Funding Strategies For Your Investment Property Empire

Running an investment property can be a lucrative but costly endeavour. There are several expenses to consider when managing an investment property, including mortgage payments, maintenance and upkeep costs, property taxes, and advertising costs.

One of the most significant expenses is the mortgage, which typically requires a higher down payment than a primary residence, ranging from 15% to 25% or more. It's important to ensure you can afford the monthly mortgage payments, especially if the property is vacant or rents are lower than expected. Maintenance and repairs are also inevitable and can be costly, so it's recommended to set aside a portion of the property's value for these expenses.

Additionally, as a landlord, you need to be aware of the applicable landlord-tenant laws and ensure that repairs meet legal requirements. You may also need to pay for advertising, credit and background checks on potential tenants, and property management services if you choose to hire a property manager.

Furthermore, investment properties are subject to various taxes, including income tax on rental income, capital gains tax when the property is sold, and property taxes. Understanding these tax obligations and available deductions is crucial for effective financial management.

Overall, running an investment property requires careful financial planning and consideration of both ongoing and unexpected expenses to ensure a positive cash flow and maximise returns.

Borrowing money to buy

Conventional Bank Loans

Conventional bank loans are a standard option for financing an investment property. These loans typically require a higher down payment, often 30% or more, and have minimum credit score, income, and asset requirements. The approval and underwriting process for conventional loans can be lengthy, and they may not be the best option for those without deep cash reserves. However, they usually offer lower interest rates compared to alternative financing options.

Hard Money Loans

Hard money loans are short-term, high-interest loans often used for flipping properties. These loans are based on the property's after-repair value and can be secured much faster than conventional loans, making them attractive for time-sensitive investments. However, interest rates can be high, and the repayment period is usually less than a year.

Private Money Loans

Private money loans come from individuals, such as friends or family. The terms and interest rates of these loans can vary significantly, and they are typically secured by a legal contract that allows the lender to foreclose on the property in case of default. While the approval process for private money loans can be quicker and less stringent, they often come with higher interest rates and fees than traditional bank loans.

Tapping Home Equity

Another option for securing an investment property is by tapping into your home equity through a home equity loan, home equity line of credit (HELOC), or cash-out refinance. This allows you to borrow against the equity in your primary residence to finance the investment property. Interest rates on these loans can be lower, but they put your primary home at risk in case of default. Additionally, the interest rates on HELOCs can be variable, leading to fluctuating monthly payments.

Commercial Loans

Commercial loans are typically used for financing multi-unit residential properties, commercial properties, or mixed-use developments. These loans have specific rules, benefits, and challenges and often require extensive documentation and larger down payments. Commercial loans may offer longer repayment terms and competitive interest rates, especially for borrowers with strong credit and solid business plans.

Other Options

There are also other creative financing options available, such as peer-to-peer lending, fix-and-flip loans, life insurance policies, credit cards, and personal loans. It's important to carefully consider the costs and risks associated with each option before making a decision.

Tax on your investment property

If you own an investment property, you will need to pay tax on any income you make from it. This includes rental income, which is taxed as ordinary income tax. You must declare it on your tax return and pay income tax on it. Rental income is any payment received for the use of your property, including advance rent and security deposits (in some cases). You must report all rental income on the return for the year you receive it.

You can deduct certain expenses from your rental income, such as mortgage interest, repairs, and property taxes. These are considered business expenses, similar to running a retail store. You can also deduct depreciation, which is a non-cash expense that accounts for the decrease in value of your property over time. Keep in mind that if you sell the property for a gain, you may have to pay depreciation recapture tax.

When selling an investment property, you will also need to pay capital gains tax on any profits. The capital gains tax rate varies depending on your filing status and taxable income. To calculate your capital gains, subtract your adjusted tax basis (original cost plus renovations) from the selling price.

There are ways to minimize or defer capital gains tax when selling an investment property. One method is through a Section 1031 like-kind exchange, where you sell one investment property and purchase another without paying capital gains tax. Another strategy is to convert your investment property into your primary residence, as there are higher exclusions for capital gains tax on primary residences.

Additionally, there are other tax deductions you can take advantage of as a real estate investor. These include legal fees related to your investment properties, business use of your home, and employees (with certain conditions).

Overall, owning an investment property offers several tax advantages, but it is important to understand the applicable tax laws and consult with a tax professional to maximize your profits and ensure compliance.

Cost to buy and sell

The costs involved in buying and selling an investment property can be high and will affect your overall return. These costs can include pest and building reports, agent's fees, advertising costs, legal fees, and, in some cases, capital gains tax.

When buying an investment property, you will need to consider the following:

• Initial home purchase costs: In many states, investment property owners must have their properties inspected and cleared by inspectors before renting them out. Make sure you budget enough money to cover these costs, such as a home inspection and closing costs.
• Down payment: Most mortgage lenders require borrowers to make at least a 15% down payment for investment properties. This can be higher, depending on the lender and the type of loan you secure. For example, a conventional mortgage typically requires a 15%-25% down payment.
• Credit score: For a fixed-rate mortgage, you will usually need a minimum credit score of 620.

When selling an investment property, you will need to consider the following:

• Real estate agent commissions: These can be the biggest fee a seller pays and are typically between 5% and 6% of the sale price.
• Closing costs: These include title insurance, recording and settlement fees, prorated property taxes, and HOA fees.
• Capital gains tax: If you sell the property for more than you paid for it, you may have to pay capital gains tax.
• Moving costs: If you are selling your current home, you will need to budget for moving your belongings to your new residence.

It is important to carefully consider all the costs involved in buying and selling an investment property to ensure you have the necessary funds and maximize your profits.

Ongoing costs of investment properties

There are many ongoing costs associated with owning an investment property. Here are some of the most common expenses:

• Mortgage repayments: The cost of servicing the loan taken out on an investment property will depend on the amount borrowed, loan term, loan type, and any associated loan servicing fees.
• Council rates and land tax: Paid annually, these rates vary depending on the local government area.
• Water rates: Whether a property investor is liable for water costs depends on whether the property has provisions for separate utility metering.
• Insurance: In addition to building insurance, many property investors choose to take out landlord insurance to limit the financial impact of unforeseen repair costs and tenant-related liabilities.
• Body corporate fees: Paid quarterly, these fees are intended to assist in the upkeep of apartment and townhouse complexes. Detached houses do not incur these costs.
• Repairs and maintenance costs: These are some of the most difficult costs to anticipate and control, as they can arise at any time and vary depending on the nature of the repair, the age of the building, and any insurance policies in place.
• Property management fees: If you go through an agency, you will need to consider listing fees each time your property is re-let, as well as ongoing agency fees taken as a proportion of the monthly rent.
• Tax on rental income: Rental payments, along with any reimbursements associated with outgoings, are subject to taxation and must be declared on an investor's tax return.
• Utilities: Depending on the rental agreement, landlords may be liable for some utilities such as water bills and fixed access charges.
• Advertising fees: You will likely need to pay advertising fees if your property requires new tenants, especially if your existing tenants vacate unexpectedly.
• Renovations and improvements: Depending on your budget and goals, renovations and enhancements can range from straightforward cosmetic updates to more intensive projects, such as bathroom upgrades.
• Income tax obligations: These will depend on whether your property is positively or negatively geared.
• Stationery: Ongoing expenses may include stationery items such as printer cartridges, paper, and pens needed to manage paperwork for the investment property.
• Travel and accommodation: If you need to travel and stay overnight to inspect your property, these costs will need to be covered out of your own pocket, although a portion may be tax-deductible.

Interest-only loans

However, interest-only loans also come with certain risks and considerations. Firstly, the interest rate on these loans can be variable, which means that it can fluctuate with market conditions. This can make it difficult to budget and plan for the future. Secondly, there is no gain in home equity during the interest-only period, as the borrower is not paying down the principal. This can impact the ability to build wealth through homeownership. Finally, interest-only loans require discipline and a long-term financial strategy. Without careful management, they can become a financial burden.

Overall, interest-only loans can be a useful tool for real estate investors, but it is crucial to understand the risks and have a solid financial plan in place.

Frequently asked questions