Property Value Guide:
Buying a home or a property is not an exact science. Every property is unique and you just can’t create a formula that is applicable to all your property investments. The Median versus Average prices record is valid but is not necessarily what you need as basis for your valuation. These numbers are only indicative of the past sales history of the area, not the current value that a buyer may offer for a given property.
So, if there is no constant formula for valuation, what should you do? The answer is simple yet somewhat complicated, “Do Your Homework”. This means that in order to minimise the risk of losing your money, you have to do the due diligence in carefully studying everything about the property that you want to buy. There are no shortcuts for this. You really need to dirty your hands in looking at past records, inspecting the property, understanding the market and having a structured way of analyzing the data you gathered about the property.
1. Purchase Price:
Identifying the right purchase price will define the success or failure of your investment. You should carefully study the current market and all the factors involved about the property. Property prices greatly vary between areas and also between houses and units. This means that even if two houses are situated to each other, their prices will still vary because there are many different factors that influence its price. Like mentioned previously, the record of the median and average prices only shows the sales history of an area and it does not really help in determining the current market price of a property.
2. Renovation budget:
Renovation is not as fun and easy as portrayed in television; one mistake could cost you a lot of money. That is why it is important to understand the underlying principles that will guide you in determining and planning what to renovate and the budget needed to implement it.
The main goal of renovating is to add value to the property. It should be well planned and carefully implemented. Here are some guidelines that will help you lessen the chances of going over-budget with your renovation and help increase your investment profits.
Buy at the Right Price
Determining the right purchase price for the property is very important in order to profit from your renovation efforts. The lower you can pay for the property, the better. You’ll be chasing your tail if you try to profit from renovating a property that you apparently paid too much for. It is good to start out by establishing the end value of the property after all the planned renovation. You can do this by researching the price of comparable renovated properties in the area.
Be Realistic With Your Budget
Focus on the essential things that would really add value to the property and work out an accurate costing for it. As the saying goes, “A dollar saved is a dollar earned.” Sometimes it’s hard to renovate a property in a market where the prices of the houses are stagnant or going down but you’ll never go wrong if you focus on the essential things and be able to set a tight budget for it.
Winners are planners! It is important to really think about what you need to achieve after the renovation. Sometimes when there is no plan, it’s just too easy to change your mind on something while the renovation is in full force. This may tend to increase the scope of work and start blowing up your budget.
Before making a plan, it would be best to thoroughly inspect the property with a paper and pen on a clipboard and start taking down notes as you walk up to the front door and into the house. It is also wise to consider the fact that first impressions count and that it creates the initial perception of value of the house. So take note of the things you see as you walk up to the front door and see if the exterior paint on the front walls are okay? Does the lawn need mowing? How about the landscaping? Does the doorbell work?
Add Value to the Property
It all boils down to perception and emotion. The main goal of renovation should be to add perceived value and that it should create an emotional attachment to the buyer right away. Avoid renovating with your personal preferences in mind because it usually costs higher than usual. It is best to keep things simple with neutral designs just to make the property liveable and functional.
3. Rental Return Yield
The yield is a percentage indicating how much cash an income producing asset generates each year in relation to the asset’s value or property value. The higher the yield means the better cash flow the property generates each year. There are two types of Yield: Gross Yield and Net Yield.
Gross Yield – Gross yield can be easily computed. For example: A property is rented out for $350 / week and the value of the property is $ 500,000, then the gross yield is computed as $350 x 52 (52 weeks in a year) divide by 500,000.00 x 100 (to get the percentage) = 3.6%
Net Yield is much more important but it’s not that easy to compute for it. In calculating the net yield, the operating expenses such as insurance, repairs and maintenance, management fees and vacancy rate is deducted to the gross income of the property
Let me give you an example for this. Given the following data, we will compute for the net yield:
Property acquisition cost — $ 400,000
Monthly rental amount — $ 2,800
Vacancy rate (Annual basis) – 6% which if applied to annual gross rent would be $2,016.00 computed as [2,800 x 12 = 33,600 (6%) = 2,016.00]
Annual insurance cost — $ 1,400
Annual Taxes cost — $ 1,600
Annual budget for repairs — $ 500
Percent of rent management fee – 5% which will be applied to annual rent less the vacancy rate. Computed as: [2,800 x 12 = 33,600 less 2,016 = 31,584 (5%) = 1,579]
Gross annual rent will be $ 33,600 minus the total cost of expenses listed above which is $ 7,095 = $ 26,505 rental income after expenses.
$ 26,505 divided by the acquisition cost or property value of $ 400,000 = Rental Yield of 6.6%
Mortgage interest and tax are not usually considered in the computation of net yield because these variables are not directly related to the property itself. But if you are an investor and you’re trying to compute for the return on investment, you should not only consider the mortgage interest and tax but also the depreciation, land tax, stamp duty, mortgage insurance etc.
Where to Get Yield Data
Where to Get Yield Data
Gross yields are listed for all suburbs in Australia and you can see this listing in the back of every copy of “Your Investment Property” magazine. Keep in mind though that these yields are computed based on median rents and median prices to which the results can be subject to statistical anomalies. What you can do is validate the data yourself by checking the rents at www.realestate.com.au and be sure not to choose the option to include surrounding areas and to choose a specific dwelling type: houses or units.
4. Purchase Cost
4. Purchase Cost
In buying a home or a property, your cost is not limited to the purchase price only. There are many other costs that you need to include in your computation as well. Listed below are the costs added to the purchase price in order to arrive at the purchase cost.
Stamp Duty – Is a general tax imposed when you do documented or non-documented acquisitions like in buying real estate, vehicles, business assets and other properties; insurance policies, gifts and home loans. This is paid by the borrower or purchaser.
Here is a list of Stamp Duty rates in New South Wales as of June 6, 2012
Dutiable Value Duty Threshold
$0 — $14,000 $1.25 for every $100 or part of the dutiable value
$14,001 — $30,000 $175 plus $1.50 for every $100 or part, by which the dutiable value exceeds $14,000.
$30,001 — $80,000 $415 plus $1.75 for every $100 or part, by which the dutiable value exceeds $30,000
$80,001 — $300,000 $1,290 plus $3.50 for every $100 or part, by which the dutiable value exceeds $80,000
$300,00 — $1m $8,990 plus $4.50 for every $100 or part, by which the dutiable value exceeds $300,000
Over $1m $40,490 plus $5.50 for every $100 or part, by which the dutiable value exceeds $1m
A solicitor or conveyancer is needed to ensure that the paperwork is all in order when purchasing a property. It usually costs about $800 — $ 1200 for legal fees depending on who you hire and the state you live in.
This is an insurance that covers the lender for the risk of the borrower defaulting on the loan. This is paid by the borrower and the cost depends on the total amount to be borrowed. The higher the amount you borrow, the higher the cost of the insurance is. It can be estimated to be around 0.5% — 2% of the mortgage and it is only charged if the loan is more than 80% of the property’s value.
Mortgage Stamp Duty
This is another tax that needs to be paid to the state government if you require a mortgage to purchase your home. The amount of duty if the mortgage is less than $16,000.00 is $5 and for more than $16,000, the duty is $5 plus additional $4 for every $1000 or part thereof. So for example: If the mortgage amount is $20,200, the mortgage stamp duty is $25.
It is however stated in the NSW Office of State Revenue website that as of July 1, 2013, the mortgage duty will be abolished.
Mortgage Application Fees – This fee varies between lenders. Some are free while others charges up to $1000. The average charge for this is around $600–800.
This cost is often overlooked by many home buyers. You have two options in doing this. One is to do it yourself by hiring a truck and asking some of your good mates to help you out. The other option is to hire a removalist which can cost more because it comes with insurance.
Connection of Utilities
This is another cost that is often overlooked by many. This includes connection of electricity, gas, telephone etc. If it is your first time to have an account with the providers, they usually require a bond and an application fee of about $60-$100 each. It is recommended that you find out these costs early on and when it is needed to be paid to avoid shortfall.
It is important to ensure that the property you are buying is free from structural defects, electrical or plumbing faults, Asbestos, ventilation issues and all other potential problems that can only be seen by building experts. This could cost about $200-$600 but it’s worth the investment. Do not take the risk of buying a property without hiring a building inspector because a coat of paint or a new carpet can be a cover up to many problems.
This is also very important and most solicitors / conveyancers will advise you to get termite control services because you’ll never know you have termites until its too late. Termite inspection costs about $200-$400.
5. Load Interest Rate
5. Load Interest Rate
Interest is the cost of borrowing money and its rate is dependent on how the economy is performing. The Reserve Bank of Australia (RBA) is the one responsible for formulating and implementing monetary policy as set out in the Reserve Bank Act or Bank Charter.
RBA regularly reviews Australia’s interest rates based on the following factors:
1. Inflation rate
2. Unemployment rate
3. Consumer Price Index
4. Producer Price Index
5. Levels of Retail Sales
The main objective of RBA is to promote long term development by maintaining low and stable inflation over the medium term. When inflation rate is low or stable, RBA also lowers the interest rates to encourage people to borrow and if the inflation is set to rise above 3%, RBA will try to slow things down by raising the interest rates.
It is important for you as an investor to understand how the prevailing interest rates change and as you establish your loan plan, it is wise to consider the possibility of increase in interest rates in the long run and factor it right into your future payments.
6. Landlord Insurance
6. Landlord Insurance
It is important to have a Landlord Insurance if you are renting out a property. This will give you peace of mind and protect you when unfortunate things or accidents happen to your investment property. You’ll never know when accidents might occur like vandalism or damage caused by the tenant, the building burns down and you need a fund to rebuild it or if the renter decides to leave unexpectedly before the lease ends and you can’t find another tenant to replace them right away. The policy may stipulate complete repair or replacement or it can also be covered only up to a certain dollar amount that you have chosen.
Basic coverage for Landlord Insurance includes:
1. Damage caused by the property owner
2. Damage caused by tenants.
3. Defined events like Fire, Theft, Storm and earthquake.
Things that are not covered by Landlord Insurance:
1. Damage caused by negligence of the owner to maintain the property.
2. Flood or tidal waves
3. Erosion or soil movement
4. Damage from tree roots or insects
There are a number of “Insurance Riders” or optional coverage that is also good to add to your policy to make it more beneficial to you as a Landlord. These are:
1. Legal Liability Clause
This protects you as the landlord if found liable in the event of injury or death of someone in your property.
2. Content Insurance
If you have furnishings inside the units that you rent out or if you store some of your belongings in the property.
3. Rent Guarantee
You can have your rent covered in cases where you cannot collect rent because your property gets damaged severely by fire or earthquake or simply the tenant defaults.
The premium for this insurance is hard to estimate because it varies greatly depending on factors like:
- The insurance provider you choose
- Location of the property
- The cost of reconstructing the property
- The kind of tenants in the property
- History of claims
- The age of the property
- Type of property (full concrete, detached, terraced etc.)
What are some things you can do to ensure that you get the best quotes for your Landlord insurance coverage?
1. State the correct re-build cost
Rebuild cost is not the same as the market value of the property. It is good to seek help from an experienced builder to get at least close to the accurate cost of reconstructing the property.
2. Buy one policy to cover all your properties
If you have more than one rental property, it is good to check if you can have one policy to cover it all. It is convenient to just have one renewal date and it can save you money too.
3. Choose the right tenant
Choosing the right tenants for your property can also give you savings on your Landlord Insurance premiums. Choose tenants that have professional occupation rather than those on income support. Vacancy rate also affects your insurance premium.
4. Get adequate protection for your property
Simple things like getting quality door locks and window locks or having fire extinguishers on strategic places to installing security alarm system and fire protection sprinklers can greatly lower down your landlord insurance premium.
7. Council rates
7. Council Rates
These are charges collected by the local council from the respective property owners in their area. Council rates consist of two parts. The first part is the charge for the “municipal and garbage services”. This is a standard charge paid equally by all property owners regardless of the value of their property. The second part is called “general rates”. This on the other hand is computed by multiplying the property value to what they call as the “Rate in dollar” which is based on the council’s budget for community services divided by the value of all the properties in the council area. To illustrate, if the given “Rate in dollar” is 0.002142 and the property value is $300,000, the general rate would be $642.60.
8. Water Rates/Charges
8. Water Rates/Charges
Wat6. Lander corporations have two kinds of water charges. The first is the “Water rates”. This is the service charge for the facilities that brings the water from their plant to the property. The second is the “Water consumption” which is the charge for the water used in the premises.
The water corporation charges the owner for the water rates assessed in the property as well as the water consumption unless otherwise stipulated in the tenancy agreement that the tenant agrees to pay them. Water costs can be shared by the owner and the tenant in a percentage figure depending on the negotiations made at the beginning of the tenancy. It is fair for the tenant to ask the owner to share in the water costs if the former is asked to water the garden.
9. Strata Rates
9. Strata Rates
Owner’s corporations sometimes need financing for building maintenance and repairs, legal cases, building applications, renovations and fire upgrades as well as new capital works.
These needs are partly caused by the law that requires owner corporations to conform with their duty to properly maintain their building to a safe and liveable standard. It is also due to the requirements of insurance companies.
The only options available for owner corporations before were to raise special levy or wait for the sinking fund to accrue enough funds, whilst the building continues to deteriorate, building costs increased, legal liability increased and tenant’s quality of life deteriorated.
Strata finance allows owners to do the much needed work immediately whenever necessary. It’s a true user pays approach.
The following are the advantages of strata financing:
1. Negotiate more competitive building contracts because the fund is readily available
2. Removes the risk of cost increases
3. When the property is sold, repayments for strata finance is passed on to the new owner
4. Covers owners from the risk of legal liability
5. Takes the hassle away of individual owners seeking alternative funds
6. It does not affect individual owner’s credit ratings
7. Have the work done today as needed and enjoy the benefits right away.
10. Building Insurance
Building insurance covers the structure of your home including the garage, outbuildings and perimeter walls as well the permanent fixtures and fittings such as the baths, toilet and fitted kitchen.
It generally covers damage due to fire, lightning, explosion or earthquake, theft, riots, vandalism, storms or flooding, subsidence, falling trees, car hitting your home, and leaking water or oil.
Building insurance is not compulsory but if you have a mortgage, your lender will require you to have one whether it is a primary home or investment and if you’re a landlord, it would be wise to take out a building insurance too.
The amount of cover you need should be equal to the cost of rebuilding your home including the cost of demolition if needed, cleaning the site, and architects and builders fees.
Taking care of the maintenance in your building is very important for the property owners. Maintenance is generally defined as the work that is done on a routine basis to keep the building in good working condition
Maintenance and repair is a complex process. It requires good communication with your handyman, contractors, tenants and tenant associations. The owner must have active participation together with everyone in the building to be able to conduct routine maintenance work, handle emergency repairs and to plan and implement long-term improvements in the building.
When making repairs, it is necessary to have a plan to properly manage the work that needs to be done. Make a thorough survey of the property and take note of the things that needs to be repaired. It is important to schedule the repair in proper sequence because you don’t want to be doing major electrical or plumbing work that requires partial destruction of ceiling or walls after you just finished doing the plastering or painting jobs.
Setting repair priorities is equally important to properly manage the repair budget. There are generally three priority categories that most repair works fall into. These are:
Emergency building repairs
These are conditions that can be a threat to health or safety
These are conditions that when left unresolved, it will lead to emergencies, leading to major damage in the building and will cost more if the work is postponed.
There are repairs that only improve the aesthetics of the building.
Here is a list of the things you need to survey when making a repair plan:
- Exterior walls
- Boiler room and boiler
- Stairs and stairwells
- Light fixtures
11. Vacancy Rate
10. Vacancy Rate
Vacancy rate is the percentage value of the number of units in a rental property that has been vacant or unoccupied in a particular time. It is a useful metric in evaluating the profitability of a rental property. High vacancy rate means that the property is not renting well while low vacancy rate means strong rental sales. It is computed in a yearly basis and vacancy rate and occupancy rate should add up to 100%.
11. Management Costs
Property management are the stewards that maintain your property. It is important that you do not base your decision on whichever agent charges the lowest fees because it reflects the kind of service that they may provide.
Although the price is very important, your main concern should be to determine what services they can provide that is tailor-fit to your needs.
In order for you to have a clear idea on how much it would cost to manage your property you should make an appointment with the agent to discuss their fees and service.
12. Income Tax Rate
Income tax in Australia is levied upon three sources for individual tax payers. These are from personal earnings such as salaries and wages, business income and capital gains. A capital gain is part of the income tax system rather than a separate tax. It applies to individuals, companies and other entities that can legally own an asset. Sale of assets which have been held before September 20, 1985 (Pre CGT assets) is exempt from capital gains tax.
Income tax from individuals is taxed at progressive rates while the income of companies is taxed at a flat rate of 30%. Capital gains are only subject to tax at the time the gain is realised.
Income tax is based on assessable income which falls under two broad categories namely: ordinary income and statutory income. When assessing the amount of ordinary income, only the profits are counted based on a notional basis.
13. Tax on Loss
Tax loss occurs when the total deductions you can claim for the year surpasses the amount of assessable and net exempt income for that same year. Tax loss for individuals including sole traders and partnerships and trusts can be carried forward indefinitely and be deducted in future years against income but it has to be utilised at the first opportunity. There are some deductions however that can’t be used to create or increase in a tax loss, these are the following:
1. Payment of retirement allowances, pensions and gratuities.
2. Contributions made to deductible gift beneficiary
3. Payments under conservation covenants
4. Personal superannuation contributions.
Australian residents compute their tax loss based on their income including those that is derived outside of Australia and their deductions. Foreign residents on the other hand, compute their tax loss based on their income in Australia and deductions incurred in earning that income.
Tax loss and Capital loss
These are tax losses based on two different things. Tax loss happens out of your income and deductions for the year. Capital loss happens when you dispose a capital asset for less than its tax value. Capital loss can only be offset with capital gains. It cannot be offset to income.
Depreciation, when claimed by the investor can increase cash flow and reduces debt to save on interest costs over the term of an investment loan that potentially enables the investor to add to their property portfolio sooner.
An investment property is made up of three components and each of these is treated separately for depreciation purposes.
- The land
- The building
- Plant and equipment
Plant and equipment includes carpets, ovens, cook tops, drapes, heaters, dishwashers and others who has been purchased for the sole purpose of generating rental income.
The rate to be used for depreciation is subject to construction date. For residential buildings are as follows:
Before July 1, 1985 — Nil
July 18, 1985 – September 15, 1987 — 4%
After September 15, 1987 — 2.5%
External structural improvements like retaining walls, paving and gates has a different construction schedule rates as follows:
Before February 27, 1982 — Nil
After February 27, 1982 — 2.5%
There are generally two methods being used in computing for depreciation: diminishing value and prime cost. It is in the discretion of the investor and the accountant which one to choose.
this method assumes that the decline in value each year is in constant proportion with the remaining value and results to a progressive smaller decline over time.
Using this method, you can claim a fixed amount every year. This method involves multiplying the original asset cost by the depreciation rate every year.
You need the services of a qualified quantity surveyor to come up with the depreciation schedule for your investments.
14. Negative Gearing and Positive Gearing
Negative gearing is an investment strategy that refers to purchasing a rental investment with borrowed funds and the mortgage expenses exceed the rental income, therefore incurring a loss. The losses can then be deducted to other assessable income like wages or business income of the investor. The result is either a reduction in tax payable or a bigger tax refund.
Why negative gearing is considered an investment strategy?
The main reason why investors use negative gearing as a strategy is to reduce taxable income while at the same time building wealth through capital growth. Negative gearing is a long term investment strategy and is popular among the high-income earners who are looking for ways to build wealth.
Positive gearing is basically when the rental income of a property purchased through borrowed funds exceeds that of the expenses and is therefore subject to income tax.
15. Capital Growth
Capital growth is referred to as the increase in value of an asset or investment over a period of time. Capital growth should be the main objective when investing in properties in order to achieve financial independence. This holds true in any economic condition.
A comparison between High income yield and Capital Growth
A high income yield produced by a cash-flow positive property might be very interesting but to illustrate the point that capital growth is better, here is an example.
Suppose you purchase a property that is worth $500,000 that yields 10% pa and the growth is at 5%. After 20 years, that property will be worth $1,326,649 and provide a yield of $66,332 pa.
But when you put capital growth as the main objective and purchase a property in a well selected urban area that has lets say 10% pa capital growth and the property is worth $500,000 with a yield of 5%. After 20 years the property will be worth $3,363,750 and provide a yield of $168,187 pa.