1. Decide – Capital gains or rental return or both?
You need to consider whether you are chasing rental returns or capital gain. A rental return will help you pay off a property over time; Capital growth will allow you to use the equity to purchase future investment properties. You may decide to have a mix of both. It will come down to affordability. An experienced mortgage broker can assist with the ability to borrow.
2. Calculate the rental return
The very first step is to calculate the rental return on the property and ask yourself the question; does this meet my criteria for purchasing the property? Some people are looking to achieve a positive cash flow on the property others look for capital growth. You can very easily do a “back of the envelop calculation” that requires finding out what the weekly rent potential is versus the value of the property. If you want to achieve a 5% return you would look for a property where the rent is the same as the first three digits in the purchase price.
For Example $400,000 house rents for $400 per week it is roughly a 5% return. In fact it is really 5.2% ($400X 52 ÷ $400,000) = 5.2%. Try it – it works! Given that interest rates are at an all-time low it becomes easier to seek a neutral or positive cash flow on the property.
3. What’s the property really worth?
It is really only worth what someone is prepared to pay for it. Statistical analysis will help; you can use RP Data or other vendors of data to offer comparisons. Things that can help your negotiations are how long the property is on the market for, where does the property “fit” with other properties similar to the one you are researching, has the vendor previously dropped the price.
What is the condition of the property you are looking at? Bear in mind if you purchase a property that needs repairs this will impact your ability to borrow for that property. The bank may request to see that you have funds available to do repairs or decline the loan because it is not a good security risk for them.
4. What is happening in the local market?
You could take a market analyst approach and research everything online. However, in my experience the most definitive way is to visit the area yourself and burn some shoe leather whilst walking around talking to local real estate agents and neighbours of potential houses that you a looking to purchase. A perfect example of this was a young investor made enquiries about a property he was thinking purchasing.
“I am looking to purchase a property in an area where all the other properties are listed at offers over $325,000. The property is 3bed, 1bath, 1car is perfectly fine condition the problem with the property is there are power lines running over rear of the property, which is the reason no one else is interested because it is well under what other properties have been selling for. A very similar property in the same street sold 2 months ago for $365,000.
Regardless of the statistical data when the valuer goes out to value the individual property, the fact is that the individual property is impacted by power lines, most people will view this as a health risk that they are not prepared to take. The majority of people may have trouble funding the property due to the adverse remarks that the valuer may add to the valuation report to the bank.
Events such as murder or suicide that have occurred on the property will dramatically affect the sale and hence the value. Once a valuer makes comment on why the property is at a reduced sale price it will alert the banks to the risk and hence the ability to borrow, especially in mortgage insurance territory.
5. Property management
It may be tempting to manage property yourself. If you are going to do this put a proper lease in place and collect the payments by direct debit. Even if the property it is rented to a family member. There are two main reasons you should put the proper paperwork together; one is to establish “the rules of the game” making sure everyone is aware, all too often the relationship that starts off good can end in disaster. The other reason is that you will need to prove that you can service future borrowings. If the bank can not verify the income on a property rented to a family member then it is assumed that there is no income on that property. This makes life difficult if you want to refinance to get yourself a better deal or grow your property portfolio. Best option is to have a local property manager do all this for you. The good ones are worth their weight in gold!
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