Financing property investment

SOURCE: NineMSN.Money.com

By Sarah Mills

Property investment - particularly the financing of property investment - is all about the numbers. People enter the business to make money and to do that well, they have to develop a plan and calculate their income, their expenses and the returns on their investment. Being able to estimate the financial position of a portfolio of properties at a glance is particularly important for the highly geared investor carrying above-average risk.

Creating a plan

An investment plan setting out cash-flow calculations and a schedule of returns over a five-year term is a powerful tool. It tells you how many properties you can afford, your margin for error and provides a clear picture for a lender to evaluate, enhancing the chances of borrowing more money. There are some excellent software packages on the market to assist with these calculations.

There are four main things you need to consider when developing a financial plan:

• The loan and your level of gearing
• The purchasing costs
• The ongoing costs
• Depreciation schedules and other tax issues

Loan

Nearly all investment properties will be bought on borrowed money given the leverage it offers the serious investor. There are a number of considerations when choosing the loan:

• Do you wish to pay interest-only or principal and interest? When it comes to financing property investment, many investors choose interest-only repayments on the majority of their properties, the reason being that interest is tax deductible. This choice will also depend on interest rates. High interest rates can be a strong incentive to repay principal.
• Loan type. Do you wish to take out a fixed-rate loan, floating/variable rate loan, a split loan (which is a combination of fixed and floating) or a line of credit? As a rule, investors only tend to lock into fixed rates if the outlook for interest rates suddenly plummets, as it reduces their flexibility and they can always switch to a fixed rate at any time. Most investors will opt for a variable rate, or, if they are adept money managers, a line of credit.
• A line-of-credit facility can be very useful in that it allows you to set up split accounts and separate your investment and personal use. It also allows you to repay debt more rapidly as every cent is put to work to reduce interest repayments.
• Equity. If you wish to borrow more than 80 percent of the value of the property, you will have to take out mortgage insurance which can be costly. The amount of equity you maintain in your properties will reflect your appetite for risk. A conservative investor will have a high level of equity and vice versa.
• Gearing. The less equity you have in a property, the more debt you will carry. Gearing is used to describe this relationship between debt and equity.
• Negative gearing. Investors can borrow enough money to guarantee that a property returns a loss each week. This is called negative gearing. Investors that negative gear properties are gambling on a rise in the property market. They are prepared to trade a short-term loss for a long-term capital gain.
• Positive gearing occurs when borrowings are sufficiently conservative to allow a weekly profit/income. Positive gearing is a more conservative strategy that yields a return as well as provides an exposure to an upswing in property prices.

Once you have decided on the type of loan and the amount you wish to borrow, you will be able to estimate your borrowing costs over time and plug these into your cash-flow calculations.

Purchasing costs

The next set of figures that need to be pinned down are the purchasing costs. These are incurred when buying a property and include:

• Conveyancing and legal representation
• Surveys and inspections
• Stamp duty
• Insurance
• Registration of title
• Strata title investigations
• Proportionate council and water rates for the remainder of the rated period.
• Loan establishment fees — legal fees, mortgage registration fees and valuation fees.
• Real estate agent's commission.

Ongoing costs

These are expenses that are incurred after you purchase the property. They include:

• Interest repayments
• Body corporate fees
• Council and water rates
• Maintenance and repairs
• Bank account-keeping fees
• Property management fees (see link)
• Insurance — building and contents, public liability and landlord insurance
• Land tax
• Pest control
• Security costs
• Travel and car expenses — investors are usually entitled to one trip each year to visit a property.
• Stationery and postage
• Lease fees and advertising
• Depending on the property, ongoing costs can also include lawns and gardens, cleaning, linen and laundry

Tax

A few things to consider here include:

• Identifying all tax deductions. Basically, this involves isolating all deductions, including interest repayments, all other expenses, and capital works such as buildings and extensions, alterations and structural improvements. 
• Identifying revenue costs. These generally include ongoing costs and count as an income-tax deduction.
• Depreciation schedules. Newer properties allow greater depreciation and you can depreciate some capital works.

Financiers

One of the major keys, not just to financing property investment, but to property investment itself, is finding a good financier. As long as their rates are competitive, a good relationship with your lender can yield far more dividends than just sourcing the cheapest loan.

A lender that can understand your investment goals and plans when clearly articulated through your financial plan is invaluable. It means that:

• If you need a quick decision on a loan for a bargain property, you are more likely to get it than with a stranger.
• If your financier has a full understanding of your financial position up-front, he or she is in a better position to lend you more money than one that doesn't fully understand.
• You don't have to go through the whole loan approval process from scratch because the lender already knows you and knows your business.

A good financier can even help you with quick calculations over the phone if you are in a rush. Sometimes this kind of relationship can save you or make you tens of thousands of dollars in a very short period.

For these reasons, if you are dissatisfied with your current financier's understanding of your business, it can be well worth sourcing one that does. Recommendations from friends, family and peers can be helpful.

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