The depreciation party is over…
Well, kind of!
In an attempt to “reduce pressure on housing affordability” the Government has announced dramatic changes to the way depreciation is claimed on property.
Let’s start with the good news:
1. Any existing investment properties purchased (contract exchange date) prior to May 9 2017 are not affected (unless they were not income producing in the 2016/2017 financial year).
2. Commercial, industrial and other non-residential properties are not affected.
3. Capital works deductions have not been affected. This means you will still be able to claim depreciation on the structure of the building provided it was built after the 16th of September 1987. And you will still need a Quantity Surveyor’s depreciation schedule to do so.
Now that we know what isn’t affected, let’s look at what has changed…
The government will limit plant and equipment depreciation deductions to outlays actually incurred by investors. In essence, unless you as the buyer had physically purchased the items – you can no longer depreciate them. This is a massive change to what you can claim – there by reducing investors’ cash flow.
Originally I thought a quick fix would be to structure the sales contract so that the plant and equipment is separated. But I suspect that the legislation will be worded such that if the plant and equipment was in situ at the time of purchase, you can no longer claim it.
You see, under the recent changes, I suspect the developer will be deemed to have bought the plant and equipment – not you.
However, the acquisition of existing plant and equipment will form part of the cost base, thus reducing your capital gains liability. So investors who hang on to their properties long term, will no longer reap the benefits of depreciating plant and equipment.
So in summary: if a residential property was built prior 1987,and has not been renovated – there will be no depreciation claim.
This is very rare as most pre-1987 built properties we inspect have had some renovation carried out.
If built after 1987 – only the construction costs can be claimed.
Whilst there is still much uncertainty regarding the specifics of this budget’s depreciation-related changes, one thing is crystal clear: If you own a residential investment property and haven’t had a depreciation schedule prepared, now would be a good time to get a quote!
Developers, Project Marketers and Property Sales Agents – If you are selling property and using depreciation numbers that include plant and equipment: STOP NOW! This element needs to be removed from the selling equation, at least until the legislation is finalised.
Here is why I think this is dumb policy.
The proposed changes are being made to “reduce pressure on housing affordability.” In my opinion, it will have the opposite effect for 3 reasons:
- Property investors may now feel the need to hang onto their existing properties to continue claiming depreciation because if they sell that property they won’t be able to get as many deductions on the next one.
- Developers rely on high depreciation figures in the early years to show investors how affordable an investment property can be. If the allowances are taken away, they will struggle to get pre-sales which are required by banks to fund the deal.
- These budget measure are forecast to save $260 million over a 3 year period. I suspect far more will be lost if developers can no longer get new projects off the ground.
Whilst I believe housing affordability is a major issues, this appears to be policy on the run…so the Government can be seen to be targeting property investors, when changes to negative gearing could have been more effective.
I will provide a further update once the legislation is finalised.
Every investor – whether expert or amateur – should be looking for the same things in a property investment to ensure its success.
While there is no exact formula for buying a successful investment, it’s handy to have a checklist to consult to make sure you’re on the right track.
Below are some of the fundamentals you should be looking for when buying. Be aware that this isn’t an exhaustive checklist. However, it can serve as property investment tips that will help guide your decisions.
Property must haves:
- Good location – The old adage still rings true; it’s all about location, location, location. Well, maybe it’s not all about location, but the fact is you can change a property, but you can’t change a location. Being close to amenities such as shops, schools, public transport and even major transport routes is key when it comes to selecting a good investment property.
- Growth drivers – Are there any major projects taking place in close proximity to drive up the value of the property? This might be in the form of new or planned infrastructure or commercial developments that will improve amenity or access to the area. This is likely to draw more people to the area, pushing up demand for homes.
- Population growth – Are people moving to the area? Look at population growth figures in the area you’re buying in. Then determine whether there are factors drawing people in, such as employment nearby and improved amenity.
- Tenant appeal – Is there demand from renters in the area and for the type of property you’re purchasing? Does your property have the features tenants want? What are the vacancy rates? Demand from your target demographic is the key to securing a strong return.
- Build quality – While location is key, the property you buy is important too. This is especially true if you want to attract quality tenants. Do your due diligence, which includes getting a building and pest inspection, to ensure the home you’re buying is of a good quality.
- Value-adding potential – A well-selected property should see capital growth. However, it’s always a good idea to have the ability to add value through a renovation or by adding a room or a car park, for example. Value-adding potential also comes in the form of a change in zoning that will allow for development. If the market slows you may need to manufacture growth to increase your equity.
- Liveability – Does the property have a good layout? Does it have the features people want, such as extra bathrooms, car spaces, security, and a nice outdoor area, whether it be a roomy balcony or a good deck and backyard? All of these things will make it more sought after. Liveability also goes for the suburb. Ensure you buy in an area with a good community due to plenty of amenity and nice aesthetics.
- Individuality – A property that is unique is some way – or that stands out from the crowd – can experience strong growth as it will be in high demand amongst buyers. This is especially the case when it comes to units, particularly in areas with a lot of supply.
- Scarcity – Does demand outweigh supply in the area in which you’re buying? This applies to the area in general as well as the property type. If there is greater demand than supply in terms of both buyers and renters, the property value and rental rate will be pushed up.
- Low maintenance – Select a property that won’t require a great deal of maintenance. This will save you money and keep your tenants happy.
- Proximity to employment – People like to live in close proximity to work, so make sure there are employment options nearby. If you’re buying in a regional area make sure there’s more than one industry in the town.
- Stability – Have property prices been stable in the area in which you’re buying? Ideally you want a history of consistent growth, avoiding areas that have experienced big price falls.
- A solid history – Do your research and make sure the property hasn’t been sitting on the market for a long time, and if it has, determine why. Make sure it’s not due to an inherent problem with the property. Finding out why the sellers are moving on is also important. The last thing you want is a property that isn’t selling for a good reason.
- The right numbers – You want the property to stack up from an investment perspective, with good potential for capital growth and decent rental yields. Make sure the numbers add up! What is the rental yield, what are the total costs, how much will you be out of pocket for?
Ahhhhhhhh, housing affordability. That old chestnut. It’s a topic that’s been hotly debated a million times over! And will no doubt continue to be for many years to come.
The general consensus is that property in Australia is unaffordable. The results of a recent survey seemed to confirm this, with the proportion of adults who own their own home falling from 57% in 2002 to 51.7% in 2014.
The annual Household, Income and Labour Dynamics in Australia survey, authored by Professor Roger Wilkins from the University of Melbourne, also found that the rate of home ownership is expected to keep falling, and may drop below 50 per cent as early as next year.
So, is home ownership falling because Australians simply can’t afford to buy properties due to hugely elevated prices, or is it due to other factors?
Property prices have significantly grown
It’s certainly true that property prices have significantly risen in Australia over recent decades.
The median dwelling price for the combined capital cities is currently sitting over $500,000, according to CoreLogic. But prices of course range widely between the capitals. Hobart is the cheapest at around $300,000 and Sydney being the most expensive at nearly $800,000.
This decade so far prices have risen across the board by 35%, and over the previous decade they rose by around 140% according to CoreLogic figures.
But since the beginning of 2010, it’s been the two major capitals of Sydney and Melbourne that have seen the majority of growth. Prices are increasing by around 60 and 40 per cent respectively (as at May this year). The other capital city markets have seen either little growth or have fallen in value, so theoretically, in some places affordability is actually improving.
This is especially the case when you consider interest rates; in this regard 2016 actually presents quite a good time to buy with the cash rate now sitting at a record low of 1.5%; very different from the double-digit interest rates investors experienced decades ago.
We, of course, also need to consider incomes in relation to price growth. Depending on who you ask, there can be a case to say housing has or hasn’t become more unaffordable. It’s clear, however, that house prices have risen faster than incomes, making it harder to save for a deposit.
Priorities are changing
While property prices have clearly risen, it’s also the case that priorities for more recent generations have changed.
Once upon a time – not that long ago really – youngsters left school and got a job, with their primary objective being to save for a deposit to buy a home.
Nowadays, however, younger generations seem to have different priorities. They often leave school with the intention of travelling abroad for a gap year (or two or three). Or if they go straight into a job they’re not necessarily saving, but buying the latest gadgets; in our modern society it’s about instant gratification.
So does that have an impact on affordability?
It makes sense that it likely impacts on the ability to save for a deposit.
We need to consider which is the cause and which is the effect, however. Some – including a Sydney real estate identity recently – argue that this generation is simply too selfish to make the necessary sacrifices, such as cutting back on commodities such as widescreen televisions and designer clothes, to save and get a foothold in the market.
But on the flipside others argue that priorities have changed simply because it’s impossible to save the huge deposit required for property these days. So younger generations are instead deciding to spend their money on something else because property is out of their reach.
But are the expectations of younger generations now just too high? When they complain about property being unaffordable, is that because they want to buy a flash pad in inner Sydney as their first home, rather than buying something further from the city in a price bracket they can actually afford? Essentially, many want to buy what would traditionally be their last property – often what their parents have worked their way up to – first.
Add to all this the fact that renting has also become more socially acceptable. The Great Australian Dream perhaps fading a little, and we have a little more insight into the affordability debate.
Consider your options
It’s clear that the debate around housing affordability isn’t clear-cut; there are many aspects to consider. As the debate continues to rage, demands for reform or government measures to curb price growth will persist.
While Australian property prices have risen and are unlikely to fall (despite claims from doomsayers), leading many to feel as though it’s impossible to break into markets such as Sydney, there are always more affordable opportunities within each capital city if you care to look. Consider buying further from the city, or a unit instead of a house. Scale down your expectations and buy where and what you can actually afford.
And if you don’t want to scale down your expectations, become a ‘rentvestor’. This means you choose to rent where you want to live and invest where you can afford to buy.
For investors, it’s of course better to buy where there’s more potential for growth. Chances are that’s in an area that hasn’t already seen huge growth. Yet where there are lower prices with more room to move.
Tyron Hyde was recently asked by Your Investment Property – “What was your best property deal?”
How long have you been investing in property?
Well about as long as I can remember! For me, the term “investing in property” means more than just buying an actual property.
I’ve been “invested in property” ever since I was about 17 and walked on my first building site.
I was that kid that would always stop and stare through the hoarding of a building under construction and look at amazement at the excavation and try to work it out.
It drove my girlfriend (now wife) stir crazy as we would often miss the start of the movie!
What was the best investment property deal you have made?
My First Investment Property
My first property investment was probably the best deal I ever did.
It was over 20 years ago, and I had just started working at Washington Brown. We were acting as the bank Auditor on the redevelopment of the Balmain RSL.
I liked the area and knew the potential this site offered. Together with a friend we put down a $2,000 holding deposit on $259,000 unit.
The builder went into administration on the job, and the project took a lot longer to complete. Luckily, the values of the property rose strongly.
And by the time settlement took place, the prices went up so much we didn’t have to put our hands in our pockets because the price rise was all the equity we needed to settle.
We ended up selling the unit 2005 for $490,000. So we turned our $2000 into $231,000 in less than ten years.
So excluding taxes, stamp duty, etc.. that works out at around a 70% compounding return over a nine-year period!!
What did this investment allow you to do?
This investment allowed me to buy more property of course! Every property I have ever sold has always re-invested back into another property.
In hindsight, with some of the recent price rises in Sydney, I wish I had found a way to hold onto them.
But it’s not always that easy.
What is your ultimate goal as a property investor?
My ultimate goal as a property investor is to live comfortably off the income I receive from my investments.
I have a mix of investments including commercial and residential and not all are based in NSW.
As I get older, I am more debt risk averse and don’t like borrowing that much if at all to fund these investments.
With Negative Gearing still around, I know this probably isn’t the wisest economic move, but it sure makes me sleep better at night.
(UPDATE: Some changes to negative gearing were made in the 2017 Budget – Read about the Budget changes here).
Now I’m not one to whinge about a system without a solution…I think the current Negative Gearing model needs some repairs for two reasons.
Reason 1 – The system was not designed so that someone could buy 100 properties, off-set those losses against personal income and never pay tax in the foreseeable future!
Reason 2 – Someone should not be able to buy a $20M house, get a terrible yield of 1-2% on such a large purchase price and offset the difference against personal income.
NEGATIVE GEARING SOLUTION
Solution 1 – Cap negatively geared property to a maximum of 3 properties per person over their investing life.
Solution 2 – Cap an individual property to the median price of an Australian property. (This takes into account the vast range of average prices across the board). So someone could buy a house in Sydney + one more in Brisbane for instance, or perhaps 3 properties in Hobart?
I’m interested in your thoughts so please leave your views below…
Dear Fellow Investors,
Cuts to Negative Gearing Stink
I get it. I get what Bill Shorten and the Labor Party are trying to achieve by cutting negative gearing…but it stinks for 6 reasons.
First, for those of you who might not know…Labor proposes to:
- Eliminate negative gearing to all residential investment properties other than new housing from the 1st of July 2017.
- Stop investors from claiming losses on secondhand properties against their wage income after that date.
- All investment properties purchased prior to this date will be “grandfathered” (meaning any current tax arrangement with your investment property will remain).
- Reduce the capital gains discount on all investment properties from 50% to 25%.
Stinky Reason #1 – How much will the budget be improved?
The latest data from the ATO shows that in the year 2012/13 property investors “negatively geared” or reduced their taxable income by approx $5.5 Bn. That’s $5.5Bn that the Government could have taxed (not necessarily collected).
Firstly, this data, the most recent available, was based upon a period when the RBA cash rate was higher than it is now.
Interest rates on borrowing have dropped since that time – meaning the losses investors can now claim will be reduced.
Back then, the outstanding rate of interest was close to 5.5%. It’s now close to 4.5%. That’s a drop of 18.2%.
I can currently get a 5-year fixed rate of 4.59% from NAB and there are many others…
If you reduce the amount investors have claimed in interest by 18% – there goes those negative gearing losses even allowing for CPI increases of other deductibles.
In order to get Labor’s forecast of $32Bn in savings over 10 years, Treasury must have predicted some significant increase in interest rates from years 6-10 right?
But let’s face it….Treasury can get it wrong – remember its forecast for iron ore prices? It was totally optimistic.
Stinky Reason #2 – Negatively Gearing new property only is risky business…
“Roll Up Roll Up”…I can hear the spruiker cry…
By allowing only new properties to be negatively geared….you are creating a “green light” situation for every spruiker to come out of hiding and promote new property to unsuspecting mum and dad investors.
Selling new property is far less regulated and commissions are rife. Time and time again I get offers to sell property to my database and receive a 10% commission on the purchase price. But I don’t.
Whilst I’d love the 10% my father lost all his super from the dodgy side of the property market and the last thing I’d want is for someone else to go through that experience.
Tip – Have you noticed spuikers generally only sell new property?
That said, not all people selling new stock are bad – currently most are good…but this type of policy might attract less scrupulous spruikers after a quick buck or two.
Stinky Reason #3 – The Reverse effect
I get it – Labor’s policy aims to increase home affordability particularly for first home buyers.
Yes. Australia is expensive on the world stage – BUT could stopping negative gearing actually inflate prices?
How? Well the first thing I thought when the policy was released was “no point selling any properties I currently negatively gear – I’m hanging on!”
According to those ABS stats I previously mentioned – there’s close to 3 Million properties that might not be sold if everyone thinks like me!
Now, I’m no Warren Buffet but I do remember one thing from economics…price is a factor of supply and demand and if you take away the supply….prices tend to head north.
Stinky Reason #4 – The elephant in the room
This stinky reason is a surprising one, and in all my research I haven’t seen any mention of it.
Whilst the Government may, in the long term, claw back some revenue if this policy is implemented, if property transactions decline, the States are going to be significantly impacted by way of stamp duty collection.
If investors hold onto stock…the building industry won’t be able to magically increase supply to make up the difference.
And if you have far less transactions, you have far less real estate agents, conveyancers, buyers agents, brokers etc paying income tax.
Stinky Reason #5 – Slippery Slope
Labor has also proposes to cut negative gearing on new share investments. This leads to a whole bunch of questions such as:
- By shares are we talking listed only or unlisted?
- How are super funds treated? Family trusts?
And back to property…
- What if I buy a commercial or industrial building? If bought in my own name it appears I can still negatively gear it. However, if that same building is part of a listed trust, then I guess I can’t. Please explain??
- Is “property” treated as land + building and plant and equipment separated? Because that’s how the CGT calculation is calculated.
I could go on…
Stinky Reason #6 – The Renovators
“New property” is not all about starting from scratch.
Don’t underestimate the amount of people who like buying and upgrading property. This has a multiplier effect in that money is being injected back into the economy through the employment of trades and the purchasing of goods and services etc.
Now I’m not going buy into the debate over whether negative gearing is for the “rich” or for the working class. I would’ve thought it was pretty obvious that those with higher incomes benefit more from negative gearing.
And I don’t buy the argument, from the Real Estate Institute of NSW, that rents will suddenly go up because negative gearing is taken away. Rent is a factor of supply and demand – not what it costs an individual to hold a property.
What I worry about is the risk/reward ratio. I think at this point of the economic cycle (China’s downturn, mining slump, drop in commodity prices and a property boom in most major capital cities around the world)… this policy is potentially playing with fire for very little reward.
I agree there are certain elements that need to be fixed to make the system fairer and here’s my thoughts on that.
PS – If you think I’m writing this article as a staunch Liberal Voter…you are wrong. I was brought up to vote Labor. In fact, my father ran for the seat of Lowe in 1975 against Billy McMahon! I’m currently politically agnostic (my father would be turning in his grave) – but times have changed!
Negative Gearing Property Investment
What is Negative Gearing Investment Property?
Put simply, negative gearing is a tax benefit offered to investors on their borrowing costs.
If your borrowing costs exceed the revenue gained from your investment, you are entitled to claim those losses against your total income.
The benefit of gearing is that it allows you to own investments that would normally be out of reach, giving you the opportunity to make a greater return on your outlay.
For instance, Jenny uses her $50,000 deposit to borrow $350,000 and buy a $400,000 investment property. At 8% the annual repayments total $28,000 on an interest only loan. The rent she receives from this property is $400 per week, or $20,800 per year – leaving her out of pocket by $7,200 per year.
Other expenses include rates, levies and maintenance costs, which add up to $3,500 per annum. Jenny has now spent $10,700 to own that asset over and above the income she has received for it.
So when it comes time for Jenny to do her taxes she will be able to reduce her taxable income by $10,700. That’s negative gearing.
But wait there’s more!
Jenny’s property was built in 1995 and Washington Brown Quantity Surveyors has advised Jenny that she can claim $8,000 in the first year for depreciation.
So now Jenny can tell the ATO to reduce her taxable income by $10,700 plus the $8,000 in depreciation allowance (a total of $18,700).
The reason we have separated the depreciation from other out-of-pocket expenses is because Depreciation Allowances are not reliant on whether the property is negatively geared, positively geared or cash flow neutral.
Is it worth is?
At the end of the day, it’s called negative gearing because it involves a loss.
So why would you want to spend more money on your investment than it pays you to own it?
Most investors are willing to accept a loss in income if they believe they will be compensated by capital growth in the future. But you must be able to fund this shortfall while you wait for the investment to appreciate in value.
You also need a taxable income from which this loss can be negatively geared against. And the higher your income, the higher the benefit will be.
For instance, if Jenny were on the highest tax rate of 45 percent, her $18,700 loss has now resulted in an $8,415 tax refund ($18,700 x 0.45% = $8,415). So in real terms it has only cost Jenny $2,285 ($10,700 – $8415 = $2,285) to maintain this investment in that particular year.
So for approximately $44 per week, Jenny owns an asset that will hopefully increase in value. If her property appreciates 5% in the first year, that’s an increase of $20,000 with a $2,285 holding cost.
Sounds good doesn’t it!
But the reverse applies – if Jenny’s property goes down 5% then she’s lost $20,000 off the market value of that investment.
At the end of the day, there is no point negative gearing into an asset class that decreases in value.
But history has shown that if you buy well-located property at the right price and hold it long term, it has been a great investment.
And if you can do that whilst keep the holding costs to a minimum – then your gains are magnified.
Can you afford it?
MoneySmart, the consumer website of the Australian Securities and Investments Commission, suggests the following three things to help make negative gearing succeed:
- Buy good quality investments, preferably with a reliable and rising income stream.
- Borrow conservatively so you can survive interest rate rises and possible loss of income.
- Maintain reliable income from your job or other sources to cover your borrowing costs, especially in the early years.
What is Negative Gearing?
Negative gearing is a tax benefit you can claim if your borrowing costs are higher than the money you’ve made from an investment property. These losses can be claimed against your total income and increase your tax return and therefore, your income on your investment.
For example, Jenny had a $50,000 deposit and borrowed $350,000 to buy a $400,000 investment property. Her annual repayments total $28,000 on the interest only loan at 8%. She rented this property at $400 per week, or $20,800 per annum so she actually lost $7,200 per year. Plus there were other expenses: rates, levies and maintenance costs which added up to $3,500. Jenny has now spent $10,700 to own that asset over and above the income she received.
Jenny will be able to claim this $10,700 loss against her taxable income by $10,700, this reduces what she might have to pay in tax. That’s negative gearing because it involves a loss.
Why Negative Gear
Most investors are willing to accept a loss in income if they believe they will be compensated by capital growth in the future. The catch is you have to fund this shortfall while you wait for the investment to appreciate in value. You’ll also need a taxable income to negatively gear this loss against. The higher your income, the higher the benefit of negative gearing as it will decrease your taxable income so negative gearing is a better option for high income earners.
What is Positive Gearing?
Positive gearing is the exact opposite of negative gearing, this is when the income from your investment property exceeds the cost of owning the property when you take into account your loan repayments, interest and all other out of pocket expenses (like rates, water and maintenance costs). If you have a property that is positively geared, you will be enjoying a net gain from your investment. If you making an income from the investment it is cash flow positive.
Why Positive Gear?
Positive gearing is a good option if you are retired (as you will no longer have a taxable income to offset against the loss) or you don’t have a high taxable income. Positive gearing means you are making money on your investment property and you will also hopefully enjoy capital gains too. Beware however that property prices go up as well as down and interest rates may not stay this low forever so your costs could increase and the value of your property could decrease. Consider also the cost of having your cash tied up in the form of a deposit.
Property is not a liquid asset (you are not able to buy and sell it quickly) and is therefore a longer-term investment. Are you getting a better return on your money than you would on a term deposit?
Buy good quality investments, preferably with a reliable and rising income stream. Borrow conservatively so you can survive interest rate rises and possible loss of income. Maintain reliable income from your job or other sources to cover your borrowing costs, especially in the early years and make sure you claim your depreciation costs to increase your return.
Washington Brown manages construction costs worth over $2 billion and completes 10,000 schedules annually. For a depreciation schedule quote CLICK HERE and follow the 3 simple steps or estimate your depreciation cost for Washington Brown’s online calculator