So you’ve scrimped and saved and bought your first home, worked hard paying off the mortgage for a few years, and now you’re wondering – should we buy an investment property?
You probably have a few follow up questions, like:
If we do buy an investment, where should we look? What kind of property makes a good investment?
How much deposit will we need?
Will the market tank right after we buy it?
Should we buy a doer-upper? Or a home that’s ready to move into?
What sort of return can we expect? (eg. weekly rent vs purchase price)
Aren’t we better paying off our own mortgage first?
I have seen friends, family and clients make good and bad decisions when it comes to investment property and what follows is some of what I’ve learned from all my years in real estate sales.
An important note before we get started: I am not qualified to dispense financial advice, these opinions are my own and are not intended to replace or substitute for the professional advice you should seek from a qualified financial planner, or accountant before making any big financial decisions. With that disclaimer out of the way, let’s get started!
Should you buy an investment property?
This should always be a personal decision, and if you don’t feel excited or comfortable with that decision you should pause and consider your options first. Do your research and read lots of books before jumping in. If you are in a relationship, make sure you are both on board with any investment decision before going ahead because it can cause a lot of stress if you’re not in it together. If your partner is initially not up for it, give them time and certainly don’t pressure them into it, and realise that respecting each others differing opinions is what makes a relationship strong. It’s what makes you a good team.
Any investment comes with some inherent risk. The benefit of property investment is that you can see it, drive past it, decide who lives there, decide how to maintain it and you can improve the value of your asset reasonably quickly with the right renovation choices. As opposed to investing in shares where you have no control whatsoever and are at the whim of whatever choices those in charge think are best for the company. I also look at it as a forced savings plan as it stops me spending the money on something else stupid!
Where should you look to buy?
I like the idea of being within 10 minutes drive of any investment. It’s a good feeling to drive past your property every now and then and see the benefit of your hard work and sacrifice. You are also more likely to know that market fairly well which will help to make a good decision when buying. If you are buying in a market you don’t know (eg. Palmerston North) make sure you visit a lot of properties and look at a lot of recent sales information before making any decision. Paying too much for a good investment is ok. Paying too much for a bad investment is hard to come back from.
What kind of property makes a good investment?
It can be tempting to buy the cheapest property you can find so you can buy it sooner and proclaim: “Yay look at me, I’m an investor!!” but you may be better to save a little more and buy something a bit better. 2-3 bedroom properties, reasonably close to schools, public transport and shops usually attract the largest number of prospective tenants and that’s really the key to a good investment – not having it empty for weeks on end while you try to find a tenant.
I particularly like 2 bedroom semi-detached townhouses in this area as they are reasonably cheap to buy and very cheap to do up (the smaller the house, the easier and cheaper the renovation is). You can do a heck of a lot to a 2 bedroom property for $5 – 10k in a short space of time (perhaps a new kitset kitchen, new carpet and paint).
How much deposit will you need?
This is where the decision becomes personal. Think about your target LVR (loan to value ratio). What sort of debt level are you comfortable with? Does a mortgage level of 80% across the two properties sound scary to you? (Note: this is probably the minimum most banks will look for). You may feel more comfortable at 60 or 70%. There is no right or wrong here and it comes down to personal preference. Check out this post for more discussion on LVR’s
Will the market tank right after you buy it?
If may give you some comfort to remember that the Wellington real estate market is fairly steady. Historically we don’t have the massive increases in value that Auckland property owners have seen of late, but we don’t have big downturns either. Even when the GFC hit around 2008 prices in Wellington only dropped 5-10% at most and recovered fairly quickly. That’s not to say a big drop couldn’t come in the future, you never know what’s around the corner., However, Wellington has been a fairly steady, safe place to own property over the years.
Should you buy a doer-upper? Or a home that’s ready to move into?
Be limited by the extent of your skills and don’t bite off more than you can chew. If you are a builder, sure, go nuts. Otherwise, stick to a home that needs painting and gardening to quickly spruce it up and hire professionals for anything more serious. Taking on more than you can handle is a surefire way to add a lot of stress to the process. The most important thing is to get tenants into your investment property as soon as possible so you’re not paying two mortgages for long.
What sort of return can you expect? (eg. weekly rent vs purchase price)
If you can buy a property with a 6% return or more in our area you are doing very well. Note: A home bought for $385k returning $450 in rent per week would provide a 6% return ($450 x 52 / 385,000). Every now and then I get phone calls from budding investors “wanting a property with at least a 10% return”. They sound so excited and often I can’t quite bring myself to tell them they are smoking in the shower and will be looking for a heck of a long time.
Do your sums and work out whether you could afford to keep the property if interest rates go up to 8 or 9% (only a few years ago people were happily fixing for 3-5 years at 9% with floating rates at 10 – 11%). The best way to improve your return quickly is to buy a property that needs cosmetic improvement.
Aren’t you better paying off our own mortgage first?
For risk-averse people, this could be the best option. The argument is paying off your 6% mortgage is the equivalent of earning 9% on any money invested elsewhere (eg, shares etc) because you have to pay tax on any money you generate from said investment. A 9% return on your money is pretty fantastic so the argument could be made that you are best placed focusing strictly on paying off your mortgage first.
The other side of the coin is that if the market does increase then owning 2 properties is a lot better than owning one. If the market goes up 10% in a year, 1 property worth $450k goes up in value $45k. 2 properties worth a total of $750k go up in value $75k. The more property you own, the more you benefit if and when the market goes up. For this strategy to work it is really important that you try to find an investment property that can largely pay for itself (where the rent at least covers the interest portion of the mortgage). This way you can still focus on paying down the mortgage on your own home as quickly as possible.
I hope this info helps. If you are interested in buying your first investment property be sure to join me in becoming a member of our local Property Investors Association which is a wonderful source of knowledge and advice.
Note: You don’t need to own an investment property yet to join.