When you have an investment property, which could be a residential property or a commercial property (I will explain these below), you get income through two ways, but you do have some expenses to pay, which hopefully will total a lesser amount than the income. Before you even start earning income, you have to pay expenses for buying the property in the first place. Then as you start earning income, there are some ongoing costs.
Purchase Costs
These are the one-off costs associated with buying the property. First of all, you have to actually buy the property. To do this, you would pay a percentage of the price of the property, as a deposit for a loan that would be the rest of the amount needed to buy the property. You have to pay a deposit to the bank you get the loan from because if the property goes down in price or you have to pay for a big repair, they will still have some money. You also have to pay stamp duty to the government, which is a tax for buying the property. You would then have to pay for a title search as this lets the government know who owns the property. And finally, you have to pay legal fees, this is to tell the bank that lent you money that if you don’t pay them the money that you owe them on time, after a while they can take the property away from you.
Income
You can make money from property investing in two main ways, receiving rent and the property going up in value. Rent is the weekly amount someone pays you for living in your investment property. The official name for the person (or people) living in your property is called the 'tenant'. The second way is by the property hopefully increasing in value over time, which means that it is worth more later when you sell it or when you get another loan on the house called equity. (After I release a podcast about this - coming out in April - I will put that explanation here)
Because the property is growing in value, the rent will also go up in price meaning that every payment (usually once a month) you get more money from your tenant.
Ongoing Costs (also called Holding costs)
The main ongoing cost for having an investment property is the repayments on the loan; that is the money that a bank will lend to you for the purpose of buying the property. You then have to pay a certain percentage back to the bank as loan repayments. This is also known as the “mortgage” on the property.
There are many other smaller costs as well. When you own an investment property, you are called the landlord of that property. When you have tenants living in your property, most landlords will pay a small monthly fee to someone else to look after the property for them, to find the tenants, collect the monthly rent and deal with any maintenance concerns with the property. This person is called the property manager. It may seem unnecessary to pay a monthly fee to the property manager to do all of this for you. But it saves you a lot of time and hassle to have a property manager rather than to deal with the tenants yourself.
Every three months you pay for water that your tenants would use. This is like paying for data for your phone so that it will work when it is not on Wifi. You would pay a set amount, let’s say $250, for a set amount of water. If the tenants go over that amount then the water bill would become more expensive, but this extra amount your tenants would pay back to you. So overall you would still pay the same amount, but the number would look bigger.
Other expenses include rates and taxes – this is a small amount you pay to the local council to provide good roads, rubbish collection etc. An unknown and unpredictable expense can by paying for maintenance and repairs - anything that may have broken or gone wrong with the property will need to get fixed. You may have lots of these or not that many. This depends on the condition of the property and varies a lot depending on other natural events (for example a big storm or flood).
By the end of the year, you really hope that the income you receive in rent covers all the costs. But the main thing that you hope for is that the rent was more than the costs so that it pays you some income along the way. But even if you don’t make money every month, the property should go up in value over time, so you make money by the growth in the property anyway.
Capital Gains/Loss
Although the terms capital gains and capital loss doesn’t only refer to properties, using properties as an example is a good way to explain it. Capital gains or loss is the amount that something has gone up or down in value since you bought it, capital means the original value, and you would add gains at the end if it had gone up in value, and loss if it had gone down.
So, using the property example, let’s say that you bought a property for $350,000, and either when you went to sell it, or just when you had someone revalue the property it was worth $420,000, then the capital change would be the difference (positive $70,000 in this case, which means it was capital gains).
Equity
Equity is a similar term to capital gains or loss, as they both refer to the difference between the property’s value and something else. The difference is that equity is referring to the difference between the property’s current value, and the amount that you still have to pay off the mortgage and any other loans, whether capital gains or loss is referring to the difference between the current value and the purchase price. You would calculate the equity of a property by finding the current value of the property, and then add together the amount that you still have to pay off all of the loans and mortgage. You would then subtract this amount from the property's current value to find out what the equity of the property is.
You can also get what’s called an equity loan, which means that you can get another loan against the property. To work out how much you can get as an equity loan, you have to find out the current value of the property, but sadly you can only get a loan out for up to 80% of this value. So, once you have figured out what 80% of the current value is, you just have to subtract the total of all of the loans and mortgage that you still have to pay for the property, and you would end up with the amount that you can take out as an equity loan. Also, keep in mind that you can have negative equity if the property has gone down in value faster than you have paid off the mortgage.
For example, if your property is worth $330,000, and you still have to pay off $230,000 from all of the loans and mortgage. You would first figure out that 80% of the value is $264,000, and after subtracting the money that you have to pay off, you would find out that you could get an equity loan of $34,000. You would most likely only get an equity loan if you were going to use the money to purchase another investment property.
Types of Investment Property
There are two types of investment property: Residential property investing and commercial property investing.
Residential Property
This is a property for someone to live in. You can find residential property in all shapes and sizes a stand-alone house, a unit or an apartment. Once you buy a property you would try and find a tenant who would pay you rent to stay there.
Commercial Property
This is a property that you let other people run their businesses in. That may be an office space, a hotel building, an industrial warehouse (usually used for storage or manufacturing products) or retail purposes (a shop, pub, restaurant, news agency or bakery). If you have a building or property with 4 or more units/apartments then that would also be classified as a commercial property.