When property investment goes wrong

When property investment goes wrong

Last week’s RBA rate hold announcement was great news for Australian property investors. With the cash rate set to stay at 2.5 percent, a high demand for rental properties and property prices across Australia booming, it presents attractive market conditions for property investors.

In March, 39.6 percent of all new home loan applications were processed for investors, that’s two out of every five new home loans, according to mortgage lenders Australian Finance Group (AFG).  If this current trends continues, many Australians will buy their first property investment in the next 12 months but just because the market is favourable doesn’t mean there aren’t also risks to property investment.

Here are some of the things that can go wrong in property investment:

Buying the wrong property

Yes, property increases in value over time – but some properties increase in value faster and at more significant rates. And some properties can lose money, such as apartments in Melbourne’s Docklands that have failed to increase in value in the past 10 years due to an oversupply.

“Everyone is looking for the perfect property they can buy for cheap and rent for a lot of money, but tenants want to live in areas with a great lifestyle,” estate agent Ercan Ersan of Bresic Whitney Glebe said.

“We’ve heard horror stories of investors buying off-the-plan properties in the western suburbs of Sydney thinking that will be the next growth area, but they’ve ended up selling for a loss.

“With investment properties, it is always about location and making sure you are close to schools, universities, hospitals and amenities.”

To avoid a financial loss, do your homework and steer clear of areas with an oversupply of apartments and buy in an in-demand location attractive to renters and with a long track record of capital growth.

Choosing the wrong tenants

If you buy the right property, finding the right tenants should be easy. And it should help avoid the problem of lost income through not being able to rent out the property. There are many things to consider when it comes to finding suitable tenants: for example, young families may provide more stability as they tend to stay in one place for years but young children and pets can also cause more wear and tear to the property.

You may also find yourself stuck with tenants who damage the property through neglect or ones that are always late in their rent payments. Managing investment properties – whether it’s a single property or a portfolio of several properties – takes a lot of work and a good rental property agent can be the deciding factor in success or failure in the property investing game.

“The biggest mistake people make is not screening tenants adequately,” Ersan added.

“They look at the short-term return of who will give them the highest rent instead of choosing tenants with a good rental history and references.”

Not having enough cash flow

Property investment is like owning a business. Having a cash reserve to fall back on in tough times will help you hang on to your property and allow you to attend to any unexpected repairs or even hold out for a more suitable tenant.

Ersan advises holding 10 percent of the value of a property in savings to meet unexpected costs, such as special levies or urgent repairs.

“The costs don’t just stop with the mortgage repayments, and that’s where some investors can go wrong by over-extending themselves,” he said.

“Often people don’t realise how much the whole process will cost, so it’s important they do more research before buying an investment property.”

Not having a strategy

One of the most important keys to success in property investment is having a strategy in place and sticking to it, according to property investment expert Michael Yardney, CEO of Metropole Property Strategists. A lack of strategy can lead to financial losses.

“The problem is that if you don’t have a strategy it’s easy to get distracted by all the so-called ‘opportunities’ that keep cropping up, many of which don’t work out as expected,” Yardney wrote on his blog last month.

“Just look at all the investors who bought off-the-plan or in what they hoped would be the next ‘hot spot’, only to see the value of their properties underperform.”

To avoid wasting your time and more importantly money on unsuccessful property investments, Yardney recommends buying high growth properties and adding value to them through renovations or redevelopment over a 10 to 15-year period.

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Mortgage Calculator, Property Value

An estimate of how much your desired property is worth. 

What is an investment loan?

An investment loan is a home loan that is taken out to purchase a property purely for investment purposes. This means that the purchaser will not be living in the property but will instead rent it out or simply retain it for purposes of capital growth.

What is a line of credit?

A line of credit, also known as a home equity loan, is a type of mortgage that allows you to borrow money using the equity in your property.

Equity is the value of your property, less any outstanding debt against it. For example, if you have a $500,000 property and a $300,000 mortgage against the property, then you have $200,000 equity. This is the portion of the property that you actually own.

This type of loan is a flexible mortgage that allows you to draw on funds when you need them, similar to a credit card.

What is appreciation or depreciation of property?

The increase or decrease in the value of a property due to factors including inflation, demand and political stability.

What is bridging finance?

A loan of shorter duration taken to buy a new property before a borrower sells an existing property, usually taken to cover the financial gap that occurs while buying a new property without first selling an older one.

Usually, these loans have higher interest rates and a shorter repayment duration.

What is equity and home equity?

The percentage of a property effectively ‘owned’ by the borrower, equity is calculated by subtracting the amount currently owing on a mortgage from the property’s current value. As you pay back your mortgage’s principal, your home equity increases. Equity can be affected by changes in market value or improvements to your property.

What is appraised value?

An estimation of a property’s value before beginning the mortgage approval process. An appraiser (or valuer) is an expert who estimates the value of a property. The lender generally selects the appraiser or valuer before sanctioning the loan.

What is stamp duty?

Stamp duty is the tax that must be paid when purchasing a property in Australia.

It is calculated by the state government based on the selling price of the property. These charges may differ for first homebuyers. You can calculate the stamp duty for your property using our stamp duty calculator.

What is equity? How can I use equity in my home loan?

Equity refers to the difference between what your property is worth and how much you owe on it. Essentially, it is the amount you have repaid on your home loan to date, although if your property has gone up in value it can sometimes be a lot more.

You can use the equity in your home loan to finance renovations on your existing property or as a deposit on an investment property. It can also be accessed for other investment opportunities or smaller purchases, such as a car or holiday, using a redraw facility.

Once you are over 65 you can even use the equity in your home loan as a source of income by taking out a reverse mortgage. This will let you access the equity in your loan in the form of regular payments which will be paid back to the bank following your death by selling your property. But like all financial products, it’s best to seek professional advice before you sign on the dotted line.

What is a loan-to-value ratio (LVR)?

A loan-to-value ratio (otherwise known as a Loan to Valuation Ratio or LVR), is a calculation lenders make to work out the value of your loan versus the value of your property, expressed as a percentage.   Lenders use this calculation to help assess your suitability for a home loan, and whether you need to pay lender’s mortgage insurance (LMI). As a general rule, most banks will require you to pay LMI if your loan-to-value ratio is 80 per cent or more.   LVR is worked out by dividing the loan amount by the value of the property. If you are looking for a quick ball-park estimate of LVR, the size of your deposit is a good indicator as it is directly proportionate to your LVR. For instance, a loan with an LVR of 80 per cent requires a deposit of 20 per cent, while a 90 per cent LVR requires 10 per cent down payment. 

LOAN AMOUNT / PROPERTY VALUE = LVR%

While this all sounds simple enough, it is worth doing a more accurate calculation of LVR before you commit to buying a place as there are some traps to be aware of. Firstly, the ‘loan amount’ is the price you paid for the property plus additional costs such as stamp duty and legal fees, minus your deposit amount. Secondly, the ‘property value’ is determined by your lender’s valuation of the property, not the price you paid for it, and sometimes these can differ so where possible, try and get your bank to evaluate the property before you put in an offer.

What does pre-approval' mean?

Pre-approval for a home loan is an agreement between you and your lender that, subject to certain conditions, you will be able to borrow a set amount when you find the property you want to buy. This approach is useful if you are in the early stages of surveying the property market and need to know how much money you can spend to help guide your search.

It is also useful when you are heading into an auction and want to be able to bid with confidence. Once you have found the property you want to buy you will need to receive formal approval from your bank.

How much is the first home buyer's grant?

The first home buyer grant amount will vary depending on what state you’re in and the value of the property that you are purchasing. In general, they start around $10,000 but it is advisable to check your eligibility for the grant as well as how much you are entitled to with your state or territory’s revenue office.

How much can I borrow with a guaranteed home loan?

Some lenders will allow you to borrow 100 per cent of the value of the property with a guaranteed home loan. For that to happen, the lender would have to feel confident in your ability to pay off the mortgage and in the security provided by your guarantor.

How much money can I borrow for a home loan?

Tip: You can use RateCity how much can I borrow calculator to get a quick answer.

How much money you can borrow for a home loan will depend on a number of factors including your employment status, your income (and your partner’s income if you are taking out a joint loan), the size of your deposit, your living expenses and any other debt you might hold, including credit cards. 

A good place to start is to work out how much you can afford to make in monthly repayments, factoring in a buffer of at least 2 – 3 per cent to allow for interest rate rises along the way. You’ll also need to factor in additional costs that come with purchasing a property such as stamp duty, legal fees, building inspections, strata or council fees.

If you are planning on renting the property, you can factor in the expected rental income to help offset the mortgage, but again it’s prudent to add a significant buffer to allow for rental management fees, maintenance costs and short periods of no rental income when tenants move out. It’s also wise to factor in changes in personal circumstances – the typical home loan lasts for around 30 years and a lot can happen between now and then.