"I'm considering investing in property as part of my financial strategy and would like to know the general key considerations. Could you explain what factors, like tax implications, mean for a property investor? I'm looking for a broad overview to better understand the basics."
- Question from Mia in Maclean, NSW
Top answer provided by:
Mark Candy
Hi Mia and thanks for your questions.
There are several considerations that one should contemplate, prior to investing in property.
The broad overarching ‘rule of thumb’ though is that finding and buying the right investment property, is very different from finding and buying your own home.
The key driver when buying an investment property is clearly to make a ‘reasonable’ financial return, whether that’s through capital growth and/or rental income. That’s why it is important to be smart about what and where you buy.
Key factors to look for in an investment property:
- The right type of property
The type of property that you will buy, will essentially depend on the budget that you have, but nonetheless think about what property type would be appealing to a person/family looking for a place to call home.
For example, an apartment/unit may work very well if there are many single and/or professional couples or university students in the area. Alternatively, a house with a backyard will more likely appeal to tenants in say a family-friendly suburb, rather than a smaller apartment.
Additionally, consider the amount of maintenance involved. A newer house or apartment will generally require less maintenance than an older property, which in turn will mean less cost outlay for you as a property owner / landlord.
- Property features
Ask yourself what features a prospective tenant or tenants would be looking for. Will they need plenty of storage space? Will they require a garage or car space? Maybe more than one bathroom and an office space to work from home. Desirable features like these, can assist with charging more rent, and therefore push up your rental return and any potential longer term capital growth, which is why it is important to keep these things in mind when looking for the ideal investment property.
- The right location
Location, location, location, is an often used catchphrase when talking about property and its ultimate value. Before buying an investment property, there is some value in ‘putting yourself in the tenant’s shoes’ and asking yourself what it would be like to live in the suburb yourself? What is appealing about the area and the lifestyle offered? Are there worthwhile amenities nearby – parks, schools, entertainment and eateries. Find out if there are any development plans or major infrastructure projects planned or underway for the area, like new hospitals or transport links, which can all add onto a property value, in the long run.
- The potential for Capital Growth
Capital growth is basically how much the property goes up in value over time. Supply and demand are the key factors when determining capital growth, as property prices will increase when demand is high, relative to the supply of properties in that area.
- Rental Yield
Rental yield is another important consideration, as it provides an insight into how profitable an investment property is likely to be. This crucial metric identifies the amount of rent generated by the property, relative to its purchase price and is expressed as a percentage and calculated by dividing your rental income by the property’s purchase cost.
For example, an investment property costs $600,000 to buy and is currently rented out at $550 per week (which equals $28,600 per year) has a rental yield of $28,600 divided by $600,000 equals 0.0476, or 4.76%.
While a higher rental yield translates into more immediate income, it can often come with a trade-off. Meaning that properties with higher rental yields, may have lower potential for capital growth (increase in value) over time, that is why it is important to strike the right balance between the two.
If you need a higher and consistent income stream to help cover your loan repayments, then prioritising a property with strong rental yields may be more prudent, however, this might mean sacrificing some potential long-term capital gains.
There may of course be other considerations such as demographics / population growth, vacancy rates, number of days on the market (DOM), along with auction clearance rates, however, the five factors that I have highlighted are to my way of thinking, the essential considerations for an investment property purchase.
Tax Implications
Whilst buying an investment property is popular for someone like yourself looking to grow their wealth and secure some financial stability, there are various tax considerations that you need to be aware of.
These may include:
- Tax deductions - which can help offset rental income and reduce taxable liabilities. Common deductible expenses include mortgage interest, property management fees, insurance premiums, repairs and maintenance, council rates and land tax, and depreciation of capital works and plant and equipment. By keeping track of these expenses, a property investor can significantly lower their taxable income, therefore maximising cash flow and their overall returns on investment.
- Depreciation and Capital Works Deductions – depreciation can allow a property owner to claim deductions for any ‘wear and tear’ on their investment property’s structure and fittings. Capital works deductions can cover the depreciation of the building’s structure over its lifetime, while plant and equipment deductions apply to assets within the property, such as furnishings and appliances. You will need to engage a quantity surveyor to prepare a depreciation schedule that can assist you with maximising your depreciation claims and optimising your tax outcomes.
- Capital Gains Tax (CGT) – when selling an investment property, you may be subject to CGT on any profit made from the sale. This CGT liability can be reduced by holding the property for longer periods, thereby qualifying for the CGT discount or offsetting capital losses against capital gains.
- Negative Gearing / Rental Property Losses – this allows investors to reduce their taxable income and receive tax benefits when the rental expenses exceed the rental income received.
- State / Territory Specific Taxes – in addition to any federal taxes that may apply, property investors also need to be mindful of any state / territory-specific taxes, such as stamp duty and land tax. Such taxes can be quite significant and may vary depending on the jurisdiction in which the investment property is located.
With any of the tax implications noted above, when it comes to property investing, it is critical that you seek professional advice from a knowledgeable tax adviser, or accountant, to assist with leveraging available deductions, depreciation strategies, and CGT concessions, so that you can minimise any tax liabilities and maximise your after-tax returns.
Overlaying all this as part of a broader financial strategy with a financial adviser, can also potentially provide you with the best possible financial outcomes, as you navigate your financial journey going forward.
Best of luck with it all!
Mark
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