Taking the rewarding step to your next investment property

Buying your second investment property can seem nerve-racking but here’s how to solidify your property journey.

If you’ve taken the rewarding step of purchasing your first investment property, then congratulations. While a first investment property seems do-able, buying a second property can be very daunting. A common concern is: “Am I going to bite off more than I can chew?”

More than a screaming, new-born baby, nothing can quite keep you up at night like a mortgage! It’s a natural anxiety.  How much debt can one afford to get into? And can you stretch your resources to cover a second property? Seemingly sleepless nights lie ahead. However remember the aim of all investors is to put together a solid property portfolio. Ultimately a strong property portfolio will generate wealth and secure your future. So a second property investment will set you down that road.

Here’s a few things to consider:

1. Income sources

You have a number of options to fund another property. You can either refinance your current mortgage or take out a new mortgage. What you decide on will have to suit your personal circumstances. If you apply for a second mortgage your LVR (loan to value ratio) will likely change as will your borrowing capacity. This is a natural consequence of increasing your debt. Therefore to satisfy the bank’s criteria you may have to use equity from other properties. Depending on your circumstances, a self managed super fund could also be used to put down the deposit for the mortgage and the SMSF would control the property. You may also want to switch your loan type, depending on your situation, from principal to interest only. Finally, consider how you can increase your serviceability through simple measures like raising the rent to generate extra income.

2. Cash flow

Once you’ve sorted out your property finance, you then need to do the sums and make sure that you can afford it.  An important part of your cash flow will be the rental income. If you are purchasing the investment property with DPN you'll get a rental income guide - an estimate of what the weekly rent will be - which they commit to, guaranteeing 92% of the base rental income if your property is unrented six weeks after handover. Most finance experts advise leaving a buffer so you’re not vulnerable to interest rate changes. The failure to have a buffer is typically what knocks out many of the lower tier property investors when interest rates suddenly rise. You can create a buffer by factoring an interest rate rise of 1 to 2% and not borrowing to your maximum. Alternatively having six months of repayments up your sleeve could be hugely beneficial if you are made redundant or lost a source of income.

3. Good debt v bad debt

Most of us are familiar with the concept of good and bad debt. Good debt being something you’ve purchased that will increase in value or wealth over time. Bad debt being something you’ve bought that will devalue (ie. electronics, cars, many luxury items). You’d automatically assume that property investment is a good debt. Not necessarily. If you’ve overpaid on your property or taken on interest rates that are too high, you could be facing a bad debt. Similarly if you’ve bought a property in an area where the local economy is about to collapse or if it’s prone to flooding or else there’s going to be an oversupply of housing, then factors like this mean your investment is now a bad debt. This is where research and a thorough understanding of the market is critical.

The failure to have a buffer is typically what knocks out many of the lower tier property investors when interest rates suddenly rise.

4. Holding costs

The holding costs of the second investment property are simply the final expenses you’ll incur annually in order to keep the property. These will be all your entire outgoing expenses (property maintenance, mortgage repayments, landlord’s insurance, property management and rates) deducted from the rental income you get each year. The final figure is what you’ll need to pay to hold the property. In other words, make sure you’ve done all your sums. It’s often a good idea to add in a contingency of around 5 to 10% in case of any unforeseen expenses.

5. Choosing the right kind of loan

This comes down to your personal needs and situation. However, many property investors find that low fixed rates are ideal for long term properties with steady capital growth.  If you opt for this kind of loan check what the clauses are regarding early exit or termination, as you may be hit with high penalty fees. In this scenario you’ll want to make sure you can cope with any sudden interest rate fluctuations. Ideally, shop around with a recommended broker and peruse the different packages out there. You may also want to reconsider your existing loans now that you’ve got multiple properties. For example, consider switching from principal to two interest only loans.

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6. Long term capital growth

Look for a property with a long term capital growth and in an area that is identified as stable and growing. This again comes down to painstaking research of not only the local area, but the market in general.  This is where DPN is able to help with access to solid property research. Your second property could be a time to try a more sophisticated method of investing. For instance, a dual income property, where you can earn two rents from the one property is a terrific way to boost your rental income and increase your serviceability.

7. To negatively gear or not?

If you’ve been negatively gearing your investment property then buying your second property is a good opportunity to consider if you want to keep going down that road. If you’re trying to grow a large property portfolio on a limited income then negative gearing may be slowing you down. It certainly affects your serviceability which in turn may limit your borrowing capacity. Ultimately it comes down to your financial situation. Certainly many high income earners with multiple properties and find negative gearing highly rewarding with the total tax deductions they’re getting. Talk to your financial advisor or mortgage broker about what will best suit you. The main point is that a second property investment should mean you’re open to reconsidering your previous financial strategies.

Finally, a second property investment puts you firmly into the league of those building a solid portfolio. From now on, all your property investments should have this bigger picture in mind.

What to consider before buying your second investment property:

  • Income sources
  • Cash flow
  • Good debt v bad debt
  • Holding costs
  • Choosing the right kind of loan
  • Long term capital growth
  • To negatively gear or not?

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