Know the purpose of the properties you buy: Cameron McEvoy

Often when I write about property investment I am quick to put forward the idea that a home purchase and an investment property purchase are two very different types of ‘buy’.

I traditionally believe that one of the best strategies is to purchase residential property for one dedicated purpose – either as investment or a home to occupy – and then never splice the two.

The truth is, I have not exactly practiced what I preached.

See, I made my start in property investment in the same way as many others have done; purchasing a property as a home, and then building equity in that property to put down as a deposit on an investment property purchase.

Since then, however, I have moved out of that first home and turned it into an investment property itself.

The key thing to note, however, is that when purchasing that first home – a very modest unit in Sydney’s west – I had purchased knowing 100% what the future use for this property would be; i.e. an investment property. It was never my ‘dream home’ and in truth, it was never planned that way.

What I am getting at is this idea of the purpose of use for a residential property.

Home buyers are very different to investment buyers; each type buying very different types of properties – even if those exist in the same street!

In an ideal world, most investors would have already purchased a home that remains a home, for the entirety of the ownership of that property, and would merely use the equity that builds up in the home to fund future properties.

However, this only works for those among us who have a personal life that is perfectly planned for the future. Not many of us have that.

Additionally, personal circumstances can and do change. Unexpected elements such as moving to another country for work, or starting a family earlier than planned, or needing to move interstate in the future for other reasons; these can mean that the home you purchased in suburb X, with the intention of living in it for the next twenty years, could become an investment property due to personal life elements changing your ‘grand plan’.

Or, you may simply want to get on the investment property ladder, but at the same time, need somewhere to live for a few years whilst saving, and park your money in.

Whatever the reason, I thought today I would create a list of factors to consider if your strategy is to purchase a property that you will call ‘home’ for a few years, and then become an investment property thereafter.

Location, location, location!

‘Yes’, I hear you say, ‘Isn’t location always a factor when buying either type of property?’. Of course, it is; however the definition of a ‘prime’ location differs for homes and investment properties.

Home buyers will look at locations in great school catchment areas; close to shopping amenities, and close to transport for commuting to work. But, so will investors. The difference comes from the other elements. Prestige, for example, is a differentiator.

Home buyers will carefully track the street itself, comparing property types on that street, recent sales, and the ratio of renters-to-owners on that street.

Investors, however, will be looking at properties from the ‘business end’. In other words, if the key drivers such as transport, education, shopping, and work proximity are all promising, the prestige of the street will not be as important as the yield they can earn in that street.

So, home buyers should focus less on the affluence of the street of their short-term home, and more on making sure the numbers add up.

What would your potential home earn per week in rent? What are others in the street of a similar type renting for?

The right property type for that suburb/neighbourhood

Traditional home buyers can (and do) buy the property that suits their lifestyle needs, in an area that they want to live in. Makes sense.

The problem with this tactic for investors, though, is that a property that works well as a home for you, may not work as an investment property, for the demographic of that area.

For example, let’s say you are looking for a home and  interested in a particularly ‘pleasant’ street in a suburb. The street is lined with modest older small 2-3 bedroom, single-level houses, with no pools, low maintenance gardens etc.  Yet within that street is a two story modern mansion; 5 bedrooms, 3-car garage, pool, deck, etc.

As a long term home buyer, it can be a great move to take the best house on the street.

If you need all that space for instance, and really like the area, then it works. However, this is clearly not a good strategy if the home is only a short-term one, before becoming an investment property.

Whilst you will most likely find a renter for that house, the rental return you’ll get for that property may only be slightly higher than most others on the street, yet the amount of mortgage you’ll need to pay off will be exponentially greater.

This means that unless your strategy is to turn your home into a highly negatively geared investment property (which few investors these days actually want to do), it would be a poor investment.

Instead, look to buy a problem that is acceptably habitable for a home for a while, but is in-line with the demand renters have for the area.

Additionally, overcapitalising on a 3-bedroom house in an area that is mostly studio apartments and small one-bedroom units could be a mistake.

No bells and whistles (apartments/units)

Similarly to the above, your dream home may have that $50K granite, steel, and glass kitchen, but as an investment, such a kitchen in most areas is a bad idea.

It is this kind of logic that most investors employ. Think about it; if you compare the penetration of investment properties to owner-occupied homes in well-to-do areas such as Toorak VIC, Peppermint Grove WA, and Vaucluse NSW, with other more modest areas in those cities, you’ll note that there are far less people renting in those areas.

Why? These residential properties typically make for very poor investments.

The above is an extreme example, but on a more modest scale, and especially for first home buyers looking to flip their property to ‘investment’ down the track, look for properties with no bells and whistles.

You may even go one step further to buy a run down or ‘TLC’ property, live in it whilst doing renovations over a couple of years, and then move out to rent it for a higher rate.

Even in these instances, do not over-capitalise on renovations. Opt for neutral themed colours, and durability over delicacy.

Go for tough basic white tiled bathrooms instead of Italian marble etc. Where possible, consider tough/durable wear and tear carpeting instead of plush European fabrics.

Paint neutral colours that are light and bright, and use high-durability paint.

No bells and whistles (houses)

In regional areas and outer fringe suburbs of metropolitan cities, many investors opt for houses over units.

First-home buyers do too; and if you’re to flip yours to investment in a few years, the most obvious point to make here is to seek low maintenance houses.

Yards are critical here; if the back and front yard is large, make sure they are easy to mow lawns, little to sparse shrubbery, and few trees.

Try to avoid houses with tall trees lining the border fences; these can cause problems down the track with neighbours (roots uplifting fences, branches and leaves falling on neighbour properties).

If you are set on a house that does have small-mid sizes trees near fencing, research them. Find out their species and see how big they will grow.

If you are living in the house a few years; it may be worth investing in a tree relocation. This is where you move a small-medium tree (that you know will grow large and provide good shade) from the fence corners, into the middle of the yard.

This can be expensive but worth it; as it grows it’ll supply shade from family tenants’ children to play in the yard, adding appeal to the rental market. The roots won’t cause problems for neighbours either.

Personally I am do not favour investment houses that have swimming pools and high-maintenance wooden back decks, though I know some investors who have added value and argue that in the right areas, these can be profitable and low-maintenance in terms of rental return. Proceed with caution there.

The ‘last’ point – finance first!

Finally, and taking things back to a due-diligence point before purchase, talk to your lender or broker about the future use of the property to ensure you have the best loan type and structure for this property.

This is the most important part of it all. You’ll need a lender that can be flexible enough to accommodate both worlds.

For example, a 30-year mortgage with offset facility from day #1; but exists as a principal-and-interest loan for the first five years, then matures to an interest-only loan from years #6 to #30.

This would allow the flexibility of chipping away at the capital for a few years, then switching to interest-only when you move out a few years later, with the offset facility enabling you to ‘park’ money against that property once you’ve moved out of it, which will help bring the property from negative-geared to neutrally-geared (if desired).

Alternatively, and if you are dedicated to growing a larger property portfolio, it’d be best to set up the loan from the outset as interest-only, with offset facility from day #1 onwards.

Another important finance note is to consider how this property will ‘sit’ in your investment portfolio, over time.

Will it remain your most expensive property? Will you only acquire additional cheaper properties; or in fact will every purchase after this one, be a more expensive property?

How you answer these questions could help determine your ‘exit’ strategy, later in life.

Knowing that tax-wise, you can only nominate one property at a time to be your ‘home’. If this is to be your most expensive property purchase, you’ll want to nominate this property as being your ‘home’ at time of sale, avoiding the payment of capital gains tax.

You may also want to investigate how a strategy such as (as I like to call it) the ‘golden six year rule’ could work for you, throughout a 20-30 year holding period, for this property.