It is imperative to choose your property investment strategy wisely. Investing in property comes with high entry and exit costs; the wrong strategy will cost you in the long run. Property investment strategies can be divided into two broad categories:
- Rental yield strategy
- Capital growth strategy
Capital Growth Vs Rental Yield – Which Is Better?
| Capital growth | Rental yield |
|---|---|
| While you may not gain a steady cash flow, you have the potential to earn a big profit when you sell your property. | You receive a steady cash flow (provided your property is positively geared). |
| You look for properties in areas that will increase in value | You look for properties in areas that have great appeal to tenants |
| Properties are usually located in high-demand suburbs | Properties are usually outside metro areas, where property is more affordable and rental return is high. |
| Associated with high entry costs, as you need to budget for stamp duty, which increases with the price of the property. | Rent payments will cover the ongoing costs of owning property but you pay tax on rental income. |
The right choice boils down to your property investment goals and financial situation. For example, if you don’t have a large deposit saved or you need what money you have to cover the costs of owning the property, a rental yield strategy might be right for you. If you’re looking for long-term opportunities to build wealth and can afford management fees and mortgage repayments, then capital growth strategies might be the best choice. Here are some pros and cons of both broad categories.
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Why Choose A Rental Yield Investment Strategy?
| Pros | Cons |
|---|---|
| You want to generate positive cash flow | You have to pay taxes on the rental income generated |
| You do not have enough equity in other properties | The properties are susceptible to economic shocks |
| The surplus rental income can pay down your mortgage, and you increase the equity in your investment property | There might be postcode restrictions, as banks will not lend in areas where the risk is high |
| You can borrow with a lower deposit and use rental income to increase your borrowing power | Tenancy problems can leave the property vacant for too long |
Why Choose A Capital Growth Investment Strategy?
| Pros | Cons |
|---|---|
| The properties are not that vulnerable to economic shocks. | The prices for properties expected to show capital growth are usually high. |
| Consistent capital growth over a longer term builds equity | As the purchase price is usually higher, you end up paying more on stamp duty and land tax |
| You can often generate equity in the short term as well | There’s no guarantee of capital growth in the short term, so you might have to hold the property for a long time to make a profit. |
| You enjoy tax benefits, like deductions for negative gearing and delayed capital gains tax. | If your property portfolio is overexposed, then some lenders might not approve your loan. |
What Are The Different Property Investment Strategies?
The property investment strategies mentioned below focus on rental yield, capital growth or a mix of both. These strategies are used for buying either residential investment properties or vacant land.
Owning Your Home
While it’s not widely regarded as a property investment strategy, your home is an asset that can increase in value. As you keep paying your home loan, you are increasing the equity, which you can access to buy an investment property or shares. For many, the home is the cornerstone of the investment journey. Owning your own home has two major tax implications that investors must keep in mind:
- When you sell your home or principal place of residence, you do not have to pay any capital gains tax. If it was an investment property, CGT is applicable for any profit made on the sale.
- The ongoing costs and expenses of owning your home are not tax-deductible.
Convert Your Home Into An Investment Property
If, a few years down the line, you want to downsize or move into another property, you can convert your home into a rental property. Holding onto your current home, instead of selling it, means you’re diversifying your property portfolio. Once you find a tenant, you earn rental income. This can be used to pay for the transaction costs of your new home. If you’ve planned all along to rent your property after living in it, you can make improvements over the years to attract the right tenant.
Buy-and-hold Property Investment Strategy
This is a rental yield strategy, as you buy an investment property and lease it to a tenant. With a buy-and-hold strategy, you have no intention of selling the property in the short or medium term. It is a favoured strategy for building a nest egg for retirement. It can also be considered a positive cashflow strategy if the rental income exceeds the ownership expenses after depreciation and taxes are taken into account.
Why Should You Choose This Investment Strategy?
| Pros | Cons |
|---|---|
| You earn passive income from your tenant. The rental income can cover your repayments. | The tenant could default on rent. The property could remain vacant for too long. |
| You can claim tax deductions, such as depreciation, interest on your investment loan and rental expenses. | You have to account for the repairs and maintenance of your investment property. |
| The property’s value has the potential to appreciate over time. You can use equity to diversify your portfolio. | Property usually does not appreciate in value as rapidly as some other investments. |
Negative Gearing Vs Positive Gearing
Negative gearing is when the costs of owning a property are more than the rental income, creating a loss that can be deducted from taxable income. Negative gearing helps you manage the initial cashflow problems of a low rental income. Positive gearing is the exact opposite. Your rental income is higher than your expenses and you pay taxes on this net income. Read about the pros and cons of negative gearing and positive gearing here.
Rentvesting
With rentvesting, you rent the home that you live in while owning an investment property. You are both a landlord and a tenant, living in a property that suits your lifestyle while owning one that fits your budget.
Why should you choose rentvesting as your investment strategy?
You can choose rentvesting as your property investment strategy if you:
- Do not have enough deposit to buy a high-priced property in a sought after area
- Do not have equity to use from another property
- Want to live in an area closer to your job and can’t afford to buy your own home due to high prices
Read about the pros and cons of rentvesting to determine whether it’s the right property investment strategy for you.
Buy, Renovate And Sell (Flipping)
If you do not want to hold onto a property for a long time, flipping might be the right option. With flipping, you aim to buy a property at a bargain price, renovate it straight away, and sell it again as soon as the market is rising. This strategy is primarily for sophisticated investors who have the finances ready to buy and renovate. The challenge here is finding a property that ticks the right boxes for flipping. Besides the right location, you have to plan the timeframe for renovating and selling at the right time. The biggest risk with flipping is that the profit earned may not cover the renovation costs, especially if your budget blows out or you bought in a location that is not ideal for capital growth.
Is Flipping A Good Investment Strategy?
| Yes, it is | No, it isn’t |
|---|---|
| If you need quick cash flow. | If you can’t be reasonably certain the profit from the sale will exceed the expense of buying and renovating the property. You must account for agent fees, stamp duty and other costs of sale when deciding whether a property is a good choice for flipping. |
| If you already have a team of trusted and experienced people who can work on the property within a given timeframe. | If you can refinance the renovated property to access equity, rather than selling it. Holding for longer can increase the capital gain earned. |
Buy, Renovate And Hold
This is a combination of two strategies, as you’re buying property at a bargain price and renovating it to attract the ideal tenant. Unlike flipping, however, you’re not selling the property in the immediate future. Instead, you upgrade the home to add value and suit the needs of your ideal tenant.
Why Should I Choose This Investment Strategy?
| Pros | Cons |
|---|---|
| You gain more in rental income, due to renovations. | It is time-consuming and expensive to renovate. |
| You’re adding value and equity to your investment property | Renovations may go over budget or take longer than expected. |
Subdivision
If you have experience investing in property and understand the council and property development process, then subdivision could be an option. With this strategy, you find a large tract of land and divide it into blocks, complying with council regulations as you go.
By subdividing and creating free blocks of land, you can:
- Sell some blocks of land
- Build a new home on blocks you keep
- Hold onto the land and let its value increase over time
Why Choose This Investment Strategy?
| Pros | Cons |
|---|---|
| You are creating additional value by splitting the land into different blocks. | Finding a piece of land large enough to subdivide and getting approval from council can take time. |
| You can sell one block and retain others, achieving capital growth and rental yield | Smaller blocks of land might not appeal to most buyers. |
| You can gain an instant increase in equity. | If there’s an existing property, subdividing the land it is own can decrease its value. |
| You have the potential to earn a large profit, especially if the property is in a high-demand area. | It is time-consuming, as it requires removing trees, connecting power, etc. |
Buying Off-the-plan
Off-the-plan properties are favoured by some investors, as they are purchasing a new property with higher depreciation benefits. Expats and foreigners who invest in real estate in Australia usually prefer this option, as they’re not allowed to buy established properties.
Is Buying Off The Plan A Good Investment?
| Yes, it is | No, it isn’t |
|---|---|
| You buy off the plan at current value. If the property appreciates in value, you enjoy capital growth. | You might be paying inflated prices, as agents are incentivised to sell, and there are high advertising costs, which rolls over to the final price. |
| You can buy with a low deposit. | Lenders are hesitant to approve investment loans for off-the-plan properties. |
| Since there is significant time before the development is complete, you have time to increase your savings before it’s time for settlement | An oversupply of off-the-plan apartments and low demand might cause price falls |
| You get depreciation benefits of investing in a newly built property | The project may miss deadlines or even never be completed if the developer runs into problems. It may also be completed by not up to standard. |
How To Choose The Right Property Investment Strategy
Buying and holding might work best for those just starting on their property investment journey. You do not need years of experience to make it work. You earn passive income, and your investment property has the potential to appreciate in value over time. For experienced investors who need to make a quick profit, flipping might work. You’re buying the property at a lower price, renovating it and selling it for a profit. Your experience will shine through when you’re negotiating deals and deciding on the right time to sell the property. If a low deposit is a constraining factor, it’s best to invest in houses and avoid off-the-plan properties. A low deposit means you’re looking to borrow with a high Loan-to-Value (LVR) ratio. Investing in houses is considered low risk by most lenders, so you have a higher chance of getting approved for the kind of loan you need. As there are different property investment strategies to choose from, picking the right one is crucial to achieving your goal. Here are some tips for choosing the best property investment strategy:
- Know your goals and what you want to achieve, so you know what you’re aiming for when choosing a property investment strategy.
- Focus on location and not just the property type.
- Since we don’t have control over how the property market performs, it’s best to organise your finances so that you have a cashflow buffer.
- Do not buy the first property you see. Do extensive research before you purchase.
- Do not self-manage your investment property or take the services of a subpar property manager. Get the help of an experienced and qualified property manager, so you get the best return on your investment.
- If it’s overwhelming to look for properties on your own, get a buyer’s agent to do it for you. Be sure to let the agent know exactly what you’re looking for in your ideal investment property.
- A mortgage broker will let you know how much you can borrow and the right way to structure your investment loan, so you get the best return on your investment.
- Policy changes and legislative changes can affect the success of your property investment strategy, so you need to be flexible and be prepared to accommodate these changes.
At Home Loan Experts, we can help you structure your investment loan to achieve your investment goal by choosing the right property investment strategy. Call us on 1300 889 743 or enquire online today.