Whether you're planning to supplement your income with a rental property, use negative gearing for tax benefits or even aiming to make a profit from the property's capital growth, it is important to be clear on your goals. This will help you decide on whether real estate is an appropriate investment option for you, as well as what type of property you would invest in.
Not everyone invests in property for the same reason, so it’s important to establish what your property investment strategy is. Broadly speaking, there a three main potential benefits for investing in property:
- Build wealth from the property’s capital growth
- Generate income with a rental property
- Use negative gearing for tax benefits
It’s also important to know what your investing timeframe is. For example, if you’re investing with the aim of generating an income stream for your retirement, the timeframe may be 20 years into the future.
Investing in property for capital gains assumes you have a view that property prices will increase over time. Capital gains refers to the profit you make when you sell your property, which is the sale price less your initial and associated selling costs.
In Australia, Capital Gains Tax is payable on the capital gain made when you sell an asset, however there are some exceptions, with the most significant exemption being the family home. Investment properties however are not exempt from Capital Gains Tax, so be mindful if this is your investment strategy.
Investing in property is a long term investment option and as with any investment, it is important to recognise that there are no guarantees. Property prices won’t always rise which could mean you need to wait years before you’re able to make a worthwhile profit from your initial investment, and should you need to sell quickly for whatever reason you may even sell at a loss.
Generate income with a rental property
Some investors will chose to invest in property to generate ongoing income. Rental yield refers to the return on the property investment. For example, if you paid $500,000 for a two bedroom apartment, and received weekly rent of $450, the gross rental yield would be:
Annualised Rent/Purchase Price = $450x52 = $23,400/$500,000 = 4.68%
Net rental yield on the other hand would require you to deduct all expenses including ongoing costs and costs of vacancy from the annual rental income.
If in the example above the ongoing costs and costs of vacancy amounted to $2500, then the net rental yield would be:
$450x52 = $23,400
$23,400 - $2,500 = $20,900
Net Rental Yield = $20,900/$500,000 = 4.18%
It’s important to get a sense of how much you would be able to rent the place for as well as vacancy rates. Aim to select a property that is sought after by potential tenants to minimise rental vacancies.
Some key indicators would be:
- General Market – Rental yields, property over/under supply in the market, community infrastructure
- Property Selection – Affordability to the local rental market, views, off street parking, suburb appeal
- Location – Access to major roads, public transportation, recreation, schools, major retail centres
- Property – General condition, kitchen and bathroom quality, heating and air conditioning, layout, storage
Whether you choose to invest for capital growth or rental income, understanding gearing and taxation may help you optimise the tax benefits available from your investment property. Gearing is the term used to describe borrowing for investment purposes.
Positive vs Negative Gearing
When the rental income from your property exceeds the costs of owning it (including interest charges on your loan, fees, maintenance costs etc.), this means the property is positively geared. Conversely, negative gearing means the costs of owning your property exceed the income it generates. The difference between the rental income you earn from the property less some of your costs related to running and management of the property may be offset against other income (for example, your salary or wages) which would reduce the overall tax that you would have to pay.
As a landlord, there are a number of expenses that you can claim against your rental income, for example:
- Real estate management fees
- Council rates
- Interest on the investment loan
Because every situation is different and laws are constantly changing, your accountant or financial adviser can help you understand this further. The ATO website can also provide useful information.
Using Equity in your current home
You may be able to use the available equity in your current home to help you buy your investment property. Equity is the market value of your home less how much you owe on it.
As an example, let’s say your home is worth $600,000 and you have a loan balance of $400,000. The equity in your home is $200,000. The Loan Valuation Ratio (LVR) for your home is currently:
Loan/Value = $400,000/$600,000 = 67%
Assuming you wanted to increase your borrowing to 80% LVR, your new balance could be:
Home Value x 80% = $600,000 x 80% = $480,000
New Loan Balance = $400,000 + $80,000
Some people choose to borrow against the value of their home to pay for the deposit to purchase an investment property. Of course this carries the additional risk of increasing overall debt.
Using equity will not be suitable for everyone, so speak to your financial adviser to understand both the risks and benefits before deciding on this option.
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This information has been prepared without taking your objectives, needs and overall financial situation into account. For this reason, you should consider the appropriateness of the information and, if necessary, seek appropriate professional advice. Read the terms and conditions before making a decision if the product is right for you.