Making quality property stack up

Investing in property is a numbers game … but the benefits are there for those with spare cash flow.

PORTFOLIO POINT: While the primary focus for geared property investing should be asset growth, there can also be substantial tax benefits for high and middle-income earners.

Last week I charted a course for the cautious investor – an individual who recognises the opportunities to be had in today’s more affordable and transparent market but perhaps isn’t quite prepared to go full steam ahead.

Whilst not completely throwing caution to the wind, there will come a time, I believe, sooner rather than later when it will be appropriate to up the ante just a little.

Here we are at the start of a new cycle and I’m seeing smart investors getting in whilst it is quiet before everyone else jumps on the bandwagon.

So let’s set aside the dinner party debate on whether the market has bottomed. Instead, let’s turn our attention to the business of prudent investing and the practicalities of investing in property in today’s transparent market.

For most investors, funding and holding costs go hand-in-hand with asset selection, so I’m going to answer one of the most pertinent questions of the prospective investor: How much spare cash flow will I need to fund a quality investment property?

It’s pertinent, because there will be a gap between incomings (essentially rent) and outgoings (debt repayment, management fees, maintenance costs, rates and so on) that will need to be covered until the process of debt reduction and rental income growth finally whittles most of that gap away.

It’s also a mature, insightful question because it is a rejection of the flawed thinking associated with the positively geared, high-yielding property proposition that you can be in the black from day one of your investment and still buy a solid, growth-oriented asset rather than something that is doomed to low capital growth. Let’s be very clear. The only justification for borrowing money to invest in property is growth in the asset’s value.

That point clarified, let’s consider the funding costs for a $400,000 property, a $700,000 property and a $1 million property. We’ll model this for a top-tier marginal income taxpayer (annual income of $180,000-plus) and a second-tier marginal income tax payer (annual income of $80,000-plus). We’ll also make a few simplifying assumptions:

  • the investor is borrowing a sum of money equivalent to the full purchase price, but has enough cash or equity in another asset to cover other transactions costs such as stamp duty, legal fees, loan fees and so on;
  • the investor will take out an interest-only loan at 6%; the gross rental yield is 4%, and management and maintenance costs consume 25% of the gross rental income.

Top-tier income tax payer

It is for those on the top-tier marginal income tax rate of 46.5% (including the Medicare levy) that the tax benefits from investing in a negatively geared property are greatest. As the table below shows, after tax, investors on the highest marginal tax rate need to find $535 a month to fund a $400,000 property; $937 a month to fund a $700,000 property; and $1,338 a month to fund a $1 million property.

$400,000
Property

$700,000
Property

$1 million
Property

Gross annual
rental income

$16,000

$28,000

$40,000

Management and
other ongoing costs

$4,000

$7,000

$10,000

Net annual rental income

$12,000

$21,000

$30,000

Annual borrowing costs @ 6% interest only

$24,000

$42,000

$60,000

Funding difference per annum before tax

$12,000

$21,000

$30,000

Funding difference per annum after tax

$6,420

$11,235

$16,050

Monthly cost after tax

$535

$936.25

$1,337.50

Second-tier income tax payer

For those at the second-tier marginal income tax rate of 38.5% (including the Medicare Levy), there is still a generous concession from the Tax Office. An entry level $400,000 property will cost $625 a month after tax.

$400,000
Property

$700,000
Property

$1 million
Property

Gross annual
rental income

$16,000

$28,000

$40,000

Management and
other ongoing costs

$4,000

$7,000

$10,000

Net annual rental income

$12,000

$21,000

$30,000

Annual borrowing costs @ 6% interest only

$24,000

$42,000

$60,000

Funding difference per annum before tax

$12,000

$21,000

$30,000

Funding difference per annum after tax

$7,500

$13,125

$18,750

Monthly cost after tax

$625

$1,093.75

$1,562.50

Johan Vloedmans, director at chartered accountants Chambers & Partners was kind enough to sanity-check my numbers.

He did warn that taxpayers looking to use the monthly costs listed in the tables as a guide for budgeting need to be mindful that they won’t receive the tax rebate until after the end of the tax year, though he did add, “you can provide your employer a written request and lodge a form with the Tax Office that reduces the tax deducted from your pay each month in line with the applicable negative gearing benefits from your investment property.”

Of course, I don’t wish to play down the challenges for individuals or families to budget for the additional impost of property investment. 

But the reality is that investing in your future financial security does require a sacrifice today in return for a superior return over the medium to long term.

If you’re fortunate, there are occasions when changes in life circumstances sees unallocated cash flow rise, such as a good promotion/pay rise at work, a change of job, a formerly part-time working parent becoming full-time, or the end of child care, school or tertiary education fees.

Conclusion

The supreme act of discipline is not to automatically increase our consumer spending habits to swallow all this extra cash flow but to allocate it to productive investment purposes. And with the property market demonstrating a firming trend, combined with great value at the moment, in a few years’ time you’ll be delighted you took the plunge today.

Property Q&A

This week:

  • Will my neighbour’s new house detract from my value?
  • Is the Northern Busway a positive for property?
  • Where to invest in Perth?
  • Can I deduct investment advisor fees?


Will my neighbour’s new house detract from my home’s value?

I live on a lovely street in an inner suburb of Sydney that consists mostly of weatherboard and brick Victorian and Federation architecture, but it’s not heritage listed. I’ve just received notice from my neighbours that they are seeking planning permission to pull down their Victorian weatherboard and replace with some modern, avant garde designed house. Will the new house detract from the value of my home?

Consistency is preferable, but sadly not always entirely achievable. Realistically, you cannot ensure the consistency of the presentation of all properties in a street – although you hope that you are surrounded by like-minded individuals. For what it’s worth, as long as the new dwelling is well designed and works with the streetscape in spite of its vastly different architectural style there shouldn’t be much of an issue. Usually clean lines rather than columns and pillars characteristic of ‘McMansions’ will be considered more desirable, even within the scope of slightly diversified architecture.

As most people recognise this, I don’t think this new property will necessarily affect the value of your property as long as there is no other issue such as the new property overlooking yours.

It may be worth obtaining a copy of the plans and having an architect review them to see if there is something you need to challenge.

Is the Northern Busway a positive for property?

Do you see the development of the Northern Busway in Brisbane as a positive factor for investing in the suburbs it serves?

The Brisbane Busway system is a network that offers customers the sort of comfort and timeliness associated with train travel without the high infrastructure costs associated with rail. Features include dedicated bus-only roads, good frequency and bus stations rather than bus stops.

In recent times, the Northern Busway, which runs from Brisbane’s central district, was extended from Herston to Windsor in 2009 and then on to Kedron in June 2012, around 8 kilometres from the CBD.

The suburbs more recently served by the Northern Busway – such as Windsor, Lutwyche and Kedron – have undoubtedly already benefited from their proximity to Brisbane’s CBD which put them on investors’ radar. The intensification of existing infrastructure is a worthy strategy and one that has had positive impacts in other major Australian cities. Transport links provided by the Northern Busway will cement these suburbs’ appeal for investors.

Where to invest in Perth?

Thank you for your advice on the cautious investor. I have $500,000 to invest in Perth, a little more than the minimum $350,000 that was suggested in the article. Where’s the best locations to invest that sum of money?

In the first instance, don’t rule out the areas I mentioned last week – North Perth, Mount Lawley and Inglewood just north of the city, Subiaco and Leederville to the west, and East Fremantle and Melville to the south. Your larger budget just opens up a wider spectrum of opportunities. Rather than focusing on one-bedroom apartments, you may well be able to consider two-bedroom apartments as well. Separately, for this level of budget you could also consider a good on- bedroom apartment in South Perth.

Can I deduct investment advisor fees?

If I engage a property investment advisor to assist with buying an investment property, is their professional fee tax deductible?

The good news is that the fees are treated favourably by the tax system, although the benefit may not accrue immediately. If the fees are for advice pertaining to a portfolio review or commission charged by a property manager, the fees are tax deductible. If the fees are for the search and purchase of an investment property, the fees are added to the capital base when calculating the capital gains tax payable upon sale. Please ask your accountant to check your circumstances.


Monique Sasson Wakelin is a co-founder and director of Wakelin Property Advisory, an independent firm specialising in acquiring residential property for investors. Monique can be found on Twitter: @WakelinProperty.

Note: We make every attempt to provide answers to readers’ questions, however, answers are of a general nature only. Subscribers should seek independent professional advice for more in-depth information that is specific to their situation.

Do you have a question for Monique? Send an email to monique@eurekareport.com.au

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