Securing a great deal is the cornerstone of any successful property investment in Australia. With property prices in major cities like Brisbane, Sydney, Melbourne, Adelaide, and Perth having increased substantially since 2013, investors are increasingly searching for a property bargain to maximise their returns and diversify their portfolios. This is where the Favourable Purchase strategy proves highly valuable.
This guide, tailored specifically for property investors, breaks down how this strategy works, how you can leverage it to potentially buy an investment property without a traditional cash deposit, and the specific lender and legal considerations in the Australian market.
What is a Favourable Purchase Under Australian Law
A favourable purchase is a financial term that means acquiring a property with a bank valuation that is higher than the purchase price. Simply put, it is paying less for a property than what the bank believes it is truly worth.
For property investors, a favourable purchase presents a critical opportunity to build equity immediately and achieve higher returns on investment upon sale or through rental yield. It allows investors to diversify their portfolios and potentially acquire multiple properties.
How Does the Favourable Purchase Mechanism Work for Investment Properties
The key to a favourable purchase for an investment property lies in leveraging the gifted equity to replace the traditional cash deposit.
Securing Finance Without a Deposit
Lenders typically require a deposit, which is a percentage of the purchase price. However, with a favourable sale, it may be possible to secure finance without a traditional deposit.
The mechanism works as follows.
Bank Valuation vs Purchase Price: The agreed purchase price for the investment property is lower than the price determined by the lender’s independent valuation.
Gifted Equity: The difference between the higher true property value and the lower purchase price is considered gifted equity.
Deposit Substitute: The lender may recognise this gifted equity as a substitute for the deposit.
For example, if an investor purchases a property for $400,000 that the bank values at $500,000, the $100,000 difference is the gifted equity. This $100,000 is equivalent to 20 percent of the true property value, which, in this scenario, may allow the investor to secure a loan without a cash deposit.
Avoiding Lenders Mortgage Insurance (LMI)
A significant cost saving for investors is the potential for a Lenders Mortgage Insurance (LMI) exemption.
LMI is generally required when a borrower’s Loan to Value Ratio (LVR) is higher than 80 percent. By purchasing below market value, the true property value is higher than the purchase price, which creates an opportunity to secure a loan with a lower effective LVR when calculated against the bank’s valuation.
A lower LVR, potentially falling below the 80 percent threshold, means the investor may not be required to pay LMI or may qualify for a reduced premium, saving thousands of dollars in mortgage costs.
What Scenarios Lead to a Favourable Investment Property Purchase
Opportunities to buy an investment property below market value can arise from several situations.
Motivated Sellers: Property owners who need to sell quickly due to financial constraints, relocation, or personal circumstances such as a relationship breakdown may be willing to negotiate a lower price.
Family Sales: A common example is when a family member sells a property at a reduced rate to assist another family member financially.
Off Market Opportunities: If a seller wishes to keep the sale private or discreet and avoids public listing, there may be fewer competing buyers, which can lead to a lower sale price.
Properties Needing Repair: Properties in poor condition or requiring urgent renovations may be priced below market value to account for the necessary investment in repairs.
Market Fluctuations: During a market downturn or slower period, sellers may be more open to accepting offers below their initial asking price.
Auctions: Opportunities can also appear when there is limited competition on auction day or when the property fails to meet its initial reserve price.
Lender Requirements and Challenges for Investors
While a favourable purchase offers substantial benefits, Australian lenders can be conservative because of the higher perceived risk of fraud, particularly when a sale is completed off market or without a real estate agent.
Investor applicants must be prepared for the following.
Independent Valuation: Lenders will always obtain their own independent valuation of the property to confirm its true market value.
Borrowing Capacity Cap: Some lenders may have policies that cap an investor’s borrowing limit at 80 percent of the property’s verified value, even when equity appears higher.
Circumstance Review: Lenders will want to understand the specific reasons the property was sold below market value, including personal or financial circumstances of the seller.
Additional Documentation: Securing approval may require extra documentation, such as valuation reports, sale contracts, or legal declarations explaining the reduced price.
Time and Effort: These opportunities are limited and often take longer to identify and approve compared with traditional purchases.
The Investor’s Pros and Cons of a Favourable Purchase
A favourable purchase offers clear advantages for investors, but it also comes with certain risks and responsibilities. The following table outlines the key advantages and disadvantages of this strategy.
| Advantage for Investors | Disadvantage for Investors |
|---|---|
| Immediate Equity Build up — The difference between the purchase price and the bank valuation becomes gifted equity, allowing investors to grow their asset base faster. | Increased Stamp Duty Cost — Stamp duty is calculated on the market value or purchase price, whichever is higher, potentially leading to a larger tax bill. |
| No Cash Deposit Requirement — Gifted equity may be recognised as a substitute for a traditional deposit, reducing the need for upfront cash. | Renovation and Repair Costs — Properties sold below market value may require significant repairs or renovations. |
| LMI Exemption or Reduction — A lower effective LVR against the true value can help investors avoid or reduce LMI, saving thousands in mortgage costs. | Competition — Other savvy buyers may recognise the same opportunity, leading to competitive offers. |
| Portfolio Diversification and Higher Returns — Investors can diversify and scale their portfolios more efficiently while targeting higher long-term gains. | Lender Scrutiny — Financing approval may require additional documentation and more stringent lender assessment. |
Stamp Duty: A Critical Tax Consideration
For an Australian investment property, it is vital to understand the potential for higher stamp duty.
Stamp duty is a state-based tax calculated on the property’s market value or the purchase price, whichever is higher. Because the property’s market value is higher than your purchase price in a favourable sale, the stamp duty will still be calculated based on the market value. This may result in being charged substantially more stamp duty than anticipated based on the lower purchase price.
Always consult with a conveyancer, solicitor, or relevant state or territory revenue office to understand the specific stamp duty implications before committing to a purchase.
The Role of a Mortgage Broker
Securing a loan for a property purchased below market value requires navigating the conservative policies of Australian lenders and ensuring all documentation is in order. A mortgage broker with experience in favourable purchase home loans can be invaluable.
They have the knowledge and expertise to:
- Guide you through the intricacies of the transaction.
- Help identify properties with the potential for a favourable purchase.
- Connect you with a wide network of lenders who offer finance for off-market or favourable sales.