Why are you exploring the possibilities of buying investment property? In Australia, the reality is the more you invest, the less tax you pay. Ultimately…the less tax you pay, it means you’ve got more money in your pocket to help drive your debt down.
Are you with me? Do you understand what is going on? 95% of what I am going to show you, you already know. The key distinctions about what makes buying investment properties is how you can put the property investments to work in your own life.
So if we apply this to your life, why would you limit yourself to one investment property? When you buy property/real estate today you are buying at a discount in relation to the future as this increase is calledcapital growth.
These are core structures for financing all of your property investments and wealth creation. In principle, it really doesn’t matter if you buy a house, renovated and sold it, if your investment money comes from business or wherever…
Buying investment property means you get your money working harder for you. The more you positively leverage you investments, the less tax you pay. Less tax…more you can drive your debt down, and more you can drive your debt down the more you can invest!
Why use equity to buy investment property? If you are already a home owner you may not need to provide a deposit to fund the purchase of an investment property because equity is the difference between value of your home vs how much you owe or borrowed from the bank against it…
Want to understand what equity is and find out how to access equity in your own home and use it to purchase an investment property? Simpy push the play button and watch this video.
There are several ways to make the most of your existing equity buying an investment property without actually tapping into your savings. Unlocking the equity in your home can be an effective way to assist in purchasing a rental property to help build your wealth.
Buying an investment property…why invest in units is a common question asked by property investors regarding tax depreciation, so why does a unit get more depreciation deductions than a house?
When investing in units you need to determine depreciation deductions available in a property, factors which affect calculations include:
(a) Purchase price of the property
(b) Date which construction commenced
(c) Settlement date
(d) Land value
(e) Value of fittings and fixtures within property (where relevant)…
The overall cost to build residential units increases due to the amount of infrastructure involved in walls, services, etc by comparison to the less compact layout of a house or residential property which can make a significant difference to overall tax claim.
Units as investments often contain more fixtures and fittings than a house which means owners of a unit not only can claim items within strata unit (i.e. lights, carpet and dishwashers, etc).
Unit investors are also entitled to claim their share of the common property. Common property has been identified by the Australian Taxation Office (ATO) as areas within a complex or development which are shared between owners.
This includes areas and items such as:
Pool and pool pumps
The following example compares a unit and a house (using same purchase price, construction date and settlement date), there is a difference of $15,000 in depreciation deductions over first five years of ownership.
Australian Taxation Office tax benefits: The ATO’s legislation recognises quantity surveyors as qualified to estimate construction costs for depreciation purposes.
As a building gets older its items wear out and depreciate in value. The ATO allows property owners to claim this depreciation as a tax deduction. Depreciation can be claimed by any property owner which receives income from their property.
Most investors are aware they can claim deductions on building structures of a unit (subject to age) including plant and equipment items within such as:
Many investors are unaware they can claim on common areas as well. Is it worthwhile for investors to consult a professional quantity surveyor to calculate the most accurate and financially returns for the property investor?
Accountants and real estate agents may on occasion estimate depreciation figures, although these professions lack construction cost knowledge and the capability to accurately determine depreciation deductions available in an investment property.
Most importantly the ATO does not recognise their figures in a tax return.
That’s why consulting a quantity surveyor which specialises in depreciation guarantees you…the investor to get the maximum legitimate deductions available.
A site inspection allows the quantity surveyor to establish maximum number of plant and equipment items within the property which includes measurements, photos and notes are taken to enhance the depreciation report.
If an investor is audited by the ATO, their depreciation claim will be supported by evidence documented at the time of inspection.
A quantity surveyor can determine correct proportion a unit owner is entitled to claim for common property based on criteria such as size, position within development (eg. penthouse or ground floor) and even its view based on relevant building plans.
If you decide to engage a quantity surveyor to complete a tax depreciation report on an investment property, any fee associated with the production of that report is 100% tax deductible.
Buying investment property means you would be in a position to pull equity out of your property(s) now and invest again. Why? Because you can…you also understand the process of paying less tax, plus how the chain reaction happens by continuing to invest.
Safe as houses an expression to satisfy a doubting person…
Oh…it’s as safe as houses, i.e., perfectly safe, apparently a figure of speech used in property as an investment.
Safe as houses phrase originated when the railway bubble began to burst, and people began to turn their attention to more reliable or stable forms of speculation, which was slow and steady…
Safe as houses, let’s firstly establish your investing strategy, criteria and action plan:
How much money can you borrow to invest
How much time required for research/due diligence
How much money can you afford to lose
How much debt can you manage
What type of property deals
How far from CBD
What’s the maximum interest rates for borrowing
Residential real estate is almost the sacred cow of Australian investment. What if your sights are set on building a real estate empire, does it mean embracing risk with open arms?
Whatever real estate strategy you decide to do, just bear in mind networking is even more important in real estate than in other industries…so start pounding the pavement as soon as possible selecting the all-important team to manage your projects.
Risk, reward and reality. It’s easiest to think of property investments from least risky to most risky and analyze the pros and cons in each category:
(a) Least risky investing means acquiring and operating existing properties/buildings (buy and hold strategy)
Property investing is all about stability and getting high single-digit returns by operating existing assets (least risk when a building is already operational and generating rental income)
(b) More risky or value-add using opportunistic strategies for improving existing properties.
This is where investors aim to make substantial improvements and renovations to existing properties instead of acquiring and operating, (returns from 15–20% range, may go higher depending on how risky the strategy)
(c) Most risky which is real estate development and building completely new properties. Most risk equals highest returns?
You might think real estate development offers the highest returns because it’s also the riskiest, right?
Real estate development involves buy, sell, develop, managing properties, third party joint ventures (stakeholders) and of course all professionals including:
Real estate agents
The real money in real estate development primarily goes to investors, which put their money at risk in the developments. To complete the construction of a new property, developers only put down a very small portion of total equity, perhaps 5% or less.
Many times the developer contributes land as the only form of equity in the project using debt and mezzanine financing to fund the entire construction cost.
You weigh up the risk versus reward before deciding. It is generally accepted the higher the reward the greater the risk. Property development slightly increases risk because of the many variables such as:
(a) Site costs
(b) Development costs
(c) council approvals and contribution costs
(d) Construction costs
(e) Resale values
Safe as houses…a thorough working knowledge of all these areas is required in order to succeed. Most of the returns go to the third party investors which come up with the rest of the funds.
How does no cash flow from properties sound like because buildings are under development, so there’s no cash flow generated until tenants move in and rental income starts flowing.
The fees property developers charge are not great compared to the amount of overheads, sometimes there isn’t much money left to pay salaries to employees.
That’s the reason why you wouldn’t get into real estate development if money is your main goal, only do it because you’re interested in building and construction side of real estate and you’ve cash resources with small surplus to cover contingencies and enough money to invest in development projects yourself.
What if you just love every aspect of real estate? People which find the greatest success in real estate focus on the end goal of owning income properties. There are actually real estate investors from all walks of life…
Investing in real estate yourself…you don’t need to raise hundreds of millions of dollars just to buy a house. The key is to find your core strengths where you can be initially be successful, so you’re able to generate enough cash flow to own properties yourself.
So let’s take a wild stab at your future goal here…you want to make a lot of money and ideally own three or more properties debt free and outright (perhaps multiple skyscrapers with your name on them one day, might even end up with your own island one day:)
You’d also like to avoid working in a job if at all possible, and perhaps you want to make the transition from investor to developer?
As an added bonus, you don’t want to earn badges from a top notch school of hard knocks to get started, right? You’re thinking its all worth learning how to crunch the numbers, and sounds like real estate investing is a good fit for you…
How to analyze real estate deals, making sure the numbers work?
Each property is unique and brings a different value to potential investors, so it’s trickier than it sounds to find the right property.
Investors generally look at three factors when analyzing a property:
(1) Investors look at what the property/building is currently doing, how much income it has been generating and what the property-level expenses are, which gives you the net operating income (NOI).
(2) Investors look at the property to make sure it can maintain its current income.
It’s one thing to have generated strong income in the past, sometimes factors like:
(b) Demographic shifts
(c) Changes to the local area can drive a property right into the ground…
(3) Investors project what the building could do in the future to increase income and/or cut expenses.
Depending on what kind of deal it is, investors will focus on either the current income or the projected income.
For example, a stabilized deal which isn’t expected to see much upside or current rents which is the key valuation driver.
There are four main real estate deal types:
(1) Stabilized deals (buy and hold) are “blue-chip stocks” of real estate investing. These properties are generally recently built and currently have a stabilized high yield, e.g. 7% or 8% per year.
When investors look at these properties/buildings, they’re generally maintaining income which is currently produced. There isn’t a lot of risk with a buy and hold (stabilized deal) and also not much reward.
(2) Renovation is the next type. A property which is a good candidate for a renovation would fit the description of an older building in a stable growth sub-market (one which can support higher rent prices) could get significantly higher income or value from renovating houses, units or entire building.
There is more risk involved with renovation type deals than a buy and hold stabilized deal, because property investors are banking on future upside of renovating the property (perhaps reselling to homeowner or another investor).
Value-add deals do limit risks? Typically the property/building is in decent condition and is a tangible asset ( i.e, asset = liability + stockholders equity) which is easier to show, discuss and understand.
An asset is a resource which is expected to provide future economic benefits (i.e. generate future cash inflows or reduce future cash outflows)…an asset is recognized when:
(a) Asset is acquired in a past transaction or exchange
(b) Value of asset’s future benefits can be measured with a reasonable degree of precision
In markets where there is increasing momentum and upside, value-add deals are easier to do because it requires vision and creativity, which is fun. Downside of increased momentum is competition from other bidders dramatically increases pricing for certain assets.
However, added value is created by gaps in information and understanding. This is where real deals can be made by being innovative,
creative and diligent with the details.
Success comes from properties which others may have overlooked or passed due to their lack of motivation and understanding.
Nothing in real estate is easy, yet if you have the desire to roll up your sleeves and get a little dirty, there are diamonds in the dirt.
Real estate is challenging and rewarding and you just got to know how to dig for the value-added, diamond in the rough deals.
(3) Real estate distressed properties, these usually need a lot of work (units or building itself is in bad shape) or under performing.
Often, these building have huge vacancy rates, so the projected income is a big factor in valuation. Real estate distressed properties carry even more risk than a renovation deal because the building needs work and it is already under performing.
4) New development deals. These are just what they sound like. Development happens when an investor wants to take raw land, then evaluates what can be built on it and what kind of future returns can be generated.
Development deals have the highest risk, and also carry the highest return. In reality, you don’t necessarily make the most money with development deals, because of inherent risks and uncertainty, don’t assume highest risk equals highest profits in your bank account.
Property valuation and due diligence: You are primarily wanting cash flow and reliable cash-on-cash returns because in real estate, property itself produces the income for your return on investment.
While the numbers are generally used to support valuation, comparable sale analysis is king when valuing properties because property is only worth what someone is willing to pay for it.
In residential “yield” is often used instead of “cap rate”. Capitalization rates are used as the primary metric in property valuation.
Cap rates are a very simple way of calculating the return on a building. Essentially, capitalization rates tell you what percentage of the funds you paid for the building comes back to you annually.
It’s just an easy metric to use; for example, if you have a 6% cap rate property and it’s at a 6% debt interest rate, you can easily see it is neutral leverage and isn’t returning any money.
Cap rates do have flaws and the biggest is everyone assumes cap rates in a specific sub-market to apply to every property within that sub-market. Simply this assumption isn’t true.
Every single property has its own nuances which makes it more or less appealing to potential investors.
If you get too clinical on only measuring cap rates, you could either be overvaluing or undervaluing your building. You really need to analyze each property/building and the market thoroughly to get a sense of how much value it is truly worth.
Another weakness, while cap rates are great to use in a city like Melbourne where buildings are constantly being bought and sold,
there’s considerably less data in other regions without as many sales taking place, so the numbers may not be reliable.
Basically due diligence means you are making sure the deal stacks up and doesn’t have more holes than a slice of swiss cheese.
Sellers want to sell their property at the highest price and investors have an interest in closing the deal.
Safe as houses, buyers need to protect themselves; due diligence is generally broken down into two components:
(1) You analyze the property at a micro level and then in the macro.
In the micro, you look at the building itself. You check the market to make sure projected rent prices at the property/building actually make sense, and people are paying those prices at similar properties in the area.
Next, you look at macro trends. You then dig deeper to make sure the tenants are in good financial shape. This is especially true if you are buying a single tenant building or more tenants in general.
You look at what other investors are paying for comparable buildings to make sure you aren’t over-paying. It’s also important to look at macroeconomic trends in the region you are investing to make sure the submarket can sustain positive economic growth over time.
Properties with equity…what is equity? Equity is the difference between what your home is worth and how much you owe on it.
For example, if your home is worth $500,000 and you owe $200,000, you have $300,000 in equity. As you continue reducing the amount you owe on your home or value of your home grows (capital growth), your equity increases. It’s that simple.
Properties with equity and how to get equity to build wealth through property investment. Unlocking equity in your home can be an effective way to assist in purchasing rental property to help build your wealth.
Residential investment properties are a popular investment vehicle providing investment funding in the form of capital growth and rental income…
Properties with equity, what if you’re already a home owner? Firstly, you may not need to provide a deposit to fund the purchase of your next investment property. Imagine if you could leverage and harness the power of your home equity…
Home equity is the difference between your home’s market value and the balance of your mortgage.
What if you’ve owned your own home for a few years? There’s a good chance you have by default already built-up some reasonable equity (in context to capital growth), and this can be a valuable resource when it comes to buyingproperty investment.
Here’s how it works. Let’s say you want to buy an investment property with a market value of $400,000. There are also additional purchase costs (legal fees, stamp duty and so on) of $20,000, bringing the total cost to $420,000.
Assuming that you meet the loan approval requirements, a lender fund 80% of the property’s market value (potentially more if you are prepared to pay Lenders Mortgage Insurance LMI)…
Meaning the bank lends you $320,000 to buy the investment property. As the total cost of the property is $420,000 you still need an additional $100,000 for the deposit. This can come from the equity in your existing home.
Let’s say the market value of your existing home is $500,000 and the balance of your mortgage is $300,000. The difference between the two is $200,000, which is your home equity.
Properties with Equity in context to an investor because it means you can access up to 80% of your home equity (without the need to take out LMI), which equates to $100,000 in this example .
Instead of coming up with a cash deposit for the additional $100,000 needed to buy the investment property, you can take this from the $100,000 of accessible equity in your existing home.
The available equity in your home is calculated at 80% of your home (without the need to take out LMI) less any current loans, which equates to $400,000 less $300,000 = $100,000.
Alternatively some lenders lend to 90% of the property value less the existing mortgage, where lenders mortgage insurance would be paid on the amount borrowed over 80%.
You should note many property investment gurus say it is important to repay the loan on your home as soon as you can.
The equity which is drawn down from your home to purchase an investment is tax effective, however any remaining debt on your home is not. Therefore the loan on your home costs you much more on an ongoing basis than the loan on your investment property.
Properties with equity…property you live in is not the only source of home equity. You can also use the equity in an existing investment property to help fund other property purchases/buying investment property.
Contact your mortgage broker to help you work out how much equity you can access in your property and how it can be leveraged as a source of funding for your next investment property.
Properties with Equity
Australian property investors guide to property investments now, where to buy investment property, positive cash flow property using proven strategies to create wealth and financial freedom