Before you invest in property, it’s important to define your goals. Investing in property is typically done for either capital growth, as the property rises in value over time, or for rental income, from leasing the property to tenants. Some people also choose to invest in property for the tax benefits.
Learn more about the benefits of each to find out which investment objective is right for you.
6 minute read
Capital growth is when the value of a property rises over time, and therefore increases your personal wealth.
When properties grow in value, you can use the equity (the difference between the value of the property and how much debt is owing on the mortgage) for personal use, for example to buy another investment property, go on an overseas holiday, renovate your home or buy a new car.
Alternatively, you can sell the investment property and pocket the profits, or use these to help pay off the mortgage on your family home. However, it’s important to note that there will be tax to pay on the profits, as well as selling agent fees for the sale of the property.
When determining your expected profits, you should also be mindful of any other costs you’ve incurred along the way, such as interest on your loan, and stamp duty and settlement fees you paid when purchasing the property.
Use our stamp duty and LMI calculator to get a full picture of the costs associated with buying property.
This means your property increases in value by a greater amount every year that you own it.
For example, if you bought an investment property for $400,000 and it increased in value by 6% every year, after one year it would be worth $424,000, for a growth of $24,000. At the end of the second year, it would be worth $449,440, for a growth of $25,440 – $1440 more than in the first year.
The more time passes, the higher the compound growth. After 20 years at 6% increase every year, that same property would be worth $1,282,854.
That’s why it could pay to take a long-term view if you’re after capital growth.
Rental income is the money you receive from leasing the property to a tenant.
If the rental income covers the expenses of holding the property (such as your loan repayments, maintenance costs and property management fees etc), the property is classified as positively geared, meaning you end up with extra money in your back pocket each week. This money is essentially an extra source of income and can be used for discretionary spending, to pay bills or help pay down debt on your family home.
If the rental income doesn’t cover all your holdings costs, you’ll have to chip in some of your own money to meet these payments – this is called a negatively geared property.
If the property is negatively geared, it’s particularly important to determine what impact extra mortgage repayments would have on your finances in the scenario that your interest rates rise.
A good way to evaluate if a property has a strong rental income is to determine its rental yield, which is a calculation of the value of the property and the annual rental income.
By determining the rental yield of a property, you can measure it against other properties at a suburb or city level to gauge how it compares. In a nutshell, rental yield is a better ‘apples-to-apples’ comparison for rental returns.
Rental yield is the cash return (i.e. rental income) you receive from leasing your investment property to a tenant. It is displayed as a percentage and can be shown as either gross yield or net yield.
Gross yield is the total cash return your property has generated before expenses, such as property management fees, loan repayments and insurance, for example. The net yield is the cash return you have left over after you’ve deducted all your expenses.
Take an investment property that is purchased for $400,000 and the tenant pays $350 per week in rent.
Find the annual rental income
$350 per week x 52 weeks = $18,200 in rental income each year.
Divide the annual rental income by the cost of the property, and multiply by 100.
$18,200/$400,000 x 100 = 4.55%
Net yield provides a better indication of whether you can afford to hold an investment property because it takes into account all the expenses associated with the property, not just the purchase price.
Here are some examples of costs and expenses that need to be considered when calculating net rental yield.
Property costs:
Annual expenses:
Because it includes so many costs and expenses, net rental yield is more difficult to work out. However, it can be calculated as follows:
[(Annual rental income – annual expenses) / total property cost] x 100.
It’s important to note that rental yields are influenced by a number of factors such as the type of property (i.e. house, apartment, villa etc), its age (newer vs older), its location (state vs state, country vs regional, inner city vs urban fringe etc) as well as demand and supply. Learn which features you should look for in a good investment property if you’re after rental income.
You can also invest in property for the tax benefits, such as depreciation claims.
If you buy a brand new investment property, you can claim some depreciation on your taxable income, such as the depreciation of the building and items considered plant and equipment (including hot-water systems, air-conditioning units and curtains).
If the property is negatively geared, you can also claim the losses as a tax deduction.
It’s important to understand what you want from an investment property and identify the types of properties that will help you meet your investment goals. Some properties may offer higher rental income and some may offer better potential for capital growth, but rarely does an individual property provide both.
It can also be helpful to speak to industry professionals, such as an accountant, financial planner, Home Lending Specialist or buyer’s agent, for relevant advice.
Once you’ve determined what your investment goals are, find the right property to reach them.
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