Misconceptions of Property Investors

Hi all,

I write articles for our website/newsletter which we usually publish on our site. PropertyChat rules prevent business members from linking back to them directly, however given that I always try to write information that I believe will assist property investors generally, I thought it would be helpful to recreate the information here. It's all original content and although I'm sure a lot of experienced investors on here will know a lot of this already, hopefully people will get something out of it.

Misconceptions of Property Investors - Part I

In my travels as a QPIA I have come across misconceptions and ideas that have the potential to cause disruption to even the most well intentioned investment plan. In this article I’m going to generally discuss some thoughts on some of the more common mistakes I come across and questions I get asked in the hope it will iron out some of the creases in your property investment knowledge.

“My property is too old for depreciation” or “What’s depreciation?”
Depreciation in relation to tax is the ability to write off the decline in value of an asset. With an investment property, this generally falls into two categories – the building component (Division 43 Capital Works) and the fixtures and fittings (Division 40 Plant and Equipment). The latter can be broken down further but for simplicity I won’t go any deeper for now. If your property was built after the 15th September, 1987 you are able to depreciate the construction cost at a rate of 2.5% per year for 40 years from the time of construction (not from when you bought it and not the purchase price). This means that if you bought a property in 2005 that was built in 1995 with a construction cost of $150,000, you will be eligible for a tax deduction of $3,750 p.a. until the year 2035 on the building cost alone.

The best part is that this is what is called a non-cash deduction meaning it’s money you didn’t have to spend every year (in theory you’ve spent it as part of the purchase price), so why wouldn’t you claim it as a tax deduction? The small catch is that for capital works allowances, the total amount claimed reduces the cost base of the property for Capital Gains Tax (CGT) purposes upon sale of the asset. This is a small negative for a large positive however because due to inflationary pressures, your dollar is worth more today than it will be in say, 20 years, when you sell and that in most cases you’re also entitled to a 50% discount on the CGT payable if you hold the asset for greater than one year. This means you get 100% of the deduction but essentially only pay tax on 50% of the amount.

So what happens if your property was built prior to 1987?

Any improvements to the property that do not form part of the building can also be depreciated at a pre-determined rate and for an effective life, as set by the ATO. This means that if, for example, you install an air conditioner on a property built in any year, you are still able to depreciate that asset! This is a very important point as it means that even renovated older properties will definitely still have a lot of depreciation in them, often amounting to thousands of dollars per year. As with Division 43 allowances, these are also non-cash deductions and even better, the plant and equipment amounts do not change the cost base for CGT purposes upon sale!

In short, there is no real reason you shouldn’t be claiming depreciation and maximising your cash flow through legitimate tax deductions. If you’ve been told your property is too old for depreciation, or you haven’t been told what it is, then it’s time to get yourself a new accountant. The best way to claim depreciation is to have a professional Quantity Surveyor complete a report that can simply be handed to your accountant at tax time (this is a one off cost).

“I have a good relationship with my local bank manager, I’m going to use them”
Banks are there to make money and increase returns for their shareholders. Whilst it might be nice to feel like your local bank manager will help get your request for finance over the line if the going gets tough, the reality is that they won’t. Credit policy ebbs and flows with market forces and the underwriters essentially have a little box of parameters which changes depending on the stage in the credit cycle. If you fit into the little box, you get a tick. If you don’t, you get a cross. Your local bank manager isn’t going to do any more for you because you’ve known them for a few years than they would for the new customer who walks through the door with the same financial position.

What will help you get your loan over the line is an experienced mortgage broker who understands the ins and outs of the underwriters’ little box and can independently advise you on what you need to do both in the lead up to applying for a loan and during the loan application process to ensure you fit within it.

What they will also do is scope out a range of lenders to make sure you are obtaining the best product for you, at the time of application. As with any item on sale, there are specials to attract business and loan products are no different. Depending on your plans, the cheapest interest rate is not always the best option so you need an experienced professional to help you canvass the market. You can’t walk into X car dealership and expect them to sell you the best car on the market at the best price at that time – they’re only ever going to sell you X when there might be Y car down the road that fits your needs better and is on sale at a better price.

“Don’t buy an apartment because land appreciates and buildings depreciate”
This is a common one and something that isn’t correct for a range of reasons. As I write this article, I’m in Hong Kong where an average, 40m² one bedroom apartment – the size below which many banks in Australia will even lend for without heavy restrictions – is worth about $A1.25million in a 60-80 apartment block…and there are thousands of apartment blocks in Hong Kong. Prices are driven by supply and demand, and whilst land content is a factor in this, it is not a driver in isolation. I’ve already written an article on this which you can find on our website.

“I don’t need landlord insurance because I have building insurance”
People are generally quite aware that there is a need to insure any valuable asset against financial loss should an adverse event happen. When it comes to property investing, the cash flow on your property is the life blood that enables you to hold it over the long term whilst it grows in value. So it’s surprising that it is less common that people feel the need to insure against cash flow financial loss. This could be in the form of income protection, trauma cover or for property investors, a component of your landlord insurance.

Landlord insurance is generally made up of a number of types of cover within the same policy and is relatively cheap – only a few hundred dollars per year and is tax deductible. Maybe the most important part is that it will cover lost rent (past the bond amount) for a number of different situations e.g. your tenant simply stops paying rent, the property becomes unlivable due to a fire, flood etc.

What most people don’t plan for is that if this happens, your building insurance will not cover any rental loss whilst you recover the situation. Of course, having a lot of money in the bank will help this scenario, but why would you potentially fork out thousands of dollars when a few hundred dollars of insurance costs could alleviate this stress if the worst should happen? In addition, items such as blinds, carpets, light fittings and any accidental or even intentional damage the tenant causes whilst occupying your property will generally be covered by landlord insurance, but not by building insurance.

The bond will only cover so much and beyond that, it falls to the owner. If you don’t have landlord insurance you could find yourself out of pocket more than you budgeted for and very quickly. Not all policies are created equal (in fact, some aren’t very good at all whilst some are excellent) so be sure to read the PDS thoroughly. In my opinion, if you can’t afford landlord insurance, you can’t afford to be a property investor.

I've actually written a lot more to this, but posts on here are limited in size so stay tuned for the part II, III and IV...

- Andrew

 

Here are some more

My friend told me XXX so it must be possible/true

Redraw is the same as an offset account

 

That one in particular can be a tax killer!

 

Not all offsets are offsets .......some are called offsets but are in fact re draw, also many are not real accounts or actually accounts at all.

 

You've gotta buy residential before you get any exposure to CIP.

 

Pay off the main residence loan and then invest

 

I've got a tax problem - I better get a ng property.

 

my accountant told me to redo the kitchen for $10k, which didn't need redoing, as my property went from cash flow negative to positive

(this is a real one that a friend told me)

 

I thought these were part of contents cover. Should an investor have contents insured as well?

 

Our first lender for our first IP told us that. They also told us that our savings account was an offset account (which they didn't link it to the loan until we asked them 12 months later).

 

Depends on your financial position and value of the contents.

It also depends on your LL insurance, if they are not covered when there is no tenant, then you need the building side to cover as well, I was going to put this in the insurance thread, but got sidetracked.

This assumes you split the insurers, if you have one to do both things, check the PDS

 

Lenders make no end of blunders, you would think the would know what they are doing, but often not.....you need to check on everything especially before and after settling IMO.

 

We found out there are a whole heap of "professionals" that don't know much. It's scary. Every starting investor needs some sort of mentor who has been there, done that to look over their shoulders, otherwise they're not going to get very far.

 

Yeah, that's a good misconception. I have heard that before

 

Actually going direct to bank is not necessarily bad, it can work well dependent on scenario. I know developers/investors who have had success going this route. Whatever it takes, my point is don't dismiss going direct

 

I think the point here is not to assume your local bank will give you a good deal because you have a relationship with the manager. My mate at work got an IP loan with her local bank because she has been dealing with the manager for years. The IP loan was at 5.45% IO. Terrible! I have referred her to one of the forum brokers to get her better deals.

 

I can see how resi experience would help though

 

Omg

 

...and he complained that even though he was collecting more rent, writing off depreciation and enjoying lower vacancies he had to spend money?

 

but also savvy investors go direct because they can also sometimes get deals over the line with the smaller banks/franchise ie BOQ