One of the advantages of direct property investment over shares (or property funds – which we will cover in a separate article soon) is that small investors can apply their own knowledge and involvement to make their investment more successful.

Knowledge of the local area (or of a regional or tourism area), experience dealing with strata bodies and councils and of renovating properties, can all make a big difference.

So you’ve weighed up the pros and cons of direct property investment, and are thinking seriously about investing? But perhaps you’re not sure how to go about it?

Before you start hunting for properties and talking to lenders, make sure you’re crystal clear on your strategy – as it will drive the sort of property you buy and even the sort of loan you take out.

Direct property investment strategies fall into three distinctly different groups.

1. Negative gearing

Many investors deliberately run their property investments at a (short term) loss. They are then allowed to offset this loss against their employment or other investment income to reduce the amount of tax they pay. This tax benefit effectively reduces the size of the operating loss on the property investment, which then hopefully grows in value over time.

This approach is great for high income earners with large tax bills and surplus disposable income. The trick is to balance the amount of borrowing so that tax deductible interest payments (on top of other costs) produce the right balance of tax offset and cash flow shortfall requiring funding.

Remember though, that although interest payments are tax deductible, principal loan repayments are not. For this reason, negative gearing property investors often borrow under interest-only loans. This means, however, that they do not accumulate wealth by gradually paying down the loan, so they rely solely on the property increasing in value.

In short, negative geared investors:

  • decide what cash flow shortfall they are comfortable with balanced against the tax deduction — then calculate what proportion of the investment they should finance with a loan.
  • consider interest only loans — to maximize deductible interest v’s cash flow shortfall.
  • look for properties that offer high potential for capital growth, even at the cost of accepting lower rental yield — often near city centres or in premium suburbs.
2. Positive Gearing

Just as it sounds, positive gearing strategies involve pretty much an opposite approach to negative gearing. This approach is great for investors with some borrowing capacity but without a large surplus disposable income or tax bill.

Older investors can add positively geared investment properties to their investment mix with limited impact on their lifestyles (maybe even with an eye on handing a starting property on to children, in time).

Younger investors despairing of owning their own homes can use positively geared investment properties to ‘get their foot in the door’ of the property market by buying something that largely pays for itself — even if it is in an area they don’t want to live in, themselves.

In short, positive geared investors:

  • determine the amount to borrow based on repayments (and other costs) being covered by rental income.
  • look for properties which offer high rental yield, even at the cost of accepting lower potential for capital growth — often in regional areas or the outlying suburbs of metropolitan areas.
  • fund properties using loans where repayments include principal as well as interest so that wealth accumulation doesn’t rely solely on price appreciation.
3. Development Investment

Some investors hunt for undervalued properties, that offer renovation or development opportunities.

At the lower end of the risk scale these include poorly maintained apartments or houses that require only cosmetic work to achieve higher rental or to attract a higher resale price. Apartment renovators must, of course, have a sound understanding of strata restrictions.

More risk tolerant investors might look for a large block offering the potential for subdivision. More risky again, some experienced investors look for a block large enough that an existing building could be demolished and replaced with multiple apartments/townhouses. Obviously these strategies are subject to zoning and town planning restrictions, and are subject to the risks of large scale building projects.

If one of these property investment strategies seems right for you, have a look at our follow-up article: Property investment tips.

What are your thoughts?

Do you own an investment property, or are you thinking of buying one? Is there more you’d like to know about property investment? Join the conversation — leave a comment below and let us know what you’re thoughts are.

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