The Australian property investment guide

ForewordMaking a Property Investment Decision Why Invest In Property? What do people want to achieve from a property investment? What returns can I get? Is Property Worth It? Can I a Can I afford an Investment property? Comparing Properties in the Market Types of Property Property Investment RisksPurchasing A Property The Purchase Process Contract Date Settlement Date Settlement Date Conveyancing and Solicitors Building Approvals Initial Purchase Costs Stamp DutyFinancing: Home Loans Borrowing Considerations Investment Gearing Investment Gearing Why do people practice negative gearing? Owning and Managing an Investment Property Accounting Expenses Agent’s Commission Body Corporate Fees / Strata Council Rates Repairs and Maintenance Repairs and Maintenance Electricity & Water Charges Bank Charges on a Loan Insurance Land Tax Record Keeping Property Investing Tax Implications Depreciation Depreciation Borrowing Costs and Deductions Capital Gains Tax (Greg) Where To From Here? Disclaimer and Conditions

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Dear Existing and Potential Property Investor,

Whether you are looking to buy your first property investment or your next one, this guide is designed to help you understand the risks, benefits and how to buy property in Australia.

It is important for you to do your research and understand what you need to be looking for to ensure you choose a suitable property. Real estate has been a significant wealth creation tool for many Australians and it looks like this will continue over the long term given the trends we have seen in the past twenty years or so.past twenty years or so.

This guide will take you through the key steps you need to be aware of before purchasing a property for investment or even as a home. Please take the time to read through this information, and let us know if you have any queries or concerns, or would like any further information on purchasing your property.

When you are ready to take the next step My Money Calculator will be happy to put you in touch with the right professionals to help you. Simply visit www.mymoneycalculator.com.au/quote

Kind Regards,Kind Regards,

Foreword

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Property has long been Australian’s preferred asset class for investment. Investing in property has helped build wealth for Australians and helped investors achieve their desired lifestyle. Here we examine some common reasons to invest in property as an asset class and answer some crucial questions that come up when making a property investment decision.

Making a Property Investment Decision


Here are 8 reasons to invest in property as an asset class:

1. People need somewhere to live; residential property satisfies this need. An individual’s demand, requiring somewhere to live, creates a market.2. Property provides a level of “bricks and mortar” security.3. Assuming appropriate population demographics, the demand for housing grows and therefore property values should appreciate. This, in the past, has provided some protection against the eroding e eroding effects of inflation.4. Financial institutions have traditionally been comfortable lending money with residential property as security; this enables you to leverage your investment.5. Tax benefits from offsetting income against expenses to create a deductible loss. Generally, new property and any improvements can be depreciated which in turn creates higher tax deductions.6. The ability to use equity in an existing property to finance the purchase of an investment property and have the tenant assist with the repayment of the mortgage.7. 7. You maintain direct control over your investment. For example, if you were unsatisfied with your property manager you would give them the appropriate notice and appoint a new manager.8. Lending institutions have traditionally been comfortable with property that enables them to lend significant amounts using the property as security. This can be useful to raise capital for other types of investments or other interests such as starting your own small business or helping your children buy their first property and diversification into other asset mediums (shares).


Some goals for property investorsare as follows;

• To create a passive income stream• To assist in building wealth in a tax efficient way• To assist in providing an income for retirement• For owner occupier purposes (as a principle residence or holiday home)• To diversify an investment portfolio• • To provide protection against inflation• To provide good leveraging opportunities

Let’s take a look at how property has performed over the past decade to help get an understanding of the returns that have been delivered to investors.

Why Invest In Property?

What do people want to achieve from a property investment?

What returns can I get?


Source: RP Data August 2012.

Capital Growth – Historically houses have provided higher capital growth than units, however in recent years units have started to outperform houses in many capital cities.

An interesting trend that has been occurring across the combined capital cities is that units have recorded average annual growth of 3.6% over the past five years compared to 2.2% growth annually for houses.

The performance of units has outperformed that of houses over the past five years in Sydney, Melbourne, Brisbane, Perth and Hobart. According to RP Data “This is most likely a response to affordability constraints present in the market and subsequently buyers seeking more affordable alternatives to detached houses. “alternatives to detached houses. “



Many people are seeking more convenient living quarters, smaller families and more focus on lifestyles. This could be one of the main causes as to why apartment style living is on the rise.

We examine more important factors that can affect house prices in the Purchasing A Property section.

Here we attempt to answer the big question: is property worth it? We provide an example of an average investor looking to buy property and compare a scenario with a property purchase versus a scenario with no property purchase. This example has been created using the Investment Calculator from My Money CalculatorCalculator that you can download for free from our website.

We provide the numbers to support the conclusion and outline all the major key assumptions. Of course everyone is different and for that reason we encourage you to download the Investment Calculator and test scenarios with your own figures.

Frank is an IT Manager, living in Melbourne and is 35 years old with $100,000 in savings and earns roughly $100,000 a year. He would like to know if an investment property could improve his financial position in the future and is concerned that just savings money in the bank will not be sufficient to have a comfortable financial future.a comfortable financial future.

In this scenario Frank does not purchase a property and continues to put his leftover cash into a savings account earning 4.5% a year. Of course he needs to pay his living expenses which we assume increase at a 3% rate of inflation.

At the end of one year Frank’s cash flows look like this:

Over 30 years Frank continues with this approach and ends up with total assets and equity of 1,816,084 at the age of 65.

Is Property Worth It?

Our Investor Profile

Scenario 1 – No property purchase



In this scenario Frank decides to use his $100,000 in savings as a deposit to buy a $500,000 residential investment property with the following details. We will explain each of these investment property costs later in the guide.

Frank’s cash flows now and at the end of one year are shown below. Note now is time 0 where Frank draws down some money for a loan and purchases the property.


Scenario 2 – Property Purchase


We note that Frank has less cash leftover at the end of the first year in this scenario. However how much will Frank have in equity at the end of 30 years, when he is age 65? Well we assume an average growth rate for the property of 6% each year. This is the average growth rate for established homes in Australia over the past 10 years as reported by the ABS. We also assume the rent increases at 3% a year with a 2% vacancy rate.

The figures below show how Frank’s assets, loans and equity grow over a 30 year period.

You can see that Frank now has $4,383,247 in equity at the end of 30 years in the property scenario and with the loan be fully repaid.

While Frank initially has less free cash flow from buying the property, at the end of 30 years when he is 65 years old he has $4,383,247 in equity. This is more than twice the amount of equity in the scenario without property. In fact he has approximately 2.5 million dollars more thanks to the appreciation in the value of the property. In this scenario you can get a simple understanding of how property could be a worthwhile investment.worthwhile investment.

For many first time property investors an often asked question is ‘can I afford an investment property?’ Specifically properties in Australia tend to require a significant capital outlay versus a parcel of shares for example.

Here we use the same two scenarios outlined above that involveour property investor Frank. We show how much it can cost to hold a property given the tax saving and rent.

Can I afford an Investment property?


Conclusion

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There are many different factors that can influence the performance of an investment property in regards to capital growth, rental return and resale potential. These include:

1. Age & condition of property2. Affordability within the suburb3. Availability of property within the suburb4. Internal and external size of property5. 5. Type & style of property6. Populations (rate of increase or decrease)7. Infrastructure within the suburb8. Proximity to amenities9. Zoning changes10. Employment levels11. Demographics of the suburb12. 12. Affordability of finance13. Percentage of investors in the area14. Proportion of property price that can be attributed to land only

We can see that the property will cost roughly $3,800 in the first year as a large portion of the costs are covered by the tax saving and rent. The out of pocket cost is around $72 a week. In simple terms if it costs Frank to hold the property $3,800 per annum and he achieves a 5% capital growth on the $500,000 property he 5% capital growth on the $500,000 property he increasing his capital by $25,000 per annum. Not a bad return.

These calculations were performed using the Investment Calculator (http://www.mymoneycalculator.com.au/investment-calculator/) available for download from My Money CalculatoCalculator. We encourage you to download the calculator to test out your own scenarios.

Comparing Properties in the Market


In short there are a lot of considerations for comparing properties. These factors are not easy for newer investors to assess and it can be extremely time consuming to do perform a detailed analysis. For this reason it is often recommended to speak with a property professional. My Money Calculator has partnerships with experienced property advocates that can help buyers find the right property. To see what they can do for you simply visit www.mymoneycalculator.com.au/quote

We can define 6 key property types as below.

1. 1. Town Houses2. Houses3. Land4. Units5. Commercial 6. Industrial

Certain considerations should be made when considering investing in a house or a unit. WWe have listed some of these.

There are many risks associated with investing regardless of your level of experience. Some investors invest in property that they perceive to be risk free, however this may not be the case. Risk does exist, and so there are ways to manage these risks. Below we outline some of the risks you may encounter along with information on possible ways to manage them.


Types of Property

Property Investment Risks


Potential Risk

Interest Rate increases

Tenant Damage

Natural Disaster

Unemployment

Capital Depreciation (loss on property value)


Fix the interest rate on the loan to help plan for repayments for a nominated period. Do your research, often the structuring of your loans can be more important than just getting the cheapest rate. Speak to a mortgage broker if you are unsure.

An increase in interest rates relates to a greater expense and where a property is used to produce income this can be offset slightly by theincreasing tax deductibilitincreasing tax deductibility.

Typically as interest rates increase so too does the demand for rental property (increased rental demand) as first homebuyers are pushed out of the purchasers market. Rental income streams can rise with interest rate hikes which can offset such increases.

Alternatively it may make sense for you to keep extra cash or equity on hand as a buffer.

Suitable insurance policies have been designed to protect landlords against tenant damage (consult with an Insurance Adviser/Broker). This policy is often referred to as Landlords Insurance.

Suitable Landlords Insurance can protect against fire or flood, etc. (Consult with your General Insurance Adviser / Broker).

If unemployment occurs due to retrenchment or other reasons it then becomes a question of the duration of unemployment. Assuming this event is short term the effects can be managed through budgeting, cash savings, equity and access to other income streams.

Conduct research of the historical performance of an area.

Research comparable properties in that particular area. Although historical evidence and trends do not guarantee future performance it may provide some basis to assist you in making an informed decision.

Research into development of infrastructure within the area of the property may identify factors that could lead to capital depreciation such as zoning changes.changes.

Risk Management

11



Prolonged Vacancy Period

Poor Building Work

Investment Gearing Risk

Loss of Income

You can reduce the rent to meet market demand while it recovers or consider other ways to make it more attractive to rent such as a some capital improvements like paint, carpets and internal appliances.

If buying off the plan, research the developers past completed properties, or have someone it for you like a registered property agent.

If buying an established property, have a building inspection done by a qualified building inspector.

Gearing levels should be set in accordance with an investors comfort zone and may be reduced by placing spare cash flow into the repayment of the borrowed principle. Also the banks have specific limits they will lend you based on your income, assets and property valuation. A typical investor may borrow up to 80% of the asset value before additional costs are incurred such as mortgage insurance.

If unemployment happens due to sickness or accident suitable insurance policies are available such as income protection, trauma insurance and life insurance, specifically designed to manage this risk. There are many things you need to consider when getting insurance, so getting professional help should be a priority.

You can get a free professional insurance quote using our enquiry form http://wwhttp://www.mymoneycalculator.com.au/free-insurance-quote/Alternatively consult with a financial adviser or Insurance broker.

NOTE: Most investments bear some risk and property is no different. Your ability to manage these risks will provide potential to generate wealth successfully over the longer term.


When you decide to take the plunge and buy a property it is important to understand what is involved in the purchase process.

Purchasing A Property


The purchase process can be a lengthy and complex. The whole process can be greatly assisted with the help of an experienced property professional. To get help finding the right property take advantage of one of our partner services here: http://www.mymoneycalculator.com.au/quote/

• Areas/ locations• Types of property• Price range

• Property inspection• Property inspection• Aspects, whether it has views, sun and other features

• Provide personal details and solicitors details• Hold property until exchange period• Check Valuation• Research rental reality of property• Ensure investor/owner ratio is not breached

• Occurs when both parties are satisfied with the contract• Occurs when both parties are satisfied with the contract• Solicitors (for vendor and purchaser) meet and exchange contracts• 10% deposit (cash or deposit bond) handed over to the vendor’s solicitor at this time• Once this has occurred then the purchaser will have secured the property

• Obtain relevant insurance• Arrange property management• Complete Finance

• Balance of contract price paid to • Balance of contract price paid to Vendor• Take possession of property• Find tenant• Obtain depreciation schedule

As mentioned this is can be an incredibly lengthy, stressful and complex process without the right knowledge. Below we provide a guide to understanding some of the most important points in the purchase process.

The Purchase Process

1. Analysis

2. View Property

3. Select a Property

4. Exchange

5. Prior to Settlement

6. Settlement



The Contract Date is the date that the contract of sale is signed. It is sometimes referred to as the sign date. A binding contract doesn’t exist until it is signed by both parties.

Two copies of the contract are drawn up so that both parties may sign identical copies. A binding contract does not exist until the seller formally accepts an offer in writing.

The deposit will be payable once the cooling-off period has expired.

In most Australian states there is a cooling-off period unless you buy the property at auction. This means that you have a short period of time to change your mind about purchasing the property. The amount of time differs from state to state.

On the contract date the property may no longer be covered by the selleOn the contract date the property may no longer be covered by the seller’s insurance. For this reason it is recommended that the buyer takes out building insurance that will kick in from the date of signing the contract. This will most likely be recommended by the bank you are borrowing with so that the bank is protected.

The Settlement Date is the date that settlement for the property occurs. “Settlement is the official process of legally transferring a property from one person to another. It is usually conducted by the legal and financial representatives – eg. Conveyancers (lawyers) of both the buyer and the vendor.”

Source: South Australian Government

The settlement date for a property is specified in the contract of sale for the propertThe settlement date for a property is specified in the contract of sale for the property. It is usually around 4-8 weeks from the contract date.

Contract Date

Settlement Date


What happens on the contract date?

Cooling off period

Insurance

When Is the Settlement Date?


A lot of important steps in the purchase process occur on settlement date including:

The balance remaining after deposits is paid to the seller

Legal documents are lodged with the required agency including:

Memorandum of transfer: transfers the Memorandum of transfer: transfers the Title Certificate from the seller to the buyer

Memorandum of mortgage: the buyer’s mortgage is registered on the Title Certificate

Discharge of mortgage: the seller’s mortgage is removed from the mortgage is removed from the Title Certificate

The Title Certificate is transferred to the buyer’s name

The buyer takes legal ownership of the property

Payment of rates and taxes is transferred

Up until the settlement date the seller is Up until the settlement date the seller is responsible for rates. After settlement the buyer becomes responsible

Once the settlement process is completed the buyer can take possession of the property and contact the seller to get the keys.

Once you have signed the contract and the cooling off period expires the contract becomes legally binding. It can become very expensive to cancel the contract. This is because the seller will be entitled to some compensation for going through the selling process only to have the buyer pull out.

The compensation amount is usually the amount it The compensation amount is usually the amount it would require for the seller to restart the selling process again including any loss on the subsequent sale. Meaning if the seller re-sells the property for $100,000 less than what you had signed the contract of sale for they may demand $100,000 compensation.

Here we provide an overview of another important step in the purchase process; property conveyancing. step in the purchase process; property conveyancing. The information is sourced from the NSW Department of Fair Trading however it is relevant for most other Australian States & Territories.

If you want to buy or sell a home, land or investment property you’ll have to sign a contract. The legal work involved in preparing the sales contract, mortgage and other related documents, is called mortgage and other related documents, is called conveyancing. It’s possible to do your own conveyancing, however, most people get a licensed conveyancer or solicitor to do the work for them.

Conveyancing and Solicitors

What happens on the contract date?

Cancelling the contract before the Settlement Date

What Is Conveyancing?


When do I get the keys for the property?


Three options for conductingconveyancing are:• using a licensed conveyancer• using a solicitor• doing it yourself.

Before you start organising your conveyancing, itit’s important to do your homework first.

In most states, conveyancers must be licensed with relevant state body. Most conveyancers hold an unrestricted licence that allows them to perform the full scope of conveyancing work for residential, commercial and rural property. Conveyancers are licensed to do legal work such as preparing documents, giving legal such as preparing documents, giving legal advice on contracts and explaining the implications. Before you decide to use a particular conveyancer, check if they are licensed with the relevant state authority.To find a conveyancer, look them up in the Yellow Pages under ‘Conveyancing Services’ or call one of the professional associations or call one of the professional associations listed on the relevant state authorities website.

Licensed conveyancers must have professional indemnity insurance to protect you in case they make a mistake or are negligent in their work. If they are dishonest with the money you have entrusted to them, you may have access to the Compensation Fund administered by the stateCompensation Fund administered by the stateauthority.

While conveyancers and solicitors are equally qualified to do conveyancing work, solicitors can also give you legal advice about other matters.

Solicitors, like licensed conveyancers, must also have professional indemnity insurance also have professional indemnity insurance for your protection.

To find a solicitor who does conveyancing:

• look up the Yellow Pages (under ‘Conveyancing Services’)• call the relevant Law Society for your state• do a search for specialists in ‘property law’ in your local area using the ‘Find a Lawyer’ page on the Law Society Society’s website www.lawsociety.com.au

Doing your own conveyancing can be risky because you can’t get the same insurance available to a licensed conveyancer or solicitor. This means that if you make a mistake you are responsible and there’s nowhere you can go for financial compensation. For example, your solicitor or conveyancer may fail to make sure the vendor has disclosed everything they are legally vendor has disclosed everything they are legally required to, such as an order to demolish the place. If you suffer loss as a result of this negligence you may be able to take action against them.

Do-it-yourself conveyancing kits are available from:

• Law Consumers’ Association Tel: 9564 6933• Australian Property Law Kits Tel: 1800 252 808.

The conveyancing process can involve the following The conveyancing process can involve the following steps:• arranging building and pest inspections• examining a strata inspection report if the property is part of a strata scheme• arranging finance if necessary• examining and exchanging the contract of sale• paying the deposit• paying the deposit• arranging payment of stamp duties• preparing and examining the mortgage agreement

The conveyancing process can involve the following steps:

• arranging building and pest inspections• examining a strata inspection report if the property is part of a strata scheme is part of a strata scheme• arranging finance if necessary• examining and exchanging the contract of sale• paying the deposit• arranging payment of stamp duties• preparing and examining the mortgage agreement


Who can do conveyancing work?

Using a conveyancer / solicitor

Finding a conveyancer / solicitor

Doing your own conveyancing

The conveyancing process


checking if there are outstanding arrears or land tax obligations finding out if any government authority has a vested interest in the land or if any planned development could affect the property (eg. local council, Sydney Water, Roads and Roads and Traffic Authority) finding out any information that may not have been previously disclosed such as a fence dispute or illegal building work calculating adjustments for council and water rates for the property settlement overseeing the change of title with the Land and Property Information NSW Land and Property Information NSW completing any final checks prior to settlement attending settlement.

Fees will vary between solicitors and conveyancers as there is no official charge for conveyancing. In addition to a legal service fee you will usually bea legal service fee you will usually becharged for ‘disbursements’.These can include:

a title search certificate fees charged by authorities with responsibility for water, electricity, roads, schools etc. photocopying photocopying registering the mortgage.

Costs other than legal fees and disbursements will usually include:

building and pest inspections survey report establishment of mortgage home building insurance home building insurance valuation fees mortgage insurance stamp duty and mortgage duty council and water rates.

Legal practitioners and conveyancers are required to disclose their costs to clients, including the clientsincluding the clients’ right to negotiate a costs agreement, receive bills and be advised of changes, among other things.

Thinking of building a new property? You may be required to get a building approval before commencing any building in order to make sure the work complies with building standards.

Building approvals are administered by local government bodies meaning different regulations may apply depending on your state and council.depending on your state and council.

In NSW there are many exemptions for projects such as barbeques, garden sheds, fences and pergolas.

However most projects like building a one or two storey home or doing major renovations will require approval. You can contact your local council, builder, architect or the Department of planning to ensure you have the proper approval.proper approval.

Again this can depend on the state and the council. In NSW it may be possible to get approval in 10 days or less for projects such as:

one or two story homes renovations adding a granny flat adding a swimming pool. adding a swimming pool.

Below are some of the key initial purchase costs involved when purchasing a property.

Purchase price Stamp Duty on the purchase price Solicitor fees to purchase

Building Approvals


Initial Purchase Costs

Conyancing / Solicitor Costs

Do I need a building approval?

How long does a building approval take?


• Solicitor fees of the lender• Mortgage insurance (if applicable)• Mortgage application fee• Stamp Duty on the loan• Registration fees• Valuations• Cost of deposit bond (if required for exchange)• Cost of deposit bond (if required for exchange)

So you’ve done some research on buying a property and have seen stamp duty come up a fair few times. What is it and how painful will it be?

Stamp duty is a tax payable on the sale or transfer of a property.

Stamp duty is administered by state authorities so Stamp duty is administered by state authorities so the rules differ according to state. Generally stamp duty is payable on all property sales and transfers after the date of exchange of contracts. In NSW the duty is payable within 3 months. The buyer pays the duty not the seller.

What about off-the-plan properties?

Thankfully many states (including NSW) will allow Thankfully many states (including NSW) will allow some concessions on off-the-plan properties. Payment of the duty must be made within 3 month of either the completion of the agreement, the assignment of the whole or any part of the purchaser’s interest under the agreement, or the expiration of 12 months after the date of the agreement. agreement.

The amount of duty is calculated based on the ‘dutiable value of the property’ at the time of sale or transfer. The dutiable value is the highest of:

1. The purchase price2. The market value of the property

As stamp duty is administered by state authorities the amount varies according to the state. Concessions (stamp duty discounts) also vary by state. You can calculate the stamp duty payable in your state using our stamp duty calculator available here: our stamp duty calculator available here: http://www.mymoneycalculator.com.au/stamp-duty-grants-calculator/

There are two options for paying stamp duty.

Conveyancer / solicitor

If you are using a conveyance or solicitor when purchasing the property they can handle the payment of stamp duty on your behalf.of stamp duty on your behalf. This is the easiest and often recommended option..

Pay through the state authority

If you are not using a conveyancer or solicitor you can contact the relevant state authority for payment options which may include the ability to pay via cheque at their physical office.


Stamp Duty

What is stamp duty?

Do I have to pay stamp duty and when?

How much is stamp duty? Can I get a concession?

How do I actually pay stamp duty?


For most property investors they will finance the purchase of a property using a loan. This carries some important considerations which we outline below.

Financing : Home Loans


It is crucial that you understand each of the following points associated with borrowing funds for your investment:

• Interest rates may increase over the term of the investment/loan, therefore creating a greater impact on the cash flow requirements for the investment. investment.• It is recommended to be in a position to afford all interest payments during any periods where the income from the property is insufficient, alternatively you should have three (3) months payments held in an “at call” cash account and/or a structured income plan.• It is recommended to have the appropriate • It is recommended to have the appropriate insurance in place to keep up payments where you are unable to work due to sickness or accident (speak to a licensed adviser).• Where possible, it is recommended obtain a loan that allows for early repayment with minimal penalties.• It is recommended to obtain independent advice • It is recommended to obtain independent advice from your taxation adviser in relation to the potential tax implications of the investment you are implementing prior to purchasing a property.• You should be aware that legislative changes could affect the taxation treatment of the borrowings, or the general market price of your proposed investment. proposed investment.

Gearing involves using borrowed funds to purchase an investment. The risk of the investment is increased as a direct result of the level of borrowed funds. There are three categories of gearing.

• Positive Gearing is when the return from the investment is greater than the cost to service the loan on the investment in after tax dollars. The level of positive gearing that exists will depend upon the size of the loan relative to your equity position in the investment, the after tax income return of the investment and the cost of funding the investment investment and the cost of funding the investment (total expenses) in after tax dollars. This can provide an additional income source.• Neutral Gearing is when the income return from the investment is equivalent to the cost of servicing the loan on the investment in after tax dollars. The primary objective being to seek capital growth.• • Negative Gearing is when the after tax cost of borrowings is not covered by the income return generated from the investment. The investment has a negative cash flow in after tax dollars that needs to be funded by another source. This negative cash flow is funded with the intention of seeking capital appreciation (growth) over time.

Depending on the type of investment and structure Depending on the type of investment and structure of the loan, a gearing strategy can commence as negative gearing and pass through neutral to positive gearing. The extent to which this will occur depends upon the potential of the income stream of the investment to grow and the cost of funding the investment. Alternatively, debt levels can be reduced by payments from another source.by payments from another source.

Investment gearing is one of a number of strategies you can consider as a tool in building wealth. It is important to carefully tailor any strategy to your individual situation and objectives taking into consideration your level and stability of income, taxation considerations, investment time frame, the need for flexibility and your attitude towards need for flexibility and your attitude towards investment risk.

There are two main reasons people negatively gear their investment properties.

1. To save tax2. To generate a capital gain

Borrowing Considerations

Investment Gearing Why do people

practice negative gearing?

Financing: Home Loans


The overall taxation result of a negatively geared property is a net rental loss. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income – such as salary, wages or business income – when you complete your tax return for the relevant income yeathe relevant income year.

Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year. If by negatively gearing a rental property, the rental expenses you claim in your tax return would result in a tax refund, you may reduce your rate of withholding to better match your year-end tax liabilitliability.

So instead of having the usual amount of tax taken out of your pay each pay check and then submitting a tax return to get your refund due to the negatively geared property, you can submit a tax variation and have less tax taken out of your pay to begin with.

This means getting your money sooner to put This means getting your money sooner to put into savings, to invest, or to pay down your mortgage. Getting your money sooner rather than later can make a big difference in the long run thanks to compound interest.

Property investors hope that by negatively gearing they can make money from the value of the property increasing over time.of the property increasing over time. They hope that the capital gain will be greater than the income loss.

Many property investors never plan to pay down an investment property loan and instead make interest only payments. In this way they are able to keep attaining a tax saving and hopefully the value of the property will continue to increase.value of the property will continue to increase.

Financing: Home Loans

Saving Tax with Negative Gearing

Capital Gains


Once you’ve taken the plunge and decided to purchase an investment property it is important to be aware of how to manage the investment. In particular there are important ongoing costs you should be aware of.

Owning and Managing an Investment Property


There are several ongoing costs associated with owning and running an investment property. These include:

1. Accounting Expenses2. Agent’s Commission (Management fees)3. Strata fees4. Council rates4. Council rates5. Repairs and maintenance6. Electricity and water charges7. Bank charges on a loan8. Insurance premiums9. Land tax10. Interest and/ or principal loan repayments (outlined above)(outlined above)

We provide details for each of these ongoing expenses below.

Accounting costs are those associated with paying an accountant to prepare any tax returns for the property and manage financial statements.

Accountants will charge different amounts depending on their own individual rates and the depending on their own individual rates and the complexity of the investment.

For a fairly simple annual tax return that includes an investment property an accountant may charge anywhere from $500 to $2,000.

Accounting expenses may also include the cost of preparing a depreciation schedule.

Of course if you handle all the tax aspects of the Of course if you handle all the tax aspects of the property yourself then you won’t pay any accounting expenses.

Many property investors pay a property agent to manage their properties for them. The agent will organize tenants, ensure they pay their rent, and may manage any number of other aspects to do with running the property as an investment.

These expenses will vary depending on the agent, the propertthe property, and the work required. The agent will generally take a percentage of the rental income in exchange for managing the property. This percentage taken may be anywhere between 2% to 6%.

Example:

Sandra hires a property agent to manage her investment property. The agent takes care of finding the tenants and managing them. In exchange for the tenants and managing them. In exchange for offering this service the agent takes a commission of 3% of all the rental income received.

As the property pays $500 a week in rent the agent will take 3% x $500 = $15 in commission.

If purchasing a unit or apartment that is part of a block of units or an apartment development you will most likely have to pay body corporate fees.likely have to pay body corporate fees. These fees are charged by those who manage the development and are charged to cover expenses incurred in maintaining the overall development. This could include things like maintaining elevators, parking facilities, swimming pools, or any number of other expenses.

This amount will vary depending on the facilities / amenities of the development and for a new amenities of the development and for a new development may range from $500-$1,500 a year.

Council rates are administered by and charged by local councils. They have revenue requirements in order to fund their expenses such as garbage collection.

Ongoing Costs

Accounting Expenses

Agent’s Commission

Owning and Managing an Investment Propert

Body Corporate Fees / Strata

Council Rates


The rate is different for each local council. Some administer the fees based on land value and others on property value and land value. How local councils determine the rates they charge changes almost every year and varies wildly depending on the council.

TTo provide an idea of how much you can expect to pay in council fees the Hills district council in Sydney charges roughly 0.3% of the land value in council rates.

You can read more about council rates in our council rates guide.

These are the expenses you expect to pay each year in maintaining the investment propertyear in maintaining the investment property.

From the ATO:

Expenditure for repairs you make to the property may be deductible. However, the repairs must relate directly to wear and tear or other damage that occurred as a result of your renting out the property.

Repairs generally involve a replacement or Repairs generally involve a replacement or renewal of a worn out or broken part – for example, replacing some guttering damaged in a storm or part of a fence that was damaged by a falling tree branch.

However, the following expenses are capital, or of a capital nature, and are not deductible:

• Replacement of an entire structure or unit of • Replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)• Improvements, renovations, extensions and alterations• Initial repairs – for example, in remedying defects, damage or deterioration that existed at the date you acquired the propert at the date you acquired the property.

Generally the tenant will pay the cost of electricity. However whether or not they pay a water charges as well can depend on whether the property has separate water metering. Many apartments will not have separate water metering and so the landlord will be responsible for the cost. If the tenant pays you are not entitled to a tax deduction and it will also not anot entitled to a tax deduction and it will also not affect your cash flow.

These costs will vary depending on the electricity and water usage by the tenants. Generally they are billed quarterly.

Expected electricity charges for a property

Electricity charges for a 2 bedroom apartment with 2 occupants on Sydneyoccupants on Sydney’s North Shore are approximately$1,000 a year.

Expected water charges for a property

Water charges will differ depending on the city or town the property is in. Water charges are divided into a connection fee that is charged for being connected to the water system and a usage fee that is charged based on usage.based on usage.

Water usage will depend on factors such as;

• whether there is a garden• how many loads of washing are done• the length of showers taken• water efficiency of showers, washing machines etc.

Residential houses can expect usage of 100-400 litres a day which will result in a water charge of roughly a day which will result in a water charge of roughly $100-$300 a year.

Connection Fee ChargeFrom Sydney Water:

“For the period 1 July 2010 - 30 September 2010, the quarterly water service charge for residential properties will be $31.33 and then $31.30 each quarter from 1 October 2010 until 30 June 20October 2010 until 30 June 2011.”


Repairs and Maintenance

Electricity & Water Charges


Water Usage ChargeFrom Sydney Water:

“All metered properties, and properties with a common or shared meter, pay the standard water usage price for water used per quarter. Most water meters are read once every quarter.

The standard water use price is $2.012 per The standard water use price is $2.012 per kilolitre (kL) - 1 kL is equal to 1,000 litres.”

Bank charges on an investment loan will depend on the bank and the package you sign on with.

The following is a small collection of bank charges by various banks:

Commonwealth Bank

• Standard • Standard Variable Rate Home / Investment Home Loan = monthly loan service fee $8 • Fixed Rate Home / Investment Home Loan = The monthly loan service fee is $8

ANZ

• Standard Variable Rate Home / Investment Home Loan = $5 p. month• • ANZ Fixed Rate Home Loan = Loan administration charge - $10 per month (applies during fixed interest rate period)

While these bank charges may seem small they can really start to add up over the life of the loan. $8 a month is equivalent to $96 dollars a year meaning over the course of a 30 year loan you are likely to have paid close to $3,000 just in are likely to have paid close to $3,000 just in bank charges!

These expenses are not to be confused with the upfront borrowing expenses involved in securing a loan or the loan approval fee charged by banks.

Insurance can be purchased to protect your investment properties. Insurance cover is tax deductible and can protect you against circumstances including loss of rent, rent default, theft by a tenant, building damage and public liability claims.

Insurance on building, contents, public liability and landlordlandlord’s insurance which covers rent defaults is deductible.

From API:“It is up to your tenants to take out their own contents insurance, but you as a landlord will need to have building and landlord insurance. You may also want to consider liability insurance to protect yourself should your tenants damage the investment property or your tenants damage the investment property or themselves.

Landlord insurance covers malicious or accidental damage by a tenant, legal liabilities, loss of rental income ... the list of hazards facing landlords is almost endless, and, not surprisingly, many choose to hand the day-to-day responsibility for their investment properties to real estate agents or property managers. properties to real estate agents or property managers. Any fees paid to a property manager are tax deductible and can be claimed in your annual tax return as an expense of the property.”

Landlord insurance varies substantially and depends on:

• the insurer• your past insurance history • your past insurance history o including previous insurers and past claims• your years of being a landlord and whether it is yourself or an agent that manages the property.• The property area• The property type• The security features for the property• • The rental agreement• Other rental properties you hold


Bank Charges on a Loan

Insurance

How much is insurance for an investment property?


There are a wide variety of online calculators from insurance providers that will provide you with a quote for landlords insurance including two of the largest Australian insurers AAMI and GIO.

For a first time landlord purchasing an apartment and no past insurance claims you can expect to pay between $300-$700 a year in Landlords pay between $300-$700 a year in Landlords insurance.

Land tax is a tax levied on the owners of land each year. In general, your principal place of residence (your home) or land used for primary production (a farm) is exempt from land tax. You may be liable for land tax if you own or part-own:part-own:

• vacant land, including vacant rural land• land where a house, residential unit or flat has been built• a holiday home• investment properties• company title units• residential, commercial or industrial units, • residential, commercial or industrial units, including car spaces• commercial properties, including factories, shops and warehouses• land leased from state or local government.

Land tax is a state administered tax that is different for each state. You can use our Free Online Land TTax Calculator to calculate land tax for any state.

You can also find information relating to land taxfor each individual state below:

You will need to create and maintain documents to record and support your transactions. The documents you will need to keep are:

• Purchasing documentation;• Loan documentation;• Related expenses;• Loan statements; and• Capital purchases


Land Tax

Record Keeping

What is land tax?

How much is land tax?


Once you have purchased a property for investment, any income or capital gain you make becomes assessable. Similarly, most expenses relating to the investment are deductible allowances over time. You need to consider the structure of your purchase, the way it is financed and the choice of purchasing entity.

Property Investing Tax Implications


Tax TreatmentBelow is a table that may be of assistance in understanding the likely treatment of the investment for taxation purposes.

Depreciation

Property Investing Tax Implication

Assessable for Taxation

Rental (income tax) Insurance Accounting fees

Body Corporate levies (if applicable)

Interest costs

Cleaning

General related expenses

Repairs

Management fees

Council/Water rates

Depreciation

Profit on sale

(Capital Gains Tax)

Deductible Expenses


Also known as building & construction cost. For rental properties purchased after Sep 15 1987 you can claim 2.5% of the construction costs each year over 40 years from the date the construction commenced.

Well if you are going to claim construction costs as a tax deduction each year theas a tax deduction each year the ATO would not like you to leave the cost base of the property the same as what you bought it for. Construction costs are classified as ‘Capital Works Deductions’ by the ATO and so reduce the cost base of your property. The ATO wants you to reduce your cost base by the amount of any of these ‘capital works deductionsdeductions’ you have made. So you have to reduce the properties cost base by the amount of depreciation you have claimed. So it kind of works in a sense that claiming depreciation will reduce your taxable income now but lead to an increased capital gain later.

These are items such as fridges, curtains, TVs etc.etc. These are deductible each year. The deduction can be calculated using 2 methods:

1. Prime Cost Method2. Diminishing Value Method

This will lead to an equal deduction in each year. The formula used to calculate the deduction is: Deduction = Fit-out Cost x (100% / Asset's Effective Life)An assetLife)An asset’s effective life is how long it can be used for by the property for a taxable purpose.

This method will lead to larger depreciation claims in earlier years and smaller depreciation claims in

later years when compared to the prime cost method. Deduction = base value x (days held / 365) x (200% / asset’s effective life) The base value is the fit-out value at the beginning of the year. So the base value will change each year due to adjustments to account for last year’s depreciation.

If for example you purchased $2,000 air conditioning If for example you purchased $2,000 air conditioning system (with a useful life of five years) for your investment unit on 1 July 2012. The following calculations could apply:

Calculating the depreciation rate to be claimed annually:

Prime Cost Method: 100%/5 = 20%

Diminishing Diminishing Value Method: 150%/5= 30%

Table 1.1

(The second year of depreciation under diminishing value method would be calculated as ($2,000 – 600 = $1400. Then $1400 x 30% = $420 and so on for year after)

Editors note: Notice that under the diminishing value method the there is still some value at the end of the method the there is still some value at the end of the assets useful life which can be further depreciated in later years. With the prime cost method the asset is depreciated in full at the end of its working life.

In my experience most professional investors in the higher tax bracket tend to use the diminishing value method and claim much larger amounts of depreciation in the earlier years of the life of the depreciation in the earlier years of the life of the assets. This has a significant impact on the net cash flows after tax especially if you are negative gearing.

If in doubt get a professional depreciation report to help you maximize the allowable depreciable amount on capital works and plant and equipment, the service of a quantity surveyor can help you with this.

Construction Costs

How does claiming construction cost depreciation affect capital gains tax?

A simple example of the two methods available

Fit-Out

Prime Cost Method

Diminishing Value Method



From the ATO:

Borrowing expenses are expenses directly incurred in taking out a loan for the property. They include; loan establishment fees, title search fees and costs for preparing and filing mortgage documents, including mortgage broker fees and stamp duty charged on the mortgage.fees and stamp duty charged on the mortgage.

Borrowing expenses also include other costs that the lender requires you to incur as a condition of them lending you the money for the property – such as the costs of obtaining a valuation or lender’s mortgage insurance if you borrow more than a certain percentage of the purchase price of the propertof the property.

The following are not borrowing expenses:• insurance policy premiums on a policy that provides for your loan on the property to be paid out in the event that you die or become disabled or unemployed• interest expenses.

If your total borrowing expenses are more than If your total borrowing expenses are more than $100, the deduction is spread over five years or the term of the loan, whichever is less. If the total deductible borrowing expenses are $100 or less, they are fully deductible in the income year they are incurred.

If you repay the loan early and in less than five years, you can claim a deduction for the balance years, you can claim a deduction for the balance of the borrowing expenses in the year of repayment.

If you obtained the loan part way through the income year, the deduction for the first year will be apportioned according to the number of days in the year that you had the loan.

Housing NSW estimates the following borrowing costs and explains what factors influence these expenses. This estimates are also relevant for all other Australian States & Territories.

This is the fee charged by a bank or other lending body when you apply for a loan.

Approximate cost: $Nil - $800Approximate cost: $Nil - $800

There may be additional costs preparing and registering the mortgage.

Your lender usually requires a formal valuation of the property you are buying. This fee may be included in the application fee charged by your lender.

Approximate cost: $Nil - $400

YYour lender will require you to take out mortgage insurance if you are borrowing more than a set proportion of the property’s valuation. This insurance protects the lender if you default on the loan and the property is sold for less than the outstanding loan amount. Premiums vary according to the loan amount, property price and the loan-to-value ratio. The mortgage insurance premium is a once-only mortgage insurance premium is a once-only payment.

Approximate cost: $300 - $12,000

Borrowing Costs and Deductions

Claiming a tax deduction on property borrowing expenses

How much can I expect to pay in borrowing expenses?

Home Loan Application Fee

Valuation Fee

Mortgage Insurance




The capital gain on the sale of an investment property can be subject to Capital Gains Tax (CGT).

CGT is generally only paid when you dispose of or sell the asset. Providing the investment has been held for at least 12 months, you should be eligible for the 50% Capital Gainseligible for the 50% Capital Gains Tax discount. It is important to check with your accountant or taxation advisor to see how these changes may impact your situation. Depending on the exact date you purchased the property your accountant can work out the appropriate capital gains tax amount.

Given that CGGiven that CGT is assessed when you dispose of the property it is important that you create and maintain detailed records of your expenditure relating to the investment this include depreciation and any capital works you may have made.

Capital Gains Tax


Now you have a broader understanding and deeper appreciation of why and how to invest in property. The next step is to find out how you can use this in your own situation, more importantly you need to know your numbers.

• How much can you borrow?• What financial goals do you want to achieve?• Where should you buy? • How much can you afford? • What locations are set for capital growth in the medium to long term? • What locations are set for capital growth in the medium to long term?

A lot of these questions can be answered when meeting with a professional property adviser.

Find out how you can get the best results with your property investing strategy to build wealth and live your desired lifestyle. Take advantage of one of our partner’s professional property services. Simply visit http://www.mymoneycalculator.com.au/quote/

Please contact us at [email protected] if you have any questions or would like further information.

Where To From Here?


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Real Estate

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