interest rate increases? Can you afford the extra repayments?
What happens if the property market falls? Is your financial gearing, ok? Are you in a position where you do not have to sell?
Maybe rents stagnate for years but your costs increase every year. Are you able to weather this investment storm? Will you be able to sleep at night?
To know whether the investment will work for you assess the investments risk profile and cast a cashflow budget.
Invest in Property on its Own Merits & Risks
The investment risk profile is only one aspect to the evaluation of an investment. Each property investment must be assessed on its own merits and risks because every property is different.
Generally, the expected investment returns must exceed the borrowing costs over the long term. Otherwise, there is no point investing in property. Some property has strong capital growth with little income return, e.g. land. Other property may have high rental income return with low capital growth. It is simply personal choice and what type of investment fits into your overall investment strategy.
Some investors choose high gearing with an interest only loan to maximize their cashflow. Others choose varying levels of gearing to produce a combination of capital growth and income to suit their personal circumstances.
Overall, investing purely to receive negative geared tax relief or be in the market to keep up with the market is not a good long-term strategy.
There is no right or wrong investment strategy. Rather, the investor has to be comfortable with the investment fitting their lifestyle and investment horizon.
Where to Buy Your Investment Property
Some people like to purchase an investment property in the same suburb or part of the city where they live. After all, when you own a home there you know the market.
However, the principle of diversification of investments means you should not invest everything in one suburb. Spread your investments into other suburbs or cities. If one area fails to perform you are not adversely affected when your investments are spread across different suburbs or cities.
The principle of diversification of property is like buying stocks. You would never invest all your money in one stock. You would spread the investment across a range of stocks representing the wider economy. If one stock is down the loss will be offset by the performance of the other stocks. However, if the whole stock market is down, you cannot avoid making a loss if you sell.
Where you purchase an investment property it comes down to your strategy and goals. You may wish to achieve capital gains, income, or some combination of both. Beach resort properties can produce high income during the warmer months but may result in poor capital gains. Suburban properties may generate less income but higher long-term capital gains.
Cashflow Management
Cash flow management is one of the most important components to owning an investment property.
Before you invest in property always create a cash flow forecast model.
The rental income pays the expenses including the mortgage. So, the property must be always tenanted to cover the costs.
Develop a simple cash flow model in a spreadsheet to plan income and expenditure. You can model changes in circumstances, such as, periods of vacancy, increases in interest rates, or increases in costs.
Financial modelling is the best way to determine whether your potential investment will make money. Before you purchase a property model the cashflow to see if it fits your investment strategy. After purchase continue to model the cash flow every year as parameters change. There is no point getting to the end of the financial year and discovering you are short of funds to pay expenses or taxes. You don’t want to put stress on yourself and your household budget.
Does Property Investment Complement Your Investment Strategy
Always conduct a final thought process to understand why real estate is your preferred investment.
Diversification of investments is important. Most financial planners will recommend investing in a diverse range of asset classes, such as, cash, bonds, stocks and property. Some years one asset class will perform better than others protecting you from a poorly performing asset class. If you already have property investments maybe it is time to rebalance your portfolio into bonds or stocks.
There is a lot of opportunity for investment in the world. It’s a matter of what’s right for you today.
Property Investment Makes You Rich
Conclusion
If you don’t have any financial training, it pays to seek professional financial advice before making any life changing investment decisions. You could be saving yourself from not attaining your investment goals or making costly mistakes.
Always build a financial model and cash flow forecast for the first 5 years of your investment. Build in changes to the investment factors, such as, changes to interest rates, property values, tenancy rates and costs. Try to build in the changes to your life – travel, study, children, etc.
Your own suburb may be a good place to buy your first investment property, however you may then have a lack of investment diversification. Maybe purchase a few suburbs away but where you know the market.