Investors confront new market dynamic

Buyers and sellers will see a significant change to the dynamic of the Melbourne housing market in 2016, according to Domain.com.au senior economist Dr Andrew Wilson.

The changed market conditions mean property investors will need to take extra care in managing bricks and mortar assets. The professional management of rental properties and the careful financing of new real estate purchases will be cutting-edge issues for investors next year.

Dr Wilson said the extraordinary price growth reported by Sydney and to a lesser degree Melbourne, over the past year will not be matched over 2016.

“While the housing market is likely to be relatively subdued comparatively, it is likely that activity from some buyer types – particularly investors – will remain robust and increase,” he said.

“Despite higher interest rates, investors will be drawn to the relatively high yields available and continued taxation advantages – particularly for small-scale investors.”

Here are some tips on how investors can prosper and expand their property portfolios – whatever the market conditions.

Managing risk

The most important consideration for first-time investors is to understand their capacity to take on debt.

Think carefully about your personal circumstances. Consider what would happen if you lost your job or if you suddenly moved from being a two-income household to living off one income. Would you still be able to service an investment loan?

Once you’ve determined how much you’re prepared to borrow, you should build in buffers. It’s smart thinking to project that interest rates will go up by 2 per cent, or that your property could be without a tenant and income for eight weeks. If you plan for these wild cards, you’ll cope a lot better if they do eventuate.

Interest-only borrowing

Many investors take out interest-only loans to keep down their outgoings while they wait for capital growth to kick in. That can work well, but only if the value of your property grows. So you need to think about protecting yourself.

Interest-only loans cost less in repayments and give you greater flexibility and leverage ability. When you have a principal-and-interest loan, repayments are higher and your lender reduces your loan limit daily.

The downside of interest-only borrowing is that if property markets fall or stagnate for a long period, investors with interest-only loans are more than likely to lose money. You are gambling that a future capital gain will cover the high cost of your interest bill and the principal cost, which you may not have paid down at all.

Tax breaks

Property investors must endeavor to secure every tax benefit they are entitled to.

This is the area where thousands of investors come unstuck. The normal deductible expenses of interest, management fees, repairs, insurance and council rates spring to mind, but other allowable expenses can be missed. These include land tax, depreciation and borrowing expenses.

Borrowing expenses – such as loan set-up fees, rate lock-in fees, solicitors’ fees, mortgage registration fees and stamp duty on a mortgage – are not allowable as deductions in the first year of expenditure.

After that, though, they can be expensed over five years. If your borrowing costs total $2,000, you can claim $400 a year for five years, as long as you keep all receipts.

Paperwork

If you buy an older or near-new apartment, the vendor may not pass on the property’s depreciation report, if one exists. Fix this by hiring a quantity surveyor to produce a new report on the property’s outstanding depreciation.

A good quantity surveyor will identify all depreciable costs that can be written off against tax. Significant claims can be made for depreciating the building structure of newer apartments as well as for replacement kitchens and bathrooms, renovated living areas, hot water systems, even the curtains.

Investors part with real dollars to get a deduction from council rates or mortgage interest. Depreciation is a far more valuable property loss to have on your books because it is generated at little or no cost to the investor.

Repairs

Don’t think for a moment that you can instantly write-off a renovation .Only repairs – not improvements – can be claimed as a deduction against income.

By contrast, improvements and renovations must be depreciated over a number of years. The Tax Office pays microscopic attention to this area.

There’s a fine line between what constitutes a repair and an improvement. Seek advice and don’t assume that every dollar you spend on an investment property is going to be a straight-up tax deduction.