Property Investor

Property is still regarded as one of the best investment tools because of its many benefits.As well as being the most favoured collateral by banks, investing in residential property can be useful for tax deductions involving negative gearing, and the property increases in value over time. Property is always in demand, and those who enter the industry intend to make money and they do it well through calculated risk management and analysis of trends.

There are plenty of wealth creation strategies that are associated with property investments, but none more sensible than the NRAS (National Rental Affordability Scheme) implemented by the Australian government in 2008. Over four years, the Australian government has pledged $1 billion to the Scheme to help encourage the construction of up to 50,000 houses and apartments for eligible individuals, families and couples.

The Commonwealth initiative works with State and Territory governments, property investors and not-for-profit housing suppliers to provide additional new houses for the rental market that will offer affordable rent for the Australian average wage earner. Additionally, this scheme generates higher-than-usual returns for property investors, encouraging stakeholders to develop additional houses to help the shortage of affordable rental housing.

The NRAS solely provides Australian low and moderate income earners with private rental properties, attempting to substitute housing commissions or social housing. The cash flow benefits and security of an NRAS property is a great incentive for any investor looking to capitalise on property.

Financial Incentives for NRAS Property Investors

2011 saw the beginning and steady rise of NRAS properties coming onto the Australian market and by 2014, the Australian government aims to encourage institutional and private investors, developers and not-for-profit groups to deliver up to 50,000 more affordable residential rental dwellings. Investors wishing to take advantage of this Scheme need to apply for NRAS Incentives and agree to rent at least 20% below market rates.

Investing in an NRAS property is a great step towards building a property portfolio. The NRAS offers tax free financial incentives to property investors who build and then rent these properties to low and moderate income households at 20% below the market rates. The Scheme provides generous financial incentives of a minimum of $9524 per lodging to property investors from the Australian Government and State or Territory contribution. This helps the community by seeking to address the shortage of affordable rental housing, and at the same time, provides benefits for the property investor. There has never been a better time to buy investment property Melbourne wide.

Property investors can take advantage of all the normal negative gearing benefits as well as receiving a tax free incentive from the Australian government and State and Territory governments for the next 10 years, meaning any property investor will receive more than $90,000 of tax free incentives spread over a decade. Not only is an NRAS property a great long-term investment, but property investors will be helping many people in their community to have affordable housing.

Eligibility: Property Investors and Tenants

To be eligible to be a property investor under NRAS, there are a few guidelines in which to adhere. First, the house must not have been lived in previously. It may be bought and built brand new or can be converted from a non-residential dwelling such as a motel, hotel, storefront or warehouse, to a residential address.

In the instance where it has already been built and made fit for occupancy but has not had any dwellings yet, the property is also NRAS-approved. What does not constitute a rental dwelling under the NRAS is moveable accommodation such as house boats or caravans, allocated rooms within a single dwelling, emergency crisis accommodation or any dwelling that does not comply with the landlord, tenancy, building, health and safety laws of the State or Territory and local government.

The income levels for eligible tenants are specified in the NRAS regulations NRAS Victoria locals is determined by the applicant’s income, and the most eligible tenants are working members of emergency and community services such as teachers, nurses, police and ambulance officers. Retirees, aged tenants and students are also eligible.

The rules for an NRAS property, NRAS landlords and NRAS tenants are the same as standard State and Territory residential tenancy and eviction laws. Furthermore, investors no longer wanting to participate in NRAS Victoria or any other state or territory, can withdraw from the scheme at any time. This can be achieved by renting the property at full market rent or exiting the tenant and moving in as owner occupier.The investor is also responsible for ensuring that tenants meet the income criteria and that they are reviewed against the criteria every two years to ensure objectivity and fairness.

Where to Buy Investment Property

The NRAS Scheme has strict rules when it comes to where to buy investment property. Building an NRAS property must be close to transport, schools, shops and other facilities so that they are desirable for tenants. The properties must also contain private facilities such as bathroom and kitchen, a bedroom and living space and a separate lockable entrance.

Building a Property Portfolio with the NRAS

The NRAS will end for new investments on 30 June 2012, so property investors should look to buy before it is too late, however owners of NRAS properties will still continue to get the tax incentives for 10 years from purchasing their property. Buying an investment property in Melbourne under the NRAS of Victoria regarding residential property laws is a great wealth creation strategy that will reward property investors over the long run.

Property Investor and their contributing authors have made every effort to ensure that the information is free from error, neither Property Investor nor its contributing authors make any representation or warranty as to the completeness or accuracy. Readers must decide if this information is suitable for their personal situation or seek advice.  

“My accountant said that the investment property I purchased is too old for depreciation?” In this week’s entry I will be focusing and expanding on `Fundamental 2’: All plant assets resume a new effective life and are revalued at each property purchase, regardless of the age of the asset.

Some investors may ask why am I focusing on the `Plant Asset’ allowance first rather than the `Building Capital’. As we see in our working example the plant assets only make up a small percentage of the overall construction cost. The reason I am covering this idea at the front of my teachings is because there is a widespread industry misinterpretation that needs to be clarified! And this little piece of the puzzle in itself justifies all investors to prepare depreciation schedules on their properties.

Claiming depreciation deductions for the plant asset alone in most cases will provide the property investor with thousands of dollars worth of deductions.

Part 2 will address the following:

- Workings behind the costing of plant assets.
- Methodology of the depreciation of plant assets and their specific rules.
- Comparison between the methods using our working example.

Costing of Plant Asset

All plant assets are valued/costed as installed and working. An example would be to buy a dishwasher at Harvey Norman for $1,000 and pay an additional $100 for the delivery, and then another $200 for the installation. This would mean that we have paid $1300 for the dishwasher in total and we can depreciate this full amount over its effective life of 10 years.

Below are the individual costs of the plant assets in our working example.

There are two methods of depreciating plant assets which we can choose:

1. ‘Prime Cost’ - commonly referred to as (Straight line) depreciation and
2. ‘Diminishing Value’ - commonly referred to as (Accelerated) depreciation

When depreciating plant assets we have the choice of either method of depreciation, although once you begin depreciating an asset you must remain with that method until the asset is fully depreciated.

Most property investors will choose the diminishing value method of depreciating plant assets as this provides the greatest depreciation in the early years, therefore maximizing the returns in the first few years of ownership (although in some cases there may be a reason in which to use the prime cost method of depreciation).

These would be:

1. The investor has occupied the property for a few years as their primary place of residence.
2. The investor has owned the property for many years without claiming depreciation. (Please note that you can revise and backdate your depreciation claim two years from your last lodged tax return).

Below is a summary of the comparison of depreciating plant assets in prime cost to diminishing value. It shows the yearly claim for each method, and then the ($) value difference between prime cost and diminishing value.

Revisiting the `tax term’ I mentioned in part one which was `Effective Life’ and I stated that the ATO publishes all the effective lives of the plant assets in the `guide to residential property handbook’. The effective life of carpet which is published in this handbook is, 10 years and equates to 10% of the assets value each year.

Please note that these effective lives are the prime cost rate of depreciation. To work out the carpet or any other plant assets effective life in diminishing value we just have to double the percent per year claim. So the carpets rate of depreciation is 20% of the assets value each year.

If we look at the following image I have listed all the plant assets in our example with the effective lives in prime cost and their % per year claim in both prime cost and diminishing value methods of depreciation.

Within the plant asset methods of depreciation we have some other rules that again assist in accelerating how much we claim for each year.

These rules are:

1. Immediate Write off: Assets with a cost to the investor equal or less than $300 can be written off in the year of purchase at 100%. This is only available if the asset or item is not part of a set.

2. Low Value Pooling: Assets with a cost of less than $1000 can be written off at a rate of 18.75% in the first year, irrelevant of days owned, and 37.5% in subsequent years. Low value pooling is only available in diminishing value method. Another reason why diminishing value method is known as the accelerated form of depreciation.

The next image is displaying the working example plant asset depreciation schedule in both methods of depreciation.It is an industry standard to schedule out both the methods in a property depreciation schedule.

“My accountant said that the investment property I purchased is too old for depreciation”.

This has been the second most common response I have had when asking investors if they have claimed depreciation on the investment properties. The first most common is that the investor does not even know about depreciation!

If we apply `Fundamental 2’ (all plant assets resume a new effective life and are revalued at each property purchase, regardless of the age of the asset), then we can now see clearly that all investment property purchases (regardless of the asset’s age) can benefit from applying depreciation to their plant assets.

This week we have covered a fairly large concept in property depreciation – looking directly at the methods and the different ways in which the plant assets can be claimed. In next week’s entry I will cover Fundamental 3 – The Building Capital depreciation allowance.

Property Investor and their contributing authors have made every effort to ensure that the information is free from error, neither Property Investor nor its contributing authors make any representation or warranty as to the completeness or accuracy. Readers must decide if this information is suitable for their personal situation or seek advice.  

Is residential property tax depreciation one of the most difficult pieces of tax legislation ever written? Yes, No, Maybe? Many property investors are not claiming their depreciation deductions!

I am still consistently left baffled at the number of property investors who are not correctly claiming their investment property’s depreciation. I have narrowed this problem down to two possibilities which all predominantly point to:

1. Lack of professional industry education on the topic.

2. Amount of misguided information that is being distributed around the industry.

The most important fact of the matter (and I can’t stress this enough) is that if you are not claiming any depreciation deductions on your investment property, then you are doing yourself out of legitimate tax deductions. Once these deductions are gone you can never get them back, whether you have claimed for them or not. The clock keeps ticking.

My aim and focus in writing this article is to provide informative information in a structured manner so that investors and property professionals can use it as a point of reference when educating themselves and others, in property deductions. If we all follow the methods I chosen to calculate depreciation then we can apply these methods to calculate depreciation on all different types of properties and investment scenarios.

As most readers are unable to accurately price the cost of construction, I will cost these items myself for the purposes of the exercise. My main goal with the following information is to display the workings of depreciation, and bring to light the main fundamentals so that we all can start to essentially understand the concept, and therefore make better decisions when choosing the most suitable provider or consultant to prepare a depreciation schedule for your investment property.

I have chosen a specific order in which I cover certain aspects of property tax depreciation as this order will aid us in understanding the first principles. Once we understand these, we can implement these principles much easier into other parts of the legislation.

The (simple) working example that I will use the figures is a new house and land package bought for $450,000 where the land component cost $215,000 and the house component cost $235,000.

A property purchase is made up a two main components, which are the house and the land. When purchasing a property, the sale can happen in few different ways: 1) The land can be bought separately or 2) you can pay for the land and the building as a combined figure. The first fundamental step in calculating depreciation is to exclude the land (price/cost) component from the equation. In doing this you are leaving yourself with the amount that reflects what you have paid for the building capital structure and the plant asset items that are contained within.

First Fundamental:

The land Component of a property purchase needs to be excluded, so that the remaining amount reflects what you have paid for (Item 1  = Plant Assets) and (Item 2 = Building Capital).

If we exclude the land component from our example we are now left with a figure of $235,000. This reflects what we have paid for the (Item 1 = Plant Assets) + (Item 2 = Building Capital) = $235,000

Item 1 – Plant Assets items are those that the ATO state do not form an integral part of the Item 2 (Building Capital). Generally these items are anything with an electronic motor, floor and window coverings, white goods, hot water units and garden sheds to name a few. Some further examples include ceiling fans, light fans, A/C split systems, cooktops, ovens, rangehoods. insinkerators, dishwashers, blinds, carpet, heat recovery pumps, garage doors/gates motor, smoke alarms, spa fixed filtration systems, water tank pumps, polythylene rainwater tanks.

Tax Terms: ‘Effective life’

The ATO publishes a list of the plant assets found in a residential building with their associated effective lives in years. To put it simply, ‘effective life’ reflects the amount of time (years) that we can claim an items value over. An example is that if we spent $1,000 on carpet which has an effective life of 10 years, we can now claim the $1000 over the ten years, which is $100 in deductions each year.

Second Fundamental:

The second fundamental in property depreciation (and which I believe is the most beneficial to property investors),  is that all of the effective lives of the plant assets renew at each property purchase. Regardless of the age of the asset, a new effective life starts for them at each property settlement and they can be valued as an apportionment of the new purchase price.

In theory this could and has opened a fairly large can of worms, but to keep everything simple, we can safely assume that this new value is no more than what the particular plant asset can be replaced (new) and installed for on the open market.

The following image illustrates a scenario where we have a property that is built in 2010 and is sold four times (each sale taking place at ten year intervals). Owner 1 can claim for 91% of the plant assets over ten years and then sells it to owner 2 in 2012, were they can start to claim for the plant assets at their new value and effective life. This follows through to owner 3 and owner 4 where they are claiming a new effective life for the plant assets.

We have now covered two main fundamentals of property depreciation:

Fundamental 1: Exclude the land component when calculating depreciation.

Fundamental 2: All plant assets items resume a new effective life and are revalued at each property purchase, regardless of the age of the plant asset.

In part 2, I will expand on fundamental 2, as we now will look at the costing of the plant asset items, the different methods of depreciating plant asset items (‘Accelerated’ and ‘Straight line’) and the pros and cons of choosing one method over the other.

Property Investor and their contributing authors have made every effort to ensure that the information is free from error, neither Property Investor nor its contributing authors make any representation or warranty as to the completeness or accuracy. Readers must decide if this information is suitable for their personal situation or seek advice.  

In the current economic climate a ‘back to basics’ approach is right for the shrewd property investor.According to Smartline Adviser Michael Sugiandi this includes getting your finances organised and having a well-executed strategy and loan structure in place.

“Lenders are increasingly rigorous, due to changes brought about by the recent introduction of the National Consumer Credit Protection Act (NCCP), in assessing loan applications, which require borrowers to have their finances organised to not only minimise approval times, but also maximise the amount they can borrow,” he says.

“Whether you are a first-timer or an experienced property investor, a cautious approach and getting the financing of your investment right from the outset is fundamental to investing success.

“It’s not unusual for lenders to request additional information while they are assessing a loan application, even if all of the documentation initially requested has been supplied.

“If you want to give yourself the best chance of being approved for a loan, you want it to happen sooner rather than later, and you want to be able to maximise the amount you can borrow, take the time to get your affairs in order first.”

Mr Sugiandi said those intending to borrow should be minimising the number of credit and store cards they have and the available limits.

Aside from making your credit file ‘busy’, which in itself can cause declines as lenders’ automated credit scoring systems can class you as a ‘credit junkie’, it can also make a big difference to your borrowing capacity.

Resist signing up for any additional debt and make sure all your bill payments are made on time – from your mobile phone account to your personal car loan. This is becoming increasingly important as more and more of your repayment history is being recorded on your personal credit file, which is thoroughly scrutinised by lenders.

Mr Sugiandi says the considerations associated with financing the purchase of an investment property go much further than getting the lowest interest rate possible, or weighing up the pros and cons of fixed versus variable.

“While these are certainly important elements in the investment loan equation, what is just as important is the structuring of the loan,” he said.

“When done properly, this is where you can ‘turbo charge’ the wealth your investment property creates for you. However, with the wrong structure, you can get yourself in a mess.”

Loan structuring focuses on the type of loan used, how you fund the required deposit, what securities are provided and what type of payments you make.

“In order to structure your investment loan appropriately for your individual needs, you actually need to know what these needs are and have some form of a strategy in place,” Mr Sugiandi said.

“You need to know where you want your investing to take you, so you can work out how to get there.”

This means asking yourself:

• Are you happy with a single investment property or do you want to build up a large portfolio? If you want to purchase multiple properties, how quickly do you want to buy them?

• What are your investment time frames (five years or 30 years)?

• How much you are able/prepared to put in every week to fund the gap between income and expenses?

• Is your focus on cash flow or capital growth?

Once you’ve given some thought to these questions, you should then be looking to work with your accountant and mortgage adviser to determine the best property investing strategy and structure that will help you to achieve your property investment goals.

Some of the considerations when investigating your investment loan options include:

Funding the Initial Purchase and any Ongoing ShortfallDo you have the cash for the initial deposit and fees associated with your property purchase or will you be using equity in your home or other properties? If you want to borrow more than 80 per cent of the value of the property, you will need to pay Lenders Mortgage Insurance (LMI), which can run into the tens of thousands. How will you be funding any shortfall as a result of the expenses and costs exceeding the income? Will this be from your weekly salary or will you be looking to use your existing equity to supplement this shortfall?

Interest Only versus Principal and InterestMany investors prefer to pay interest only on their investment loan, particularly if they still have a loan on their owner-occupied property. This means that if the investor is looking to reduce debt, they can focus on reducing the non-deductible debt on the family home.

Offset Account versus RedrawBoth offset accounts and redraw facilities can be a good way for an investor to help reduce their investment loan debt. However caution needs to be exercised when putting money in and then pulling out from the redraw facility as this can have implications from a taxation point of view. Using an offset account may be a better option. It’s also important to talk with your mortgage adviser about the differences between partial and 100% offset accounts and the impact these can have on the amount of interest you pay.

Fixed versus VariableA fixed rate is often preferred by investors as it provides certainty when managing cash flow, but at present there is a gap between fixed and variable rates (of about one per cent), which means variable rates can look quite attractive. Alternatively, fixing a portion of the loan and having the remainder variable can provide the best of both worlds.

Deposit BondsA Deposit Bond allows property buyers to make a purchase without having to provide a cash deposit. The guarantee is issued by a third party leaving the purchaser free to use the funds, which may, for example, by placed in a term deposit to earn interest. Providing the guarantee is paid according to the terms of the agreement – both long and short-term guarantees are available depending on the length of settlement – this option can see buyers leveraging funds that would otherwise sit in a trust account.

For example, if a deposit of $35,000 were placed in a term deposit account paying 6.35% pa, for six months, the investor would earn $1111.25 in interest. Minus the $420 Deposit Bond premium, the benefit to the investor would be just over $690.

Mr Sugiandi said that the current cautious economic and lending environment did not mean that those on what is considered a low income were unable to consider investing in property.

“What is required, however, is thorough homework and a bit of creative thinking,” he said. “For example, the choice of property is critical for those investing on a low income.

“The best type of properties for the low income investor will be those that are at the lower end of the scale in price, but with high rental returns.”

As with all aspects of property investing, it’s critical to do your homework on the best way to finance your planned property purchase and get the best deal possible.

A good mortgage adviser will be able to compare what’s on offer from a wide range of lenders, which can lead to surprising results.

Smartline Home Loans Pty Ltd and their representative have made every effort to ensure that the information is free from error, neither Smartline nor its representative makes any representation or warranty as to the completeness or accuracy. Readers must decide if this information is suitable for their personal situation or seek advice.  

Winner Announced!Congratulations to Anthony Lang, winner of the iPad 2.

Thanks to everyone who entered this competition. Given its popularity, we’ll definitely be looking at running more competitions in 2012!

Got the time? We’ve got the bandwidth. Take the PI 10. You don’t necessarily need to be a professional working in the field of investing in order to contribute to Property Investor; we’re keen to publish any tips, insights or advice which can benefit our readers. Whether you’re just starting out or are a seasoned professional, we’d love to know your thoughts.

1. How did you get started in property investing?

2. What does your current portfolio look like? (Just give us snapshot).

3. What are your short, medium, and long-term goals in terms of your own portfolio?

4. What are the three things most important to you when buying a new investment property?

5. What’s generally more important to you, a cash-flow positive property or capital growth?

6. Given a choice between a unit/apartment and house/townhouse, which do you prefer, and why?

7. Location, location, location. Yes or no?

8. How important is proximity to inner city to you?

9. Is there anything you would have done differently if you could start afresh?

10. What is the single most important piece of advice you would give to people who are just getting started in property investment?

Please send your responses either in an e-mail or word document to media@propertyinvestor.com.au (preferably with a picture of yourself).

With the release of the new Property Investor website, we’ll be publishing regular articles, interviews, and book/product reviews. Articles: in order to maintain quality control, we’ve set a few basic requirements for articles (minimum word length etc.), which can be viewed HERE. When submitting articles anything goes, as long as there is value to our readers. For this reason we cannot accept articles which are essentially business reviews or business profiles. For every article published, we’ll post your business name and a link to your website.

Interviews: Think you’re interesting? Our readers probably will think so too! Let us know about what it is you or your business does, and if appropriate, we’ll interview you. This does not necessary have to be in the form of a face-to-face interview, or even an interview over the phone. In many cases, we can conduct an interview online either via live chat, or simply via e-mail correspondence.

Book/Product Reviews: If you’d like to promote your product in the form of having it reviewed by PI, we’d be more than happy to take a look at it with a view to providing our readers with a useful review.

Get in touch – we’d love to hear from you!