As part of the third series of the Financial Freedom Friday videos, we talked about the pros and cons of building an investment property.
We've successfully assisted hundreds of clients across Australia to buy land and build on that land, and guided them every step of the way through the build process, from purchase to settlement.
In our exprience we beleive there are certain advantages and risks to consider when building an investment property, as per the following, but not limited to.
Advantages of building an investment property
1. Stamp duty savings
The first advantage that a lot of people are surprisingly not aware of is stamp duty savings. When you build a house, you don’t pay stamp duty on the house, as no transfer is taking place. You only pay stamp duty on the block of land you buy.
Stamp duty varies for each state in Australia, but as a rule of thumb, it’s 3-4% of the property value. The key takeaway is it could ultimately save you thousands of dollars!
This saving could potentially be directed into servicing the interest on the land while the house is being built, and additional house upgrades or features to make it more appealing to tenants and buyers when you’re ready to divest.
2. Tax Benefits
The second advantage of building an investment property are tax benefits. Our good friends at BMT Tax Depreciation are experts in this field and in this case we are sharing their intel.
There are two main tax benefits to building a new investment property:
1/ The first one is depreciation deductions for eligible plant and equipment assets within the property. Unlike an owner of second-hand real estate, an investor who builds a new property is not affected by legislation changes passed in November 2017.
These changes eliminated the ability to claim a deduction for previously used plant and equipment assets found in second hand or previously owner-occupied residential investment properties.
Owners of new property are still entitled to claim depreciation deductions for all eligible plant and equipment assets found within their property.
2/ The second tax benefit is that the owner of a new property is eligible to claim a deduction for the entire cost of the building structure over forty years. Owners of an existing property can only claim the remaining years available.
To make sure you are taking advantage of these benefits like all of our clients, reach out to the BMT Tax Depreciation team who can assist with drafting up the depreciation schedules on your property investment purchases.
3. Home warranty insurance
Most residential building work done in Queensland valued at over $3,300, which includes labour and materials, must have home warranty insurance.
This is an added layer of protection you have on construction work as well as the structural building guarantee, that you don’t have when purchasing an existing dwelling.
Under the home warranty insurance, the work is covered for a period of 6 years 6 months from the date, whichever is earlier, when the premium is paid, a contract is entered, or work is commenced.
As part of the building process, the contractor or builder pays a premium to Queensland Building and Construction Commission to insure the construction.
The amount is included as part of your contract and is paid before work begins. If QBCC pays out on a claim, they pursue the contractor to recover the claim amount.
As part of the building process ensure you have a contract with your builder as this is a legal requirement under the Queensland Home Warranty Scheme.
4. Tenant and resale appeal
Another advantage of building an investment property is being able to enhance the tenant and resale appeal. As we have all recently found out, our home is no longer just our castle! It is our office, kinder garden, school classroom, gym, playground, living, sleeping, eating and entertaining areas all combined!
With a new build, you have the chance to design and build the type of property that the rental and owner-occupier market is looking for. It is also likely to attract a bigger pool of prospective tenants or home buyers seeking a modern home with new fixtures and inclusions - and who don't mind paying higher rent or purchase price as a result.
When it comes to design, one of the significant advantages of building new is that you can choose the home’s orientation on the lot and maximise its aspect. For example, a north-facing home maximises the sunlight, reducing the need for artificial light during the day.
Another advantage of having the main living spaces, like the lounge, dining room, kitchen and the backyard facing north, is that in the height of the summer, the sun is directly over those spaces, while in the winter, its low trajectory means the light will still come in.
Good orientation can increase the energy efficiency of your investment property, making it more comfortable for tenants to live in and cheaper to run.
Building the property to suit the tenant or future buyer will help boost the property's value, the rental yield and ensure it remains occupied.
5. Low maintenance
New appliances, fixtures and inclusions mean fewer outgoings and disruption to the tenant and more secure cash flow for the owner. Generally, in the first few years of owning a new rental property, you will only have to worry about preventative maintenance to keep everything in good shape.
But with an established home, depending on its age, you will have to budget for unexpected repairs or replacements and necessary improvements, which could prove to be quite costly over time.
In a new property, the appliances such as the oven, stovetop, rangehood and air-conditioning are covered by the manufacturer’s warranty. The warranty period may vary from 1 to 10 years, depending on that appliance. If anything is faulty during that period, they will repair or replace it. Claiming it may be a bit of an inconvenience, but at least it won’t be an out-of-pocket expense.
Risks to consider when building an investment property
Whilst there are plenty of advantages of building an investment property, there are some risks involved too.
1. Buying land in the wrong area
The current land supply shortage in major cities is proving hard for investors to source registered land to build on. So you might be looking into suburbs you are unfamiliar with, which can be risky.
Invest time in educating yourself first about the area before you buy. Pay attention to rental vacancy rates, comparable sales and price growth of the suburb to determine how easy it will be to keep your property rented and maximise returns or capital growth over time.
Avoid buying land in areas where there is increased competition, like in large scale housing developments, where you might find more similar investor-owned properties. It might be cheaper to start with, but the increased supply and the competition could negatively impact your capital growth and vacancy periods.
When we are looking for land on behalf of clients, we stick to built-up, urban areas close to major cities that appeal to tenants and owner-occupiers. If you cannot find an infill block or subdivision to build on, another option is a block within a boutique development.
2. Overcapitalising on the build
Remember that investing is a numbers game, do not let your emotions get the better of you. When you do, it is possible to overcapitalise by choosing upgraded fixtures, inclusions and or appliances, which could negatively affect your rental yield.
The property will generally get rented or sold at around the median price or rent of properties in the street regardless of spending thousands of dollars on upgrades. However, you need to get the balance right to ensure the property has immediate rental appeal over the competition and, in time, resale appeal.
When building an investment property, you can also choose to enter a Full Turn Key Fixed Price Contract with the builder to give you more certainty over the building costs.
The truism in real estate is that land appreciates and buildings depreciate. Therefore, if you invest large amounts of money into a property that is disproportionate to the value of the land, you risk losing money.
3. Mismanaging the project
If you’re building for the first time, you might not have the experience to manage the project effectively. Time is also a significant factor. It is impossible to try and do everything yourself, especially if you’re going through the process whilst holding a full-time job.
Edward Reavy, Founder and Director of EKR Property was in your shoes too many years ago and had to start somewhere, so he leveraged the knowledge and experience of professionals to help him manage risk, save time and money.
As a qualified property investment advisor and build consultant, Edward can take you through the entire process from sourcing the land, the build design and build tender process, managing the build, to renting the property.
He can manage those time-consuming tasks such as the build progress payments, organising independent building inspectors to check for defects, arranging a tax depreciation schedule and sourcing the right property manager to manage the property on your behalf. Plus much more.
Take the guesswork out of the build process and get in touch with Edward at 0404 784 864 or emailing info@ekrproperty.com.au