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.
What’s the bottom line?
A very important step in choosing an investment property is to have the cash flow figures worked for you to make sure that the property suits your financial circumstances.
There are several professional programmes designed for this purpose, but with any computer-generated information, the output is only as good as the input.
A qualified and professional Property Advisor will provide the assumptions their model is based on and explain why these are important.
Based on these assumptions after rent and tax rebates and all associated costs, the property should return approximately + $35 per week to the investor.
This result assumes that the tax rebate of $4,420 is collected week by week after submitting a PAYG Withholding Variation. If it weren’t, then the investor would need to contribute approximately $50 per week.
Calculated by taking away the expenses ( interest cost and the rental expenses) from the income the property generates (rent) : $21,403 – $16,195 – $7,818 = – $2,610 / 52 = $50.19 per week:
Manipulating inputs such as anticipated rent, vacancy rates, inflation rates etc. will distort the truth and impact the bottom line result, making the costs appear better than they are or implying growth in capital value and rental income that cannot be guaranteed.
Be wary of rental guarantees – these sometimes provide a subsidised rent from the developer or the vendor at higher than market rates for a limited time. These can be very worthwhile and a great way to start with rental income right from the point of settlement, BUT if the cashflow is worked based on this ‘inflated’ rent, it will not give an accurate long term view of the holding costs. Sometimes they are used, and after the guaranteed period ends, the property owner receives a shock when suddenly they are asked to contribute more to the property than was projected at the point of purchase. Always ask your advisor to work the figures at verified market rates to see if you are still comfortable with the bottom line.
However, if the vendor is offering a rental guarantee that corresponds to current verified market rates or has identical properties in another development already achieving that rent, then the guarantee is a legitimate bonus.
A powerful way of looking at the affordability of a property investment purchase is to see who will pay to cover the holding costs of the property.
In this particular case, after rent and importantly, PAYG tax credits are collected, the property costs, on average, are serviced by both the tenant and the ATO:
“Begin with the end in mind.”
Everyone needs to start somewhere.
The first property you buy will most likely require a cash contribution.
Having a deposit requires diligently saving over an extended time. Reaching a savings goal, such as a deposit for a property, no matter how modest is proof positive of your ability to exercise financial discipline and delay gratification.
Fortunately, lenders see it the same way!
If you can save consistently, it is reassuring to them that you will be able to do so when it comes to servicing your debt. This routine is especially promising if your rate of saving is commensurate with the anticipated mortgage payments.
The maximum LVR (currently) is 90% including Lenders Mortgage Insurance for investment purposes or 95% including LMI for a principal place of residence.
Other sources of cash for a deposit could be an inheritance or a gift. A gift must be authentically a gift and not expected to be repaid; otherwise, it would be considered a liability and reduce your borrowing capacity.
The lender will require a Statutory Declaration from the benefactor to officially renounce any expectation of the money being repaid in the future.
Parents can assist their children by providing access to their equity. They can guarantee a separate loan of 20% of the property’s bank appraised value plus costs, secured by the equity in their property.
The borrowers, however, must be able to meet 100% of the repayments required. Should they default, the parents are responsible for the separate loan and must make good the outstanding amount.
FIRST HOME BUYER GRANTS and STAMP DUTY CONCESSIONS
State governments from time to time offer grants and stamp duty concessions to assist first home buyers to enter the market. Questions arise about whether it makes more sense to buy a home to live in rather than invest and become ineligible for any grants or stamp duty concessions in the future. Once again, there is no simple or ‘one size fits all’ answer, but consider the following:
If borrowing capacity and employment allow a purchase in a location they are happy to live in, and they can comply with all of the qualifying guidelines, including the mandatory occupation conditions, then accessing the FHOG and stamp duty concessions may be an excellent approach for many young people.
However, if borrowing capacity limits the options, then rather than not be ‘on the ladder’ at all for an extended time, it’s probably a tactical move to invest where the budget allows and realise the gains of several years of tax concessions, rental income and possible capital appreciation, rather than holding off and doing nothing. (Remember the opportunity cost of not making a decision to invest)
Depending on the time involved, an investment property could be cashed in down the track to provide a deposit for a home or possibly provide equity to leverage off.
Grants and concessions are not permanent fixtures; they vary according to the size of the state and federal treasury’s coffers, the state of the economy, the property cycle, lending criteria and political climate. Delaying entering the market until you have a bigger deposit or the qualifying criteria relaxes, may mean missing out altogether if prices rise in the interim or the incentive payments are withdrawn.
Remember the value of time in the market – delays mean missing out on potential growth.
Many young people prefer to ‘rentvest’ – they cannot afford to buy where they prefer to live (remember the section on Locations and Infill vs Greenfield sites? Millenials tend to opt for proximity over the often more affordable space) and so rent to maintain lifestyle and access to employment and invest where they can afford.
Lenders will include the estimated rent (rental appraisal needs to be supplied) from the investment property as income, increasing the applicant’s borrowing capacity. (if the applicant is renting that’s a cost that needs to be included in their living expenses). In conservative times, lenders will count less than 100% of the rent to be received and 100% of the rent being currently paid!
Once again, the advice and support of an expert, up to date, specialist broker is crucial.
A group who have the opportunity to invest and build wealth for the future by virtue of some very distinct advantages they rightly enjoy in return for their dedication is our Defence Force personnel.
As the finance ‘goal posts’ constantly shift for most of us, their reliable and recession-proof income make them dependable finance applicants. Their access to subsidised housing and government-sponsored grants and concessions without the usual criteria imposed provides a golden opportunity to invest in property and reap the benefits of time in the market.
It pays to consider all your options and to think outside the square.
Equity is the value of an asset
minus any debt outstanding.
In the case of property:
In the example above the $500,000 property was purchased with a 20% deposit ($100,000). Over time the property has appreciated, and the debt has been paid down, giving the owner equity of $600,000 – $350,000 = $250,000.
Equity in this particular property is now 42% ($250,000 / $600,000)
If you have equity,
you have the opportunity to use some of that equity
as security to purchase
an investment property.
Equity is calculated on the current market value of your home (or investment property) minus what you owe the lender. As an investor, you can access up to 80% of your current property’s equity (without the need to take out Lenders Mortgage Insurance)
In the example above, the home was purchased for $500,000 with a 20% deposit ($100,000). Over time the property has appreciated and now has a market value of $600K (determined by a professional valuer’s report arranged by the lender) and the loan has been reduced to $350,000.There is now total equity of $250K.
However, the available or useable equity is calculated after retaining 20% of the market value ( $600K x 20% = $120K) and taking that away from the total equity $250,000 – $120,000 = $130,000
(Retaining 20% in the property avoids incurring LMI on the property offered as equity)
This $130,000 can then be used as security for another property.
Usually, the lender will then allow you to borrow 100% of the purchase price of the investment property plus your costs. This means there can be no cash outlay required.
Assuming once again, the homeowner would like to avoid LMI, they would be able to purchase property up to the value of approximately $500,000. (20% of $500K = $100K and this then leaves them $30K for costs)
However, given the variability of valuations, it would be wise to stay within their capacity and perhaps purchase a property for around $450,000 – allowing them to keep a buffer in reserve.
Borrowing capacity does not necessarily equal comfort range. The investor needs to decide what is sustainable and comfortable, long term, for them.
This can be verified by having the cash flow figures worked at different purchase prices and stress-tested for changes in interest rates, rent returns and vacancy rates etc