Before you buy your first investment property – Part 1.

Before you buy your first investment property – Part 1.

Buying an investment property can be a great way to build your wealth and also to potentially save tax. Before you buy your first investment property it is worth going through the following 10-point checklist.

1. Why am I buying an investment property?
2. How much can I afford to spend?
3. What are the tax implications of buying an investment property?
4. Where should I buy – how do I determine a good location?
5. What sort of property should I buy?
6. What will the numbers look like?
7. What are my risks?
8. How can I protect myself against those risks?
9. How do I structure my lending?
10. What is the process and how do I get started?

In this post we will look at the first 3 reasons and in later posts, we will look at the rest.

1. Why am I buying an investment property?

This might seem like a silly question, but is well worth analysing why.

Am I buying this property as a long term investment, am I buying it to renovate and sell, or am I buying to attempt to make a quick profit?

The last reason, to make a quick profit, is going to be hard to achieve in the real world. Property has significant purchase costs (stamp duty, legal fees etc) and sale costs (agents fees, legal fees, capital gains tax etc.) and these need to be taken into account.

As an example a $500,000 property in Queensland will attract around $17-$18k in legal fees and stamp duty, taking our total cost to say $518,000. Let’s say we then spent $2,000 on a quick clean up (easy to do).

If we sold the same property for say $540,000, we would have marketing fees – say $3,000, agents commission, say $15,000 (standard rates), legal fees say $2,000, mortgage discharge and bank fees, say $1,000. Thus would nett us just $519,000.

What sounded like a great opportunity at face value – I can buy this for $500k and sell for $540k and make a quick profit is in reality no opportunity at all – we will in this case make a loss of $1,000, and waste a whole lot of our time.

Buying to renovate and either sell or hold can face many of the same problems and more. The numbers (including how much you will need to spend) need to be calculated carefully. You will also need to count the cost of not being able to receive rent while the property is being renovated. In reality, it is very difficult to make a quick profit from a renovation, especially if you have no experience. For a builder or other tradies who can get cheap or mates rates labour, it can be a little easier, but it is generally best left to the experienced investor who also has time on their hands.

Now I don’t like being negative, but the latter two reasons in my opinion are very difficult for your first investment property. However, buying your first investment as long term investment, assuming you can afford it (read on below) is a great reason to buy your first investment property.

Generally speaking, a carefully selected investment property, bought in a good area, at a reasonable time in the property cycle and held for longer than 10 years will be very rewarding and the longer you hold it, generally the more rewarding.

As an example the median house price in Brisbane in September 2016 was $470,000. 32 years earlier, in 1984, it was just $58,950, and this is effectively just the average.

So let’s focus the rest of these posts on buying for the long term, as opposed to speculating.

2. How much can I afford to spend?

How much you can afford to spend on your first investment property will depend on the following factors:
a. How much savings you can put towards the purchase.
b. How much equity you have in your current home.
c. How much you can borrow from a bank.
d. How the numbers from the chosen property stack up.
e. Your current cashflow (your income and your expenses) and your expected cashflow over the next few years.

As an example. Amy and Joe have a current home worth $600k and they owe $400k. This means they have equity of $200k, which can be used as a deposit on an investment property.

Amy earns $100k pa and Joe has just gone back to work after being home dad for 4 years and will be earning $50,000. They have been living OK off Amy’s income for the last four years and now want to use Joe’s part time income to pay for school fees and build their wealth. They work out they can allocate $15,000 to an investment property.

After sitting down with their financial planner and mortgage broker they work out they can comfortably borrow $550,000 to buy an investment property. In theory they could have borrowed more, but they didn’t want to push the limits.

3. What are the tax implications of owning an investment property?

The general tax principles of owning an investment property are:
a. Rental income is taxable to the owner
b. Most expenses (except improvements) for looking after the property are tax deductible.
c. Interest costs from the borrowings used for the purchase of the property are tax deductible.
d. You may receive extra deductions for “depreciation” of fixtures and fittings and the write off of the building costs. These are generally bigger for newer properties and may not exist at all for older properties. Specific tax advice around the property being looked at should be obtained.
e. If and when you sell, if you make a profit, it will be subject to capital gains tax, and if you make a loss, you can offset that against other capital gains, if you have any.
f. You will pay local government taxes – known as rates.
g. You may pay state government taxes – land tax, particularly as your wealth grows.

You may have heard the term negative gearing. What is negative gearing. This is simply when the total tax deductions for a property are GREATER than the taxable income. This results in a loss for tax purposes which can be used to reduce the tax that would otherwise be payable on your other income from salary etc.

Positive gearing is when the taxable income is GREATER than the tax deductible expenses.

You, and your advisers will need to do the numbers carefully as their will be two important things to determine.
1. What is the cashflow required to hold this investment property BEFORE TAX, and
2. What is the cashflow required to hold this property AFTER TAX?

In coming posts we will walk through the remainder of the checklist.

WARNING : All of the information in these posts are provided for general purposes only. That means they do not take into account your specific circumstances. They are designed to improve your knowledge in all areas of your financial world. Before you act on any information in these posts, you should get good advice that is specific to your own circumstances and goals. If you would like help in any of these areas, please free to contact us for a free 15 minute phone consultation to determine if we can help you.

Have an awesome day 

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