Property Investment

Step 1: Why invest in property?

Property investment has many benefits when it comes to building long-term wealth, but this wealth is not always guaranteed. As a means of diversifying your exposure to different asset classes, property can be less volatile than shares (although not always), and tends to be the haven investors rush to when other assets suffer. Sensible investments in property have many attractions. Your first investment in property doesn't have to be something you live in. Indeed, buying a small apartment to rent out can be a good way to accumulate a big enough nest egg so you can eventually buy your own place. Generally, investing in real estate gives you access to two benefits: capital growth and the tax advantages associated with negative gearing.

What is capital growth?

Capital growth is the money you make as the value of your property appreciation. The larger cities – especially Sydney and Melbourne but more recently Brisbane and Perth – have enjoyed occasional boom periods. These booms have seen many home owners with properties that have sometimes doubled in value. While there's no guarantee your property will gain in value, historically property has experienced steady growth.

What is negative gearing?

Gearing basically means borrowing to acquire an investment. A property that is negatively geared is purchased with a loan, and has an annual net rental income amount that is less than the annual interest paid on the loan, plus the deductible expenses associated with maintaining the property. You get tax benefits by being negatively geared, as you are able to deduct the costs of owning an investment property from your overall income. The biggest part of this deduction is the interest portion of your mortgage, but you can also claim such expenses as property management fees, loan costs and repairs. Whilst negative gearing deductions offset your income (they are most beneficial to high-income earners), you shouldn't over-commit yourself in order to get one. That is to say, the more you borrow, the more interest you pay and the bigger your deduction – but you still have to make the mortgage payments, and those lucrative tax benefits don't arrive until the end of the financial year. In periods of low inflation, the benefits of negative gearing are usually negligible.

Step 2: What to buy

Where to buy

Because investment properties are bought as investments and not as owner-occupied residences, purchasers are able to take the emotion out of the decision of where and what to buy. To benefit from as much capital growth as possible, the first rule is to buy in a growth area. Experts define suburbs located up to 10 kilometres from a city's central business district as likely to be growth areas. The best strategy is to visit a number of areas to get a feel for what they offer. As you will be renting out the property, be aware of features tenants look for when they rent, such as access to transport, shops and leisure facilities. An attractive property in a sought-after area will also ensure strong rental returns and ongoing tenancy.

What to buy

While owning a house may be nice, units are far easier to rent out. They may also be easier to maintain, as they generally have as no lawn to mow, and when things go wrong in the building, any expense is shared amongst the other owners. Look for a property that can be sold quickly if you find you have to sell in a hurry. Again, look for additional features that are attractive to buyers, such as an apartment with a balcony, internal laundry and garage. If the property you are interested in is currently being rented, ask about its history of tenancy. Have there been periods where it has been unoccupied? If so, find out why, as you might inherit past problems with finding tenants. When buying an investment property, ensure you do everything you would do if you were purchasing a home you would be living in. This includes all the normal inspections and familiarizing yourself with property prices in the area. The last thing you want to do is overpay on a property and not see any capital gain.

Step 3: Renting your property

Tenants

Investment properties are generally rented out unless you're in the enviable position of not needing the rental income. When calculating what you can afford to buy, you will need to factor in contingencies such as the property being empty for short periods, whether this is for repairs or for finding new tenants. Rental income helps generate the cash flow to pay the mortgage but don't forget to include this income when you file your tax return, as this money will count towards your total income for the year.

Making your investment pay

If you hold onto your investment property for long enough, hopefully you will reach the stage where your losses are turning into gains. This occurs for two reasons. First, the rent you are charging will probably rise as it keeps pace with the market value for rents. Second, you and your tenants are steadily whittling the mortgage away and, once your rental income exceeds your mortgage repayments, you are no longer negatively geared. You may instead be neutrally geared or positively geared. Seek advice from a tax agent or financial planner before leaping to sell a positively geared property investment. The temptation is to reap your profits and plough them into another property – and this is a perfectly reasonable strategy – but don't lose track of the costs involved in doing that. Stamp duty alone can be a prohibitive disincentive. Another strategy would be to leverage the equity in the existing rental property and the positive cash flow to help pay for the mortgage on an additional rental property.

Do you DIY or choose a property manager?

While it is possible to manage a rental property yourself, and in doing so you can save the cost of a management fee (usually around 5%), it can be time-consuming and it's hard to remain emotionally-detached if you have tenants ringing up complaining about every little thing. Employing a property manager has many advantages additional to the factors of time-saving and convenience they offer. As they manage so many properties, they will have also access to a large number of reputable tradespeople with whom they may have negotiated cheaper service fees. They can also deal with the time consuming tasks of vetting potential tenants and checking their credit worthiness. As they deal with tenants and rentals every day, property managers have up-to-date information on what the market is like and what tenants are prepared to pay. They may also have access to tenants whom they can recommend for your property. And don't forget their fees are tax deductible.

Insurance

While it is up to your tenants to take out their own contents insurance, you will need to have building insurance. You may also want to consider liability insurance to protect yourself in case your tenants damage the property or themselves. See Insurances: Landlord’s Protection.

Step 4: Tax implications

Capital Gains Tax (CGT)

CGT is the tax charged on any capital gains that arise from the sale or disposal of any asset bought or acquired after 19 September, 1985. You are liable for CGT if your capital gains exceed your capital losses in any income year. Any capital gain must be shown in your income tax return for that year. While you do not pay capital gains tax on your place of residence, investment properties are subject to the tax when sold. Where an investment property is acquired on or after 1 October 1999 and held for at least one year, you are eligible for a rebate of half of your capital gain. The resultant gain is then divided between the owners of the property according to their respective share of the property and added to their taxable income for that tax year. The tax payable is then calculated at the marginal tax rate for the combined income sources for each person. If you acquired your property before 1 October 1999 and have held it for at least one year before selling it, you may choose to include in your assessable income either:

half of the nominal gain; or
the difference between the consideration on disposal and the indexed cost base frozen as at 30 September 1999.

Get your tax refund early

Variations are commonly sought by investors who have undertaken a negative gearing program and who want to use the extra cash in their pay packet to help fund their interest expenses. So, if you can reliably estimate your income and expenses for the year, you can have less tax deducted from your pay now in lieu of getting a refund at the end of the financial year. It's not quite the same as getting a cheque for next year's refund now, but it's close. For example, if you have an annual gross income from your employer of $45,000, but estimate you'll make a $15,000 loss on an investment property, you can apply to have your tax payments calculated on an income of $30,000. That could cut your weekly tax payments by about $85. Contact the Australian Tax Office for further information on Pay-As-You-Go (PAYG) withholding payments.

Land tax

Land tax applies in some states of Australia, including New South Wales and Western Australia, where you hold more than one property. See your state Office of State Revenue for information that may affect your situation.