Investing in Residential Real Estate

Who Does It?

Investing in real estate has always been popular in Australia, especially residential properties.
Around 20% of households own a second residential property.  Of course, some may well be second homes, and they may be investment properties for some of the time, but a significant proportion of them will be pure investments.  On a world-wide basis, that’s up there. 

There are probably several reasons why Australians favour this investment vehicle, not least the favourable tax treatment compared with some other countries.
Currently, (September 2013) prices are starting to move upwards and property investors are contributing to this rise.  Historically low interest rates are helping to drive this movement.


How Do You Get Started?

This is one way.  Most, but certainly not all, property investors own, or have substantial equity in their principal place of residence (their home!) which means that through a combination of paying off the mortgage and increasing prices, they owe much less than the house is worth.  This means that their Loan to Value Ratio (LVR) would be much lower than the maximum required by a lender to give them a loan.  In effect, they have the equivalent of another deposit tied up in the value of their home.

This can mean that they can borrow the full amount for an investment property without an actual cash deposit.  The lender can "cross-collateralise" the security for the new loan.  What does that mean?  Well, the lender values the two properties in total, and what the potential borrower will owe in total if they grant the new loan, and if the new LVR is acceptable, the borrower will have met this condition to get the new loan. 

They will, of course, need to meet other conditions, especially serviceability.



This condition addresses the borrower's ability to make the total repayments on both their home and investment property.  All the factors for this are the same as for the original home mortgage.  The main change is that higher total repayments have to be made to cover the investment property loan. 

The borrower may already have surplus income that can be diverted to this, but it will be augmented by the rent that the investment will yield.  The lender takes this into account but does not look at the weekly rent and just multiply by 52 to get the yearly income.  They will do this but only use around 75% of this amount in their calculations.  This is to allow for expenses like rates, management fees, water rates, vacancy time, etc. 

If after all this the potential borrower still has adequate total income to pass the test and meets any other requirements, they should be able to get the loan and proceed with their investment.


What are the Advantages of this Investment over Some Alternatives?

It's an easily understood investment and less complicated than some alternatives.

It's often easier to get a loan for this than some of the alternatives.

Raising a loan for this type of investment is usually cheaper with a lower interest rate.

The LVR is usually higher.

If all goes well, substantial gains can be acquired in the medium to longer term.

Again, if you have chosen wisely, rents should gradually increase, making your cash flows higher over time.

There are tax incentives:

  •   When you sell (if you have held the property for over one year) capital gains tax is levied at half the marginal rate of the investor.
  • Depreciations are applicable to the structure if it is under a certain age and to some fixtures and fittings.
  • If you have bought the property for capital growth rather than a positive cash flow now from rents, and are running at a loss until you sell, your annual loss is regarded as a business expense and thus reduces any income tax you pay.  This is called negative gearing.



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