Investing in residential property has
many benefits, including capital growth. Property has been a
popular route to wealth for many Australians for many years. Buying
their own home is often the first investment many people make;
purchasing another property may well be the second even before
shares and other assets.
But your first investment in property needn't be your home. Buying
an apartment to rent out can be a good way to accumulate
funds so you can buy your own place. Increasing numbers of young Australians are choosing
this route, buying in one area while renting in a more expensive area or living at home for a while longer.
Still others are diversifying into non-residential property via
property trusts and syndicates. Sensible investments in property
have many attractions. Property can be less volatile than shares
though not always and it tends to be regarded as a safe haven when
other assets are declining in value.
It has the potential to generate capital growth (an increase in the
value of your asset) as well as rental income. Then there's the tax
advantages associated with negative gearing (more about that later).
Investors need to have a keen awareness of the interest rate
environment how higher rates might affect their expected net return
and the market for their property should they wish to sell. They
also need to make sure the return or yield from their property
stands up against the return they might have achieved had they
invested in shares, for example.
Returns come from capital growth and from rental income.
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 me 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.
Let's say you bought a unit for $400,000 and rented it out for
$350 a week (or $18,200 a year). That's a yield of 4.5 per cent. But
let's say you bought a workers cottage in a mining town where prices
are low but the rental income as good as in the big city. Pay
$350,000 and rent the property out for $600 a week and you will achieve
a yield of 9 per cent.
Remember, yields fall as house prices rise (if rent does not rise
commensurably). If landlords have to fight for tenants, they won't
have much pricing power with regard to rent. However, if the rental
market is tight, and tenants are competing for properties, they will be
prepared to pay a bit more to get in the door.
Many people invest in property with the aim of taking advantage
of Australia's negative gearing rules.
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
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.
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. It's 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
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 can't find tenants happy to pay the sort
of rent you'll need to make the exercise worthwhile.
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.
One option of particular interest to investors is the
interest-only loan, where you don't pay off any of the principal,
just the interest. Such a loan can make it easier to estimate
the true returns from a property. A tax advantage is that interest
payments for investment properties are tax deductible, while
payments off the principal are not.
One strategy that is being touted is to take out an interest-only
loan and divert the money you would have paid off the principal to
your tax-efficient superannuation fund. Upon retirement, you use
your super pays off the loan. Remember, though, that this money is
locked up until at least age 55 and you wont have access to it if
you strike a cash-flow problem.
Ready to look at some potential