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How To Buy An Investment Property - Articles

Should I Buy an Investment Property or PPoR First?

Date: 20/02/2015

In a recent article, “Who’s Been Buying Australian Real Estate?,” I mentioned a growing trend of first homebuyers opting to purchase an investment property, rather than buying a principal place of residence (PPoR).

National Australia BankAccording to the most recent residential property report out by National Australia Bank (NAB), nearly one out of 10 property sales last quarter went to first homebuyers purchasing for investment.

After factoring in those who bought a PPoR, it appears that about one third of first-timers are opting to buy an investment property, rather than a personal residence.

This is really not much of a surprise in light of housing unaffordability in and around capital cities. Sydney prices are now 10 times the median income, and in Melbourne the multiple is 8.7 to one. With prices in some parts of Australia as low as three to four times income, many first-timers seem to be opting to rent where they want to live, and buy where yields are higher. In light of the RBA’s recent rate cut, it’s unlikely that we’ll see a slowdown in this trend anytime soon.

So, which option is best for you? Here are four important questions to consider if you’re trying to decide whether to live in your first home or rent it out. If you can answer yes to all four of these questions, then buying an investment property may end up being your wiser choice.

1. Are You Willing To Forego Immediate Gratification For The Sake Of A Long-Term Reward?

 Immediate Gratification In the late 1960’s and early 1970’s, a psychologist at Stanford University conducted a series of experiments on delayed gratification. Small children were offered a choice between a small reward immediately, often a marshmallow or cookie, or two small rewards after a fifteen-minute wait.

The researchers found that the children who were able to hold out for the greater reward tended to experience a higher level of success later in life.

The consistent willingness to forego immediate gratification is one of the most important character traits of wealth creation. The ability to say no to yourself empowers you to spend less, save more, and invest wisely for the attainment of your financial goals.

Choosing to rent rather than buy requires sacrifice. Sometimes, landlords are inflexible and can be a pain to deal with. For instance, you can’t always decorate how you prefer, or hang artwork on the wall without permission. Making improvements is a waste of money, because you receive only a short-term benefit. It’s even more challenging to find a place to rent when you have pets. And those small ovens and stovetops can be a real pain in the backside.

Of course, none of those things matter if you have a compelling wealth creation vision empowering you to forego your immediate desires.

2. Is It Impossible, Based On Your Current Income, To Save Enough Money In The Next Few Years To Buy Where You Live?

Save Enough MoneyAs property values have risen dramatically in capital cities, so have the required deposits for first homebuyers. This is your greatest barrier of entry when you’re buying your first home. You’re competing against people who already have a house and who have benefitted from many years of strong growth.

If you’ve got $50,000 in the bank and work in a capital city, you might find it challenging to buy a PPoR. Of course, you might be able to get a low-deposit loan and cop the lenders mortgage insurance, but that will cost you.

An alternative would be to buy an investment property in a regional area where prices are still relatively low and yields are higher. Even though some regional areas have experienced eight to nine percent capital growth over the past year, it’s not unrealistic to still find homes in the $200,000s.

3. Would Buying A PPoR Compromise Your Borrowing Ability?

Borrowing AbilityUnless you have a high income, if you buy your PPoR first, there will be a negative impact to your borrowing power. Therefore, delaying the indulgence of home ownership may help you build wealth at a faster pace.

Your loan serviceability is the measurement of your ability to make repayments on a home loan. Because the bank is taking on risk by loaning you money, they calculate and minimize that risk by ensuring you’re a safe bet. They look at your income, your life and your family expenses.

They also look at your current debt levels and your ability to keep paying them after future interest rates rise. Buying a PPoR means greater debt and higher expenses, which means when you go back for an investment loan, they might say, “tough luck.”

Check with a mortgage broker or your bank to determine your borrowing power based on your financial situation. If buying a PPoR would compromise your ability to achieve your wealth creation goals through property, perhaps you should wait.

4. Do You Have A Vision For Property Investing Beyond “Buy, Hold And Hope?”

When I wrote last week about the finer points of NAB’s quarterly residential property report, I mentioned my concern that the primary drivers for first homebuyer investment is a combination of euphoric speculation and the fear of being left behind.

If you’ve been through our Property Apprenticeship course, or heard Steve McKnight speak recently, you’re aware of the importance of being an outcome-driven investor, rather than a speculator. Speculators simply acquire assets and hope for profit. Outcome-driven investors begin with their end goal in mind, and use their investing skill and expertise to create, rather than buy their profits.

Buy, Hold And Hope

The psychology of a speculator sounds something like, “If I don’t buy now, I might miss my opportunity. I’ll be locked out of the property market forever.”

Those who fear they will be left behind if they don’t buy quickly usually make rash and unwise purchases, just to get their foot in the door of the market. They fear that property values will never cool off and that there will never be a better time to buy.

The smart money is not “buying, holding and hoping.” Unless you have a vision beyond speculation, invest in your education before you invest in real estate. Gain the knowledge and skills to assess your risks wisely and buy on fact rather than impulse. Then you’ll have the ability to make money, regardless of what the overall market is doing.

Conclusion: Invest In Yourself

I’ve coached hundreds of students in Steve’s Property Apprenticeship course. After the first few sessions, many of them say something like, “%#&$, I wish I would have done this course before buying my last property!”

Although it’s never too late, the best time to educate yourself in property is before doing your first deal. You’ll find there are some fundamental truths that can save you from a world of pain down the track.

Whether you learn from Steve or from someone else, be sure to invest in your property education. You’ll thank yourself later.

Profile photo of Jason Staggers

By Jason Staggers

Jason is a personal mentor working with Steve McKnight's Property Apprentices. He has helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom.

Comments

  1. Profile photo of MilkTruck

    I think it’s unfair to characterise a person who prefers home ownership to a child who can’t delay gratification. I think the way you live and put down roots isn’t equivalent to that. Life just insn’t a financial investment! There are lots of considerations. Besides, there can be solid financial reasons to invest in home ownership. If you add value and sell there are CGT discounts. And there is nothing stopping you accessing equity in the personal home to build a portfolio anyway. Sure, you are losing the gap between mortgage repayements (also rates etc) and the rental price. But if you buy well you can still make good financial gain even if it may not be the absolute maximum. If you just buy and hope you can be hamstrung either way you go. Just my thoughts anyway. MT

    • Profile photo of Jason Staggers

      @MilkTruck, thanks for your thoughts. The marshmellow illustration was simply to illustrate the character trait of delaying gratification and it’s connection to success. For those who determine that they can achieve their financial goal quicker by delaying the joys of home ownership, there’s a sacrifice involved when continuing to rent.

      Unless you earn a massive income, choosing to invest will generally involve some kind of delayed gratification. For most people, it means spending less and saving more. For others, it might be delaying the purchase of a PPoR.

      If you can achieve your financial goals with a PPoR, it’s definitely the preferred choice for most.

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