Strategy: Consider multiple cheaper Properties

Strategy: Consider multiple cheaper Properties



This strategy post shows how important it is to consider the value of the type of property you will be investing in – Multiple cheaper ones or fewer larger ones.



The structuring of property ownership is also very important. Here simple strategies of single name ownership rather that joint ownership can save you so much money as well.


In this example let’s imagine there is a couple who want to buy $2mil worth of investment property.

They have several choices such as

A 1 x $2mil property

B 2 x $1mil properties

C 4 x $500,000 properties

D 10 x $200,000 properties

Etc.



From a tax point of view they would be better off with smaller properties rather than one larger property. Here is why:



1. Stamp Duty

In NSW stamp duty on a $2,000,000 purchase would be $95,490

Stamp duty on a $200,000 property would be $5,490. So 10 of these would be $54,940.

Buying 10 cheaper properties rather than 1 expensive one would save you $40,550 in stamp duty. The cheaper option is almost half of the expensive option.

Note that you probably can’t buy a $200k property in NSW, but these figures are just illustrative.



2. Land Tax

In NSW land tax on $2mil worth of property, assuming no other property owned other than the main residence, and not owned by a trust, not a foreign person, the land tax would be approx. $23,316 per year.

This would be the case whether the property is owned by one person or owned jointly.



However where buying 10 properties the couple may decide to buy 5 each so that they are each holding $1mil in land in NSW.

If this were the case the annual land tax would be $7,316 per year each. That is $14,632 combined.

Compared to owning one larger property this would save $8,684 per year in land tax.



But this land tax could be eliminated completely buy them buying say $500,000 worth in NSW each and $500,000 worth in QLD each.



3. Income Tax

Say the couple have paid off their non-deductible home loan. They still have $2mil in debt on the investment properties but have $1mil in cash in an offset account. They are saving about $50,000 in interest doing this.

But where the one investment property is jointly owned the benefits will flow to both of them. However where one is on the highest marginal tax rate and one is not working at all then they are paying more tax.



If instead the properties were owned in individual names, say $1mil of loans each, what they could do is to move the $1mil in the offsets over to the loans used to acquire the properties in the non-working spouse’s names. This spouse would then have $50k more income, because they had $50,000 less in interest to claim.

Assuming the non-working spouse had a taxable income of zero prior to this (from depreciation, expenses etc. bringing the rental income down to $0) then this spouse would have a taxable income of $50,000 and have to pay $8,547 in tax.



If the properties where held jointly 50/50 then the $50,000 interest saved would go equally to both of them so the lower income earning spouse would have a taxable income of $25,000 and have to pay $1,213 in tax.



But where the other spouse is on a high income, let’s say $200,000 then their income would increase (less interest) to $250,000.

Tax on $200,000 in income would be $67,632

Tax on $250,000 in income would be $92,132

Difference is $24,500



So having the $2mil of properties jointly owned 50/50 would result in $25,713 in extra tax if they had $1mil cash in offset accounts.

But where they owned $1mil each the extra tax would have been $8,547

That is an annual tax saving of $17,166



4. Capital Gains Tax

Imagine the $2mil in property has double in value to $4mil. The owners now want to sell down in part to begin early retirement.



With one big property it will be difficult to sell part – it could be done to related parties though. So selling the whole property may be the only option.

This would bring all the capital gains to one tax year.

It would be roughly as follows

$2mil in gains,

$1mil after applying the CGT discount

$500,000 each if they own 50/50

So each of their taxable incomes would jump by $500,000 in that year.

Assuming they sold on 02 July they would have no rental income for the year and if they stopped work they would have no other income except of the $500,000 capital gain.

Tax on $500,000 works out to be $214,632.

This is each, so their total tax would be $429,264.

That is a lot of money – but still it works out to be just 21.5% of the $2mil gain they made.



Where they owned 5 $200k properties each with each of these doubling to $400,000 the CGT could be more easily managed by using simple strategies. They may start off by selling one property each in the year of their retirement.

$200k purchase price with a $400,000 sale price would leave $200,000 gain.

Applying the 50% CGT discount would bring this down to $100,000.

Even if they did nothing else they would have a taxable income of $100,000 each.

Tax on $100,000 is just $26,632 each of $53,264 combined.

If they sold one property each per year for the next 5 years, assuming no growth, they would have to pay 5 times this amount (assuming rate rates constant). Over 5 years the sale of all properties would result in $266,320 in tax paid in total.

This represents a saving of $162,344 compared to selling one large property.



There are other benefits too, because selling all the property holdings would mean no more income is received from them. Selling in stages means more income received from rent.

Delaying sales may also mean more capital growth is achieved.

The sales may even be delayed as the rental income is increasing which means more money to live in, sell the first one will give you a few years living expenses perhaps. But the time these sale proceeds have been used the rent would have increased further. It may be you don’t need to sell any more as you can live on the rents.

In addition the sale proceeds would be parked in an offset account so they would be saving more interest which would mean more money for living expenses.



Other non-tax benefits include

Borrowing

- It may be more easier to borrow for cheaper properties

- Generally cheaper ones are higher yielding which helps servicing

- Generally easier to tap into equity on the cheaper ones

Location

With one larger property all of your eggs are in the one basket. This could mean higher risk. With cheaper ones you can spread them out more.



Strategies

Easier to implement various strategies such as

- Related party sales

- Related party loans

- Debt recycling



In summary

The following savings are potentially gained by holding smaller properties:


Stamp duty

$40,550 upfront.

$2,208 per year in interest (at 5%) by not having to borrow as much


Land Tax

$8,684 per year in land tax (or potentially $23,316 per year if the properties are purchased in different states


Income Tax

$17,166 per year


CGT

$162,344


All of these savings add up to be a lot. This could shave more than a few years off your working life – a decade even.



Note that you also have to consider the area you are investing in. Could a $2mil terrace in Paddington Sydney have more capital growth than 10 $200,000 properties in Elizabeth, SA? That is something for your crystal ball. But the above shows that even where Paddington may grow faster it may still be better for you to invest in Elizabeth.



See a list of my other strategy posts here:

https://propertychat.com.au/community/threads/terryws-structuring-strategies.11564/

 

Here are a few disadvantages for buy many cheaper properties rather than fewer more expensive:


Disadvantages

• 10 properties to manage rather than 1 means more headaches

• Higher tax agent fees

• Multiple conveyancing fees on purchase and sale

• More chance of tenant litigation

 

More maintenance too, more rates and insurance etc

But you can also sell one or some in smaller chunks and pay off others or use the cash.

No way to avoid the management, this is main headache, can be somewhat diluted by buying close by in multiples in multiple locations.

 

A big issue with these properties is that council rates, water and sewerage are relatively fixed costs. My parents bought a house renting for $10,400 per year. Rates alone are around $1,300 per year. Add property management fees, land tax, insurance and landlords insurance and there won't be much cashflow from one property. For example, if they bought a property rented for $15,600, there would be better cash flow because most of the regular costs don't scale up much. I didn't explain this well but basically, the $15,600 would lose less of the cashflow to expenses.

 

No you have explained it well
Basically as % of the rent cheaper properties have higher cost
Higher value properties also self manage their outgoings too ...commercial properties that is

 

The

The way you reduce management is by buying the right sort of commercial or residential property
A $1m pa rental from one tenant can have less management than a $10k pa rental

 

There's a practical aspect as well; cheaper properties attract cheaper tenants which means that your retirement income could be uncertain.

Could still take advantage of all the things Terry mentions by investing interstate though. Eg 400k properties here are probably in equivalent areas to 800k properties in Melbourne but 2 could be had, enabling advantage to be taken in the ways Terry mentions.

 

@Terry_w, can you go through the list in the first post for a single person - a lot of the positives seem to only be positive if you have another person to share the pain/gain with.

 

The single person can still benefit by buying at the cheaper end
stamp duty is cheaper
land tax is more easily managed
income tax would largely be the same
CGT can be more easily reduced by selling in stages.

The single person, although lonely, may also set up other entities such as trusts and/or companies.

 

Multiple smaller IPs is certainly the investment decision that I've made. The reasons in the original post played a factor, but by far the largest component was the fact that the cheaper the property the higher the yield generally is. So even after accounting for higher outgoings (as a percentage) you're usually still better off taking this route.

 

Yes, the higher outgoings don't factor in to the serviceability calculations so the higher yields help you borrow more.

 

As many of you know I went down this line.

It has been interesting.

Would I do it again?

Strategy, : yes
Locations,: no. I went too regional


Pm me if you want to ask any questions?

 

Good post Terry.
We sold a 1 mil NSW IP (which was finishing up 6 year CGT excemption) and replaced with 2xSA + 2xQLD. We did that mostly for listed benefits.

 

[QUOTE="Terry_w, post: 343428, member

The single person, although lonely, may also set up other entities such as trusts and/or companies.[/QUOTE]

Although if the single person is becoming rich through smart property investing & following terry's tips - they may not be lonely for long! (Their choice of course).

 

There is a balance there...I tend to buy properties for 250-350k mark in the major cities....this gives me the appropriate serviceability and capital growth.

For example....my properties in Wollongong, Central Coast, and Maitland have performed very similar to Sydney properties....but these are regional places who have ridden off the booms in Sydney and Newcastle. However, I like to invest in major cities like Sydney, Melbourne, Perth, Brisbane...this is where the action is. Adelaide is also ok in select areas.

 

Thanks TerryW. Food for thought. I probably need more cheapies in my portfolio (not necessarily bottom end though - there is a fine line between risk/return).

 

good post @Terry_w
as @spludgey mentioned, generally speaking lower valued resi properties generally have a stronger yields than the higher value properties.

also, if the tenants at your $2M property vacate - you have 100% vacancy.

 

Have to wonder how many people would actually buy a $2M investment property??

I get the numbers from a tax/financial perspective, but which is going to be the better investment will ultimately depend on which property achieves the highest growth in the shortest time frame, and you would need to balance this out with holding costs I guess.

 

This has been our strategy - a portfolio consisting of a lot of lower priced properties. Pros and cons.

I'd like to think if we needed cash.... such as to buy yatch, then can offload 1 or 2 easily.

 

Would you buy $2m plus properties if the properties pretty well never become vacant in say the first couple of hundred years of the lease and over 30pc of the net rental was profit while the rental moved up by the growth in the land ?