Originally published on Smart Property Investment on 14 November 2019.
Property investment is one of the biggest financial commitments anyone can make. As such, aspiring investors must be equipped with the knowledge and skills to manage their finances over the long term. How can they maximise opportunities and mitigate financial risks?
As one of the most lucrative types of asset, property has become a popular tool for creating wealth.
How much money does it actually take to buy the first property that will jump start a wealth-creation journey?
According to property professional Jack Needham, while there is no magic formula for determining the amount of money that investors will need in order to start investing in real estate, there are certain factors that will influence the initial expenditure of budding investors.
Among the things to consider when setting a budget for property investment are:
1. Location and type of asset
When purchasing properties, the budget will be largely dependent on the location and type of property that the investor wants to buy.
Houses and units vary in costs, and so do regional and city-based assets due to population and other socioeconomic drivers.
2. Investment strategy
Similarly, the investor’s chosen investment strategy will also affect how much money they will need to jump start their investment journey.
Investors may opt to buy a more expensive property in a “blue-chip” suburb, utilise negative gearing concessions and hope that the property achieves enough value growth to offset short-term losses.
On the other hand, they can purchase a low-cost property with a higher rental yield if the priority is to sustain cash flow.
Whichever strategy they decide to implement, it’s important to remember that the price of a property is not a sufficient indication of its potential for success.
According to Mr Needham: “Spending the same amount of money on two properties will not guarantee that each will perform as well as the other. Growth and yield will come down to how well a property’s attributes stand up to the market.”
“With this in mind, any investor needs to conduct thorough research into the property they are planning to purchase to ensure it stacks up and maximises their investment dollars.”
The deposit, which is defined as “the amount of money you put down at the start of the purchase in order to secure the property and financing” that is calculated as a percentage of the purchase cost, is one of the first costs associated with a property purchase.
In most cases, the deposit ranges from 10 per cent to 20 per cent of the purchase costs, but it could go higher depending on the chosen lender, the property type and the buyer’s profile.
Investors who pay low deposits, or below 20 per cent, and those who purchase properties at higher risk of default are often required to pay for lender’s mortgage insurance (LMI), which protects the lender if the borrower defaults on his mortgage.
“It is a one-off payment but it can be capitalised into the ongoing repayments on a home loan,” Mr Needham highlighted.
Meanwhile, paying a higher deposit may improve the investor’s serviceability or increase the amount that they can borrow, thereby giving them the opportunity to secure a higher value property in the future while avoiding additional costs such as the LMI.
However, a higher deposit may also lower their capital and hinder them from making further purchases for a number of years.
Stamp duty and other costs
Stamp duty depends on jurisdiction and property value and can range from as low as $20 to tens of thousands of dollars.
“Stamp duty is also charged on the registration of a mortgage. This is a charge imposed by state and territory authorities, and varies by jurisdiction [and] …is typically paid on an investor’s behalf by a lender and absorbed into mortgage repayments.”
“Some states, such as New South Wales, have signalled their intention to abolish mortgage stamp duty,” according to Mr Needham.
Pest and building inspections are also included in the initial costs associated with a property purchase. It may cost $400 or more, depending on the size of property.
Buyers will also have to pay conveyancing fees to the legal representative for facilitating the property purchase and conducting title searches.
Once the property is secured, there will be more associated costs to holding the investment property, some of which are loan repayments, council rates and land tax, water rates, insurance, body corporate fees, repairs and maintenance costs, property management fees, and tax on rental income, among others.
How to avoid overcapitalising
Before beginning a property investment journey, investors are advised to make sure to set a budget so they don’t go overboard and spend their life savings to build a portfolio.
“Properties are tangible assets that are susceptible to damage from the people residing in them and the outdoor elements,” Mr Needham concluded.
“It is important to maintain a buffer for emergency repairs, ongoing maintenance, and periods of vacancy, or where your primary income might be subject to unforeseen change.
“It might mean making sacrifices to your day-to-day living expenses or limiting your initial investment amount, but maintaining access to emergency funds will pay off in the long run – often in ways you might not expect.”