Australia: Buying an investment property: pros and cons

Wealth Management update: Winter 2014
Last Updated: 20 June 2014
Article by Martin Fowler

Welcome to our winter Wealth Management update

Buying an Investment Property

With interest rates at record lows, interest in investment properties has boomed. This article explores the pros and cons of buying investment properties.

How can I fund an investment property?

If you have equity in your own home, most financial institutions will allow you to borrow up to 80% of the combined value of your own home and the proposed property. This is subject to meeting serviceability criteria (which is essentially having sufficient cashflow, after tax and living expenses, to be able to service the monthly repayments).

Example: Joel owns a home worth $800,000 with a mortgage of $400,000. Joel earns $80,000 per annum. He wants to buy an investment property but is unsure about how much he can borrow and whether or not it is affordable.

Joel could borrow the lesser of the maximum permissible loan amount under the loan to valuation ratio (LVR) calculation or that worked out under the serviceability calculation, as follows:

Part a: maximum amount borrowed under LVR criteria

IMAGE HERE

Part b: credit assessment (serviceability) Under the LVR calculation, Joel could theoretically borrow a maximum sum of $1,200,000. However, when the bank applies their credit assessment criteria, it becomes clear that he would not be able to service a loan of that size. Using their methodology, he would have an income shortfall of approximately $23,448 per annum, calculated as follows:

Investment property value
Stamp duty
Loan required
1,150,000
48,740
1,198,740

Maximum Borrowing Amount Actual Assesssed
Groos income 120,000 120,000
Gross rent 57,500 57,500
less: rental expenses (14,375) (11,500)
163,125 166,000
Expenditure

Tax payable 23,058 23,058
Living expenses 30,000 30,000
Home loan repayments(25yrs@7.00%pa) 33,925 33,925
Invesments loan repayments(30yrs@6.00%pa) 71,924 101,669

158,908 188,653
Net Surplus/(Loss) $ 4,217 $ (22,653)

Note: Tax estimate $
Assessable Income 163,125
less:
Interest expense on property 71,924
Taxable income 91,201
Tax on taxable income $ 23,058

Part c: maximum loan amount under serviceability criteria

Under the serviceability criteria, the maximum
amount Joel could borrow would approximate $591,000,
calculated as follows:

Investment property value
Stamp duty
Loan required
570,000
21,000
591,140

Maximum Borrowing Amount Actual Assesssed
Gross income 120,000 120,000
Gross rent 28,500 28,500
less: rental expenses (7,125) (5,700)

141,375 142,800
Expenditure

Tax payable 28,720 28,720
Living expenses 30,000 30,000
Home loan repayments(25yrs@7.0%pa) 33,925 33,925
Invesments loan repayments(30yrs@6.0%pa) 35,468 50,137

128,114 142,782
Net Surplus/(Loss) $ 13,261 $ 18

Note: Tax estimate $
Assessable Income 141,375
less:
Interest expense on property 34,468
Taxable income 105,907
Tax on taxable income $ 28,720

What potential return could I expect on my investment?

The potential return from investment properties are dictated by a number of variables including:

  • the rental return generated
  • the growth potential
  • the amount borrowed
  • the marginal tax rate of the investor
  • the actual rental expenses
  • depreciation and/or building allowances
  • ultimate gain or loss

Example

Joel decides to borrow the maximum amount possible to buy an investment property worth $570,000. He holds the property for 10 years and then sells it. It proves to be a sound investment. The annualised return equates to 12.36%, calculated as follows:

Assumptions

Purchase price
Borrowings
Marginal Tax Rate of investor
Interest rate on borrowings (p.a)
Interest prepaid annually in advance
Rental expenses (as a % of gross rent)
Rental yield (p.a)
Annual rent increases
Depreciation (as a % of initial cost)
Growth rate per annum
$570,000
$591,000
38.5%
7.00%
no
25%
5.0%
1.0%
1%
3.00%

Cashflow details
Year 0 Year 1 Year 5 Year 10
Capital transactions
$ $ $ $
Initial investments
(570,000)


Loan establishment fess (est. 0.5%)
(2,955)


Borrowings (up to 100% of investment)
591,000

(591,000)
Stamp duty (NSW rates)
(21,140)


Projected sale proceeds



766,032
CGT refunded/(paid)
- - - (37,736)
Post tax cashflow
(3,095) - - 137,296
Income transactions




Gross rent
- 28,500 29,657 31,170
Rental expenses

(7,125) (7,414) (7,793)
Interest expense
- (41,370) (41,370) (41,370)
Pre tax cashflow
- (19,995) (19,127) (17,992)
Income tax refunded/(paid) Note:1 - 12,462 12,041 11,491
Post tax cashflow
- (7,533) (7,086) (6,502)
Combined post tax cashflows ($)
$(3,095) $(7,533) $(7,086) $130,794

Project After-tax IRR 12.36%

What are the potential benefits of owning an investment property?

  • Investment properties provide a long term income stream that typically rises over time.
  • Property markets in Australia have historically enjoyed moderate long term growth. Should this continue, your investment should grow in value.
  • There are tax advantages associated with negative gearing. Where the expenses exceed the income generated, the loss can be applied against other income, reducing tax otherwise payable.
  • There are other tax benefits including the ability to depreciate fixtures and fittings over time. You may also be entitled to a building allowance deduction.

What are the potential risks of owning an investment property?

  • There is a risk that the value of your property may be worth less than what you paid for it. Any capital loss is magnified when leverage is involved.
  • There is a risk that your property may not always be tenanted. In a worst case scenario, you may be forced to sell.
  • There is a risk that a tenant could damage your property, become unruly or become difficult to evict.
  • There is a risk that repairs and maintenance expenses could become significant (e.g. concrete cancer or termites).
  • There is a risk that interest rates could rise, impacting your ability to service your loan.
  • There is a risk that you could become unemployed and no longer benefit from the tax deductions provided by negative gearing.

Who can I talk to about my loan requirements?

Moore Stephens Wealth Management now has a dedicated mortgage broker, Lino Abruzzese. Lino has over 25 years' experience in the industry and so is well equipped to provide you with professional and practical advice. Should you be looking for a new loan or considering refinancing an existing loan, please do not hesitate to contact Lino, who is happy to discuss your needs obligation free. He can be contacted on 0422 708 369 or 02 8236 7761.

Conclusion: To buy or not to buy?

Many Australians have an emotional attachment to property. This is understandable given the long period of price growth that has occurred since the mid 1990's. When considering residential property as part of a diversified portfolio, investors should consider the following:

  1. Is the return generated commensurate with the risks undertaken? If your property investment generates net returns after expenses lower than a term deposit (but with far greater risk), you need to consider the validity of the investment. Any investment involves a risk/ return trade-off. If alternate assets provide a better risk/return profile then property may not be the immediate answer.
  2. If your circumstances change, or problems arise, do you have an exit strategy in place? If you lose your job or can no longer fund the investment property expenses, you need to have a back-up plan in place so that you do not have to become a forced seller. Access to a line of credit or savings can buy you time in such situations.
  3. Does the investment have merit purely on the income it generates, or are you reliant on speculative capital growth? Many property investors undertake a negative gearing strategy in the hope that asset prices will continue to rise indefinitely. Australian residential property markets were relatively immune to the big falls in property prices experienced in the United States and Europe during the Global Financial Crisis. This does not mean we will be so lucky when the next recession comes along. Often the best property investments are those that generate enough income on a standalone basis without the need for capital growth.

This publication is issued by Moore Stephens Australia Pty Limited ACN 062 181 846 (Moore Stephens Australia) exclusively for the general information of clients and staff of Moore Stephens Australia and the clients and staff of all affiliated independent accounting firms (and their related service entities) licensed to operate under the name Moore Stephens within Australia (Australian Member). The material contained in this publication is in the nature of general comment and information only and is not advice. The material should not be relied upon. Moore Stephens Australia, any Australian Member, any related entity of those persons, or any of their officers employees or representatives, will not be liable for any loss or damage arising out of or in connection with the material contained in this publication. Copyright © 2014 Moore Stephens Australia Pty Limited. All rights reserved.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Related Topics
 
Related Articles
 
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions