How to Budget for Your First Investment Property

One thing I distinctly remember about my first investment property was the shock of the additional costs I incurred at settlement. I learned an important lesson. The total cost of acquiring a property will always amount to significantly more than the contract price.

In our Property Apprenticeship course, we train investors to treat their property investing like a business, not like a hobby.

One clear way to demonstrate a business-like mindset is to establish a thorough buying budget before making a purchase.

After all, how can you manage your cash flow unless you know exactly what you expect to pay? In addition, how can you even begin to search for an investment property unless you know exactly what you can afford?

In this article, I offer these five simple steps to establishing a buying budget:

1. Determine how much you can borrow.
2. Factor in your cash savings and other sources of finance.
3. Itemise acquisition and improvement costs.
4. Start shopping for a property.
5. Apply your budget to the property.

After I posted that piece, a reader, who is new to property investing, asked exactly what I meant by number three, “Itemise acquisition and improvement costs.” It dawned on me that without a precise understanding of all of the costs associated with buying and holding a property, it’s pretty tough to create a buying budget.

Even if you’re a year or two away from buying your first property, it’s crucial that you know what you’re getting yourself into. At the very least, you’ll need an idea of how much you should save toward a deposit. Many lenders want investors to pay some part of the acquisition and improvement costs out of pocket.

Here’s an overview of the common costs investors incur when they buy an investment property:

Acquisition Costs

Here Are The Top Five Acquisition Costs Investors Should Consider:

Purchase Price

The most obvious upfront cost in the property transaction is the purchase price. This is the amount that you and the vendor have agreed upon in order to exchange ownership of the property.

In order to secure the deal, you’ll need to pay a deposit at the time you exchange contracts. A typical deposit would amount to 10 percent of the purchase price. You can always offer more to incentivise the vendor to accept your offer, but in a buyer’s market, you might get away with a much smaller deposit.

You will need to pay the remaining portion of the purchase price using a combination of out of pocket cash and borrowings from a lender. Check out what I’ve written here for a more detailed explanation of how to fund the purchase of a property.

You’ve probably heard people refer to “closing costs.” These are all of the other acquisition costs payable upon settlement of the property.

Legals

After you and the seller have agreed on a purchase price, it’s time to put a legal professional to work to handle the details for the change of title. Conveyancing is the legal process of transferring ownership of a property title from one person or entity to another.

Because there are legal procedures to adhere to, both parties in the transaction should have qualified legal representation.

These legal costs will vary depending on whether you use a solicitor or a qualified conveyancer. You should expect to pay anywhere from $800 on the low side, to upwards of $2,000, depending on what is required for the title transfer.

To learn more about what a conveyancer does and how to find a good one, check out my article, “Property Conveyancing 101.”

Government Taxes

With so much wealth changing hands through real estate, it’s not surprising that the powers that be want a piece of the action. The nastiest upfront tax you’ll pay is stamp duty to the state government where your property is located. This tax is incurred at the time of transferring the title of the property.

Stamp duty legislation differs in each state and territory, so you’ll need to understand the specific rulings related to the location of your intended purchase.

The amount you pay is dependent on the value of the asset. Every state and territory has its own tiered scale, so stamp duty will be higher in some states than others. You can generally expect to pay somewhere in the range of three to five percent of the purchase price.

To strengthen the building industry, many states offer bonuses and reductions in stamp duty if investors buy a property off the plan before the dwelling has been built. For instance, in Victoria you only pay stamp duty on the unimproved value of vacant land. This could add up to a massive savings of tens of thousands of dollars.

ACT

NSW

NT

QLD

SA

TAS

VIC

WA

As if stamp duty wasn’t enough, you should also expect to pay a portion of both the land tax and the local council rates. These are both due annually. Land taxes go to the state government, and are generally only payable on a portfolio of investment properties with a cumulative value over a certain amount. Council rates go to your local municipality, and they help cover the cost of council services.

Each of these taxes are usually apportioned between the buyer and the seller as an adjustment upon settlement. This insures that each party in the transaction picks up their share of the tax burden for the portion of the year they own the property. You must own a certain value of real estate in order to be subject to land tax; therefore, this tax may not be part of your property settlement. Be sure to check with your solicitor, so you’ll know for sure.

Borrowing Costs

Before the bank will loan you money, they’ll want you to pay some fees up front. You can expect to pay an application fee, a valuation fee and also quite often, an establishment fee – just to get your financing across the line.

If you pay a deposit that’s less than 20 percent of the value of the property, you should also plan to pay for lender’s mortgage insurance (LMI). When I first encountered LMI, I was surprised that the bank wanted the full fee upfront rather than spreading it out over the life of the loan. This was unfortunate for me, since I planned to sell the property within 12 months.

Due Diligence Costs

Before agreeing to purchase a property, it is wise to pay a qualified building and pest inspector to make sure the dwelling doesn’t have major issues. If you are planning to do a subdivision or development on a property, you may need to engage the services of a qualified town planner. Be careful not to spend too much money before the property is under contract.

For more insights on including a due diligence clause in your offer, be sure to read “4 Simple Rules for Submitting Offers.”

Improvement Costs

If you’ve been around the PropertyInvesting.com community for long, it’s quite likely that you’ve heard someone talk about the strategy of finding problem properties and providing solutions for your target market. With the solution you provide comes improvement costs. These are the expenses you encounter to increase the value of the property according to your investment strategy.

You will incur the most common improvement costs when renovating a property, or undertaking a subdivision and development. Even if you purchase a simple buy and hold rental property, you still may need to touch up the walls and make simple repairs to the dwelling before moving a tenant in.

Also, don’t forget about the costs of connecting utilities. You will need to have all the utilities and services installed in preparation for the tenants who will move in to your rental property. If you’re working on a subdivision or development, service connections could include major works and a significant outlay of capital. A town planner will be able help you create a thorough and precise feasibility study, so you can appropriately budget for larger, more complicated projects.

Conclusion

We’ve only just scratched the surface on how to plan for the costs you should expect when buying and improving an investment property. Be sure you’re using a thorough due diligence system, so you have no surprises.

Also, to fully prepare for the cash flow requirements of holding real estate, you should take into consideration the costs of renting out a property.

In Steve McKnight’s Property Apprenticeship course, we offer an entire session on how to create a thorough buying budget.

We even include a buying budget itemiser template that lists every likely cost with cash-flow planning tools, so you can note the timing of the payment and whether you will pay it off with cash or borrowings.

We also include multiple sessions on due diligence and number crunching, with templates to help you systematise your purchases. Our aim is to empower investors to scale beyond owning just one or two properties.

By Jason Staggers

Jason was a personal mentor working with Steve McKnight's Property Apprentices. He helped hundreds of investors apply Steve's teachings in the real world and achieve greater results on their journey to financial freedom. Jason now lives in Perth, WA where he leads Neuma Church.