Buying an investment property? Be aware of short-lived benefits

The RBA’s decision to leave interest rates on hold earlier this month is unlikely to have any negative effect on the property market. Interest rates have already fallen to a point where investors are being enticed to act and when investors come out so do the property marketers ready to sell.

But when you’re leafing through the glossy brochures and touring the display suites, remember that today’s financial benefits could be tomorrow’s financial headaches. These benefits are nothing new to the market as they are rolled out each time investors get active. Here are the most common ones to look out for:

Depreciation benefits

Buildings and their contents depreciate (decrease) in value, whilst land appreciates (increases). When you buy a new property, the tax office will enable you to defray part of the purchase price by allowing you to claim depreciation on certain items. This can be helpful in increasing your cash flow, particularly during the early years when the property is likely to be negatively geared.

However, the downside is that most of the depreciation you can claim comes from fittings and fixtures like the oven, air conditioner, blinds and carpets, which fully depreciate in five to 10 years. Furthermore, depending on the way you calculate your depreciation allowance, the amount you can claim may decrease each year. This means it will cost you more to hold the property as each year goes by.

Claiming depreciation can also have a hidden tax consequence because it will also increase the amount of capital gains tax you pay when you sell. I’m not saying you shouldn’t claim depreciation – but you should be aware that it may have financial consequences later down the track.

Stamp duty savings 

When you buy property off the plan in Victoria, you will only be liable to pay stamp duty on the property’s value on the date of purchase. If construction is partially completed, you’ll only pay stamp duty on that portion of the building, plus the land value. If construction hasn’t begun, you’ll only pay stamp duty on the land value.

Don’t let short-term benefits hold too much sway when you’re choosing an investment property.

Whilst this can help considerably when you first buy a property, it’s only a one-off saving that won’t help you after the loan has settled and you have to make repayments. What’s more, when you come to sell the property, potential buyers won’t have the same benefit of a stamp duty reduction, so there’s less incentive for them to buy it.

Rental guarantees 

When you buy a property brand new or off the plan, the developer will often undertake to provide a guaranteed level of rent each week for the first year or two that you hold the property. This kind of guarantee generally applies even when the property isn’t tenanted, because the developer picks up the tab.

Although it is reassuring to have certainty of rental income during the early stages of holding an investment property, there are two significant downsides. First, you’ll pay a premium to secure the rental guarantee; the developer will build it in to the sale price. Second, in accepting a guaranteed rent level, you’re insulated from market forces. Once the guarantee expires, the amount of rent your property can command will depend on a range of factors including supply and demand.

As newer properties come on to the market and tenants have a wider choice of places to live, the market rent for your property could fall. This is a particular risk in areas like the CBD and Docklands where there’s likely to be a substantial amount of new construction during 2009 and 2010 as developers scramble to keep up with demand from investors returning to the market.

Remember also that when you’re no longer protected by the rental guarantee, you’ll have to have sufficient cash flow to hold the property during periods when your property is not tenanted.

In summary, don’t let short-term benefits hold too much sway when you’re choosing an investment property. Focus instead on the long-term factors that will influence capital growth and rental demand: land values, demographic trends and the balance of supply versus demand. If these factors don’t add up, move on to another property.

You can visit Mark's website iProperty Plan.