Investment Property Holding Costs

February 2015 Update
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February 2010 Update

In Dec 2008, we sent out an email which highlighted holding costs relative to interest rates (click here to see an excerpt of that email ) .  As interest rates again decreased we sent out a further update in February 2009 with new figures (click here to see an excerpt of that email ).  As interest rates are now on the rise we have updated the information and have used a more expensive property (which we sold in late 2010) to illustrate that holding costs still remain relatively low and property investment remains an excellent option given the historical security that property has offered and the fact that rental increases and capital growth are expected to continue throughout 2010/2011 given our increasing population and continued lack of property availability.

Looking at the projected holding costs, here is the bottom line!

Based on a property of $450,000 (see below for the assumptions etc):

As a resident Australian Investor, borrowing 100% (assuming that you have some existing equity) of the property price, the projected year 1 net cost per week is $43.  This includes a projected tax saving of over $8,773 in year one.

As a non resident investor, borrowing 80% of the property price, the projected year 1 projected net cost per week is $108.  A total cost now of around $5,638 per annum.

Our assumptions:
We have based the figures on a $450,000 1 bedroom plus study apartment in North Melbourne (which we sold in late 2009 and is due to complete in early 2011) renting at $450 per week, which is the current rental projection.  We  have looked at the bottom line after taking in to account rent in, costs out (including depreciation) and have compared the costs on an interest only loan at 6.3%.  

For local investors we have assumed a tax bracket of 39.5% (this  is the tax bracket for those currently earning between $80,000 to $180,000 per annum) with an actual income of $95,000  and have allowed for the subsequent tax refund in the net cost used.  We have assumed local investors have borrowed 100% of the property price $450,000 plus all purchasing costs (stamp duty, loan costs, solicitors fees etc, $5,070) this assumes that the investor already has existing equity in another property to allow them to borrow the full amount including costs.  Plus if local investors exchange contracts on a deposit bond rather than a 10% cash deposit, there would also be the initial cost of the deposit bond.

In year One (once property completes which is projected for March 2010):
Cash In:
Gross Rent                     $22,932

Cash Deductions:
Interest                         $28,669
Property expenses            $6,070

Pre Tax Cash Flow:          -$11,580

Non Cash Deductions:
Depreciation                     $11,908
Loan Costs                          $554

Total Deductions:            $46,974

Income tax Credits:           $9,586

After Tax cash Flow            -$2,221  or $43 per week

Note: Investors can apply to the taxation office so that tax savings are paid throughout the year, rather than waiting until the end of the year for a tax refund.

For non resident investors we have assumed that the rental income from this property is your only Australian income and therefore have based the figures on the lower tax bracket of 29% (for those earning a net taxable income up to $34,000).  We have assumed non resident  investors have borrowed 80% of the property price and have paid cash for the other 20% ($90,000) plus purchase costs (ie stamp duty, loan costs, legal costs etc assume $5,070) giving total upfront costs of $95,070.  10% of the purchase price ($45,000) is payable at contract exchange, the remainder of the $95,070 is payable at settlement, projected for March 2011 in this example.

In Year One (once property completes which is projected for March 2010):

Cash In:
Gross Rent                      $22,932

Cash Deductions:
Interest                          $22,500
Property expenses             $6,070
Pre Tax Cash Flow            -$5,638

Non Cash Deductions:
Depreciation                     $11,908
Loan Costs                           $554
Total Deductions               $41,032
Income tax Credits                   $0

After Tax cash Flow            -$5,638  or $108 per week.

If you’re a local investor and you’re in the lower tax bracket (earning between $34,000 to $80,000pa) assuming you are earning say $75,000 then on the above figures, your projected net cost to hold the apartment would be $77 per week, just $4,007 per annum.

In year One:
Cash In:
Gross Rent                     $22,932

Cash Deductions:
Interest                         $28,442
Property expenses            $6,070

Pre Tax Cash Flow:          -$11,580

Non Cash Deductions:
Depreciation                     $11,908
Loan Costs                          $554

Total Deductions:            $46,974

Income tax Credits:           $7,573

After Tax cash Flow            -$4,007  or $77 per week

Note: Investors can apply to the taxation office so that tax savings are paid throughout the year, rather than waiting until the end of the year for a tax refund.

If you would like all the details on the assumptions made etc, please send me an email and I’ll send you a generic cash flow report on this particular property. Just click here to email me.

Income & cost  projections will vary on each project, but these figures are fairly typical for a new Melbourne apartment, around the $450,000 price mark, given current market rents, interest rates, costs etc.

Please note that the above projections are hypothetical information for illustrative purposes only and must not be taken to be in any way to be a guarantee of the future circumstances that will apply in connection with an Investment or the benefits to be derived from it by an investor.

Is it worth the cost? 
Let’s be really conservative and project  that the property will have an average capital growth of just 6% per annum.  According to the Sept 2008 Matusik Report, units have had an annual growth of 12.8%pa over the last 10 years.  For 2009 medium residential property prices rose 12.1%  according to the Australian Property Monitors.  But we are just going to assume a conservative average 6% growth.

So after just 5 years, the $450,000 property is worth $602,202, a gain of $152,202. 

After 10 years it’s worth $805,881, a gain of $355,881.

Not a bad return given your projected per annum holding costs!

How the income tax works:
As a general overview:
For resident investors: 
Rental income is taxable but most of the rental expenses, including any interest on loans and including depreciation (which is particularly relevant on new properties) are tax deductible.  So in the case of our example above, the net result is that the new tax deductions by far outweigh the new taxable income, so you are then in a position of negative gearing, leading to a significant tax deduction (compared to the tax that you currently pay) and in the above example this tax deduction along with the rental income from your tenant actually fully funds the projected holding costs of the property.  Let me know if you would like more details and I will send you a generic cash flow report on this particular property.

For non resident investors: 
Rental income is taxable but most of the rental expenses, including any interest on loans and including depreciation (which is particularly relevant on new properties) are tax deductible.  You have the same rental deductions as local investors, but as you are not already paying income tax in Australia, you have no existing income to draw deductions against, so the tax benefits are not as great.  However, the tax benefits do ensure that you will not be having to pay any income tax for many years, on the above example.  You do still need to lodge an annual tax return though and we work with accountants who can assist our clients in this regard .  Let me know if you would like more details and I will send you a generic cash flow report on this particular property.

Is it wise to invest now?
As you can see holding costs of a property are still relatively low.  Remembering that whilst rates will likely rise further, rents are expected to continue to increase, population growth continues to be  at an all time high, we continue to have a housing shortage and developers are continuing to find it difficult to fund projects, so the shortage will be with us for the foreseeable future.  Whilst developers are finding funding difficult, individual investors are not, Australian banks are well capitalise and are lending to invetsors.  Taking these fundamentals in to account, is now the right time to invest, we think so. 
As was the case throughout 2009, we are particularly mindful of the lack of new properties that are being released, many many projects that were planned to release cannot obtain funding.  Bad for those developers and bad for those investors who cannot find a property.   But great for investors who can get in to the market on a good project, as there will not be too many of them around and this scarcity will put further pressure on rents and capital growth in the medium to long term.

Please let me know if you would like any further details. 

Hope the above is helpful.

Regards

John Faulkner
Managing Director & Licenced Real Estate Agent

(The above article was part of a Priority Investors Update which was emailed to our Priority Investors in Feb 2010)

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