Returns come from capital growth and from rental income.

Capital Growth
Capital growth is the increase in the value of your property over time and is one of the main reasons people invest in residential real estate. Historically, Australian residential property has experienced strong capital growth the long-term average annual growth rate for property is about 9 per cent but periods of stagnation and even decline are also part of the picture. The nature of the property cycle means real estate should probably be thought of as an investment with a 10-year horizon.

Your best chance of achieving capital growth is buying the right property, in the right place, and most importantly at the right price. Research current house prices. Keep an eye on sale and auction results in the papers, or buy reports on specific suburbs from researchers like Australian Property Monitors Home Price Guide. Talk to us about recent sales prices in your desired area.

Rental Income And Yield
You should apply the same standards to a property investment as to any other investment, benchmarking the potential return against what you might achieve elsewhere.  An important measure is a property's yield. That can be calculated by dividing the annual rent it generates by the price you paid for the property and multiplying that by 100 to get a percentage figure. 

Many people invest in property with the aim of taking advantage of Australia's negative gearing rules.

Negative Gearing
Gearing basically means borrowing to invest. Negative gearing is when the costs of investing are higher than the return you achieve. With an investment property, that's when the annual net rental income is less than the loan interest plus the deductible expenses associated with maintaining the property.

When your negatively geared you can deduct the costs of owning your investment property from your overall income reducing your tax bill. High-income earners benefit the most, because they are in the top tax bracket.  In addition, while you record a loss on the income from the property, in theory capital gains in the value of your property should make the investment worthwhile.

But don't over-commit to property just to get a tax deduction. Those tax benefits generally don't come until the end of the financial year and you have to make your mortgage payments in the meantime. That said, you can apply to have less tax deducted from your pay to take into account the impact on your overall income of expected losses on an investment property.

Say you earn $45,000 a year, gross, in your day job but you can reliably estimate that you'll make a $15,000 loss on an investment property. You can apply to have your tax payments calculated on an income of $30,000 rather than $45,000 giving you more cash in hand now, rather than a refund at the end of the year. Get your sums wrong, though, and you will owe the tax man money at the end of the year.

See www.ato.gov.au  for information about pay-as-you-go (PAYG) withholding payments.  Remember, too, that a capital gain which will be taxed is never assured. What is more, the benefits of negative gearing are smaller when interest rates and inflation are low and can be offset by charges such as the land tax levied.

Depreciation
The owners of investment properties can also claim depreciation of items such as stoves, refrigerators and furniture. That involves writing off the cost of the item over a set number of years the effective life of the asset. The ATO sets out what it considers to be appropriate periods. The cost of a cook top, for instance, is generally written off over 12 years you claim one-twelfth of its cost as an expense each year.

There are two different types of depreciation an allowance for assets such as the cook top, and an allowance for capital works, such as the cost of construction.  Its a good idea to talk to a quantity surveyor or other depreciation specialist right from the start, so you make full and correct use of the available depreciation allowances. The higher the depreciation bill, the higher the amount to offset against income when you're negative gearing.

Capital Gains Tax
Capital gains tax (CGT) is the tax charged on capital gains that arise from the disposal of an asset including investment property, but not your place of residence acquired after September 19, 1985. You're liable for CGT if your capital gains exceed your capital losses in an income year. (If you're smart, you'll time asset disposals so that if you really must take a capital loss it'll be at a time when it can offset a capital gain).

The capital gain on an investment property acquired on or after October 1, 1999, and held for at least a year, is taxed at only half the rate otherwise. This means a maximum rate of 24.25 per cent if you are in the highest tax bracket. The capital gain is the profit you've made over and above the cost base the purchase price plus capital expenses such as subsequent renovations. Make sure you keep good records of these sorts of expenses. Capital gains tax is a complex area, so it pays to get specific advice about how it applies in your individual circumstances.

Making Your Investment Pay
If you hold your investment property for long enough, hopefully you'll reach the stage where losses start turning into gains. The rent you're charging should have risen over time, and you'll be steadily whittling away at the mortgage. Once your rental income exceeds your mortgage repayments you'll no longer be negatively geared, however. And no negative gearing means no tax advantages but that doesn't mean you should rush to sell.

Yes, you'll have to pay more tax because the income you're making is more than your losses but the fact is you're making money, which is why you invested in the first place. The temptation may be to take your profits and plough them into another property and that can be a perfectly reasonable strategy.

Good buys aren't necessarily close to home.

Having worked through the financial considerations, and bearing in mind that you are not actually going to live in the property, you should be able to make a fairly rational decision about where and what to buy. You'll want to benefit from as much capital growth as possible, so the first rule is to buy in a growth area.  That might be a suburb located within 10 kilometres of the city centre, or a suburb with special attractions such as a beach or trendy cafe strip. Proximity to a hot suburb could mean your suburb will be next to rise in value.  It could even be a regional town supporting a booming industry.

Narrow your search down even further by looking at a property's access to transport, shops and leisure facilities and its appeal to your market whether they're young professionals or blue-collar workers. Another decision is what to buy house or unit? old or new? Units usually are a much better proposition for landlords. They are easier to rent out and easier to maintain: there's no lawn to mow, and when things go wrong in the building the expense is shared with the other owners.

Properties with a view are always more desirable than those without, and tenants like facilities such as balconies, internal laundries, undercover parking and security. These sorts of facilities may not be available in an older property, which may have to compete with a new apartment building down the road with all the mod-cons.

If the property you're interested in is already rented, ask about its history of tenancy. Have there been periods when it hasn't been occupied? If so, find out why. You don't want to inherit those problems. The bottom line: balance what you can afford to buy with the rent you'll be able to charge. There's no point buying a waterfront property if you cant find tenants happy to pay the sort of rent you'll need to make the exercise worthwhile.

Buying
Once you've found the right property, the actual mechanics of buying it will be the same as if you were buying a home to live in. There are few differences between borrowing for a home and borrowing for an investment property. Some lenders charge a higher interest rate for investment properties because they say their risk is higher, but shop around and you should be able to get a rate that's the same as for an owner-occupied property.