Five golden rules of residential property investment

golden rules of residential property investment

For many, the ultimate goal of investing is to make enough passive income to support themselves and their families. Property investment is a great way to get yourself closer to such financial freedom. Properties can appreciate in value, be leveraged for further investments and generate a positive cash flow. 

However, property investment is not as simple as simply buying a home and waiting for the money to start rolling in. There are a few basic rules that you should familiarise yourself with if you want to be successful. 

To help you get started on your investment journey, we’re going to take a look at these golden rules of property investment. 

1. Don’t overpay 

The first rule is to never overpay for a property. Though this might sound simple, there are plenty of investors that simply don’t do enough research and end up spending more than the property is worth.

Here are a couple of methods that you can use to gauge the value of a property. 

Sales comparison 

This primarily involves looking at a number of recently sold homes in the area in which you’re looking to invest. The value of comparable homes sold in the area should provide a general guide to the value of the property you’re looking at. Trend analysis and market surveys are also used to get a more accurate estimate. 

When using the sales comparison method, make sure to look at homes that have similar features to the property you’re thinking of buying. Some features that you should consider include the number of bedrooms, the number of bathrooms, the size of the garage, outdoor facilities and the quality of the interior. The condition and age of the properties should also be considered. 

Automated valuation models 

Alternatively, you can use one of the online automated valuation models (AVMs) provided by various lenders and real estate websites. To evaluate properties, these models process a large amount of data from public records and property listings. These systems also take into account home features like the materials used for the interior, the quality of the air conditioning system and so on. 

Keep in mind that the AVMs that are publicly available are typically used for the primary purpose of lead generation. As a result, they are often not as in-depth when compared to the AVMs used by real estate professionals. 

Regardless, by using either of these methods, you should be able to get a rough idea of the value of a property. This will help you gauge whether or not you’re overpaying for a property. 

2. Always consider ‘location, location, location’ 

There’s a reason why the saying is so ubiquitous. When it comes to investing in real estate, location is one factor that you don’t want to overlook. People want convenience and are more than willing to pay for it. So, when you’re looking at an investment property, make sure to look at its proximity to such amenities. 

You’ll likely find, however, that most properties in in-demand areas are quite expensive. This makes it difficult for newer investors to get a property in an optimal location. 

One way to get around this is to invest in a newer community that is slated for future developments. Since that area won’t have as much developed infrastructure, the properties in that community won’t be as desirable and therefore will likely be more affordable. 

As commercial and government plans come to fruition and more amenities are added, the desirability of those same properties will start to increase. Because of this, if you buy into a new community early, your investment property could show significant capital growth over a short period of time.

3. Ignore the hype 

It might seem like following the crowd is a logical approach. After all, people always find safety in numbers. However, it’s important to remember that the majority isn’t always right. 

There are a couple of major reasons why you shouldn’t follow the herd in property investment. You can argue that following the herd is a form of emotional decision making. You’re not making decisions based on your own research or conclusions; you’re essentially relying on the enthusiasm and the opinions of others. By not doing your due diligence, you can find yourself overpaying for a property or owning a home with a suboptimal location. 

You also won’t be able to discover new investment opportunities by following the herd. Let’s say for example that homeowners are buying properties in a suburb that’s undergoing gentrification. If you follow the herd, by the time you get to buying a property in that suburb, the prices of the properties would have likely levelled out. The largest returns that you can get come from opportunities that no one else sees. This could be a developing community, a home that can be renovated or a suburb that is showing early signs of growth and demand. 

Even more concerning is the idea that following the herd can lead to an economic bubble. When a large majority of investors begin to follow a market trend, the price of certain assets can become overly inflated. Remember to base your investment decisions on quantifiable data rather than emotional or abstract drivers or trends. 

4. Add value to the property

One of the best things about real estate investing is that, once purchased, you have control over your assets. For example, you can theoretically add to the value of your property by undertaking renovations or expansions. At the very least, these home upgrades will add to the appeal of your property and therefore increase its desirability. 

A popular investment strategy is to purchase an older, more affordable property and then renovate it. With the right renovations, the value of the property could increase significantly. This gives you the opportunity to get larger returns either through house flipping or generating a higher rental yield. 

If the home is your primary place of residence, you might even be entitled to tax deductions. For more information on this, please visit the Australian Taxation Office website

Keep in mind that your property’s value also depends on a variety of other factors. Because of this, there are instances where home renovations and upgrades may not provide you with the increased property value that you’re looking for. 

5. Know the terms 

There is a lot of property investment terminology that may be unfamiliar to the new investor. It’s important that you have a firm understanding of this terminology as some of these concepts can make or break your investment. 

Equity 

A term that you’ll hear a lot in real estate investment is equity. Equity is measured by subtracting your liabilities from the value of your current assets. For example, let’s say that your property is worth $500,000 and you have an outstanding loan of $350,000. This means you have $150,000 in equity. 

This equity can potentially be used as a security when purchasing another investment property, or for other loans like business loans or car loans. 

It’s important to note that you can’t just use and access all your equity. If you want to borrow against the value of your property, you have to first calculate your usable equity. Most banks will allow you to borrow up to 80% of your property’s value minus the amount of money that you still owe. For instance, let’s take that same $500,000 property and take 80% of its value. That would leave us with $400,000. Subtract from that the $350,000 of debt and you’re left with $50,000 in usable equity. 

Another big advantage of this is that if your equity can cover the 20% deposit for your next investment property, you won’t have to take out Lenders’ Mortgage Insurance (LMI). Of course, this is assuming you have enough funds to cover additional costs like settlement fees and stamp duty. 

Capital growth vs. cash flow

Another two terms that you’ll often hear are capital growth and cash flow. 

Capital growth refers to the increase of your property’s value over time. It is calculated by taking the current value of your property and comparing it to the initial price that you paid for it. 

Cash flow, on the other hand, refers to the movement of money. For example, if you’re renting out a property, the rent money that you receive is part of your cash flow. The aim is to have a positive cash flow. That is, having more money coming in than money going out. 

In real estate investing, it’s important to balance both concepts. Capital growth is what provides you with the further investment opportunities as discussed above. It allows you to use equity to further invest in other properties. Meanwhile, cash flow can be used to pay for holding and maintenance costs as well as loan servicing. 

These were just five basic but important rules in property investing. As you’ll likely find, there are other ‘rules’ that you need to learn if you’re to be a successful investor. When it comes to your finances, it’s important to be knowledgeable so that you can make safe and smart decisions. To help you with this purpose, it’s best to consult with real estate professionals as well as trusted financial advisors.