Buyer's Agent Brief - first investment property

Taking the plunge into property investment can be a daunting proposition for those who haven't done it before.

The myriad of factors that go into choosing an investment property can often be overwhelming, and many prospective buyers can be left with information overload.

This month's Buyer's Agent Brief aims to take the mystery out of the equation, and provide a window into how one can take those crucial first steps along the pathway to financial freedom. 

Our hypothetical scenario:

Sydney-based panel beater Tony has recently had some success in trading cryptocurrency and is considering shifting his earnings into a bricks and mortar investment. However, Tony is slightly hesitant to move into property as he would like to avoid any unexpected expenses he may accrue by managing a rental.  

Tony pays around $1,400 per month for his home in Seven Hills that he purchased in 2012 and has no other major debt commitments. He has the equivalent of $85,000 in his cryptocurrency portfolio and is willing to use $70,000 of that as his deposit, while his annual salary from his job is $83,000. Tony has obtained a pre-approval to borrow $480,000 and wants a cash-flow positive investment.  

What are the best options to ensure Tony’s rental property won’t leave him out of pocket? 

The good news for Tony is that properties at the price points of below $500,000 generally have better cash flow than their more expensive counterparts. 

The first thing I would advise Tony is to seek advice from an accountant to determine which structure he needs to set up for this purchase. His home in Seven Hills is likely to be in his personal name, however, with his first investment he may need to consider whether purchasing in a trust is right for him. 

He needs to weigh up the asset protection of a trust against the changed tax implications and whether he needs a discretionary trust set up for his family. His accountant will discuss with him whether asset protection is a top priority in his line of work as a panel beater.

Although Tony has his pre-approval in place he will need to sell the equivalent of $70,000 in crypto to raise his deposit before he can start sourcing properties.

The numbers for Tony’s property’s purchase will look like the following. He will need to purchase at 90 per cent LVR so assuming a $400,000 property purchase this will be a $40,000 deposit. 

Tony will need to allow $16,000 for stamp duty and $3,000 to cover legals and incidentals such as building and pest inspections. This takes the total funds required to be $59,000, leaving him $11,000 in buffer for any small repairs or upgrades that need to be done. Although Tony’s pre-approval is for $480,000 my recommendation would be to limit the purchase price to $400,000 because of his available deposit of $70,000. This is assuming Tony is employed as a panel beater. If he is self employed it will be harder for him to get a loan at 90 per cent LVR and he may need a larger deposit as most banks only lend 80 per cent to sole traders.

The key to Tony’s purchase is to buy a property which is slightly positively geared or even better, cash flow positive (before tax) so it won’t leave him out of pocket.

While cash flow is important for this scenario, growth is also important. We will be targeting specific regional areas, which have good growth drivers with decent rental yields.

It is important that Tony has a cash flow positive property as he is already paying $1,400 per month from his salary on his home in Seven Hills and needs to be able to mitigate cash flow risks.

For Tony’s purchase I would be advocating Armidale in North Western NSW which has seen an average of 5.86 per cent growth in houses over the past 12 months and this is trending upwards. The average rental yield is 5 per cent and median house price of $375,000, meaning we should be able to get something well under Tony’s budget.  The key is to buy under the median in a suburb. 

Buying well below Tony’s pre approved budget along with having good cash flow, will help him with his serviceability for his next property, when he is ready to enter the market again. It is important that Tony does not get maxed out otherwise he won’t be able to buy further investment properties.

Armidale has the University of New England and the hospital recently had an $81 million upgrade. Armidale is a testing ground for the NBN network and is also one of the NSW Government’s ‘Evocities’.

There is a shortage of rental properties in Armidale at the moment and rental prices are increasing so this will help ensure Tony has a property, which will be easily tenanted and will not cost him any money. For Tony’s scenario we are looking at below a 2 per cent vacancy rate.

I would also advise Tony to be on an interest only loan to ensure his property is cash flow positive and he may need to refinance it at the end of the interest free period to ensure he can extend the interest free terms.

We have some great news for Tony! He is in a position to not only buy one sole sufficient property, but rather multiple in succession. 

The basic rule of thumb in today’s financing climate is that the banks will lend Tony approximately 6 times his income. With no bad debt agains Tony’s name, lending circa $500,000 should not be a problem.

By targeting high growth, low vacancy rate regional markets with strongly yielding assets, buying a property which generates $540 per week from a $450,000 purchase price with a gross return of 6.3 per cent yield would return approximately $12,233 per year.

Assuming Tony took out an interest only 30 year loan at 3.5 per cent. On a 10 per cent deposit, LMI, solicitors fees and stamp duty, Tony would be able to secure this property for $69,250. Tony’s new serviceability from the addition of his new 2.75 per cent net yield increases his serviceability.

Now, we haven’t spoken about the home which he owns yet. In 2012 when Tony purchased the house, the median price was $397,300.

Some 11 years later, the median has risen to $832,400. Without considering any repayments that Tony might have made, he has a potential available equity position of $407,800.

While he starts his first purchase from his crypto success, he would be able to begin the refinancing of his home to jump straight back into the market with investment property number 2, 3, 4 and 5.

With Tony’s new increased serviceability and sizeable chunk of change from his refinanced property, considering he purchases properties of similar yielding profiles or higher, Tony would be able to buy, buy and buy again, eventually replacing his $83,000 salary with income generated from his tenants.