A CONSUMER’S GUIDE
Frequently Asked Questions on the subject of investment property. And the answers to them.
Your Questions Answered Questions lead to knowledge. The biggest single reason why there are not substantially more working Australians taking advantage of the significant wealth building opportunities inherent in investment property is a lack of easy-tounderstand information. Here are some of the most frequently asked questions and the answers to them.
Why didn’t my accountant tell me about investment property? Accountants are similar to your local GP in that they service standard customer requirements. When you need a specialist, you may need to look elsewhere. Specialist accountants focus on one specific field, such as public accounting, liquidation, taxation, payroll, auditing and of course, property investment. Many general accountants who look after standard tax returns might not be familiar with the advantages and benefits of owning an investment property.
What does the body corporate do?
What if I lose my job?
Homeowners in most medium density developments hold a strata title. As a strata title holder you are granted exclusive use of your apartment, villa or townhouse. A strata manager manages the maintenance and presentation standards of the public areas such as the grounds, walkways, swimming pools and tennis courts. A representative committee of owners within the development is referred to as the body corporate.
When confronted with an important financial decision, a common reaction is to think about the impact of losing your job. It’s the “worst case scenario”. The rational approach is to sit down and consider the likelihood of either you or your partner becoming permanently unemployed.
Body corporate fees are fully tax deductible. These fees allow for day-to-day maintenance and the development of a sinking fund, which is money that has been set aside for future maintenance.
For argument’s sake, let’s assume you did lose your job. Review your experience and skills in relation to the job market. Project how long you are likely to be unemployed. Be resourceful. Examine alternative occupations. It is comforting to know that the current unemployment rate is just about the lowest it’s ever been. It’s unlikely that you would remain unemployed for long. Even if this meant moving to one of the states experiencing the greatest shortage of skilled labour i.e. Western Australia and Queensland. In life there are no certainties. And while the worst-case scenario is unlikely to come to pass, the careful investor puts away spare cash regularly to provide a buffer against the effects of just such a misfortune. You could also consider income insurance. There are a variety of policies on the market. An extra account or income insurance leaves you free to take your time and find the job you really want.
What is Capital Gains Tax? Capital Gains Tax (CGT) is payable on the capital growth of your property in the event that you sell the property. It is only payable once you have sold it. In 1999 a new method of calculating CGT was introduced. It is now calculated at 50% of your marginal tax rate. Previously it was calculated at a rate of 100%. Since your tax assessment is based on your marginal income tax rate at the time of sale, any tax payable would be reduced if you are retired or have a small income. In addition, your capital gain is further reduced by deducting both the purchase costs and selling costs such as stamp duty, legal fees and agent’s selling fees.
Why do you recommend an interest-only loan? As the name suggests, an interest-only (IO) loan consists of payments of interest only. It is up to you when you want to reduce the principal. The weekly IO payments are less than their principal and interest (P&I) counterparts. Most IO loans are fixed for 3 to 5 years. After this period they are automatically converted to P&I loans. At your discretion you may continue on an IO basis. As the value of your investment property grows every year, the value of the principal shrinks. For example, a house bought for $8,500 in 1960 is probably worth over $515 000 today. Wouldn’t it make more sense to pay this relatively insignificant principal amount later rather than earlier?
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The Mortgage Company
What if the mortgage company goes bust? The title of the property or deed is in your name and at all times you have legal ownership. In the unlikely event of your mortgage company going broke, it does not have right of claim to your property. The only claim is on the money borrowed, not on your property. Another financial institution may take over the defunct company. In the worst-case scenario you might have the inconvenience of having to refinance with another company.
The Mortgage Company
But debt is a burden, isn’t it? Traditionally debt has been perceived as a burden. But it is important to remember that there are many different types of debt. Not all debt is to be avoided. There is very little in this world that actually appreciates in value.
Bank
We know that cars, boats and computers depreciate at an alarming rate. And the over-use of credit cards for luxury items and consumables has certainly become a worrying social trend. In contrast, on average, a residential property close to a metropolis doubles in value every seven to ten years. Therefore residential property is described as an appreciating asset. In addition, as property values rise so do rental returns. Borrowing for investment property is a necessary tool to build wealth. It’s one of the few instances where debt actually works for you.
What if I don’t have a deposit? When you think of a deposit, you think of cash required up front to purchase a property. Cash is not necessary when you have equity in your own home. Your home is used as security to purchase a new property. For the first-time property investor, initial concern at using existing equity is a natural reaction. After all, your home is your most important asset. If you were borrowing for a speculative venture like a shopping centre, an ostrich farm or a new business, all of which are statistically high risk, then concern would be warranted. In reality, using the equity in your home to purchase another residential property is considered to be conservative. As your investment property grows, you can ask the bank to revalue it, rewrite the loan, and release your family home as security. Lenders today readily advance 80% of current value. Considering the projected value of your investment property, your home may be released in as little as 3 or 4 years.
What if interest rates rise? Economic growth, inflation and interest rates are inextricably linked. Apart from unforeseen mishaps, our economy behaves in a cyclical fashion, sometimes known as the “boom and bust effect”. Interest rates rise, peak, fall, then bottom out, only to eventually rise again. There are always clear indicators as to which part of the cycle the economy is going through. The Reserve Bank interest rate “hikes” and reductions are intended to smooth the trends. Fortunately for property investors, rising interest rates and inflation are linked to increasing rentals. The clever investor uses prevailing economic conditions to best advantage. Interest rates have been on the rise in the past few years after bottoming out at some of the lowest levels on record. While interest rates could rise further given the strength of the current economic cycle, it is possible to buy investment property and lock into fixed interest rates. Rates and rental returns may rise, but your repayments will remain fixed. Alternatively, flexible rates might be preferred if you forecast that we are nearing the peak. (Note: specialist advice should be obtained prior to making this decision). In addition, when you are sitting down to work out the numbers, be conservative. If you decide not to choose a fixed rate for your investment, anticipate a continuation of rising rates in order to be prudent. For planning purposes use a higher interest rate for your calculations, for example 1% above the current rate.
If there are too many investors, where will I find tenants? About one-third of Australians are tenants, and this has been an underlying upward trend for the past three decades. There are a number of reasons for this. Some people are saving. Others prefer to share and live in comparative luxury. Others again find renting more convenient, particularly the increasingly mobile segment of society. Capital cities enjoy the highest occupancy rates. But there’s no point investing in a capital city if you have a run-down, unattractive property. Reasonable rent, position, facilities, maintenance and proximity to local amenities are paramount considerations to a prospective tenant. And regional shifts are of prime importance.
The northward migration to Queensland continues unabated, which means more and more demand for housing and consequently demand for rental properties in this state. The MLC Survey found that most people believe property to be the best investment option. However, according to the Australian Bureau of Statistics, only 6% of the population invests in investment property. When you consider that 90% of the nation’s wealth lies in the hands of 10% of the population, you have to wonder why so few of us take the initiative. Many of us lack confidence in our ability to make decisions, which is one characteristic that separates the rich from the poor.
Should I buy one house for $1 million or two for $500K? Depending on the area, it is generally better to buy more properties at a cheaper price, thereby multiplying your rental opportunities. One million dollars can buy several types of properties; a luxurious house in the country, a premium inner city flat, or two suburban homes. The country estate, although a romantic notion, is a gamble to say the least. City apartments have a relatively high turnover. They are fine provided you are certain the area is protected and improving. Urban development can compromise a previously well-positioned apartment.
The well-maintained suburban home offers the most advantages, attracting the lion’s share of the tenancy market. Older properties should be avoided, unless you are an experienced renovator with lots of time and money. Many new homes now offer Master Builder guarantees of workmanship for up to seven years, which is a great bonus. In addition, less expensive properties like suburban homes yield a higher “rent to mortgage ratio”. And if you’re planning to sell on retirement, the desirable midrange suburban home draws more buyers, particularly first-time buyers.
When is it better to put the property in one name? Couples traditionally register their properties under joint names. If the property is bought for cash, the taxation position is unaffected. However, if there is a mortgage, joint ownership can considerably diminish the significant benefits of negative gearing.
In some cases it might be tax effective to split the ownership of the property. For example 99% could be placed in the name of the highest earner and 1% in the name of the other partner (known as Tenants in Common). Splitting the tax benefit this way can be most beneficial. The rights of both parties are equal under the Family Law Act. Your solicitor can draw up a written statement in the event of dissolution. If you and your spouse earn similar incomes (e.g. equal business partners) and prefer joint ownership, then the benefits of negative gearing are unaffected. There are also other ownership structures into which to place the properties. For example trusts. Trusts hold great value in terms of protection as well as tax benefits. Again, specialist companies are able to assist you in this area, as the right decisions can have a major impact on your long-term returns.
What if the rules are changed? It is important to note that a very high percentage of elected politicians own investment property. If they changed the rules to the detriment of investors, they would be on the receiving end of such change. In 1985 the Labor Government of the day quarantined negative gearing. In its place they introduced a 4% capital allowance on the construction of new buildings, assuming that this strategy alone would stimulate the housing industry. The move backfired and investors shied away from investing in property. A lack of investors resulted in a shortage of rental properties. With high competition from prospective tenants, rents skyrocketed, causing an unprecedented housing crisis. Not surprisingly, negative gearing was reintroduced in 1987, only 18 months after it had been quarantined. The Government understands that negative gearing leads to increased rental property in the market. This reduces pressure on the Government to provide new public housing, which bites into the Federal Budget as it is. There are no signs that the rules as we know them would be adversely changed any time soon.
What if I get bad tenants?
What if I already have a mortgage?
Insurance policies are available that will cover you against any risks or losses for relatively modest fees. This means that concerns about tenants need not be a reason for not taking advantage of investment property opportunities.
In all likelihood your home is worth a great deal more than your mortgage. Your mortgage is not a problem; instead, it is actually an opportunity and a tool to accumulate investment property. Most people don’t realise their family home is considered “equity� even if it is not fully paid off. You can use your equity to raise the finance to purchase one or more investment properties, including all the usual start-up costs such as conveyancing fees and stamp duty. Banks view median-priced property as a good investment and willingly provide financing for it.
It is essential to investigate your mortgage options. There are great advantages to interest-only (IO) mortgages, particularly to property investors. The weekly outgoings are less than their principal & interest (P&I) mortgage counterparts. Every year the value of your property grows and the relative value of the principal shrinks accordingly. A house bought for $8,500 in 1960 would be worth $515 000 today. The principal debt is insignificant in terms of today’s values. Contrary to popular wisdom, the best time to pay off the principal is later rather than earlier.
What about land tax? Land tax is a state-levied tax imposed on those who own one or more investment properties (other than their own home). The tax is calculated on the total land holdings within a particular state or territory. Land tax is based on the unimproved value of the land only. The tax does not apply to any buildings. Each state has different rates and rules. New South Wales land tax rates have increased steadily over the years. In NSW, where the land tax threshold is $352,000 (equal to or above), it is a stinging rate of 1.7%. Not surprisingly there’s considerable public concern as high land values have caught out many property holders, particularly the elderly, who’ve never paid the tax before and are finding it difficult to manage. In Queensland, however, the threshold is $500,000 (equal to or above). As property values are lower in Brisbane than in Melbourne or Sydney, you could own 3 properties and still be exempt from paying land tax.
Act now Don’t put the decision off any longer. Make the first move towards becoming one of the thousands of investors whose lives have been changed forever through discovering the benefits of investment property. For a free consultation with absolutely no obligation, contact McCarthy Group today on (02) 9687 3601, or email us at info@mccarthygroup.com.au It could be the most valuable call you’ll ever make.
This guide is intended to provide general information of an educational nature only. Any information contained in this guide does not have regard to the investment objectives, financial situation or individual needs of the reader. Neither McCarthy Group Pty Ltd nor its affiliates intend by this guide to provide any financial product advice, and information in the guide cannot be relied upon as such. All readers should consider obtaining independent advice before making any financial decision concerning property or any other investment product.
© McCarthy Group 2008
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