Pros and cons of buying an investment property

Canstar’s guide is here to help any potential property investor down the path to a wise investment – and to remind you to think with your head – not your heart.

While we talk about the struggles for young New Zealanders to get their foot in the door in the property market, let’s not begrudge those lucky enough to consider investing in property. For those in-the-know, property investment can be a very wise financial decision. Conversely, going in blind can lead to unmanageable repayments and a stressful experience.

For some, investing in property is the next step to building up wealth, and that may be exactly the right decision to make. But there’s a lot to consider before diving in headfirst.

What do you need to consider before investing in property?

Before investing in property, you need to consider why it is that you are doing it. The reasons for making such a big financial commitment need to be well-though out and make sense. While great in principle, “to secure my financial future” doesn’t cut it when it comes down to it. Instead, you need to think about your short-term and long-term goals with property, and how these goals apply to your own financial situation.

For instance, are you a first home buyer who is buying property to rent out rather than live in it? Or, are you an owner/occupier who would like to do more with equity already built up in your home?

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Whatever your situation is – and whatever the reason is that you want to become a property investor, the core research needed will be the same. Here are some pros and cons of investing in property.

Possible benefits of investing in property:

Buying your first home

  • Provided you pay the accompanying mortgage off at some not-too-distant point, investment properties can provide a long term income stream that typically rises over time.
  • Property markets in New Zealand have historically enjoyed moderate long-term growth. Should this continue, your investment should grow in value.
  • There are tax benefits associated with holding an investment property, including the ability to depreciate fixtures and fittings over time. You may also be entitled to a building allowance deduction.

Possible disadvantages of property investment

  • There is a risk that the value of your property may be worth less than what you paid for it. Any capital loss is magnified when leverage is involved.
  • There is a risk that your property may not always be tenanted. In a worst case scenario, you may be forced to sell.
  • There is a risk that a tenant could damage your property, become unruly or become difficult to evict, causing you financial loss.
  • There is a risk that repairs and maintenance expenses could become significant.
  • There is a risk that interest rates could rise, impacting your ability to service your loan.
  • There is a risk that you could become unemployed and no longer benefit as much from the tax deductions due to your lower tax rate.

Five tips for having a rentable investment property

When you’re out visiting houses, it pays to think about what aspects of the property carry property – making it easier to rent out or to sell on later.

Check that your renters have:

Some amenities close by  

Running water

Renters won’t expect every store under the sun to be on the doorstep. But having at least a supermarket not too far away will increase your chances of renting your property out.
A working shower These days, renters probably aren’t expecting a bath, but at least make sure they have a working shower!
Heating/insulation Cold, damp houses will have renters running for the hills.
Fixed windows etc. Window open You’re not going to get renters in if you’re holding windows together with duct tape.
Reasonable rent Yes, you have bought the property to rent out as an investment. But don’t hike the prices so high no one is prepared to pay it.

What return could I expect when investing in property?

The potential return you could expect from investing in property is, of course, a key decision to go ahead. The return generated will be dictated by a number of variables, such as the tenancy rate of the area you are looking at. What kind of properties rent well in this area: houses, units, townhouses or apartments? Does this area have growth potential, transport infrastructure, any main employers in the area, major retailers moving to or from the area or other major projects happening?

Once you have ascertained the rental return you could expect and the sum you would have to borrow for a home loan, you can start doing the figures for an idea on expected ultimate gain or loss. Don’t forget to include the actual rental expenses (management fees, maintenance costs, landlord insurance), along with depreciation and/or building allowances.

Is an emotional attachment enough to invest in property?

Having an emotional attachment is not strong enough of a reason to invest in property. When considering residential property as part of a diversified portfolio, investors should put the emotion to one side and think about the following:

Is the return generated proportionate to the risks?

Finding out whether the return generated is proportionate to the risks includes comparing the profits with what you would get in a term deposit. If your property investment generates net returns after expenses lower than a term deposit (but with far greater risk), you need to consider the validity of investing in property. Any investment involves a risk/ return trade-off. If alternate assets provide a better risk/return profile, then property may not be the immediate answer.

What is an exit strategy and why do I need one?

An exit strategy is finding a way to fund the investment property if, for example, you lose your job. You need to have an exit strategy to work as a back-up plan should this unfortunate situation arise, so you are not forced to sell in an unfavourable market. Access to a line of credit or tapping into savings accounts can buy you time in such situations.

Can you bank on rising asset prices for your investment strategy?

Unfortunately, you can’t just bank on rising asset prices for your investment strategy; changing markets mean it’s not a foolproof solution. Often the best property investments are those that generate enough income on a standalone basis, without the need for capital growth.

Buying is exciting and scary at the same time, so ensure you minimise your risks and maximise your potential profits. Do all the research needed, including comparing home loan rates. Talk to a financial planner or accountant. But, above all, keep your eye on the prize (and your finances).

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