24/08/2018

After starting off as an 'accidental investor' with one property, our reader Andy asked for help to create a clear vision, sound strategy and concrete goals to help him build his property wealth.  We engaged the expertise of Michael Beresf0rd from OpenCorp to draw up this gameplan for Andy.

"I am 30 years old and I am a computer developer living in Sydney West. I bought my first house in 2016 in Sydney for $700,000. I rent it out and rent a room nearby to live in. Because property prices increased significantly in 2016 and 2017, I have some equity in the house, so I took $70,000 out of the equity and used some of my savings to build a granny flat at the back in 2017. 

I moved into the granny flat in October 2017, and continue to rent out the main house. My salary is $75,000, and the rental income is $1,800/month. Now I’m not sure what to do next! “I will be getting married soon; my partner is working as a registered nurse and has a good salary of around $80,000. Should we keep investing in further properties, or should we aim to pay down this mortgage first? After marriage, do we need to create a trust and move our assets into it to protect them? 

Also, I live in the granny flat but rent out the main house. Does this mean the property is my PPOR, or can I still use negative gearing? We would love some guidance!

- Thanks, Andy"

When it comes to investing in property, everyone is unique. We all have unique financial, personal and aspirational circumstances that require personalised strategies.

That’s what makes my job so challenging, yet so rewarding at the same time. When I received this enquiry from Andy, a Your Investment Property reader, I jumped at the opportunity to provide an answer. 

Let’s call it our ‘Game Plan for Success’. I studied the situation and tried my best to put myself in Andy’s shoes. This is what I came up with…

Starting with the basics 

There are a lot of factors that are unique about this situation. The first thing is that there aren’t many 30-year-olds out there who have a) bought a property, b) been able to add a bit of value to that property, and c) are thinking clearly enough to understand how they can use their financial resources to be able to get them as far ahead as possible. 

"You … have an amazing ability to invest in property and let time work for you and achieve significant compound growth"

I love that you’re thinking creatively about how you can ensure you’re putting as much of the income that you earn into your own pocket by using legitimate and effective ways to not only reduce tax but grow your asset base and your wealth position from there. 

So, first up, well done! To recap: you took $70,000 in equity out of the property that you bought in 2016 to build a granny flat at the back of that same house, which you now live in. 

You want to know: is that something that could be negatively geared? 

It’s a really good question, and I’m happy to disclose that I actually took this offline and ran it past an accountant, because I’m not a qualified accountant myself, and I wanted a thorough answer. It was some really good learning for me as well. The advice was that if the front property – the initial house on the block – is being rented out, then those expenses could be claimed as a tax deduction and therefore be negatively geared. 

However, the percentage of those expenses that would be claimed or are claimable will depend on the footprint of that property and the footprint of the granny flat as a percentage of the total land size. 

Essentially, it depends on how much of the block your living space takes up. To give you an example, if the block was 800sqm in size and the front house that was being rented out also had some backyard and took up a total of 600sqm of the total block, then it would account for 75% of the block, and you could claim 75% of the rates and the water and so on as claimable expenses – given that the other quarter of the property, the 200sqm of land that goes with the granny flat, would be effectively used for owner-occupier purposes.

"The best time to invest is right now, and the sooner you’re able to start the process, the better your financial future will look"

The crossroads: where to next? 

At the moment, you and your fiancée are trying to figure out your next steps, wondering if you should invest in another property, without overextending yourselves. 

You could say you are at a bit of a crossroads! From the information you have provided, it sounds like your current living situation is a really cost-effective way to go about it.

At OpenCorp, we talk a lot about the benefits of rentvesting: renting and paying a smaller amount than you would pay on a mortgage in the area you would prefer to live in, in order to grow your asset base through land-based investments that give you compound growth over time. It sounds like this is similar to what is happening with you. Living in the granny flat is very cost-effective because it only cost $70,000 to build. 

So, if I work out a mortgage on that $70,000, it’s even cheaper than the cost of renting in a lot of areas. Having the foundation of a really good growth asset – the main residence on the property – means you are also bringing in decent cash flow in rent. You should also be getting some decent tax benefits, so the overall holding cost on the main property should be small. 

That allows lifestyle choices to be made around getting married and so forth, and creates choice for you and your partner. Your property will likely continue to create equity over time, and you are on a double income with no kids so your borrowing capacity will be high. This will give you the ability to be able to create a bigger asset base and get compound growth into the future. 

With approximately $150,000 in household income, you appear to be in a position to move forward with another investment property, if you choose to. It will purely depend on where your property is located in Sydney and its current bank valuation.

Without running a servicing calculator, your situation looks like it is strong from a servicing perspective. Presuming that there is sufficient equity to cover the deposit and costs on a new property, and/or cash savings, then I don’t see how your financial situation wouldn’t stack up, providing your living expenses are fair and reasonable. As we always say, the best time to invest is right now, and the sooner you’re able to start the process the better your financial future will look.

Tax considerations 

In terms of reducing your tax, my first recommendation would actually be about keeping tax benefits in perspective. One of my favourite quotes of all time was Kerry Packer’s line: “Anyone who doesn’t try to legally reduce their taxes needs their heads checked”.

That said, while reducing taxes is effective, it should never be the primary purpose of any investment. I’d encourage you to maximise the amount of tax benefit that you can get, but in such a way that it is used to fund growthfocused assets. 

There are other investments out there that can give you a bigger tax return, but if they don’t grow in value or they’re ineffective from an investment perspective or they don’t fit your investment goals, then going for minimal tax savings year-on-year isn’t a sound choice. For instance, reducing your tax bill on a depreciating asset such as a car, in my opinion, is not sound advice.

At 30 years old, you and your partner have an amazing ability to invest in property, let time work for you and achieve significant compound growth over the long term – which is why it’s great to start young. 

Definitely keep the focus on the capital growth side of things and growth-focused investments. First and foremost, make sure you’re buying new properties, not only for the depreciation and tax benefit but to maximise the rent you can get from each property. You’ll also minimise the stamp duty you’re paying and reduce the exposure to maintenance costs, just because you’ve got a brand-new property.

"Maximise the amount of tax benefit that you can get, but in such a way that it is used to fund growth-focused assets"

Formula for success

When deciding upon your next step, the first thing to understand is your goals. The second thing is your borrowing capacity.

In order to be able to guide anyone with their investment portfolio, we need to ensure that the strategy they adopt is able to get them to the outcome they want. Assuming that the strategy and goals align, we need to understand their borrowing capacity, as obviously we need money from a bank to be able to make this happen. 

If your borrowing capacity is there, you work through a process to understand where the best investment is, based on the capital city markets in Australia, and then take steps to invest. 

If your borrowing capacity does not stack up at this point in time, we need to ask the question: what are the little levers you can be tweaking to be able to get your borrowing capacity to a point where you can buy another property and add an asset to your portfolio as quickly as possible?

You also need to ensure that you’ve given thought to all aspects of owning an investment, such as making sure you’ve got some financial buffers in place and ensuring that the cash flow is not going to impact your lifestyle. 

For example, if you’re putting your wedding on hold purely to stretch and build an investment portfolio, both you and your partner need to be aligned on that journey, as that could cause some friction. Make sure there’s clarity there. 

Having said that, I can’t see why, in your situation, both planning a wedding and investing in property wouldn’t be possible in the short to medium term. 

Assuming that you can buy another property, I don’t have enough information here to be able to provide a recommendation regarding making the purchase in your personal names or a trust.

The determining factor in making that decision is: what is the purpose of the trust with respect to the individual’s specific circumstances? You then do a cost-benefit analysis of having that trust versus buying the property in their personal name.

What I mean is that the main benefit of trusts is that they are great for asset protection, and also in terms of passing assets on to beneficiaries in the future. Given that you are both 30 years old, that’s probably going to be less of a consideration.

"What are the little levers you can tweak to … get your borrowing capacity to a point where you can buy a property?"

The main restriction of a trust is that, if you are a PAYG income earner – ie you’ve got group certificates and payslips and you get paid on a weekly, fortnightly or monthly basis by an employer – then you can’t claim the tax benefit in the year that it occurs when the property is in a trust. So you have to offset those tax losses against future income gained. 

You get the tax benefit eventually, but it may be 10 or 15 years until you get it. So it’s really something that is determined case by case and that would need to be explored based on your personal situation. Your situation is unique, but I think you and your partner are asking the right questions and considering the right approach. 

You look set to build a strong property portfolio: just stay focused and remember your goals. I love being presented with scenarios such as this as they allow us to tailor our advice to get people like Andy the best possible result. I’m always happy to have a chat with anyone who is looking to effectively and safely build a property investment but is unsure what steps to take next.

Michael Beresf0rd

Property consultant Michael

Beresflord has successfully guided

thousands of Australians to amass

over $400m in property and

effectively build sustainable wealth