Two Basic Rules For Choosing the Right Investment Property

I think property investment is the best way to build wealth. It's the best and safest way to get seriously rich, but it does take time.

For all those readers who have already decided to buy an investment property, this article is a taste of what's to come. These two rules will help ensure you get the maximum return from your property investment.

1. Know why you are buying

Before you buy an investment property you have to know why you're buying.You must be clear about what investment strategy you are going to use so you can buy an appropriate property. Are you buying a property to renovate and sell for a quick profit or do you want to hold onto it for the long term?

Are you investing to build your wealth, improve your cash flow or build equity and reduce tax at the same time? What's your focus? Two popular property investment strategies for everyday Australians are capital growth and cash flow. Capital growth property investment is a long term strategy for building wealth. Over time your property increases in value and thus your net worth increases. The goal is to buy property that increases in value as quickly as possible.

Typically high capital growth investment property when highly leveraged is negatively geared. This means that after deducting the interest on the loan used to buy the property and the running costs from the rent received, the property actually makes a small loss.

The tax office then allows you to deduct this loss against your other income to reduce your tax bill. You've got the rent coming in, you get some tax breaks, but you still need to put in some cash out of your own pocket.

On the other hand, cash flow investment property actually puts some cash in your pocket. The rent you receive covers the interest payments on the mortgage and running costs, leaving you with a small cash surplus.The goal is to find properties that can be rented for more than their overheads. Typically these properties will be on the fringe of densely populated areas, in rural or regional areas where the capital growth for property is much lower than in capital cities.

The trade-off between capital growth and cash flow property investment is between capital growth and income. If you buy a capital growth investment property depending on your equity or gearing level you may have to put some of your own money in. However, provided you've purchased in the right location you will receive a superior return on your capital growth.

With a cash flow property you are getting some money in your pocket every week, but sacrificing part or all of the capital growth in the long term. Choosing the best strategy depends on your circumstances and your goals. If you have some money to spare or could benefit from some forced saving, and long-term wealth creation is your plan, then high capital growth property could be best for you. If you don't want to put any of your money up and/or your goal is passive income now, then you may want to go or cash flow investment property.

You might be wondering if it's possible to get both capital growth and cash flow from the same investment property. Yes it is possible, but you usually don't get a great result either way. You end up with modest cash flow and modest capital gain. I think it's better to choose one strategy for each investment and go for either maximum capital growth or maximum cash flow. There is no reason why you can't get a couple of each property type over time if that is appropriate for your situation and long term goals.

2. Choose the right area

Once you've decided which property investment strategy suits your needs and aspirations, you must choose the right area to meet your investment goals. Just like buying your home, I suggest you pick one area and focus on it. Physically inspect 100 properties in that area so you'll know what properties are worth.

If I want to buy a capital growth property I'll always be looking for an area that has potential for above average growth in the future. I'm interested in what's been happening over the past five years, but I'm more interested in what's going to happen in the next 10.

Look for areas that haven't done much for a while, but are primed for capital growth due to upcoming redevelopment or increases in demand due to changing lifestyles and demographics.

This type of investing takes a bit of foresight, commitment and planning. To find up-and-coming areas like this visit local councils and do some research. Find out what's up and coming in the area? What's good about it? What's bad about it? Drive around and check out which are the good streets and the not so good streets. Talk to the locals.

With a cash flow property investment your first consideration is whether the numbers stack up. You need to find a location where rental yields (the net income of the property divided by the sale price) are high and prices are low.

The second consideration is rental demand in the area. You need a good supply of renters to make your investment work. While the same is true of capital cities, rental demand in country areas can be more fickle due to local economic conditions.

If you're going to buy positive cash flow property in the country the town should have a population of 25,000 or more and more than one industry. (Some lenders won't give you a mortgage if the town has less than 25,000 people living there permanently.)

Imagine you've bought a cash flow property investment in a town where the main industry is mining. What happens if the mine closes down? Suddenly there's a whole stack of people out of work and the town's economy can go down the tube. If your tenant can't pay their rent, what do you do? It's not like you can kick them out and get someone else in, because everyone else is suffering too.