Assess property affordability like a professional
Affordability is the single-most important consideration before purchasing any investment. Before you conduct any property research, ensure that you know how to assess affordability like a professional.
Upfront affordability
There are varying costs associated with the purchase of most assets, it’s often not just the investment of capital. For property, it’s imperative to assess purchase costs thoroughly as they can often be more expensive and more difficult to calculate than for other assets like direct shares and managed funds. The typical costs incurred when buying an investment property are:
- Conveyancing and legal fees;
- Stamp duty;
- Building inspection;
- Pest inspection;
- Bank/mortgage fees;
- Property valuation;
- Mortgage insurance;
- Buyer’s advocate; and
- Miscellaneous expenses like surveyor’s costs, if relevant.
Some costs may be added to your loan whereas other costs will need to be paid by you personally. Identify the costs to be incurred by you and what will be covered by the bank. Ensure that you hold sufficient capital (with a buffer for initial repairs and maintenance, vacancy and for unexpected upfront costs) before purchasing the asset. Don’t be short at settlement!
Ongoing affordability
You’ve assessed your position and determined that you can meet the upfront acquisition costs, fantastic! Is the property cash flow positive, neutral or negative? Do you have sufficient surplus cashflow (from other income sources) to meet any ongoing investment property expense shortfall?
This is a two-step process, the first being quite easy. How much rent will I receive? Review suburb analytics (Onthehouse is a reliable and free sources for this type of information) and/or check with a trusted property manager in the area.
The second part of the ongoing affordability equation requires the assessment of ongoing expenses. Many ongoing costs can be estimated with a reasonable degree of accuracy. However, similar to rental income, you can ask a reliable property manager for more accurate estimations. Ongoing expenses you should consider include:
- Mortgage repayments and loan fees;
- Property management and tenant advertising;
- Repairs and maintenance;
- Vacancy rate;
- Utilities (including council rates, strata and body corporate);
- Insurances;
- Property taxes (including land tax); and
- Miscellaneous expenses like additional accounting costs, if relevant.
Remember to also consider the impact of income tax on your final cash flow position as it may increase or decrease your cash flow. Also consider near-term renovation expenses. While not a regular expense, they have the potential to seriously impact cash flow and cash reserves.
Learn the components of a loan, the importance of stress-testing repayments and how to avoid mortgage stress here.
Now that you have calculated all ongoing income and expenses, subtract your expenses from the income you expect to receive and determine your net cash flow position. If the property doesn’t generate sufficient income to over costs, ensure that you have readily available income from other sources (such as employment or other investment income) to cover the shortfall.
Finally, go one step further. Assess your overall position following the property purchase. Determine when you’ll be able to purchase another property. Ensure that the acquisition of the investment is a good fit for your portfolio goals – and that it’s not just a good investment.
That’s it, you can now carefully consider investment property affordability! However, to develop a clearer understanding of longer term affordability, stress-test loan repayments with ease and assess potential financial returns, use one of our property calculators.
About the author: Brenton has more than ten years experience in the financial planning industry. His specific qualifications include financial planning, margin lending, SMSF (self managed super funds) and direct shares. He is also an experienced investor.
Last reviewed: 5 July 2022
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