The interest rate rises in 2010 bumped some first-home buyers out of the market and taken heat out of prices at the bottom end. Both those factors make real estate a buyer’s market for investors.

If you own your home outright or have healthy equity, good cash flow and adequate super, do the current real estate conditions mean it’s a good time to dip your toes into property investment waters?

Over the long term, the returns from housing and shares tend to be the same – or an average of 11.5 per cent per annum over the past 80 years or so, according to AMP Capital Investors – so there is an investment case for holding property.

But to get that return investors need to make sure they find the right property and then consider if their circumstances are a good fit for dabbling in real estate.

“I’ve had some clients who have had a residential investment where the yield is 2 per cent when ideally it should be 4 to 5 per cent,” says Dacian Moses, financial planner with Waterfall Way Associates.

Be brutally honest

The first step to getting real estate right is an honest personal audit.

“The first thing people have to do is a realistic budget that lists all their income and all their outgoings,” says Suzanne Hadden, principal of BFG financial planning. “You can’t buy an investment property if you don’t have spare cash or cash flow.”

Most first-time property investors borrow money to pay for the investment and Hadden says that’s not possible if you don’t have the cash flow to support loan repayments and other expenses.

“You should always do the ‘what if’ test. What if I lost my job? What if I got sick for six months? If you can’t cover those what ifs, you need insurance, if you can’t afford insurance, you can’t afford the investment property.”

The type of insurance Hadden refers to is income protection. It’s particularly important if you’re relying on a negative gearing strategy to invest in property because you will be dependent on your income to support your investment property loan.

If you have healthy cash flow, the next step in determining whether you’re ready to buy an investment property is to gain an understanding of the risks involved.

Not as safe as bricks and mortar

Bricks and mortar is still a sentimental favourite with Australians – there is a strong perception that real estate is low risk, that properties will always go up in value – but there are definitely investment risks.

The first risk is not being able to adequately diversify your portfolio.

“If you buy a property in a large city it is such a major investment that most of us can’t afford to have more than one property even if we would like to. So if you get it wrong, you often get it wrong on half a million,” Hadden says.

“Another factor is liquidity risk, because you can’t sell off the bathroom or family room. So it can get quite lumpy,” she says.

Then there are the risks associated with relying on tenants and proceeds from rent to cover loan repayments and other expenses related to your property. If your property is vacant for a period of time or a tenant gets behind with their rent, you will still have to be able to meet all expenses associated with the investment.

Even if your property remains tenanted with rent coming in regularly and it is appreciating in value, expenses related to maintenance can be a drain on your cash flow. If the roof springs a leak you will need to find the money for the repairs.

Plan for poor cash flow

That’s one reason why you need to have a long-term investment horizon to become a real estate investor – you may have periods where the capital value of the property is increasing but cash flow is poor.

Moses says you also have to be prepared for risks like natural disasters, as the catastrophic events of this summer have demonstrated. That means having adequate funds to cover the cost of insuring the replacement or repair of the property and landlord’s insurance.

“Your strategy needs to be able to withstand a catastrophic loss,” Moses says. “People seem to think they are immune to this happening to them.”

“Then there is the chance that the property isn’t worth as much as you thought it was worth. Property prices do go down – not all of the time but some of the time,” Moses says.

“I’ve had clients who have successfully bought and sold and made good money on the way. But I’ve also had some clients who were left down to their last dollars. In that instance, they paid too much, bought at the wrong time,” he says.

Income or capital growth

There can be a trade-off between a property that delivers a high yield in terms of regular income from rent and a property that enjoys strong capital appreciation over time. It’s a matter of determining whether you are investing for income or long-term capital growth and then finding a property that will deliver the type of return that fits with your investment objectives.

Those objectives will depend on your life stage. If you’re a retiree, the main objective might be to hold a property that delivers a steady stream of income; capital growth may be a secondary concern.

Risk of loss is magnified with property because most investors use borrowed money to fund an investment.

“Anytime you borrow money you are magnifying the risks as well as the potential returns. If someone said they were going to borrow $600,000 to invest in shares, most people would say they were crazy but if they borrowed that much to invest in real estate people would be more supportive,” Moses says.

Then, of course, there’s tax – land tax, stamp duty, income tax and capital gains tax. You have to get your tax structures right the first time, including whose name you buy the property in. It’s not easy to move the ownership of the property around between tax structures as you will have to pay stamp duty.

Brace yourself for CGT

When the time comes to sell, you have to take the hit for capital gains tax in one lump. That’s another reason why it is essential to be able to hold on to the property through tough times and not be forced to sell at a time when you can least afford the capital gains tax bill.

Once you’ve determined that you have the cash flow to meet interest repayments and expenses even through the tough times, and then crunched the numbers to determine whether you’re in a high enough tax bracket for negative gearing to be beneficial, it’s time to think about the type of property you wish to purchase.

Moses says residential real estate is the property class that most investors feel comfortable with.

He also says commercial and industrial properties are generally more expensive and out of the price range of most individual investors.

Selecting an investment property is a very different process to selecting a home to live in. You must assess whether it is a competitive investment.

“You have to remember that if you are buying a property for investment you don’t have to love it personally,” Suzanne Hadden says.

It’s nothing personal

“Try to take the personal emotion out of it. Analyse how much it is, the rent expected, outgoings and vacancy rates.”

You may love the suburb you live in but should you have two properties in that suburb?

Hadden says people approaching retirement often fall into the trap of purchasing an investment property in the area that they eventually want to relocate to.

“So really think through why you are buying that property. Does it have a secondary reason? You want to buy something that has rental proposition and long-term capital growth,” she says.

There are also certain rules that an investment property must meet in order that you can claim expenses such as loan interest on your tax return. In order for a property to be classified as an investment it has to be rented or advertised as available for rent.

For example if you buy a property that is vacant and it takes a period of time before you find a tenant, you have to show the Tax Office that you’ve advertised it.

A holiday house, for instance, is a lifestyle asset and doesn’t usually qualify as an investment for tax purposes.

A holiday home can only really be categorised as an investment because it appreciates in value over time so if you sell it there is the potential to make a capital gain.

If you do have a property that is usually rented or advertised for rent but that your family does use from time to time, you will only be able to claim your expenses on a pro-rata basis. The next challenge will be to find, keep and manage good tenants.

Most investors use property managers so you don’t have the stress of dealing with tenants .

Dacian Moses says it is important to check that the real estate agent you use as a property manager is being pro-active and conducting regular inspections.

“I’ve had some clients who have successfully managed their tenants but they have had a legal and property background,” Moses says.

The secrets of success

Suzanne Hadden says successful first-time property investors are those who work hard at analysing their cash flow, the security of their income and the position of their property.

“They are the ones who make sure they can hold their property through a global financial crisis and are not pushed into a corner. You always want to sell through choice not financial necessity.

“Successful property investors don’t wrap themselves up too tightly with expenses so that they can hardly live, because that forces you into stressful choices like not waiting for the best tenant, not holding on to the property as long as you should because you panic and sell it,” she says.

Investing in residential real estate can also have estate planning implications.

“The big issue for investment property is estate record keeping. You must keep all of your records, such as the cost of purchase and deductible expenses that haven’t been claimed,” Hadden says.

“When you own it in your own name the issue of capital gains tax is a ‘when’, not an ‘if’ unless you bought your property before September 1985.

“At some point someone has to pay capital gains tax, it will either be you or your beneficiaries.

“In estate planning if your beneficiaries inherit your property, they also need to inherit the capital gains records.

“This is because when they sell it or their kids sell it, it’s going to date back to when you bought it.”