Five questions you must ask before buying an investment property

Choosing to build wealth through residential real estate requires a significant investment.

And I’m not just talking about money, but the commitment of time and emotional energy that’s required as well.

In the beginning you’ll need to work hard to support the costs associated with property ownership, so it’s understandable that many people suffer buyer’s remorse after making such a monumental purchase.

Suddenly, that decision you were so confident about, starts to seem a little questionable.

Maybe you over-capitalised? What if the area is second rate? Have you bought a dud?

While it’s difficult to entirely rid yourself of niggling self-doubts, going into your property transaction with your eyes wide open will give you more confidence and alleviate a few fears.

With that in mind, here are five questions you should answer honestly before making your next property purchase.

1. What happens if the market falls?

There’s an old real estate cliché that says to, “buy in the gloom and sell in the boom”.

But we’ve been enjoying a more buoyant phase of the real estate cycle across most major city markets and inevitably a correction will occur in the future.

So is now the right time to buy?

Rather than trying to time the property cycles I believe investors should buy when there finances allow them.

Remember there is not just one property market in Australia.

Each state is at its own stage of the property cycle and within each state are multiple markets – some defined by price, others by geography and yet others by the type of property.

There will always be good investment opportunities it you do your research and look for them.

But property values don’t go up in a straight line.

In any 10-year period, there are likely to be a number of years of strong growth, a few boom years of exceptional growth and two or three years of flat markets, poor growth or even falling property values.

However, if you buy the right type of property in one of our four big capital cities, while the value of your property may correct a little, it’s unlikely the value of your property will crash.

Understanding how the market works means you must get into property with long term plans and be prepared to sit it out for at least two or three cycles to make the most of your investment.

2. What if interest rates head north?

Sure interest rates are low at present but in due course they will move up, as they have every other cycle.

And when they do some property investors will get caught out not being able to keep up the negative shortfall on their mortgage payments.

To avoid becoming a statistic, do some financial modeling around inevitable future rate rises and assess your capacity to service your loan based on “worse case scenario” outcomes.

If things look like they may be tight, perhaps you need to take a bit more time to save a bigger deposit or build further equity in any existing properties.

Today’s low interest rates may be enticing but you’re in this for the long haul so you have to be able to see it through when rates go up, down and sideways.

Of course you can always lock in your interest rates using a fixed rate loan to give you a level of certainty for the next three to five years.

3. What if my employment circumstances change?

Life is unpredictable. The best plans can be waylaid by something out of our control that causes a dramatic change in personal circumstances, such as losing your steady source of income.

It might be confronting to consider the possibility but it’s critical that you work out whether you could still afford to keep your property in the face of unemployment or a lower paid position.

Some ways to protect yourself include having a sufficient rainy day back-up in the form of a cash flow buffer (maybe an offset account or line of credit) as well as things such as income protection and life insurance.

4. Will the rental income cover my repayments?

The simple answer is probably not. Not even in today’s low interest rate environment if, like many investors, you borrow 80% or so of the value of your property.

So it’s important to understand your household income cash surplus or how much you can can afford to subsidise your negative gearing in the first few years of your property journey.

Alternatively, borrow more than you need and have a cash flow buffer to help subsidise your negative gearing shortfall

5. What’s the current market price?

A lot of people get carried away with the idea that unless they pay below market value for a property, they’ve made a poor investment decision and will forever be on the back foot, trying to play catch up with their asset’s value.

That’s not necessarily the case.

In fact, I’ve often paid a little over in order to buy the “right” property, knowing it will make a first class long term investment.

You make your money when you buy not by purchasing a cheap property but by buying the “right” property.

The key is to establish a fair market price and then set your own spend limit according to personal circumstances and needs, and your overall investment strategy.

If the figures don’t add up, be prepared to walk away. There’ll always be another deal.

All of the above questions are like barometers, indicating whether you’re ready for the commitment of a property acquisition or not.

If you fail to answer them honestly in light of your situation, chances are you’ll end up with a severe case of buyer’s remorse.

Respond truthfully however, and you’ll be one step closer to making a great property purchase and meeting your wealth creation objectives.

Michael Yardney is a director of Metropole Property Strategists, which creates wealth for its clients through independent, unbiased property advice and advocacy. He is a best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Update blog.

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