Purchase Costs

Purchase costs of an investment property

 

In addition to having the required cash deposit or available equity, the following costs are standard for a property investment purchase:

Stamp Duty – levied by each state and territory government, stamp duty is payable on the full purchase price of a one-part contract (apartments, townhouses and houses) and only on the land component for house and land, 2 part, split contracts.

Legal Fees – a solicitor or conveyancer handles the legal review of the contracts and coordination and management of the exchange and settlement process.

Loan Costs – lenders charge application/establishment fees (can be negotiated or) for the loan and for stamp duty on the mortgage, their solicitor’s fees, a valuation fee, search fees and the cost of registering the mortgage.

Loan Mortgage Insurance – If the LVR is more than 80%, the lender will charge LMI. Lender’s Mortgage Insurance may be funded as part of the loan and may not require a cash outlay.

Pro-Rata adjustments– On settlement, you will have to allow for adjustments to the rates pro-rata for the year, (council rates, body corporate fees etc.,) In other words, pay your share of the annual costs.

Independent Building Inspection – it is advisable to engage the services of an independent building inspector to make sure that any defects are rectified before settlement takes place.

Quantity Surveyor’s Report – to claim the maximum deductions allowable for depreciation, it is essential to have a professionally prepared, itemized report that is handed to your accountant once for the life of the property.

Insurances – property investment like any other investment, carries some risk. Insuring your valuable asset will manage the risk via building, contents and landlord’s insurance. Lenders will require the property to be insured, naming the lender as the interested party, before advancing the borrowed funds.

As a guide, it is recommended to allow 4-5% of the purchase price for the costs of purchase in addition to the required deposit.

For example, to purchase a $500,000 property as a cash depositor, avoiding paying LMI, you would require:

DEPOSIT = $100,000

COSTS = $25,000

TOTAL = $125,000

 

 

To purchase the same property relying on the adequate available equity in other property, you would require: 

DEPOSIT = NIL

COSTS = NIL

TOTAL = NO CASH OUTLAY

 

 

If the contract is a 2 part, house and land construction, stamp duty will be levied on the land component only, presenting the opportunity for a significant saving. However, there needs to be an allowance made to service the loan during the construction period.

The land is funded first, and then the house is built and paid for in stages.

One month after settlement of the land, interest will be payable on the outstanding balance.

Once construction starts, the building is paid for in stages, and so the loan balance progressively increases until fully drawn down after the final construction payment.

It’s like making ‘mini mortgage’ payments. The first full mortgage payment will be due one month after the loan is fully drawn down by the borrower.

When the reduced stamp duty applicable on land only is added up with the cost of servicing the loan during construction, it will be very similar to stamp duty payable on a single contract.

Both stamp duty and interest during construction are considered to be sunk costs and can be offset (claimed) against any capital gains tax liability when the property is eventually sold.

 

Contract Types

One of the considerations for choosing

a particular type of property might be

the stamp duty and servicing costs payable

 

One of the advantages of buying a house and land package is that the contract is in two parts, and stamp duty is levied on the land component alone.

Once the land is registered and settled, ownership is transferred to the investor. The building plans are then stamped in the new owner’s name, a process that may take up to 6 weeks or longer, depending on the particular council process.

The house is then built in stages generally over about 6-9 months. When you allow for council permits to be issued, the build process and then occupation certificates to be issued at the end of construction, and allowing for delays due to inclement weather, a house and land package can take up to 12 months or more to complete.

Typically, the stages for house construction and the percentage progress payments are:

One month after the land settles, the lender will require interest to be paid on the portion of the loan that has been drawn down to date. As the build progresses through the stages, the lender funds more progress payments, the outstanding balance grows, as do the repayments.

Servicing the debt while a house and land package is built is like making ‘mini mortgage payments’. These payments become progressively larger until the first full mortgage instalment is due one month after the final progress payment has been made.

For example:

Assume a house and land purchase in Qld, for $430,000:

1.Land component $200,000

2. Stamp Duty on the land = $5425

3. House contract = $230,000

4. Borrowing 100% of the purchase price (costs covered by buyer)

5. Interest-only loan at 4.5% pa.

*Note: It is assumed for the sake of a working example that the stages of building happen in discrete months – in reality, some steps may happen more quickly or more slowly.

When we consider the difference between purchasing a single or a 2 part contract of the same value:

*using an example of Qld stamp duties

Had the purchase been a single contract at $430,000, the stamp duty would have been levied on the entire purchase price   = $13,475

The house and land duty payable on the land is $5,425, but the debt has to be serviced during construction bringing the total outlay to $14,916                                                          

It’s worth noting that the interest costs vary for a host of reasons, including monetary policy to smooth the business cycle. Currently, the total interest cost to fund the construction would be significantly lower due to the record low current interest-rates.                                                                                                                                                                                                                                                                                                                 

 

In contrast, stamp duty rates are not dialled up and down as conditions in the economy and housing market change. As a result, in a low-cost credit climate, 2 part house and land contracts may be more even more cost-effective and attractive given the relative reduced initial outlay.

The land value and the proportion of the land in the overall package price will also vary from place to place as do stamp duty rates and therefore the comparative affordability of single contract compared to a 2 part, house and land construction will differ.

Stamp duty and interest during construction are offset against capital gains tax obligations when the property is eventually sold.

https://www.ato.gov.au/uploadedFiles/Content/IND/downloads/Rental-properties-2020.pdf