When it comes to purchasing a residential investment property, it’s often a very different approach than the one taken with a main residence.
For example, whilst there may be some emotional and personal value attached to a residential investment property, largely, they are an asset purchased to help achieve an investment objective, and their acquisition is based on financial benefit.
Consequently, when considering the purchase of a residential investment property, the rate of return becomes important, both income-generation and capital growth potential.
In terms of income-generation, one of the major components of this is a residential investment property’s capacity to attract and retain tenants over a specified investment time horizon. Put simply, periods of vacancy can affect income-generation and subsequently place a strain on an investor’s cashflow, especially if it’s a geared investment or has been established as an important source of income for a wealth accumulator or retiree.
As such, there are many variables to consider in terms of whether a potential residential investment property has the capacity to attract and retain tenants over the short, medium and long-term. For example, location, building features (and signs of obsolescence) and rent price. These variables are what can drive supply and demand (one of the fundamentals of economics) in the rental property market.
We explore location, building features and rent price in more detail below, with the aim of helping you to understand that purchasing a residential investment property requires more than just an analysis of things like borrowing power and buying costs. It also involves an in-depth analysis of the rental property market.
We have all probably heard of the catchphrase, ‘Location, location, location’. Location can play a considerable part in the attraction and retention of tenants. As such, when considering the purchase of a residential investment property, it’s important to take the time to assess the following:
The abovementioned considerations are largely out of your control in terms of their capacity to change; however, it’s still important to keep them in mind when purchasing a residential investment property, as they are things that can affect the attraction and retention of tenants.
Building features (and signs of obsolescence)
After an assessment of location (discussed above) and rent price affordability (discussed below), tenants often choose a specific property that most closely meets their needs for space, configuration and features. Consequently, a residential investment property not only needs to cater to current users, but also have the capacity to be adaptable to the changing requirements of future users. This last point is especially pertinent if the residential investment property is held as a long-term investment. If consideration is not given towards this then there may be the potential risk of vacancy occurring initially or over time.
Although, there is an exception to this in some circumstances. For example, when there is a shortage of supply in the property market, tenants may overlook certain deficiencies in relation to their needs around space, configuration and features; however, retention of these same tenants may be hard when supply in the rental property market increases, leading to vacancies after leases expire.
Therefore, in conjunction with an appropriate understanding of the relevant demographics at a city/region level (and, implications of the potential for change over time), the following are typical things that may need to be assessed when purchasing a residential investment property:
Please note: Considerations towards building features can vary. A prime example of this can be seen through the impact that land availability can have on space, configuration and features, namely, differences between high-density and low-density living areas. For example, a tenant in a high-density living area may be less inclined to consider a property without secured parking for two cars as a sign of obsolescence, whereas a tenant in a low-density living area may.
Lastly, we talk about rent price, another important consideration in terms of the attraction and retention of tenants to a residential investment property.
Tenants are often price-inelastic, in that they know what they can and can’t afford. Consequently, they will look within a specified rent price range and then filter out properties based on things such as the abovementioned considerations of location (i.e. suburb and street level) and building features (and signs of obsolescence). As such, here are two important things to consider regarding setting the rent price for a residential investment property:
It’s important to note that this is not a comprehensive look at all the variables that can impact the attraction and retention of tenants (e.g. tenancy agreements and initial/ongoing property management services). Nor does it cover other things that can affect income-generation (e.g. interest rate movements and gearing, council rates, insurances, depreciation, property management fees etc.).
Furthermore, income-generation is only one side of the equation when it comes to the rate of return of a residential investment property; another key consideration is capital growth potential – especially if negative gearing is involved.
Despite the above, it does serve to highlight that the property market is a complex place. As such, if you are seeking to purchase a residential property investment to help achieve an investment objective, it’s important to seek professional advice so that all considerations are appropriately addressed.