To buy your first investment property, you will need a deposit of about 20%. It definitely helps if you have equity in your home already. If you don’t have say 50% equity already, then maybe you should save as much as you can to come up with the deposit. How much equity or deposit do you need? I would suggest your first investment property should not be too costly, maybe a one bedroom apartment in an average suburb within 10 km of a capital city. So check out the property websites and see what’s available. Work out 20% of the asking price and add about $10,000 to $15,000 for stamp duty and legal fees. That gives you the amount you need to get started.
Let’s talk about equity.
Equity is the difference between what your property is worth and how much you owe on it. For instance, if your house is worth $400,000 and you owe $200,000 then you would have $200,000 or 50% equity. This calculation is known as Loan to Value Ratio (LVR) and is an important formula for property investors. It is one of the main factors banks use to decide if they will loan you money. If your LVR is too high, banks see you as a riskier investment and may not finance you. If it is too low, you really are not using your equity to your advantage. I like to keep LVR to about 50%, but starting out, 75% is ok. Anything over 80% I feel is getting too risky and not for the lazy investor.
Serviceability.
This is the term used to determine how easy it is for you to afford your property. If banks don’t think you can service the loan, they won’t give you the money. Banks take two things into consideration.
1 What is your current income?
Banks will allow around 35% of your income toward property repayments
2 What is the rental return of the property?
Banks will allow around 70% of the rental return to be taken into consideration.
Example: - Your income $75,000 Rental return $16,000
X 35% $26,250 X 70% $11,200
Total Payments can equal $37400 PA ($26,250+$11,200)
If you borrowed at 5% then your lending capacity would be $748,000
Gearing, Positive or Negative?
Gearing is the term used to describe cashflow. Negative geared property means rental of the property does not cover its own costs. Positive geared shows a profit. Since the whole idea is to make money why would anyone consider a negative geared property? For the tax deduction. The net amount it costs to hold a property will be deducted from your assessable income giving you a tax return. In calculating the costs of holding the property, depreciation can be a major factor. 2.5% PA of the building cost over 40 years can be deducted. Unfortunately the ATO will add it back within CGT when you sell.
If at all possible, try to have your property zero geared, meaning it costs you nothing but make nothing. It may be hard to find these properties, but as you follow the plan above and years pass, rent rises on you current properties to fund your next property. The longer you hold property the easier it gets.