You’ll likely want to enter the property market if you’ve saved some deposit money. Most first home buyers gradually move up the property ladder, starting with a modest owner-occupier home.
However, more and more buyers now realise their deposit may not be enough to help buy a dream home suited to their lifestyle and careers. Consequently, many are opting first to purchase an investment property in an affordable location while continuing to rent or live at home.
Is this strategy right for you? Here are some pointers to help you make your decision.
What is the Difference Between an Investment Property and First Home?
Prospective first home buyers should be familiar with the fundamental difference between the two types of properties. This sets the scene for your first property strategy. The differentiating factors comprise:
Purpose
To begin with, probably the most significant way your own home differs from an investment property is that your primary residence serves as a shelter for you and your family. You buy it in a preferred location to live in and sell it when ready to move on. In short, owner-occupier homes run more on emotions and are a consumption asset.
On the other hand, an investment property is an income-producing asset. You purchase it to generate a return in rental income, capital growth, or, ideally, both.
When you buy an investment property, you can choose the timing and location of your purchase to ensure the best possible return. For example, rather than buying a home to live in, settle for a property that meets the demands of the type of tenants in that area.
Access to Finance
It’s usually more challenging to borrow an investment loan for a rental property than your home. Some lenders may have lower limits for investment properties. This is because borrowers are more likely to default on investment property loan repayments in case of financial difficulty than on their main residence.
Cash Investment and Property Maintenance
When you buy a home, you have to incur mortgage repayments, insurance, and utility bill payments, and also spend on maintenance or repairs wherever needed. This can swell up your monthly expenses substantially.
In contrast, buying an investment property does not involve this amount of ongoing cash investment. Of course, you will have to look into maintenance, repairs, council rates and potential property management fees. However, if you’ve bought a good investment property, the outlay should be less than a home.
If you want to determine your borrowing power or compare home loans, our free online calculators can help you get started.
Can You Buy an Investment Property as Your First House?
Yes. You can buy an investment property as your first house in Australia. This is a growing trend in capital cities like Sydney and Melbourne.
High property prices in these places have made it challenging for younger generations, especially first home buyers, to buy in areas close to capital city centres.
Also called rentvesting, this trend involves buying and renting out your investment property while you rent a home in a preferred location with great amenities.
Buying a First Home as an Investment Property
As per an ABS media release, the value of investor loan commitments in August 2022 was nearly 70% higher than pre-pandemic levels. This information may encourage those considering buying an investment property as a first home.
However, it is essential to remember that deciding to invest in property should not be taken lightly. Before taking the plunge, it’s worth noting the pros and cons and understanding all the risks involved.
Benefits
- Stepping Stone to Home Ownership: By purchasing an investment property, you may be able to enter the property market sooner than if you were saving for a home to live in. This is because buying property investment in an affordable location may not require as large a deposit as purchasing a home in a capital city.
- Tax Benefits: Property investors can take advantage of tax benefits such as depreciation and negative gearing. Also, with most banks willing to lend up to 80% (even more in some cases), the ability to leverage property price appreciation enables potentially higher returns on cash investment.
- Strong Positive Cash Flow: Buying an investment property can help you generate positive cash flows if your rental income surpasses the cost of holding the investment property. The rent from property investment will cover your loan repayments and help you build wealth in the long run.
- Capital Growth: The property investment first strategy gives you flexibility. You can choose and invest in potential areas and suburbs that show high potential for capital growth. For instance, when property prices in the area increase over time.
- Property Cycle Leverage: Rent vesting allows you to capitalise on growth property values while benefitting from great amenities in your suburb. Once you attain growth in your new property investment, you can use that equity or sell it. In addition, the funds can be used to purchase a dream home suited to your circumstances.
- Improves Your Borrowing Power: If your investment property is ‘positively geared,’ your rental income will outweigh your expenses. The savings will not only build wealth but will also increase your borrowing power for any subsequent loans in future.
- Live in a Better Home: Generally, the cost of rent in high-end homes is often lower than mortgage repayments if you buy that home. This property investing strategy can help you live in a better house or locality than your financial situation can afford.
Limitations
- Lack of Stability: The main limitation of investing first is that you won’t enjoy the stability of owning your home. Nonetheless, you can look for longer lease terms to work around this situation. Some landlords prefer 3-5 year leases with occasional rental increases. This can help you get stability and security for a longer period.
- Rental and Loan Repayments: Unless you are living rent-free, for example, in your parent’s home, you will need to pay rental costs and your mortgage too. If you bought your own home first, this is not something you would be doing. Moreover, if your property is negatively geared, your expenses will shoot higher than your rental income. In such a scenario, you’ll have to cover rentals and shortfall costs.
- Higher Interest Rate: Investment loans usually have slightly higher interest rates as they are viewed as at higher risk of default by lenders and even regulators. Investors often look at interest-only loans due to tax benefits. However, after the interest-only period, you’ll have to start making principal and interest (P&I) repayments at a higher rate.
- Tax Implications on Selling: Capital gains tax (CGT) is applicable when you sell your investment property for a profit. On the other hand, it doesn’t apply when selling the house you live in. However, according to the ATO, you can qualify for a capital gains tax discount of 50% if you own the property for at least 12 months before the ‘CGT event,’ i.e., the point at which you make a capital gain.
- High Costs of Home Buying and Selling: You have to be ready to spend around 5% of the purchase price when buying an investment property. You won’t qualify for stamp duty exemptions and concessions. Likewise, you should earmark about 3% of the purchase price when selling the property towards real estate agent fees, marketing costs, and other miscellaneous expenses.
- Restrictions to First Home Buyers’ Schemes: Many government incentives pitched for first home buyers do not include investors. Where they apply to those who have never owned any residential property in Australia, you generally won’t be able to access such grants or loan deposit schemes.
- Uncertainty: Risks are inherent in any investment. Risks such as low rental demand, low rental yields, or property downturn can affect your earning potential for investment properties. Over and above, rising interest rates will increase your monthly repayments and reduce your cash flow.
Buying a First Home
Buying and owning a home is one of the most significant achievements and financial commitments you’ll make in your lifetime. Therefore, the decision to first purchase a primary residence may suit many prospective buyers.
However, you may also feel your personal circumstances and financial situation point towards an investment property as your first home. Knowing the pros and cons of buying a primary residence may help you decide which suits you better.
Benefits
- Personal Fulfilment: Owing the place you live in gives a sense of pride. You can renovate it to match your tastes and needs.
- Security and Stability: You can stay in your home as long as it suits you. You don’t have to go through a round of re-negotiations for rent each year.
- Cost of Loan: Owner-occupier home loans are less expensive than investment property home loans in terms of interest rates and additional closing costs.
- First Home Owner Grant: The amount for first home owner grants by the Australian Government depends on where you live. Nonetheless, the Grant is only available for owner-occupier properties, irrespective of the state or territory you live in. The Grant can significantly help when you need to put in the deposit for your first home mortgage. Our comprehensive resource on First Home Buyer Grants 2022 can help you get familiar with the grants and schemes you can access as a first home buyer.
- Tax Time and Other Savings: Owner-occupied homes are exempt from capital gains tax when sold. Therefore even if your property value increases, you won’t be taxed on those gains. Furthermore, incentives, including stamp duty reductions, make purchasing your first home more affordable.
Limitations
- May have to Compromise: Many home buyers who first purchase a main residence have to compromise on the location, type of property and size to stay within the budget.
- Short-Term Gains: Opting to buy your first home to access government grants and stamp duty incentives in a particular area may not necessarily be a good investment decision.
- Instead, buying an investment property in an area with potential for capital growth and/or strong cash flow will help you increase your equity and cash position sooner than the small upfront savings your primary home may offer.
- Difficulty in Moving: Once you’ve settled into your first home, you may find it hard to move even if an opportunity for a better job arises. You’ll have to go through the hassle and cost of selling your property and finding a new one.
- Borrowing Capacity Impacted: Your borrowing capacity and serviceability may get exhausted if you access almost all the money you are eligible to borrow for your primary home. In addition, your home loan payments will make it challenging to buy investment property anytime soon. This reduces your chances of building long-term wealth with property.
So, Should You Buy an Investment Property or Home First?
Buying an investment property is very different from buying a primary place of residence. Your objectives and financial situation will ultimately determine whether purchasing an investment property or a home to live in is the better option.
Purchasing an investment property may be a practical option if you’re looking for capital growth and/or cash flow.
Nonetheless, careful planning and due diligence are essential when looking for an ideal investment property. Likewise, speaking to an expert and getting tax advice at this stage will prevent any unwanted surprises down the road.
What to Consider When Buying an Investment Property?
Here’s our list of top things for first home owners to consider before buying an investment property:
Home Loan Interest Rates
Investment property rates are generally higher than residential home loan rates. Therefore, you will need to factor in the higher interest repayments when evaluating an investment property.
Location
The location of the property is crucial. Choosing an area with high demand and good capital growth potential is essential. Infrastructure development, population growth, employment opportunities, low crime rate, and good public transport and amenities are all positive signs.
Property Condition, Type and Size
The property’s size, type and condition will affect its rental yield. It would help if you hired a specialist to assess the quality of the house before purchasing an investment home. It’s best to settle on a property in good condition.
Poorly maintained properties requiring repairs and maintenance expenses may defeat the purpose of earning rental income and affect your cash flows. The best would be to purchase a property that’s ready for tenancy.
Rental Demand
If there are more renters than properties available, you’re more likely to have consistency. Likewise, a good rental market is often characterised by low vacancy rates. They give you the power to charge a higher rent and reduce the chance of your property being vacant.
Income Yielding Potential
Look for an investment property that can generate a strong monthly cash flow. For example, a newer property in good condition will likely attract higher rental income and achieve better capital growth than an older property needing repairs.
The more income it generates, the greater the help to cover costs, including home loan repayments, property management costs, maintenance, and tax implications.
Potential for Capital Growth
Apart from cash flow, you should be able to generate profit from your investment property. The most common metric used to determine profit is cash on return because it considers how the property is financed. Experts say a good investment property fetch return of about 8% or more.
Check Your Eligibility for First Home Buyer Grants
The Australian government offers first home buyer grants and concessions. Understand your eligibility for first homeowner grants or stamp duty concessions in your state or territory before deciding to buy an investment property as your first purchase.
This will help you know if you can get any financial assistance to reduce the deposit amount you need to save.
Use Joust to Help Guide Your Home Loan Journey
If you’re a first-time home buyer, Joust can help make the home loan process simpler, faster and more transparent.
Our Live Auction takes the stress out of crawling through websites for suitable home loan deals. Our lenders will bid for your business in real-time based on your requirements and repayment ability. So you can compare and then choose the most suitable deal for you!
What’s more, you can do this all from the comfort of your own home, without any obligation to accept any offers.
FAQs
Can You Buy an Investment Property and then Live in it?
Yes, you can buy an investment property in Australia and then live there. However, whenever you plan to convert an investment property to your principal place of residence, you will have to inform the Australian Taxation Office (ATO) of this change.
Can You Access First Home Buyer Grants When Purchasing an Investment Property?
Strictly speaking, the answer is no, as the First Home Owner Grant is only available it’s first home buyers who have never owned property before. In addition, for some states, you must move into the property within 12 months of purchase.
The information in this article is general in nature and should not be considered personal or financial advice. You should always seek professional advice or assistance before making any financial decisions.
