Fountain Plaza

Corporate Building B - 1st Floor

2 Ilya Ave Erina NSW 2250

PO Box 3327

Erina NSW 2250

matt@optimumloans.com.au

02 4337 5151

0458001158

Optimum Home Loans and Finance is a credit representative (No. 461273) of BLSSA Pty Ltd (ACL No. 391237).

ABN: 33 722 525 794

Investment Property Info

Before looking for an investment property, it is worth considering the below.

 

  1. Your current financial position - Are you well placed to afford an investment property, particularly during the inevitable periods of vacancy?

  2. Can you afford a quality property? - Can you afford a property that will attract decent tenants and deliver healthy long term price increases?

  3. Where are you heading? - Are you prepared, and can afford, to hold onto your investment for the long term? Will you need access to your capital (money invested) in the near future?

  4. How much money will you need? - As with your home, purchasing an investment property can involve significant upfront costs and ongoing maintenance expenses.

  5. How much can you afford to borrow? - Getting an idea of your borrowing capacity is the first step in finding out the type of property and location you can afford. 

  6. Do you need a cash deposit? - If you own your home, did you know you may be able to use home equity instead of a cash deposit?

 

Finding the right property

 

Your investment property will ideally meet two key criteria - being affordable for you, and appealing to a wide range of tenants.

 

  1. Affordability - In the first few years of being a landlord, it's likely your property will be negatively geared, which means it costs more to own the property than it earns in rental income. While this can offer tax savings, you still need to be confident that you can cope with the expenses. Even the best properties experience some periods of vacancy, so you also need to be able to cover loan repayments when the property is not generating income.

  2. Tenant appeal - No matter how affordable a property is for you, it won’t be a successful investment if it doesn't attract quality tenants. Consider properties objectively and think about whether you’d be happy to live there. If you're not sure, prospective tenants are likely to think twice too. Once you have a clear picture of your current position, your personal goals and your ability to afford an investment property, you’re ready to start creating - or adding to - your investment property portfolio! 

 

Tip - Aim to invest in an area with a low vacancy rate. Local real estate agents should be able to provide this figure. A vacancy rate below 3% indicates an undersupply of rental properties, which means you can afford to charge a decent rent and experience fewer periods of vacancy.

 

Your borrowing capacity

 

If you currently own your home, you’ll be familiar with the process lenders use to determine your 'borrowing capacity'. It works similarly for investment mortgages, but alongside your regular income, lenders will also consider the potential rental income you’ll receive, which increases your borrowing capacity.

 

The rent earned by a property can make it more affordable for first time buyers to own an investment property rather than buying as owner occupiers. We can crunch the numbers for you to see if this could put you in front financially.

 

Using equity in your existing home

 

If you’re already a home owner and have built up some home equity (the difference between your home's market value and the balance of your loan) it may be possible to use this equity instead of a cash deposit.

 

Here's how it works. Let's say your home is worth $800,000, and the balance of your mortgage is $300,000. The difference of $500,000 represents your equity. Assuming you meet other lending criteria (such as earning sufficient income), many lenders will let you use up to 80% of that equity as a deposit for the investment property ($400,000).

 

Secure pre-approval

 

Seeking written pre-approval for a loan sets a clear limit on the price you can afford to pay, which will narrow down your property search and also show agents you’re serious about buying. We can help you to apply for pre-approval and enable you to negotiate with confidence - or bid at auction - knowing you have finance in place.

 

Rental yields or capital growth?

 

Your investment property will deliver a combination of two types of returns - regular rental income plus capital growth (an increase in the property’s value).

 

  • Yield focused strategy - The rent return is often referred to as 'yield', and is calculated by dividing the annual rent through the value of the property. For example, a property with a market value of $500,000 thatcan be rented for $485 weekly - or about $25,220 annually, would have a gross (before expenses) rental yield of around 5% ($25,000 divided through $500,000, then multiplied by 100). It’s useful to know a property's yield as it lets you compare the rent return between properties, and against other types of investments. A focus on yield can be useful if you don't want to borrow heavily, or if you’re seeking a source of extra income to live on. In some regional areas, rental yields can be as high as 10%, which is an exceptional return. On the flipside, the long term price growth is unlikely to be as strong as a metropolitan property. It's even possible to find 'positively geared' properties, where the rent covers all the expenses of the property with some extra income left over for you. By contrast, metropolitan areas - especially state and territory capitals, tend to earn a rental yield at around of 4% to 5%. This compares favourably with many cash-based investments, but remember you will also get the benefit of long term capital growth that adds to your total returns on the property.

  • Aiming for capital growth - The right property, in the right location, at the right price, has the potential to deliver rewarding rates of capital growth over time. If you’re aiming for capital growth, it’s vital that you can afford to hold onto the property until you see a substantial rise in the investment's value. For some investors this isn’t a problem because of the tax relief that comes with negative gearing, but do the sums to see if this applies to you.

 

Gearing

 

When it comes to investing, the term 'gearing' refers to borrowing to buy an asset. Most investors use some gearing in the form of their mortgage to fund their rental property. The loan interest is often a major expense but it can be claimed as a tax deduction when the property is tenanted or available to let, and this can significantly reduce the cost of the loan.

 

Whether your investment property is negatively or positively geared, you can claim a variety of property-related costs as long as the property is tenanted or available for rent. If the property is taken off the market for a period, for example, to undertake renovations, you won't be able to claim the costs that relate to this time span.

 

The following expenses can normally be claimed on tax:

 

  • Advertising for tenants, property management fees

  • Accounting fees

  • Borrowing costs like valuation fees, loan establishment/ registration fees or LMI premium (these may need to be claimed over a period of five years)

  • Interest payments and ongoing loan fees

  • Stationery, phone costs, book keeping fees and any travel relating to the property

  • Council rates, body corporate fees, land tax and strata fees

  • Repairs, maintenance, pest control, cleaning and gardening

  • Electricity, gas and water (part of these costs may be paid by the tenant in which case they cannot be claimed by you, the landlord)

  • Insurance premiums for building, contents, public liability and landlord insurance

  • Depreciation of items such as stoves, fridges and furniture plus the building

 

Most of the above expenses are normally deductible immediately in the year they are paid, while others such as borrowing costs must be claimed over a period of years.

 

Costs associated with the purchase of your property including legal fees and stamp duty can only be claimed when you determine any capital gains on sale of the property. Always seek tailored advice from a qualified accountant or tax agent when making a claim for rental property costs.

 

Negative or positive gearing?

 

Negative gearing - Negative gearing occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.

Let's say for example that Bill owns a rental property generating $25,000 in rent each year. The costs of holding the property, including mortgage interest, come to $30,000. This gives Bill a taxable loss of $5,000, which he can use to reduce the tax payable on his salary.

If you know in advance that your investment will record a loss over the financial year, you can apply to the Tax Office to reduce the amount of tax taken out of your salary. This is called PAYG Withholding Variation and it can provide a real boost to your personal cash flow. You can chat with us about options and with a tax advisor or accountant for more details.

Gearing often plays a significant role in all investors strategies. Knowing your investment strategy is important, and getting expert financial advice is smart if you need help identifying the right approach to maximise your profits.

 

Positive gearing - An investment is positively geared if it earns more in rental income each year than it costs to own the property. For example, a landlord may receive $20,000 in annual rent but only spend $15,000 on the property including mortgage interest. In this instance, the difference of $5,000 represents profit and additional income to the landlord. As this profit is taxable, landlords of positively geared properties need to set funds aside to cover the tax they will pay on their investment each year.

 

Capital gains tax

 

Capital gains tax is based on the difference between the selling price and the purchase price, which can include the sum paid for the property plus legal fees, stamp duty and other upfront costs as well as the value of any capital improvements (renovations) completed by you.

CGT only applies to properties purchased after September 1985. For properties purchased after October 1999, a discount of up to 50% may be available on the capital gain calculated for tax purposes (eligibility is dependent on the ownership structure of the investment- see your tax accountant for more information).

 

When it comes to calculating capital gains tax, the Tax Office will regard the date you entered the contract to buy the property as the date of purchase - not the settlement date. Check the calendar before you sell, as the discount only applies if you have owned the property for a minimum of 12 months. Capital gains tax can be complex, so be sure to get good advice from your accountant when selling your investment.

 

Depreciation

 

Two main types of depreciation can be claimed. The first applies to fittings and fixtures like stoves, hot water heaters, light fittings and carpets. The second relates to depreciation of the building itself. If your property was constructed between 1985 and 1987, the building cost can be depreciated by 4% annually.

Those built after 1987 can be depreciated at 2.5% each year. Have a look at www.ato.gov.au for a list of rates and effective life of depreciable items.

Depreciation is an area where it pays to get professional assistance. A quantity surveyor can inspect your rental property and draft a complete depreciation schedule that ensures you are neither missing out on depreciation deductions nor overstating your claim (which could result in tax penalties). Trying to estimate your own depreciation charge could leave you facing tax penalties if you get the figures wrong.

 

Types of loans

 

Like an owner occupier, you can choose to use a basic or more featured standard variable rate loan to fund an investment property. However there are certain loan options that can offer particular benefits to landlords. 

For tailored advice, ask us for help, we can suggest the type of loan best suited to your individual situation, goals and budget. 

 

  • Fixed rate loans - Many investors choose to fix their mortgage interest rate. With a fixed rate loan, the annual interest charge for each year is known upfront. This means landlords can prepay up to 12 months of interest each year - a cost that may be claimed as a tax deduction. This can be a way of evening out your tax bill in years when income from other sources (such as wage and salary payments) is higher than normal. The success of this strategy hinges on having sufficient cash to prepay interest, and it’s always sensible to speak with your tax advisor to ensure you can claim the full interest charge as an expense in the current tax year.

  • Unlike most other loan types, Interest only loans involve payments that solely include loan interest - there is no repayment of the principal. The principal is repaid when the property is sold. As some investors aim to make a profit on the sale of the property rather than eventually owning it outright, an interest only loan can be appealing for landlords. This type of loan offers two key advantages - first, the monthly repayments are less than for a principal + interest loan. Secondly, all your repayments are tax deductible as they don’t involve capital repayments of the loan. Most loans permit interest only payments for a limited period, generally up to five years. After this you will need to renegotiate the loan payments with your lender.

  • Line of credit - A line of credit loan allows borrowers to withdraw cash from their loan up to a certain limit as and when they choose. Each month the loan balance is reduced by the amount of cash coming in and increased by the amount paid for drawings, direct debits or cash withdrawals. There are usually no set repayments, so this loan is best suited to experienced investors with the discipline to manage the loan carefully.