The numbers don’t lie
Buying an investment property is not about guessing if it will make you money or not. Being clear on what type of property niche you are working in and how much you expect the property to make will ensure that the property meets the objective making money. Once you are clear on the specifics of the property it makes communicating with agents a whole lot easier and they can be on the lookout for properties that suit you.
If your sole objective is to reduce your tax and that is the only objective you have, you will lose money, for sure. Many people are sold on the idea of saving tax when they buy an investment property. In order to save on tax, you have to lose money on your property investment. The strategy is known as negative gearing. The Australian Tax Office allows you write off any of the losses you have on your investment property against your personal income. Sounds good but is it really? As an example, let’s say you are earning gross $100,000 annually and your tax rate is 35 cents in the dollar, your tax bill for the year is $35,000. Your investment property loses $10,000 in the financial year. For the calculation of the tax, the $10,000 loss is deducted from your gross income of $100,000, making it $90,000, the tax is then calculated on $90,000 making the tax bill $31,500 instead of $35,000. You meet the objective of “saving tax” of $3,500 however it cost you $6,500 to save $3,500.
This is the crazy part, the property has cost you money, and that money comes out of your pocket. Some people argue that the capital growth of the property will exceed the losses. Sometimes it does and sometimes it doesn’t, at the end of the day this is a hope and pray strategy. All too often I see people with 4 or 5 negatively geared properties because they were sold on the idea of “saving tax”. You only have to have one small thing go wrong and it puts enormous pressure on you personally and can force you into a sale that may not be convenient.
If your objective is to make money, look at a property from its income earning potential versus the capital outlay. I have seen too many investors get caught up with the price of the property instead of looking at the return on the property. They are so focused on the actual price they forget about the return.
You can very easily do a “back of the envelope calculation” that requires finding out what the weekly rent potential is versus the value of the property. If you want to achieve a 5% return you would look for a property where the rent is the same as the first three digits in the purchase price. For example, $400,000 house rents for $400 per week it is roughly a 5% return. In fact, it is really 5.2% ($400X 52 ÷ $400,000) = 5.2%. Try it – it works! Given that interest rates are at an all-time low it becomes easier to seek a neutral or positive cash flow on the property.
If that same $400,000 property only earned $300 per week it would only be a 3.9% return. If the interest rate on your loan is 4.5% you are in a losing proposition from day one. The good thing about a very simple calculation it allows you to sift through and sort out the properties that you may consider buying.
Saving tax is a very poor reason to buy an investment property. The numbers don’t lie, and you can always rely on them. Understanding the numbers on a property combined with some solid market research should yield you a return that you are seeking. Armed with this information you can sit down with your accountant or financial planner and get the appropriate advice to move forward building your property portfolio.
Happy investing
Felicity Heffernan