So you want to buy an investment property.
Some would say it’s not for the faint-hearted. Well, it’s certainly not for everyone.
Property investment is a long-term strategy needing a lot of preparation.
In particular, it’s most likely you will need to borrow money. Borrowing to invest in property is called gearing.
That means property investment is a financial strategy, not a ‘bricks-n-mortar’ strategy.
Consequently, it can get quite volatile and there are a number of significant trade-offs.
Property investment must be approached with realistic risk-reward expectations.
Related Reading: 'Gearing - you don't get 'owt from nowt'
What is risk?
Risk means we don’t know what the future holds. Is that good or bad? We don’t know yet.
To prepare, it’s important all pros and cons are considered to determine if borrowing to invest is right for you.
Risk typically refers to the probability of loss. The level of probability determines the likelihood a negative event will occur. If the likelihood is high, then some people will not attempt the strategy i.e. they are risk averse.
Those with a high risk appetite may adopt this type of strategy because the payoff is high i.e. the risk of gaining something more.
Therefore, it’s important to know your own risk profile.
Risk appetite
Your individual risk profile consists of:
- Risk required: to achieve the financial reward you want.
- Risk capacity: how much risk can you afford / capacity to pay.
- Risk tolerance: how much risk are you comfortable with / can I sleep at night.
The first two are financial considerations through seeking independent, professional advice. The third is psychological and is shaped my many personal factors and experiences.
Benefits of borrowing to invest
A key benefit of gearing is leverage, allowing greater exposure to the investment opportunity. The greater the capital base, the greater the returns.
Other benefits include:
- Capital growth
- Passive income
- Tax offset
There is only an advantage if the rate of return of the property investment strategy is higher than the cost of the strategy.
Risks of borrowing to invest
Most property investment is highly geared, especially during the early stages, creating greater sensitivity to negative factors that may cause failure.
A key consideration is having enough available cash to service the strategy. This may be called upon for a number of reasons:
- Investment income: strategy is not achieving targets.
- Interest rates increase: cost of borrowing goes up.
- Loss of income: redundancy, illness, injury.
- Capital depreciation: property value falls below loan amount.
- Illiquid market: can’t convert asset to cash
Ultimately, if the investment strategy fails you still need to pay the loan.
Related Reading: 'A quick look at bank versus non-bank home loans'
Recap
Borrowing to invest is one of the most powerful tools you can use for increasing your long-term wealth.
Have fun looking at different investment properties, whilst developing your own risk profile using the following questions:
- Do we have a reliable source of income backed by strong cash reserves?
- Are tax deductions available to help our cash position and serviceability?
- Are we prepared for a long-term pay-off horizon?
- Is our property investment strategy flexible?
- Can I sleep at night?
3 Golden Rules
Seek independent professional financial and tax advice.
Shop around and haggle for the best investment loan deal.
Know your personal and financial limits.
Thinking of property investment?
One simple conversation about your investment ideas could improve your financial position and lifestyle at the same time.
At Loan Avenue we know one size doesn’t fit all. It pays to have a conversation with a real a person who wants to hear your story and run through some investment scenarios with you.
Why not incorporate a discussion about property investment as part of our free no obligation home loan review?
It’s just one of the many features and benefits included in a tailored investment loan from Loan Avenue – affordable home loan solutions for everyday Australians like you.
Let us show you. To make an appointment with one of our experienced and accredited finance professionals call 1300 56 26 28 today or leave a message here.
