Columnist Peter Boehm

With the worst of the global crisis seemingly over, house prices on the rise and the end of the first home owners grant about to level the playing field, now seems like a good time to review the idea of property investment.

Buying a home to live in is the first step most Australians take into the property market. In addition to providing a place to live, we also buy because - when it comes time to downsize - we're likely to make a sizable (and tax-free) capital gain.

But some of us don't stop there. We follow up with further property purchases, choosing to invest in residential property rather than shares or other assets.

Why residential property? One reason is that we see it as a relatively safe investment when compared to the volatility of the share market. It offers long-term capital growth, rental income and useful tax deductions (through negative gearing).

But while it can provide handsome returns, residential property isn't an investment panacea. Entry and ongoing maintenance costs can be high and your investment strategy needs to be carefully considered and well planned, with clear goals and an understanding of the risks and rewards.

Considering an investment in property?

Like any investment, you first need to decide upon your goals. Are you looking to maximise your capital gain, your rental income or both? How much are you willing to spend?

Some suburbs will deliver good capital growth but lower rental yields, while others will offer lower capital growth but better rental yields. Be clear about which will suit you and what you can afford.

Cash flow

An important consideration is your cash flow. Investment properties are normally cash flow negative - that is, you usually spend more on finance, maintenance and operating costs than you make back through rental income.

You should develop a gearing strategy (either positive, neutral or, most likely, negative) that takes into account taxation allowances for things like building, furniture and fixtures depreciation.

Before investing, it's vital to prepare a budget that quantifies what your cash flow position will be, as you'll be the one who has to meet any shortfalls. If in doubt, consult your accountant or property specialist.

Investment loans

When taking out a loan for your investment, it's critical that the loan support your investment strategy.

For example, taking out a five year fixed loan but then selling after three years will create some hefty interest penalties. Similarly, if your loan doesn't support lump sum or additional payments, you may not be able to pay it off as quickly as you'd like.

You should also check that your lender will accept your investment structure - that is, whether you're buying in your own name, or through a company or trust.

What and where

The biggest decision to make is what to buy and where. Do you want to invest in the inner city, the suburbs, the outer suburbs or a regional area? Will you invest in a house, an apartment, or a flat? How close will your investment be to schools, transport and shops?

These factors will determine not only the cost of your investment, how much rent you'll charge and the type of renters you'll attract, but ultimately the profit and capital gain you'll realise.

Be sure to research the market thoroughly before making your choice. Speak to estate agents, purchase property reports (especially those that detail high-yield and high-growth suburbs), and attend auctions to get a feel for price and rental returns.

Evaluate your potential investments from a renter's point of view. Be wary of buying anywhere where rental vacancies are more than 3 per cent, as this can indicate poor rental demand.

How to decide

A quick way to compare different property types and different locations is to calculate an annual return. To do this, divide the annual rent by the property's total cost. For example, the annual return on a property worth $350,000 with a rental of $27,000 per annum is 7.7 per cent (27,000/350,000).

A more comprehensive way to compare investment properties and their returns is to undertake a full cash-flow analysis - accounting for each property's rental income, outgoings, taxation, capital gain and capital gains tax.

Managing risk

Buying property is a big commitment and you need to protect yourself against the threats to your investment - both before and after you buy.

Beforehand, make sure your research shows that you're buying in an area that offers the right combination of rental demand and capital growth.

As a landlord, you'll be responsible for repairs and maintenance, so spend that little bit extra on a professional structural survey and pest inspection to discover any faults in your potential investment before you have to pay for them.

After you've bought, protect your investment with insurance such as building, contents, loss or rent, theft by tenant and liability. Without adequate insurance, you could be wiped out if things go horribly wrong.

Remember that your mortgage has to be paid whether or not you have a tenant, so set aside at least three months' outgoings just in case.

Finally, if you're looking to develop a property portfolio, don't put all your eggs in one basket. Diversify your risk by buying different types of properties in different places.

Summing up

While property investment can be a great way to build wealth through a familiar asset, there are no guarantees. Be sure to do your home work when choosing a property and be clear about your investment strategy and cash flow needs.

Above all, get the right home loan for the task at hand and take steps to minimise your exposure to risk. That way, you'll be able to enjoy the highs of property investment while being better placed to ride out its lows.

Are you thinking about investing in property? Have you already done so and have a tip to share? What investment did you make and what has been the result? (tell us below).

Thinking about buying a home? Visit Our Home Sweet Home for everything you need to know about home buying, including a free seven week email course. Follow Pete on Twitter and join the conversation at the Our Home Sweet Home blog.