When it comes to investing in property, there are a number of very costly mistakes that are made time and time again by first time investors. If you’re thinking about buying your first investment property, then make sure you don’t fall into these traps.
1. Not buying property in the right structures
If you’re thinking about buying an investment property, make sure you begin the process by having a meeting with your accountant to discuss your intentions, create a wealth management plan and establish the appropriate structures and entities to purchase your investment for tax planning and asset protection purposes. If you haven’t established the correct structures before signing your contracts and sign them on behalf of the correct entity, it becomes very costly to transfer the property. In most cases, you will need to pay stamp duty again.
By speaking with your accountant first, you can work together to choose the right type of properties to acquire and ensure that you purchase them in the appropriate structure for your needs, whether it is a company/trust structure or in your own names.
2. Not doing the appropriate due diligence before purchasing.
The novelty and excitement of purchasing a new property and becoming a “property investor” can quite often cloud the judgement of first time investors, causing them to overlook the business side of property investing and purchase a dud property.
Due diligence for a seasoned property investor includes:
- Performing soil tests on vacant land, to ensure that there are no nasty surprises in terms of contaminated soil or poor soil strength that will result in additional footing costs during construction.
- Appropriate building and pest inspections to ensure that the property that you are purchasing is structurally sound and safe for tenants to live in.
- “Running the numbers” and making sure that the property is suitable for the portfolio that you are trying to build, whether that is negatively geared with capital growth or positive cashflow.
- Researching and understanding the local property market in the area you are buying, to become a local property market expert and understand the sale prices of homes and vacant land (if appropriate), as well as typical rental incomes.
- Carefully doing price comparable research to ensure that you don’t overpay for the property.
You can speak with other investors or your real estate agent to get contacts for companies that can perform those tests for you and guidance about what else you should be checking before purchasing a property in the particular area.
3. Letting emotion sway your choice of investment
A very large number of first time property investors will choose to purchase an investment property that is located within 5 kms of their own home. The rationale behind this decision is usually along the lines of “We know it’s a good area to live in” or words to that effect.
First time investors are also more likely to purchase a property that they would feel comfortable living in themselves, rather than looking at it from an objective viewpoint as someone who is looking to purchase an investment.
In order to consider a property objectively, the following are factors that should be taken into account:
- What gearing am I targeting – positive/negative? Does this property suit that?
- What is the expected weekly rental income for a property of this nature in this area?
Also, if it’s currently tenanted, what’s the current rental income?
- What improvements can I make to increase the capital value and rental income of the property? Think along the lines of renovations, extensions, subdivisions, etc.
- How much are comparable homes in this suburb or neighbouring suburbs selling for? Is this property a good deal?
- How close is the property to key facilities such as shopping centres, transport, hospitals, etc. What are the expected outgoings for the property – ie council rates, water rates, strata management fees, etc.
Remaining objective when looking at potential investment properties for your portfolio is really important to make sure that you don’t end up paying too much or purchasing a “dud”. Using an agent can really help you here, by removing you from the search and selection process of buying an investment property. It’s important to remember that you’re buying something to assist your wealth creation and possibly provide an additional income stream, rather than looking for something that you’d personally like to live in one day.
This leads into the next of our 5 common mistakes, which is…
4. Not being willing to walk away from a property deal
When it comes to buying an investment property, first time investors are a lot less likely to want to walk away from a deal. Instead, they tend to become attached to the deal and are willing to pay a premium, in much the same way that many people looking to buy their own home are, in order to ensure they secure the deal.
As a result, they are likely to continue trying to raise their offer to make the deal happen when they should instead choose to walk away and find a more suitable deal for their portfolio. When you’re looking for an investment, always “run the numbers” – and be willing to walk away from the deal if you can’t make it stack up.
5. Not performing appropriate financial modelling for the deal
When purchasing an investment property, many first time investors don’t take the time to correctly perform financial analysis on the deal and check that their chosen property is right for their portfolio. Instead, they get swept up in the excitement of “becoming a property investor” and pick the first property that they see their own suburb or a neighbouring suburb that includes the words “Suits investor” in the ad.
Appropriate financial modelling allows astute investors to predict the expected outcome of owning a property or undertaking a development project. Financial modelling can include:
- Budgeting the costs of a development project (buying vacant land and building) against the expected income from the sale or rent of the completed dwelling.
- Budgeting the expected rental income vs all expenses (interest, insurance, council rates, water rates, management fees, etc), including factoring in possible vacancies in the property and unexpected expenses such as repairs and maintenance.
- Determining the Return on Investment (ROI) and Return on Cash (ROC) for the property, so that it can be compared against other asset classes.
- Making an informed calculation of the expected market value of the finished property after construction/renovation based on current listings and comparable sales for properties in the area over the last 6 months.
While this is a list of 5 common mistakes that are made by first time property investors, I’d like to take this concept one step further. Please leave a comment below with the biggest mistake you made when you were beginning your property investing journey.
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