Are you seeking a rental income while having some fun – or will it be the small business you never intended to own?
If you read my previous article, ‘Why invest in property’, then you are familiar with the story so far and evidently are determined to use your spare cash and earnings to buy property as an investment.
As you might have guessed, simply having the funds to make a property purchase is not enough to guarantee a return on investment (ROI). To make sure your investment is a sound one, you need to decide what kind of investment to make and what you intend to get out of it. To that end, there are a few key questions that you need to ask your inner investor.
1. Will this be an investment purely for the sake of an income or return on investment?
If yes, then consider an investment property with options for (a) long-term tenancy or (b) short-term, back-to-back tenancy (e.g. student accommodation). This may include an apartment or house-and-land package in any location where people need to live, work, go to school or raise a family. In and around city centres and suburbs often provide a decent pool of potential tenants. Examine the rental market carefully. In order to cast the widest net possible, have a look at the type of housing and locations that the majority of tenants are looking for.
2. Or are you looking to get some fun out of it?
If you want to receive a return on your investment and have the option for using the property for your own merry-making, then here’s the option for you: (a) holiday rental investment, or (b) second home.
A holiday rental is an investment property in a destination where you and other people like you (your potential tenants) will want to visit, such as a beach or golf resort, an exciting cosmopolitan city or unique cultural attraction.
The only difference between a holiday rental investment and a second home is the amount of time you spend in the property, and whether or how often you rent it out. Spending a few weeks there sounds more like a holiday home, whereas you might spend several months each year in your second home, perhaps renting it out when not in use (or not at all).
3. Just how much time to you have to devote to management, maintenance and occupier prospection?
If you were just thinking that a holiday rental or second home is your kind of investment, know this first: the more complicated your property interaction means (a) more time spent managing the property yourself or (b) a higher percentage of income to pay for professionals to manage the property on your behalf.
Here’s an example: golf resorts have excellent year-round rental and will often take care of everything for you. But their fees for condo association, property management and rental commission could well eat up all of your rental income. If you finance your purchase instead of paying cash, this may very well mean you won’t earn enough to pay the mortgage.
However, there is some good news. Let’s say that you do own a holiday rental property on a golf course, then you get to take your family and friends on holiday as much as you like in the off-season. While that is good news, it might just get even better: would you have taken that holiday even if you didn’t own that holiday property? If so, then don’t forget to factor this cost into your income/debt scenario for your investment. In other words:
Operating costs, maintenance costs, loan payments, fees
Accommodation for holidays you would have taken elsewhere but now take in your holiday home
Your profit (hopefully).
For an investment property that is not located on a resort with built-in management options, you will need to hire a property management professional, especially if you live far from your investment. This begs the next question.
4. Are you prepared for the business of owning an investment property?
Managing a holiday rental investment is a business. So unless you plan on spending your free evenings and weekends cleaning, repairing, greeting tenants, prospecting tenants and researching their backgrounds/credit histories, collecting rent, filing taxes, mitigating tenancy issues, filling out insurance forms, calling plumbers, electricians, satellite/cable TV repair men… you’ll need some help.
Management fees will be somewhere between 4% and 12% of the income earned from rent, so let’s use 8% as an average standard fee. Then again, there will always be some extras, so let’s take 10% as a round, conservative estimate. Operating costs of an investment property don’t end at a cleaning service or management company, unfortunately. On top of the 10% estimate I just mentioned, you still need to factor in:
- (a) condo fees, co-op fees or other ground fees (where applicable)
- (b) insurance fees (always applicable)
- (c) fixture and fitting replacements (in addition to standard maintenance and repairs)
- (d) taxes (sigh)
If you do your homework, run the numbers, and are still convinced that investment property is your destiny, then I’ve done my job. So with that, I will leave you with one, final piece of advice:
- Get yourself the best financial advisor or accountant you can afford. The money you spend on his or her fees will increase the money you earn from rental income, or at a minimum, save you money on fees and taxes.