Quick Tip on How to Analyse An Investment Property in 3 Steps
Property investment can be a thrilling experience.
Throughout my time helping foreign investors to invest in Australian Property I realised that markets respond concurrently with any major event.
Take COVID-19 as an example. It's caused a slump in the Australian Dollar and opens up new opportunities that weren't previously available in a Bull Economy.
There's always a buyer regardless of the economic condition that's presented. These were the wise words of one of our clients. When an opportunity crops up and if you've planned adequately you would be in a position to take advantage of it.
Here's how you can plan for your property investment in Australia and how you can leverage on financial options to help you take full advantage of any opportunity.
Disclaimers: These are a quick a dusty methods to help you to quickly calculate and ascertain if a property is worth considering or not. Do understand that property investments can be complex and rely on many factors. These factors are what make an investment property successful.
Here are 3 Quick Steps to Analyse any Investment Property
Step #1: The 1% Rule
This is the easiest rule to employ and helps you to quickly sift through what a property is able to offer to you. Start with the 1% rule for your investment property first.
The 1% rule for foreign investors of property in Australia helps you to learn quickly and as a general rule of thumb if this is a property that you should consider.
A $500,000 property should rent for at least $5,000 a month. Or approximately $1,150 per week.
Although this may not be practically possible all the time, there are areas that you need to consider such as renovations, renting out individual rooms, or investing in multi-family homes as strategies to upgrade your investment property to meet this target.
To some investors, the 1% Rule is too lenient some prefer the 2% rule. It is up to you how you want to grade your investment property and you are flexible to determine if 1% or 2% is sufficient to cover your home loan as a foreigner.
However, a great way to classify your investment property (or to establish investment criteria of when to use 1% or the 2% rule). You can classify investment properties using the following example:
It would make sense to adjust your rule according to the risk of the property. For example, Class A investment property can be classified under the 1% rule, while Class C investment property can be classified under the 2% rule.
Why is the 1% rule being recommended by everyone?
To put this into context if a property earns 1% per month, that would mean it would make 12% per year. And if you consume half of those earnings are paid back towards maintaining the property, you would end up with 6%. With inflation and tax, your return on cash flow is substantially lower.
The 1% rule essentially intends to force you to consider if an investment property is worth your time to study further or if an opportunity is something that you can consider broadly before diving in deep.
Step #2: The Cap Rate
After an investment property passes the 1% rule, the next test I would put the investment property through is to measure the capitalisation rate (or Cap Rate for short).
What the Cap Rate essentially does is measure the investment property's cash flow relative to the value of the investment property.
Looks more complicated than it actually is.
All you have to do is calculate your rental income per year. For example, $1,300 rental per month x 12 months = $15,600. It costs you 10% to maintain your property, therefore, it is $15,600 - $1,560 = $14,040.
Take into consideration that you may not be able to rent out your investment property for the whole year, $14,040 - $780 = $13,260 per year.
If you purchased your property for $100,000 including all other costs, you would have a Cap Rate return of $13,260 ÷ $100,000 = 0.1326 (or 13.26%).
After considering if the property has adequate cash flow you can sort through the list of investment properties which passed the 1% rule to see if which of the choices available are able to provide you with the best returns.
Step #3: The Cash-on-Cash Return
Here's the final step to see if the investment property you are interested in is to use cash-on-cash returns.
Here's the biggest secret in property investing which all my investors rely on day-to-day. It's calculated based on the amount of cash you actually use to purchase an investment property.
If you purchase a home with a $150,000 downpayment (including all fees) for a $500,000 property, and you receive a net rental income of $800 per month or $9,600 per year (including financing).
You essentially made 6.4% returns in a year. Wow. Compared to committing 100% of your property investment, you would have instead made $2,000 per month or $24,000 a year and received 4.8% returns in a year instead.
This formula illustrates why property investing is so powerful.
Of all the formulas the 1% Rule is the easiest and the most intuitive. Your success (or failure) as a real estate investors happens before you buy.