Hi,
I am new to investing. I have a place in my home country in the UK which has been rented since we moved to Oz just over a year ago. I am currently saving a deposit for our first house in Australia and after doing that I would like to look at buying another house. I work in the mines and am currently earning around $170k per year so can do good things with the money when I get the knowledge I currently lack.
My simple attitude towards investment properties was merely that if a property was paying for its own repayment mortgage (as is the case on my uk property), great. In 17 years it will have paid off the mortgage for me ( assuming no problems) and I will have the rent to put towards my retirement fund. As I learn more and more about investing I understand that there are benefits to be had regarding tax etc which as yet I don't entirely understand and that is the basis for my post.
The reason that my UK property is able to pay for itself currently is that my mortgage rate is a variable currently sitting at 1.25%. The mortgage payment is 540 pounds and the rent is 650 per month. The property is worth around 150k and has an outstanding mortgage of 106k. The extra money pays for the insurance on the property, life insurance on the mortgage and boiler cover leaving me 30 a month which I overpay on the mortgage. Now, remember that I am inexperienced here so don't jump down my neck for my naivety but in my opinion, even of the rate goes up a couple of % because I fix it and puts my payments up to 750 pounds per month plus ins etc and I have to send money home, it is still a good thing because the way I see it is that regardless of what I spend the money on, I am getting paid 650 a month which I use to pay for a house I was buying anyway and any income is a bonus right? In 17 years I will be mortgage free and then I will be getting paid 650 a month before tax and at todays exchange rate that gives me about $1000 a month income pre tax. A good goal right?
Now, I have recently come across the delight that is defense housing, which as I'm sure you will know has a an assured income contracted to 12 years if you so desire. The downside being that they self manage the properties and charge you a handsome 13% of the rent. My basic math gave me a figure that was something along the lines of a $400,000 property on a repayment mortgage would require me to top up the mortgage by $400 a month. The upside is that I would not expect a call to maintain the property unless something significant went wrong with it. The rents would be reviewed continually and on the outset it looked like a good deal if I was happy to have to top up. I was using the same mentality that I applied to my current property in that it would be a retirement fund. It seems like a good deal to me because it is low hassle despite the top up and at the stage of experience i am at I think thats a good thing.
I would like to receive as much advise as possible on this and honest advice at that. I'm happy to be picked up on obvious cock ups if I have made any but my main question refers more to the negative gearing. My understanding of negative gearing goals is that any "losses" I make on the property like interest payments, management costs and the myriad of others that I am yet to learn are all tax deductible. They come off of my $170k earnings reducing what I am liable to pay tax on. If I had losses of $20k on a property, my earnings for the year would be $150k but as I will have already have had tax taken by my employer on $170k the accountant would submit a return highlighting the losses and I would receive a cheque based on my overpayment. So if we took the figure I mentioned earlier of a loss of $400 a month to run the defense house my loss for the year would be $4800 ($400 x 12) so my earnings for the year would be $165200. Because I am already paying 48% tax I wouldn't get a rebate of $4800 I would get 52% of the $4800 back?
Is this basically how negative gearing works? If so it seems to me that apart from the deposit, the house will cost me $2496 per year to buy on a repayment mortgage over 30 years. $74,880 to buy a $400k house. Seems like a sound retirement plan to me. Once I have paid it out the house will pay me a wage of around $1600 a month pre tax forever and will continue to do so for my kids too?
I'm sure I will have had a slight misconception of how it works so if anyone can give some sound advice and even better some tools for seeing how any deal stacks up that would be great.
Many thanks
Paul
Hi Paul
Welcome to the forum and hope you enjoy your time with us.
Always glad to see another Pom on the board especially with how the cricket went in Brisbane.
I am actually in the UK at the moment and certainly looking at picking another property or two over here.
Anyway back to your enquiry.
Certainly a Defence Housing home is an option for a new investor who wants a no worry investment with guaranteed tenant however you have to consider the downsides.
In the main these homes tend to be in areas that have lower growth due to the location and the ongoing management fees are considerably higher than a standard Letting Agent.
The other thing is you need to understand that the sale price and the valuation can be different.
I have financed a number of these for clients for them to find out that they have overpaid for the property and of course can only borrow against the purchase price or valuation whichever is the lower. You could find it takes a number of years for the valuation to get back to the purchase price.
Personally when starting out i would suggest a lower cost investment combining a healthier yield with capital growth potential.
Realistically you are going to be limited to a maximum loan of 90% of the purchase price / valuation (hence my comment on valuation) plus the acquisition costs i.e stamp duty, legal fees etc.
On a purchase price of say $450K and depending on the State you may well find you need a deposit of circa $65K +.
Quick summary of how negative gearing works
1) Add the gross income from the rent to your current PAYG income.
2) Deduct from this total all of your expenses i.e interest, Council Rates, insurance, property management expenses (all of which are a cash expenses) and then non cash expenses such as Depreciation and Capital Allowances.
3) Your Tax is now recalculated on the adjusted income figure.
Remember any loss is only offset at your marginal tax rate.
Personally i prefer positive geared properties or at least neutral geared properties.
You cannot live of potential capital growth but you can certainly retire off rent. (Trust me read my API article).
Not trying too put you off but i think it is the sort of investment you need to go into with your eyes open and understand the downsides.
It is not the sort of investment we would recommend to our clients.
Cheers
Yours in Finance
Richard Taylor | Australia's leading private lender
Hi Richard
thanks for your comments. I'm interested to know why it is that you are investing in the UK if you are residing in Oz. As I think I said above, my current rental property is in the UK and I hadn't really considered another one there although they are cheaper there and would suit my current aversion to risk and lack of knowledge about how to make it profitable and I also know the market better there too.
So to summarize, a negatively geared house basically means you have to top it up out of your own pocket and you can claim that as a loss of earning and reduce your tax liability. A positively geared house turns a profit and neutral is in between the two. If i'm right then of course, the + flow is better despite paying more tax so I don't understand why people are so keen to -gear a house as a loss is still a loss despite paying less tax…
How do I work out yeild on a property? Is it simply the %age if its own value that it pays back in rent each year. $400k house earning $20k per year is 5% yeild?
Thanks again
Paul
Hi, the house won't cost you $74,880 to buy a $400,000 house. That's how much on top of the $400,000 to buy it.
But that's assuming rents won't go up. After a few years one hopes the rent will go up and it will no longer be CF-.
Negative gearing can be a wonderful thing but remember to get the tax break you need to be losing money. If there is no capital gain you are losing money year after year.
Sometimes you can be negative on paper but not costing you anything out of your pocket. This can b because of depreciation (which is deductible against your tax even though you are not paying it).
Make sure the investment is a sound one BEFORE the tax breaks. Tax breaks are not set in stone and can be changed.
When investing remember tax breaks are the icing on the cake, it is not THE cake.
Hi Paul the downside is that even as a British Passport holder there is no lender who will consider Non resident loans in the UK so you would need to be paying cash for the property.
I have 1,2 or now nearly 47 investment properties in Australia so as i spend time in the UK and Europe each year i am always looking to add to my portfolio in SE England.
Cheers
Yours in Finance
Richard Taylor | Australia's leading private lender
Catalyst wrote:Hi, the house won't cost you $74,880 to buy a $400,000 house. That's how much on top of the $400,000 to buy it.Hi Catalyst. I was basing that figure on how much of my own money I would be using to buy it based on the fact that the tenant would be repaying a repayment mortgage for the rest of the money.
So I need to understand the financing of investing better. I know I will be paying roughly 8% for a management company, the interest on the loan is a loss and any profit made is taxable at my marginal rate. I also know that depreciation is involved but I don't know how this works to well yet.
I have asked the question somewhere that am I better off paying extra on my domestic mortgage or using that money to run an investment property at a loss because of negative gearing although when I asked the question I had in mind that I would set up the mortgage on the IP to be a repayment. I can see now why that setting up an IP with a repayment mortgage is not a smart move unless you don't want to invest any more and just want the mortgage gone. With an interest only mortgage you have a greater chance of making a profit and then using that money to pay off your own mortgage quicker. Using the tools on an app I recently got I can see that just $400 a month extra on a $400k property over 30 years with 5% deposit can make a huge difference to the amount of time you owe on that property. It takes ten years of the time and saves you $132,492 in interest.
What else should I be considering as part of my costing and due diligence?
Hi, No the tenant will not be paying your mortgage off. If it is negatively geared that means the rent is NOT covering the costs. Or have you worked the negative gearing based on P & I plus all the outgoings? If that's the case it wouldn't be really negatively geared and you can't claim all of that on your tax. You can only claim the interest.
Are you basing this on a specific property? If so can you give the figures? It might make it easier to see where you are coming from.
You need to cost ALL outgoings- council and water rates, strata (if applicable), insurance, management fees (including an approx maintenance amount). Most people only count 50 weeks a year rent to allow for vacancies.
Depreciation is an amount you can claim as a deduction. A property can produce an income but still (on paper) be CF- because of depreciation benefits. That's why some people prefer to buy newer properties as the depreciation is higher.
You're getting there. Keep asking questions.
Firstly, thanks very much for being encouraging more questions. I have used forums for many things in the past on different subjects and have always felt that there is someone at the other end thinking "AAAAARRRGGGHHH, have you still not got this?, I don't want to explain it again" so thanks again.
Your absolutely right I had been doing my workings out using a repayment mortgage which of course makes the outgoing a whole lot more expensive than an interest only mortgage. I have only really recently understood the value and the reasons behind having interest only mortgages. My main goal in the past was to own outright as many properties as possible to have a great retirement. My thought was even if I own two plus my own home outright, putting that with my pension will give me a good retirement. Now that I understand that the interest on an IP is considered a loss ( I hate the term tax deductible as it makes it sound like the loss comes out of your tax rather than being deducted from your earnings before the correct amount of tax is paid, so still a loss…) and that the interest on my own property would not be, I can really see the benefit to structuring your debt in a way that is cost efficient and although my goal is still the same, I want to retire comfortably at the very least, I now have a better plan to carry that forward and achieve it.
Because I am new to Australia and have never owned a house here yet, I have no idea yet what exactly I will need to factor in to the equation. I am currently in a rental and I pay my own water bill in here and rent and pool maintenance. I have only recently heard the term strata fee too. I need to know exactly what I will be paying out when the time comes and how to factor that into my plans. I have no desire to own a negative geared property at the moment simply because, as I understand it, that type of arrangement generally relies on capital gain on renovations and area rises etc and also being able to spot a house being sold under market value and picking an area. I don't posses these skills yet but I'm sure with experience I'll develop them. Thankfully at the moment I am in a financial position to make mistakes without them wiping me out but I don't know how long that will last.
I have no particular property in mind as yet and before I go into the investment world again I will be buying myself a house to live in with either the thought of renting it out when I decide to move on up or staying put and buying something else. To give you an idea of the figures I have been working with I had been looking at the defense housing with the fixed sale prices and fixed rent prices. As I think I said at the beginning of this thread, I liked the idea of them for the lack of maintenance and I had been doing my calculations using repayment mortgages. A particular house I think I was looking at was as I recall $440k with a rent of $440 per week. I know they charge a nice 13.5% for management fees so costs are as follows…. I think….
$440 per week x 52 = $22880
Mortgage at $418k LTR 5% so house value at $440k on a repayment mortgage at 5% interest over 30 years giving $2243 per month of which $1741.67 is interest. Interest for the year is $20900.04
Rent per year $22880 – 13.5% management fees = $19791.20. Divide that by 12 months = $1649.26
I am in a high tax bracket so lets say for example and ease that I was earning $150k per year. I know that to work things out I need to take my $150k and add my rent ( after management fees in this example to keep it simple)$150k + $19791.20 = $169791.20. from this I need to deduct my interest for the year. $16791.20 – $20900.04 = $148891.16 so I will pay less tax because I have had a loss.
On $150k I would have paid $43446.63 according to my tax calculator but with the less earnings I will be paying $43036.36 so I will have saved $410.27 in tax but I will have also been paying a repayment mortgage at $501.33 per month ($2243 – interest of $1741.67) $501.33 per month is $6015.96 – the $410.27 I have saved in tax leaves $5605.69 as my payment for the house per year so if I have done my calculations correct I will be buying a house outright with few problems for $467.14 per month or $5605.68 per year or $168170.40 for the entire 30 years plus the cost of the deposit and any set up fees. Is that wrong?
I am sure that I have left out a good few thing which I am not yet aware of but that's my basic workings out using a few apps for tax and mortgage calculations etc. If anyone can point out my mistakes or things that I have not thought of I would be very very grateful because with good mentoring and guidance you guys and your experience really can change the lives of my wife and kids and help us achieve a few of our life ambitions. Remember I am working out using a repayment mortgage.
Hoping you can help and hoping I have not fallen asleep at my ramblings. Thanks in advance.. Paul Oh and just to round off, I have no idea about depreciation yet and how it works. I understand its the value of what fixtures and fittings and what they have lost in the years counted as a loss but that's about my extent of knowledge on that subject.
I have an IP in Gunn, Darwin that is not defence housing. Quite a few defence housing properties in this suburb.
Whilst I initially thought Defence Housing was not a good deal due to high management fees-was 16.6% pa including gst as opposed to about 8.8% gst incl. for a private property.
However the big plus is you receive rent for defence housing whether it is occupaied by tenants or not. With a gap in vacancy on my private rental over Xmas (which equated to 2 months) defence housing would have been a better proposition.
I understand defence housing repaint inside the property at the end of the 15 year lease period as well.
Only problem with defence housing is its harder to sell as it only attracts investors (and only those investors who believe in the defence housing concept).
As I understand you can buy a plot of land and build to defense housing specifics and then rent it to them with the same perks and as a result you could get all the full depreciation of a new build which I have just learnt about and but in your chosen area so long as it suits the defense. If this is true you could avoid the hang up of having to stay with defense and its systems if you decided it wasn't for you.
I got that information from this video below. A guy talks on defense housing and his success on it.
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