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October 20, 2010

New investors – be prepared for the costs of investing in property


Before you sign the contract for your first investment property, make sure you’re going in with your eyes open.

BY DAMIAN SMITH

I recently read a report by Datamonitor which found that out of a large survey sample, eight per cent are intending to purchase an investment property in the next 12 months. While this sounds low, it’s actually an increase on the prior 12 months. According to the same source, there were only five per cent who intended to invest in property last year.

The fifth consecutive month of no change to the Reserve Bank’s official cash rate (at 4.5 per cent) certainly explains some of the likely growth, by easing concerns of a dramatic rise to interest rates. We’ve actually seen a fall in fixed rate home loans – for example the benchmark three-year fixed rate, which is the average of the major four banks, has dropped by 33 basis points since May to the current rate of 7.45 per cent.

Along with limited supply underpinning good rental prospects, and ongoing economic growth, these indicators point towards an attractive market for budding investors. But this is also a market that’s likely to attract many who are new to the investment market, and they need to be prepared with realistic expectations of how much it’s likely to cost.

For example, the national average mortgage size is $289,300, according to the Australian Bureau of Statistics. Using the average variable comparison rate for this loan size of 7.09 per cent (from RateCity’s database of more than 100 lenders), mortgage repayments would be about $2061 per month.

Let’s say that rent covers about $1520 per month, so on day one you’re going to need to find $541 per month. And of course this is just repayments – it doesn’t include other costs that you’re likely to incur such as stamp duty, maintenance of the property and other fees and charges from your lender such as lenders mortgage insurance.

Property insurance (such as landlord’s insurance) is another cost that you should take into account. And don’t forget the money you’ll need in case your property is untenanted for a period of time.

Of course, negative gearing (where possible) gives you some handy tax breaks against many of these expenses, but that doesn’t cover the cash flow issues on day one. While residential properties have tended to be an attractive investment over the years, new investors should go in with their eyes open, and be aware of upfront and monthly costs that they’ll need to cover before seeing any return or tax benefit.

And of course, make sure you do your research and shop for the best home loan deal available.

Damian Smith is CEO at financial comparison website RateCity (www.ratecity.com.au). He’s one of Australia’s most experienced internet and technology executives, with leadership roles in Australia, the US, Japan and the UK for over 13 years. Damian holds a Masters Degree in Public Policy from Harvard University.

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