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Real Estate Investment – not that simple?

A large number of Australians have a diversified portfolio when they retire consisting of investments, including cash, shares and superannuation and in a substantial number of cases, an investment property.

During a person’s working life the investment property can provide a number of benefits including possible increases in the property’s value, a regular rental income stream and depending on the level of borrowings, a tax benefit via a common strategy called “negative gearing”.
I would like to discuss the treatment of an investment property under the Social Security Act, for the purposes of calculating a person’s age pension entitlement

A person’s age pension entitlement is based firstly on their age, and then on their assets and income.

For the purposes of this article, I will explain the assessment of the investment property under each test separately, starting with the assets test.

The investment property is an asset and the “net” value of the property adds to the total sum of all your assessable assets.

If you have borrowed money to purchase the investment property, and the borrowings have been secured by a mortgage against this property, the value of the investment property is reduced by the borrowings. For example, if the property is worth $500,000 and has an outstanding mortgage of $300,000, the net value of the property for the purposes of the asset test is $200,000.

However, if the borrowing of $300,000 is mortgaged against the age pensioner’s own primary residence – which is an exempt asset – then the value of the investment property is now $500,000 because the $300,000 has not been secured by a mortgage against the assessable asset – the investment property.

Even more confusing is the situation where the borrowings are mortgaged against both the age pensioner’s primary residence and an investment property. In this scenario, the borrowings are apportioned between the two properties based on the value of each. We know the investment property is worth $500,000, but if the pensioner’s residential home is worth $750,000, then only one-third of the $300,000 borrowing – i.e. $100,000 would be assessed as borrowings mortgaged against the investment property, reducing the value of the investment property to $400,000.

Now let us examine the treatment under the income test.

The assessment under the income test is a little easier to understand. The gross weekly rent being received is assessed as income. This income can be reduced by the expenses associated with the management and maintenance of the property. A good guide, if you have not completed a tax return is to maintain a deduction equivalent to one-third of the gross rent. A further deduction, which can be made from the net rent (after expenses) is the interest payable on the borrowings.

Interest paid on borrowings to purchase the investment property is a deduction from the rent, received regardless of which property the mortgage has been secured against. This is providing the purpose of the borrowed funds was to purchase the investment property.

At the beginning of this article I mentioned a tax strategy called “negative gearing”. This strategy allows for any losses incurred by your investment in the property to be used to reduce other taxable income.

This is not the situation under the Social Security Act. Any loss of the rent you are receiving may not be used to reduce the value of other income being assessed to establish your correct age pension entitlement.

Mark Teale | Centrepoint Alliance

Total returns show why housing investment remains so popular

Despite the recent slowdown, housing finance data highlights that investor activity in the housing market is starting to rise again and when you look at total returns from housing it’s no surprise.

The CoreLogic RP Data Accumulation Index has been published since June 2009 and highlights the total returns from residential property.  The total returns include both the increase in values as well as gross rental returns.

The first chart below shows the annual change in the total returns (accumulation) index over time.  While combined capital city home values recorded longer and deeper falls during 2011-2012, total returns were negative for only a short period of time thanks to the uplift from rental yields.  More recently you can see that the annual change in total returns across the combined capital cities has remained quite strong.

Combined capital city annual changes in total returns for houses and units

Housing 1

In the below chart it shows over the 12 months to May 2016, combined capital city home values have increased by 10.0% while total returns have been recorded at a higher 13.9%.  Looking at the individual capital cities, all cities except for Perth have recorded positive total returns over the past year.  Sydney and Melbourne which have been the most active investment markets have seen the highest total returns at 16.9% and 17.5% respectively over the past twelve months.  It should be noted that gross rental returns in both of these cities are now at record lows highlighting that the majority of these returns have come via an increase in home values.

Annual change in capital city total returns, 12 months to May 2016

Housing 2

The third chart below highlights the total returns over the past five years across all capital cities.  Again, Sydney in particular, has seen far superior total returns compared to all other capital cities.  Melbourne has also experienced relatively strong total returns over the past five years.  Again this highlights why these two cities in particular have remained so popular with investors.  In all other capital cities returns from residential property have been positive.  In many of these cities the total returns have been driven more so by the rental returns rather than the capital growth which has been the key driver in Sydney and Melbourne.

5 year total change in total returns, to May 2016

Housing 3

Despite the recent rebound in value growth, the mature capital growth cycle and record low rental returns in Sydney and Melbourne, total returns are unlikely to be as strong in these cities over the coming years.  A more balanced investment approach which focuses on moderate capital growth and relatively strong rental returns is likely to be a superior housing investment profile over the coming years.  This data also highlights why housing investment has been so popular.  In a low interest rate and subsequently low return environment housing has, over recent years, offered attractive returns.  Whether this continues to be the case remains to be seen.

 

Source:  Cameron Kusher – CoreLogic RP Data

AFD Financial Solutions can help you with all your home loan needs for either owner occupied or investment property. Give us a call today on (08) 8132 2655.