Not everyone that purchases an investment property makes money.
To get more more often, why not follow us on Twitter? We're @FairfaxMoney
The success or failure of investing in property is all about making the right choices.
The first decision that must be made is whether it is a lifestyle property investment or a financial property investment.
A lifestyle property investment is purchased more for lifestyle and emotional reasons than to just make money.
An example is someone who would like to either have a tree or sea change when they retire. In this situation it can make sense for someone to buy an investment property in an area that they would like to retire to, have tenants help pay off loans needed to make the purchase, and then look to shifting into the property once retired.
When a property is purchased to deliver the best financial return possible a choice must be made between commercial or residential property.
Commercial properties tend to have a higher rental return than residential property, a commercial tenant pays all outgoings including rates whereas a residential tenant only pays the rent, and the rental period for a commercial property is often at least three years while a residential rental period tends to be only 12 months.
Where a residential property investment is often superior is in capital appreciation.
Because land is a greater component of a residential property than a commercial property, and because the main driving factor for increasing property values is the increase in the value of land, residential properties often increase in value more than commercial properties.
If the decision is made to invest in residential property the next choice is whether to buy an existing property or one from a developer off the plan. It has been my experience that the capital gain made by investors buying established properties is greater than buying a yet to be completed property from a developer.
There are often so many layers of cost included in yet-to-be-constructed properties, such as marketing and selling costs, that investors pay more than the true market value. If a property is purchased from a developer a comparison of its cost should be made with properties offered for sale in the same area. It can also be wise to contact a quantity surveyor and ask for their opinion on the value of the new property.
One advantage of buying from a developer is that the investor will maximise their rental tax deductions. This is because in addition to claiming interest on a loan used to purchase it, and other costs such as agent's fees and rates, a deduction is also allowed for the write-off of the value of fixtures and fittings in the property and the cost of the building itself.
Properties built after 1985, used to produce rental income, receive a tax deduction for 2.5 per cent of the construction cost of the building. The advantage of buying a property from a developer is that they often provide a schedule that details and maximises the deduction for the building and fixtures and fittings write-off.
Once the property has been chosen a decision must be made on the type of loan to use. As a general rule it is best to purchase an investment property using an interest only loan rather than a principal and interest loan. This is because only paying interest on the property investment loan means an investor can use any excess cash to either pay off private loans or make other investments.
The final choice is how long it will be retained. While a person is working and accumulating their wealth a negatively geared residential property makes a lot of sense. The problem is once they retire the low rental income produced by a residential property is a major disadvantage.
A decision should therefore be made as a person nears retirement to sell the rental property, minimise the capital gains tax payable as much as possible, and use the proceeds to provide the highest most tax-effective retirement income.
Max Newnham is the founder of www.smsfsurvivalcentre.com.au
Morning & Afternoon Newsletter