How to Invest in Residential Real Estate

There are more than 2.2 million property investors in Australia, according to the most recent data¹ from the Australian Taxation Office. The main reason property investment is so popular is because it’s helped many people build wealth over the years. The combination of capital growth and rental income – magnified by leverage – can produce strong long-term returns.

But real estate investing, like any form of investing, is not all upside. Buying an investment property is more difficult than acquiring shares. Also, if you choose the wrong property investment strategy, or choose the right real estate investment strategy but err with the execution, you might experience low or even negative returns.

With that in mind, here are 10 steps to follow if you want to successfully add real estate assets to your investment portfolio.

1. Establish your goals

Before you research investment properties, you should establish your wealth and life goals, so you can devise an appropriate strategy. That’s because a strategy that suits one set of goals won’t suit another.

To use an analogy, you should begin by determining where you’re going, so you can plot the most direct path to your destination. A path that leads to one destination won’t lead to another.

2. Select a real estate investing strategy

Once you know where you want to go, you need to decide how – by what path – to get there.

Your choice of strategy will influence not only the value of the property you buy, but also the type of property and the location.

For example, some properties (such as houses located in the major capital cities) tend to produce higher capital growth and lower rental yield, while other real estate assets (such as units or those located in regional areas) tend to produce lower price growth but higher rental income.

Your choice of strategy will also influence the structure in which you purchase the property, your loan-to-value ratio and the method you use to pay the deposit (whether using cash or borrowing against equity in your owner-occupied home).

3. Choose between direct investment and co-investment

As part of the strategy discussion, you’ll have to decide whether to invest directly (i.e. purchase the property on your own); co-invest with a partner, relative or friend; or co-invest through a fund such as the HOPE Fund. That final option is discussed in more detail below.

4. Assess your finances

As part of the process of establishing your goals and selecting a strategy, you should get clear on your finances. That means understanding your assets, liabilities, income and expenses – both now and in the years ahead. For example, if a member of your household was planning to leave the workforce for a couple of years to have a baby, that would affect your future income. On the other hand, if you identified ways to reduce your living costs, that would improve your expenses.

The stronger your finances, the more creditworthy you’ll be in the eyes of lenders. That will produce a triple dividend – you’ll find it easier to qualify for a loan, you’ll have a higher borrowing capacity and you’ll be more likely to be offered a lower interest rate.

5. Consider getting professional help

One of the most common pieces of advice experienced property investors give when asked how to invest in residential real estate is to consult experts. That may include:

• Financial adviser – to help you determine the right investment strategy.
• Mortgage broker – to help you find a competitive home loan and choose a suitable loan structure.
• Buyer’s agent – to help you identify a quality investment location and then acquire a quality investment property.
• Conveyancer – to help you review the contract of sale and manage the transfer of ownership.
• Property manager – to help you secure good tenants, collect the rental income and maintain the property.

While this property investment advice comes at a cost, it means you’re less likely to make expensive mistakes and more likely to make profitable decisions.

6. Research different property markets

If you appoint a buyer’s agent, they will research potential property investment locations for you, including those in different states; if you don’t, you will have to do this research yourself. In that case, you should try to form a view of each location’s demand and supply factors, for both now and the future.

Demand factors may include:

• Days on market – How long is the average property taking to sell? And are days on market trending up or down? Those two data points will help you assess the strength of local buyer demand.
• Asking prices – Are vendors raising their asking prices or lowering them? And at what rate? Those metrics will provide more insight into the state of the local market.
• Local economy – Generally, people want to live in areas of strong employment, so the more jobs a location has, the more in-demand it’s likely to be among both owners and renters. It’s also important to assess the diversity of the local economy, because if a location is dependent on one industry (such as resources) and that industry suffers a downturn (such as the local mine closing), property demand would probably suffer too.
• Crime rate – Study police statistics to find out what the local crime rate is, how it compares to other locations and whether the level of crime is trending up or down.
• Population growth – Find out how fast the population is growing in both absolute terms and compared to other locations.
• Amenities – What currently exists and what’s in the pipeline?
• Infrastructure – What currently exists and what’s in the pipeline?
• Demographics – It’s also worth researching the make-up of the current population and comparing them with the demographics of new residents, because that could affect future development. For example, if the suburb has a lot of families but many of the new residents are singles, that may change the type of housing that gets built. If the suburb has a disproportionately high number of older people but many of the newcomers are younger, that may affect the kinds of amenities that get built.
• Natural disasters – The more prone a location is to floods, bushfires and cyclones, the less long-term demand it will experience.

Supply factors may include:

• Inventory levels – This metric tells you how many months of stock are on the market, assuming properties keep selling at the same rate. When inventory levels are low, buyer demand is strong; when they’re high, it’s weak. The trend is also important, as that indicates whether buy demand is rising or falling.
• Vacancy rates – This metric tells you the share of untenanted rental properties in the local market. A low vacancy rate means the market is undersupplied; a high vacancy rate means it’s oversupplied. Again, the trend is important.
• Residential construction – How many homes are being built right now? And what type of properties are they (e.g. houses, townhouses, units)? This will give you an insight into how the local housing supply will change in the short-term.
• Building approvals – How many homes have been approved for construction? And what type? This will help you understand the medium-term outlook.

7. Conduct due diligence

It’s generally a good idea to order a building inspection and a pest inspection, so you can identify any hidden structural problems and pest infestations.

If you’re buying an investment property in a strata complex, it’s generally a good idea to order a copy of the strata report as well. That will reveal the condition of the building and common areas, the by-laws and rules of the complex, the financial position of the owners’ corporation and whether there are any ongoing legal disputes involving the residents or strata scheme.

8. Understand the risks of real estate investing

Identifying the potential risks gives you the opportunity to implement measures that will reduce the chance of those bad things occurring and minimising the impact if they do.

Potential risks and responses may include:

• Rising interest rates – Many people reduce their expenses in the lead-up to a home loan application to increase their chances of being approved. If you continue to minimise your expenses after you buy the property, you should be able to handle any rate rises.
• Job loss – You might struggle to make your mortgage repayments if you lose your job or suffer an injury that forces you to leave the workforce. You can guard against these risks by taking out mortgage protection insurance.
• Falling property prices – This would be an issue if you were forced to sell during a downturn. By protecting yourself against rising interest rates and job loss, you should also protect yourself against being a forced seller.
• Rental vacancy – Appointing an experienced property manager who understands the local property market and has a database of tenants will reduce the risk of your property being unfilled.
• Falling rental income – An experienced property manager will also reduce your risk of under pricing your property.
• Tenant problems – Taking out landlord insurance will cover you if tenants don’t pay their rent, while building insurance will cover you if they damage your property.

9. Establish and maintain buffers

It’s generally a good idea not to empty your bank account when buying an investment property. True, that gives you the chance to put down a higher deposit and purchase a more valuable asset. But it also means you don’t have a financial buffer if you experience an expensive personal emergency (such as a medical bill) or property emergency (such as a burst hot water system).

That’s why some experts recommend that you start your property investing journey with savings equivalent to at least six months of personal expenses and six months of investment expenses – and that you continuously maintain these buffers.

10. Plan next steps to maximise your real estate investments

Depending on your strategy, buying an investment property might be just one step towards achieving your goals rather than the only step you need to take.

In that case, once your purchase has been completed, you should start thinking about your next move, which might include anything from adding a granny flat to your existing property to saving up to buy more real estate assets.

Property investment with HOPE Housing

Much of the information in this blog is about direct real estate investments. But, as mentioned earlier, your strategy might actually involve co-investing through a fund, such as the HOPE Fund, which is an option for wholesale or sophisticated investors (but not retail investors).

Under HOPE’s model, investors partner with essential workers such as nurses, cleaners and first responders. Investors’ funds are invested in the full portfolio of properties within the HOPE Fund, while each essential worker is an owner-occupier who takes a stake in just one property. The essential worker takes responsibility for their share (which can be up to 50%) of the purchase funds and mortgage; the HOPE Fund contributes the rest.

This is a win-win-win outcome for essential workers, society and investors.

Essential workers (who often earn low-medium fixed salaries) benefit because it becomes easier for them to buy a good home close to their workplace, rather than a cheaper property on the city fringes.

Society benefits because these essential workers now have a reason to stay in their vital jobs, rather than switch to a higher-paying career.

To learn more about investing with HOPE, book a 30 minute call with our Investment Team.^[i]