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How to choose the right investment property

In this article:

Determine the potential capital growth and rental yield Consider location, property type, unique features and age Evaluate what you are prepared to compromise on

Once you’ve made the decision to invest in property, you need to select the one that's right for you.

Here are a few key questions to ask yourself:

What is the potential capital growth?

Capital growth is the increase in the value of your property over time. As there are significant costs associated with buying and selling property, as a general rule, you need to retain a property for at least 5-7 years in order to generate enough capital growth to make it worthwhile.

It’s wise to invest in locations that are set to expand in the near future - perhaps due to a new transport network, recently developed business infrastructure, or re-zoning that will mean positive growth.

What is the yield?

Rental yield is the pre-tax income you receive from rent. It’s usually talked about as a percentage of the total property value. So a rental yield of $25,000 on a $500,000 property delivers a 5% pre-tax yield. However, this is not the entire picture.

When you’re looking at property as an investment, you should be considering the total gross yield. This is the rental income added to the capital growth of the property. So if the average growth in the suburb is 3% per annum, the total gross yield on the above property would be 8%. Naturally this gross yield is just that - the total income, part of which is only realised on the sale of the property (capital growth won’t help you make your loan repayments). As such you need to also be aware of and account for the expenses of owning & managing the property.

It’s also worth remembering that theoretical yield numbers are only one side of the story. Investment property, like any other asset, is subject to change. Property can drop in value, not grow at all, or not grow as expected. Interest rates change and a significant upward movement could result in a situation where rental income doesn’t cover the costs of the loan. Rental income itself is not guaranteed to stay at the level you may anticipate.

When investing, it’s vital you do your homework and plan for a range of possible scenarios.

House or apartment?

Historically, houses provide greater rewards in terms of capital growth, and apartments offer greater rental yield. Some investors believe the value of property lies in its land, which appreciates in value, rather than the building itself, which depreciates. So the more land you have, the greater your appreciation.

When you buy an apartment, you need to consider the costs and limitations associated with having a body corporate. With a house, you need to be aware that the ongoing maintenance costs - as well as the initial outlay - are generally greater.

When making a decision, investigate the likely rental returns and occupancy rates for both houses and apartment in your price range.

Where will you buy?

While it’s tempting to buy an investment property that’s close to where you live, it can sometimes be short sighted. There are plenty of online resources from reputable property authorities such as RP Data that can help you compare locations and identify high growth areas. Expert advisers can also provide you with insights regarding local areas, and help you determine where would be the best location or your personal situation.

As a general rule, it’s important to buy within proximity of shops, train stations and schools.

Similarly, be sure to look for a market with a low rental vacancy, and strong infrastructure that can support growth.

If you’re prepared to rely on a property manager, you may even want to choose property that’s in another state or territory to where you live.

Naturally, budget limitations will also impact on where to look. If you are unsure of how much you can afford, a visit to a mortgage broker or financial planner may give you a good starting point.

Old or new?

When you buy a new property, it’s essentially ready for tenants to move in and start paying rent. While this is appealing, it’s also a short-term benefit.

When you buy an older, more established property, it may present the ability to renovate, where you can give your apartment or house a real boost in terms of its long-term performance. With a new property, your scope is limited, as you don’t have the same ability to actively drive an increase in value.

Sometimes it can pay to look for potential rather than perfection.

A new property may also offer you additional depreciation allowances which can provide you great savings at tax time. However, this may also impact on calculations with respect to capital gains. Whilst in most cases property investment decisions should not be solely driven by the tax consequences, it is best to be aware of the tax consequences and how this may impact on your investment strategy and returns.

How unique is the property?

As you’ll want to attract tenants to your property, it’s important to choose one with broad appeal. However, look out for certain characteristics - such as original Art Deco or Victorian features, which are scarce, and can therefore increase demand.

What are the key features?

As a rental property, certain elements tend to excite tenants. Look out for views (especially if they have potential to be enhanced), outdoor living spaces (for both apartments and houses), and off-street parking.

Some online search tools (such as Domain) even let you narrow down your search by very specific property features such as air-conditioning, solar panels, floorboards, and many more.

What will you compromise on?

In an ideal world, your investment property will meet all of your criteria. However, budget, logistics and timeframes don’t always make this possible. Write down a list of criteria, and separate them into two parts: things you refuse to compromise, and things you may be prepared to. Evaluate every property against these criteria, and remember that your first property may not always be your dream one.

Which option is right for you?

When it comes to understanding your options and choosing a property, the right information can make a big difference. Therefore, you should consult with an expert specialising in property investment and advice.

Where Yellow Brick Road can assist is with queries relating to financing, and in particular helping you to identify how much you can afford to borrow.

Contact us today on 1800 927 927.

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