Don't let your investment property weigh you down

http://www.abelrealty.com.au/news/DOM100405.htm

Don't let your investment property weigh you down
10 April, 2005

Discover the best tips on how to squeeze every cent from rental properties.If you believe the economic pundits then an interest rate hike still looms like a storm at the end of a humid day. The Reserve Bank may not have increased interest rates last week, but that hasn't stopped speculation that we will see another rise in the coming months.If you have an investment property, another interest rate rise could really hurt. So there's no better time to make sure you are maximising your returns.We've made it easy for you - just follow these six steps to ensure you're squeezing every cent from your investment.

1. Evaluate your home improvements
A quick flick through the plethora of home improvement television programs and you would be forgiven for thinking that every investment property should be the subject of an elaborate renovation project.But veteran property investor and managing director of Destiny Financial Solutions Margaret Lomas says all renovations should be subject to cost-benefit analysis.As an example, Lomas bought four flats in Armadale in Melbourne - only two had renovated kitchens and bathrooms. The renovated apartments were let for $140 a week, while the unrenovated pair went for $115 a week.

Lomas calculated that the $350 a year in interest she would pay on the extra $5000 she would need to renovate was easily outweighed by the $2600 more she would earn on rent from the newly renovated apartments.The timing of renovations is the key to whether they can be claimed as a suitable tax deduction.Paul Moran, principal financial planner at Cameron Walshe, says a property must be on the rental market for renovations to be deductible.This means you should not make any renovations before registering a property with a real-estate agent.

2. Manage your cash
Most financial advisers will tell you that when you are still paying off a debt on a family home, investment debts should be interest-only.This allows you to focus on reducing the family home debt, so-called bad debt because it is not deductible. Once this loan is paid then you should turn your attention to paying down debt on investment properties.But Lomas, who owns 21 investment properties, does things differently. She only buys positively geared properties (where the rent covers the expenses) or positive cash flow properties (where the rent plus the tax refund covers the expenses). See tip four on how to make your tax refund cover any shortfall in rental income and more. She then ploughs any excess back into the loan and builds her equity so she can buy more positively geared or positive cash flow properties. Lomas says that because all of her properties are, in effect, making money, they give her a buffer against interest rate rises. Where are these magic properties, you ask? Lomas says you must be prepared to look all over the country and thoroughly research your market."People say to me 'how can you buy somewhere you have never been before'. But I do my research. I know about an area's long-term growth. I would know the area better than someone who lives there." (See the 'How To Buy Right' panel for Lomas's tips on researching an investment property). Effective management of an investment property should also include regular evaluation of rents. In a market with falling vacancy rates, an increase in rent will fairly represent market values.

3. Review your outgoings
When times are tough for a small business, the first step is always to review the outgoings. Moran says to apply the same methodology to your investment. He says don't be afraid to negotiate with the agent to try to get the best possible management fees, and be informed about agent-specified repair services."There could be a minimum call-out fee of say $75, so a simple light fitting change could end up costing you $150," he says Investigate your home loan, too. Moran suggests flexibility is the key in uncertain times. The best mortgage is one that can be switched between fixed and variable rates and debt reduction and an interest-only arrangement."If you are without a tenant for two months it might be beneficial to switch to interest only during this time to make sure the investment is sustainable," he explains.Your other obvious outgoing is insurance (see tip six). Moran advises you shop around to make sure you are getting the best bang for your buck.

4. Make the most of your age
The key to maximising the returns from your investment property will be through your tax refund and the key to the best possible tax refund is depreciation. National Tax and Accountants Association (NTAA) legal counsel Rob Warnock says for all buildings built after July 17, 1985 you can claim a depreciation rate of 2.5 per cent over a period of 40 years from the time of construction. However, for those lucky enough to have a property built in the first years of the introduction of depreciation rates (July 17, 1985 to September 15, 1987) you can claim 4 per cent depreciation. But what happens if you have a property built before 1985? You may not be able to claim depreciation of the building, but you can claim depreciation of all the fittings and fixtures. The best way to do this is get a quantity surveyor to go through the property and make a list of the assets on which you can claim depreciation and their value. Examples include a dishwasher at an effective depreciation rate of 15 per cent over 10 years, ovens and cooktops at 12.5 per cent over 12 years and removable light fittings at 30 per cent over five years. A quantity surveyor will only cost about $500 (also tax deductible) and this will quickly be made up in the tax deductions it will give in the following years. "It could just make the difference as to whether the property remains affordable," says Warnock. Moran agrees, pointing to the following calculations. Say you have a property that is worth $400,000, with a loan of $350,000 at 7 per cent interest (over 30 years). It earns $17,500 in rent and costs $27,800 in interest, maintenance, agent's fees and insurance each year. If you are in the highest tax bracket then, after a tax deduction of $4990 (48.5 per cent of the $10,300 loss), you are out of pocket $5300. If interest rates jump another half a percentage point then it's $6200 each year.But Moran says that by adding $5000 worth of depreciation costs to the calculations your property will only end up costing you $2880 at 7 per cent interest and $3780 at 7.5 per cent (because your refund increases).

5. Get your refund
Don't let the tax office keep your interest. By making a Request for Taxation Variation you can receive your tax refund weekly, fortnightly or monthly, depending on when you are paid. What this means is that instead of receiving your refund in a lump sum at the end of the financial year, less tax is taken from your salary each pay.That extra few hundred in your pay each fortnight could determine whether you can meet the expenses of your investment property. If you are attempting to pay down the debt of your property it could enable you to save thousands of dollars worth of interest and reduce the time of your loan.Let's return to Moran's example above. If you are in the highest tax bracket, with a $400,000 investment property and you were to receive a tax refund of $7400 (for the $10,300 loss and depreciation costs of $5000) and were to plough that refund back into the loan annually you would pay a total of $256,868 of interest and reduce the 30-year loan to 18 years.But if you were to pay your mortgage fortnightly with your tax refund of $285 you would pay only $248,915 interest over 16 years. So your loan reduces by two years and you save almost $8000.

6. Protect yourself
Landlord's insurance is a must - it is the most effective way to minimise your losses.A good landlord's insurance policy will cover you for all unforseen damage and expenses. For example if a tree falls on your property and you are unable to rent it, or a tenant damages the property so you are unable to rent, the insurance will cover you for the rental amount for this period.It will also cover you for any tenant damage and costs you might incur while trying to recover money from tenants.Just be sure to read the fine print.

HOW TO BUY RIGHT
In a climate where speculation continues about interest rate hikes, the purchase of an investment property may seem risky. But Margaret Lomas, author of How To Create An Income For Life, follows a list of set questions to ensure she is purchasing a sustainable investment.

What is the cash flow of the property?
Lomas will only buy positively geared properties (where the rent covers your expenses) or positive cash flow properties (where the rent plus your tax refund covers your expenses), insulating her against interest rate rises and helping to build equity for further purchases.

What is the age of the property?
Lomas advises buying properties from 1985 onwards so that you can maximise your tax return through depreciation. If a property is older than this then it must have some outstanding feature so that the rent covers the costs.

What is the population growth?
A declining population or high commercial vacancy rates could indicate a region without good long-term rental prospects.

Why do people live in the area?
By knowing why people live in the area, you know what sort of rental property to buy. For example, if it is a retirement area you should buy property without stairs or a large backyard.

Is the property tenant-friendly?
You are not going to live there so don't be attracted by high-quality fixtures and fittings, which are costly to repair and replace.

Putting a block on negative gearing - would it pay off?

http://www.theage.com.au/articles/2003/07/11/1057783355098.html

The tax break that favours property investors is disadvantaging people looking to buy their first homes. Peter Weekes reports.

Negative gearing and other "baby boomer" property tax breaks need to be re-thought if the great Australian dream of home ownership is to be realised by future generations, consumer and community groups say.They argue that with house prices now at record highs and showing no signs of falling, the property market has become so skewed towards investors that future generations will be relegated to a lifetime of renting.Catherine Wolthuizen, finance policy officer with the Australian Consumers Association, says: "It is certainly appropriate to examine the justifications put forward for negative gearing (and other tax concessions). We are sceptical they are appropriate in the current environment."The ACA wants all of what it terms "baby boomer" tax breaks re-examined to help reduce home prices, while the Australian Council of Social Services, Brotherhood of St Laurence and the Democrats have called for the outright scrapping of negative gearing."It's a generational issue," says Wolthuizen. "People who were able to buy when property prices were much lower are now not only getting massive capital gains but a windfall compounded by an extraordinarily generous tax regime."The issue of negative gearing was put back on the national agenda when Mark Latham - Labor's newly appointed spokesman on Treasury matters - called for it to be scrapped.
Though his comments were quickly doused by his leader Simon Crean - conscious of the broad popularity of the tax concession - the issue has been picked up by a number of groups that have long been opposed to negative gearing.
So what is negative gearing and how does it work? Why is it so loved by investors? How is it affecting prices and cash-strapped first-home buyers.
A property is said to be negatively geared when the costs of holding it, including interest charges on the loan, exceed the income, that is, rent. That is, it produces a running loss when all income and costs are taken into account.
The significance of this loss is that it is tax deductible against any other assessable income you may have. This has the effect of reducing your tax bill, especially if you are on a higher marginal tax rate.

Figures compiled by The Age economics editor Tim Colebatch from Tax Office statistics reveal that in 1999-2000, 54 per cent of rental housing landlords claimed to be operating at a loss. Their entire rental income went in costs, and an additional $3 billion, saving themselves tax of more than $1 billion - a bill picked up by all taxpayers.
This surge in deductions has led the Tax Office to signal that this year it will conduct an audit program to review income and rental deductions claims.
While a switch in investment priorities in the wake of the 1990s sharemarket collapse has played a part in the residential boom, there is little doubt that it has been lubricated by negative gearing, the first home owners grant, interest rates at 30-year lows, new banking products tailored to investors, such as the split loan, and, since mid-2001, the Howard Government's reduction of capital gains tax on year-old investments.
"The flood of investors has produced a very real distortion in prices and that has overwhelmingly been to the disadvantage of people wanting to buy their first home," Wolthuizen says. "People who don't have the borrowing or purchasing power of many of the property investors can't compete when it comes to auctions. The answer to that, traditionally, has been to raise interest rates, but the Reserve Bank can't do that at the moment."
The RBA is trapped. If it raises rates, the differential between local and US rates means global funds will be "parked" in Australia where they can earn more money. This means the Australian dollar will be in high demand, pushing up its value against the US greenback and further hurting exporters and farmers who are already suffering from a strong currency and the worst drought in 100 years.
Instead, RBA governor Ian Macfarlane can only warn of the risks posed by the residential lending boom - with property now accounting for 80 per cent of household debt - and investor borrowing in particular. Investors now account for 30 per cent of the value of all home loans, rising at a rate of 21.6 per cent over the past decade, compared with 13.4 per cent for owner-occupation. The bank says 12 per cent of taxpayers are property investors.
The effect has been higher prices. Market forecaster BIS Shrapnel this month released a study that found the median house price in Melbourne had soared 114 per cent in the past six years, and 85 per cent in Sydney during the same period.
The price spiral will not let up in any capital city for at least the next three years, it said.
Still, some economists and accountants are dismissive of suggestions that scrapping negative gearing will have a positive effect on housing - and the economy in general which has been underpinned by the property boom.
Mark Leibler, senior partner at law firm Arnold Bloch Leibler, and one of Australia's most experienced tax advisers says: "The fact that it's been raised in a political context means that groups like the Democrats and ACOSS are going to get on their old bandwagon.
"But you can't isolate negative gearing on residential property, because negative gearing is a feature which applies to business generally. It has got to be imbedded in any tax system which doesn't simply measure wealth from year to year.
"If you eliminate negative gearing, you are also going to eliminate a lot of risk taking across the board. It's a general principle of tax law, and to single out the residential property market would be artificial in the extreme."
In dismissing Latham's comment, Simon Crean said scrapping negative gearing had been tried before with "very serious (negative) consequences for the building industry".
However, ACOSS says the former Hawke government's short-lived withdrawal of the concession in 1985 was not to blamet for a rental squeeze that saw rents rise by 26 per cent Australia-wide shortly afterwards.
It cites published research by University of Adelaide academics Blair Badcock and Marian Browett that found other factors such as rising interest rates and the competition for funds from a booming sharemarket were to blame.
Ironically, it says, just after the then-government committed a backflip and reintroduced the concession in September 1987, the stockmarket crashed, heralding a return to bricks and mortar.
"It is quite probable that under these circumstances (the crash), there would have been a surge in private 'other dwelling' commencements without the added inducement of full negative gearing," the report says.
Still, Leibler argues that the logic of using tax law to influence economic activity in one sector - residential property - is debatable.
"Attempts to manipulate the markets are usually doomed to failure because there is always an under-reaction or over-reaction, producing distortions which are not warranted in terms of the market or the economy," he argues. "You will always have ups and downs, cycles in the property market. Government has other instruments available to it - an increase in interest rates for example would probably have a much more direct and more predictable impact on the residential property market than an attempt to roll back negative gearing.
"And if the proposition is that the government should manipulate the tax system by removing negative gearing when the housing market is hot, then, logically, when the market is too depressed it would want to put negative gearing back in again to give it a jump start. Our tax system ought not be mis-used in that way."
KPMG tax partner Michael Andrew agrees. "Why discriminate against the direct residential investment property sector, when the same principles apply to gearing equities, business investment and all commercial endeavour? It's a fundamental principle that your interest outgoings are an ordinary business cost."
He says, however, there is one tax concession available to residential investors which could be scrutinised. The 2.5 per cent annual capital depreciation allowance on residential construction costs is an example of "positive discrimination" in the tax system. It produces a benefit that is skewed towards new residential projects, and one that is not generally available to taxpayers, he says.

Pollies tell fibs about negative gearing

http://www.smh.com.au/articles/2003/08/24/1061663676588.html

Pollies tell fibs about negative gearing
By Ross Gittins August 25, 2003

We all know that when Paul Keating got rid of negative gearing in 1985 this proved disastrous for the rental market and he was forced to restore it.
We all know this because the politicians - from John Howard to Simon Crean - keep reminding us of it.
There's just one small problem: it's not true. It's remarkable how bad we are at remembering events - and how easily history can be rewritten by people with an axe to grind.
A negatively geared property investment is one where you borrow such a high proportion of the cost of the property that your interest payments and other expenses exceed the rent you earn. You then deduct this operating loss against taxable income from other sources.
In July 1985 - and as part of a much bigger tax reform package - Treasurer Keating moved to "quarantine" losses from negative gearing by stopping them from being deducted against other income. The US Congress had already done something similar.
But, so we're asked to believe, this caused investment in rental accommodation to dry up. Vacancy rates fell very low and rents shot up. By September 1987 - just over two years later - Mr Keating was forced to admit his error and restore the old rules.
However, Saul Eslake, ANZ's chief economist, has gone back to check this story and can't find it.
His examination of the Real Estate Institute of Australia (REIA) figures for the capital cities shows that rents rose sharply only in Sydney and Perth (and the Bureau of Statistics' figures for dwelling rent don't show a marked increase for any capital).
If the tax change was causing trouble, you'd expect it to be showing up in all cities, not just one or two.
Mr Eslake's conclusion is that rents in Sydney and Perth surged because their rental markets were unusually tight for reasons that had little to do with the tax change.
And this conclusion is supported by an earlier study by Blair Badcock and Marian Browett, geographers at the University of Adelaide.
They say Sydney was the only case that provides support for the claim that the tax change caused problems. "And even here the flow-on effects of the tax changes have to be weighed against the contribution of the general turndown in housing activity in Sydney to the deterioration of the vacancy rate and a real rise in rents," they say.
But the academics remind us of a factor the pollies gloss over: the central role that politics played in the whole affair.
The REIA began campaigning against the move to curtail negative gearing even before it was put into effect. The estate agents predicted that ending negative gearing would have dire consequences for renters, and they really stepped up their claims of disaster in the federal election campaign of July 1987.
They managed to win the support of the Labor governments of NSW, Victoria and Western Australia, and they put the frighteners on Bob Hawke to the point where, in just the last week of the campaign, he agreed to re-examine the issue.
It may be significant that the decision to restore negative gearing came only a little over a month before the stockmarket crash of October 1987. It may be that the preceding boom had drawn investors' attention away from real estate, whereas the bust caused them to flood back.
Be that as it may, it seems clear that when today's politicians tell their porkies about why the abolition of negative gearing was reversed, what they're really saying is: if someone as tough as Keating got beaten by the real-estate agents, why would you expect a wimp like me to take them on?
Well, I think it's all in the timing. The time to move against negative gearing will be when the looming over-supply has finally caught up with the rental apartment market. When the boom has busted, prices have collapsed, vacancy rates are way up and rents have fallen even further.
That's when the property developers' get-rich-quick gulls will be discovering they're down the mine to the tune of several tens of thousands of dollars - and will be looking for someone other than themselves to blame.
That's when people like me will be pointing out that the Howard Government did much to induce them to make their foolish investments by thinking it was great policy to take negative gearing and combine it with a 50 per cent discount on capital gains tax.
Here's something to remember the next time you hear Peter Costello scoring a cheap point by noting the huge revenue gain the NSW Government has made from the property boom thanks to its stamp duty on conveyances.
About 30 per cent of the growth in conveyancing duty has effectively been diverted to other state governments because of the way the Commonwealth Grants Commission's formula for dividing the GST revenue between the states penalises NSW and Victoria.
Like all federal politicians from those states, Mr Costello believes his ambitions are best served by continuing the rip-off of his fellow state taxpayers.