Why do people Buy Investment Property?
There are many reasons.
Over the years, our clients have cited the following main reasons:
- They understand property, can see it, touch it and manage it themselves.
- They are risk adverse and like the slow and steady gains in property as opposed to the potential wild swings in the share market
- There are huge tax benefits available and the Tax Office ends up subsiding your purchase over time
- One day they want to move into the investment property as their final home
- They want to use their super to invest in property via a self managed super fund (SMSF) rather than leave their super to someone they don’t even know to manage
- They want to be able to provide a property for their kids in the future as house affordability continues to deteriorate
Using Equity to Buy Investment Property
You can use the equity you have built up in your own home to buy and investment property.
Ideally you need a 20% deposit to purchase a property. You can get by with a lower % but you will need to pay loan mortgage insurance and that’s expensive.
Instead of putting down a 20% cash deposit you can use the value you have in your home.
Home Value: $ 500,000
80% Of Home Value: $ 400,000
Less: Loan Against Home: $ 250,000
Net Equity Available: $ 150,000
This $ 150,000 net equity becomes the maximum deposit you can use to purchase an investment property. This amount becomes your 20% deposit.
Assuming you earn enough and have no problems with servicing, this $ 150,000 equity can equate to a maximum investment property value of $ 750,000 (including costs)!
Of course you don’t have to buy a rental property worth $ 750,000, but this example shows you the potential power of unlocking the equity in your home.
What is Negative Gearing?
“Negative gearing” occurs when the expenses of an investment exceed the income received from that investment.
With property, it occurs when the expenses you pay (council rates, interest, water rates, etc) exceed your rental income.
When a property is negatively geared, it makes a loss. This loss is tax deductible and available to offset your other income including salary and wages income and business profits.
This means you pay less tax or get a tax refund.
The tax refund lowers the overall cost of holding that property.
In effect, the Tax Office subsidises the ownership of your rental property.
The real skill comes in maximising your tax deductions against the investment property and that is where Loan Initiatives are experts.
Rental Income $ 15,000
Less: Expenses ($ 25,000)
Rental Loss ($ 10,000)
Tax Refund at 34% effective rate $ 3,400
Tips for a Successful Investment Property
In order to get the most out of your investment property and make it a hassle free investment, every investor should consider the following issues.
Self Management vs Property Manager
Who will be responsible for collecting rent, inspecting the property and organising maintenance?
You can do it yourself or appoint a property manager, usually via a real estate agency. Property managers will charge you a percentage of rent received for their services.
Your choice will depend on whether you are interested in controlling the process and the amount of time you have.
In South Australia, the laws pertaining to investment property rental are governed by the Office of Consumer and Business Affairs (OCBA).
Unless you are planning to move into your rental property at some time in the future, it is important not to get emotionally attached to it when purchasing. Research the type of property you will be buying and remember it is an investment you are making to create wealth.
Consider what appeals to the market, not your own personal preferences.
This is readily available insurance, sometimes linked to your building insurance. Landlord insurance:
- Protects you against damage caused by your tenant to the property;&
- Gives you piece of mind that your cash flow is covered if the tenant defaults
Getting the ATO to subsidise your property purchase is one of the main drivers for many clients to purchase an investment property. Things to consider include:
- Negative gearing and its tax effect
- What your property actually costs you each week after tax
- PAYG withholding variations
- Timing of paying certain expenses
- Strategies in respect of change of use of the property
Interest only vs principal and interest
How you repay your loan can affect your tax refund and family budget position:
- Do you plan to reduce the debt quickly via principal and interest repayments
- Can you structure your affairs to maximise your tax benefits
- Would you prefer interest only repayments to maximise your cash flow for other purposes
Depending on the age of the property you buy, you may be able to claim depreciation on the building structure and all improvements over the life of your rental property.
This concession represents one of the major tax benefits of owning an investment property:
- Consider capital gains tax implications of claiming depreciation
- Engage a Quantity Surveyor who provides a money back guarantee in respect of tax savings
Capital gains vs high rental returns
Generally investors purchase properties that have either a good chance for capital growth or high rental returns.
It is rare to find a property that provides both at the same time.
- Consider your investment objectives and tax position – do you want/need instant cash flow or would you prefer to defer you tax through unrealised capital gains.