The Risks of First-time Investors and How to Structure Your Investment So You Don’t Get Caught Out
Mar 3, 2016 - By Nicholas Scott Property Investments

Substantial sums are being invested in bricks-and-mortar, and with low interest rates and good capital growth potential, many first-time investors are ready to get into the property game.

If you invest wisely, property investment can provide an excellent source of passive income and yield big returns. First-time investors must embark on this new journey fully prepared, however, and manage risks in order to succeed.

Risks of First-Time Investors

Jumping into property investment can be a scary leap, especially when there is so much information available. It’s hard to decipher which strategies are the right strategies and who you should trust.

You are going to be investing hundreds of thousands of dollars into a property you’re not living in, so you need to be vigilant. While there are many pitfalls to avoid, these are some of the most common risks first-time investors face.

  1. Flashy Sales Seminars and Overpriced Properties

While you can get a lot of excellent information from “property education” seminars, remember that they are likely sales seminars in disguise. Many properties promoted as good investments at education seminars are overpriced, and while they might look like a good deal, keep your eyes wide open. Glean from the information you learn, but don’t jump on the bandwagon simply because others are. Do your research to avoid an emotional decision.

  1. Investing for Tax Purchases

For many first-time investors, their biggest reason for investing in property is for a larger tax refund. Known as negative gearing, the reason you’re getting a larger refund is because you’re making a loss. Seasoned investors, and those who are really successful with their property investments, have a long term goal of owning properties that earn a profit.

Many first-time investors are negatively geared in how they approach property investments.

The deduction for depreciation on the building cost of property and the items within it is one of the best tax benefits of property investment. An accountant who is experienced in property investment will help you fully grasp the tax advantages of investing in property and the tax legislation.

  1. Lack of Practical Strategy and Plan

Before you select a property, you need to know what you want to achieve and what your long- term and short-term goals are. Read everything you can get your hands on, do your research, and choose the strategy and approach that fits your goals.

  1. Impatience

First-time investors risk becoming impatient if the yield or capital growth isn’t steady at first. Many also decide to sell after one bad tenant. Property is a long-term investment, so there will likely be years of ups and downs. Property isn’t a “get rich quick” scheme. The more times you go through the economic cycles, the more money you’re going to make, because, historically, property prices have doubled every seven to ten years.

  1. Renovating, Renovating, Renovating

Don’t renovate an investment property with your heart, but with your head. Don’t over-invest in top-of-the-line fittings and trendy floor plan designs if the profitability just isn’t there, and make sure you know how the renovation will affect your bottom line before you get started.

  1. Ignoring Insurance

Landlord insurance covers accidental damage, malicious damage, legal liability, and rental default. It’s also tax deductible and, in the long run, could save you a great deal of headache and financial loss. Don’t fall into the trap that just because you have a property manager, you don’t need landlord insurance. Again, research is key!

Now that we’ve discussed some of the risks first-time investors face, let’s have a look at the ways you can structure a property investment and some tips to help you succeed.

How to Structure Your Investment

Buying an investment property should be about securing your financial future and increasing your wealth. In order to avoid common pitfalls and get yourself on the trajectory towards property investment success, you’ll have to structure your investment carefully.

You can structure your property investment in a few different ways: through a corporate structure, as part of a partnership, through a discretionary trust, or as a sole trader.

The most common reason investors use a company to hold their investment properties is because it provides limited liability to the shareholders of the company, meaning the extent to which you’d be liable for debts is to the amount you’ve invested as capital. In addition, company creditors can’t access your individual shareholder assets.

Also, once your investment is positively geared, you’ll pay tax at the corporate rate, which is significantly lower than the top rate for individuals or trusts.

A downside to using a corporate structure to hold your investments is that it will be challenging for you to tax advantage of the tax benefits of a loss. Investing as an individual with a negative gearing property investment is very attractive, because you can take advantage of the loss relief and capital gains tax relief. Companies can’t take advantage of the 50% capital gains discount that individuals can, which means you may owe more taxes if or when you sell the property.

At the end of the day, you’ll have to research the advantages and disadvantages of each structure to ensure you don’t end up in a bad financial situation you’re unprepared for.

The Right Property at the Right Price

When you’re investing in real estate, you’re looking for properties with substantial capital growth potential. You’ll have to put in the time doing your research in order to find the right property at the right price. As you research, you’ll soon become familiar with what’s a great deal and what isn’t. Don’t buy property in an area you’re unfamiliar with until you’ve taken the time to get familiar with the area.

Property due diligence and suburb due diligence will ensure that you start your property transaction well informed.

Do Your Sums and Manage Cash Flow

You don’t want to get caught up in a situation where you have to sell your investment property before you’re ready, so managing cash flow is incredibly important.

You’ll need to take into account: stamp duty and other costs, interest cost (if borrowing), rates, land tax, insurance, property management fees (if applicable), and capital gains tax. It’s important to add into your calculations the taxes involved in property investing, so you know the real term impact.

Also, remember that banks only look at 80% of rental income to take into account vacancy rates and letting fees when determining if you can afford an investment loan.

Knowing the risks and doing your due diligence will help you pave the way to property investment success. If you have questions about investment property or would like to speak to a qualified property investment professional, contact us.

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