Real estate investment is an Australian favourite but it's not without its pitfalls, writes Bina Brown.



There's something about being able to see and touch property that makes it a popular investment.



The fact it comes with tax advantages, can offer income and capital gains and is perceived to be low-risk adds to its attractiveness.



Talk of higher interest rates and a reduction in the first-home buyers' grant might be slowing new lending and pulling back house valuations but continuing demand for property in key areas is helping keep prices relatively strong.



Record migration levels, a rental property shortage and a generation of baby boomers on the move are a few of the factors underpinning demand for residential property in both city and "lifestyle" locations, such as the coast.



While higher interest rates mean higher borrowing costs, the fundamentals of buying an investment property remain the same.



Investors would have heard real estate pundits talk about position, position, position. Those fundamentals don't change whether interest rates are going up, down or remaining steady.



Like most investments, property is a long-term acquisition and there are risks associated. Values fluctuate and you have to be able to meet the debt repayments.



Unlike shares or managed funds, if you need access to capital you can't just sell part of the investment. Selling the whole property can take time.



Negative gearing



When the income a property generates is less than the costs, including interest on the loan and other outgoings, the investment is said to be negatively geared.



While you are, in effect, making a loss, the advantage is the loss can be used to offset your tax on income from other sources, such as salary, a business or other investments.



For example, a person earning a salary of $55,000 a year and who receives $8000 in rental income from an investment property would have taxable income of $63,000.



If the property has a $120,000 mortgage with an interest rate of 7 per cent and costs $2000 to manage, he or she can reduce taxable income to about $52,600 in the first year (see table).



When property is sold for a profit, the capital gain will be taxable. Where a property is held for more than 12 months, there is a discount on the capital gains tax payable, so the amount due is halved.



Of course, the property can sell at a loss. In this case, the capital loss can be offset against capital gains made on other investments.



While it may be tempting to invest because of the seemingly attractive taxation benefits, the chief executive officer of accountantsRus, Adrian Raftery, says tax shouldn't be the driving factor when buying a property.



"I have been amazed by the number of people who get sucked into thinking that negative gearing is the best thing since sliced bread," he says.



"Yes, you get a nice tax refund and you think your accountant is an absolute legend for working out the numbers ... but the reality is that you have to incur a cash-flow loss [where expenses are greater than your rental income] first in order to get that refund."



Tips and traps 



There are several ways for people to get into property, including buying with friends, family or work colleagues, a manager at Mortgage Choice, Kristy Sheppard, says.



"Each year, affordability is a concern for many, so more and more Australians are taking advantage of pooling their resources with people they know in order to get into the property market," she says.



For a loan to be approved, the applicants must be able to meet the repayments but lenders don't care if one party earns more or has greater liabilities than the others.



At the end of the loan term, the property may not be owned in equal parts. Sheppard suggests an initial visit to the solicitor to have a contract drawn up outlining who pays what and how much of the property each applicant will own in the end.



Existing home owners may be able to use their home equity, or equity from another investment property, to buy additional property for investment.

Anyone considering property investment should do their research, Sheppard says.



Read property-related articles, use data from reputable property-research companies, search the internet and talk to people who are knowledgeable. Find out about rental yields in each area, what infrastructure is in place and planned and what property-price growth has been experienced and is expected. "Invest the time to fully understand the market - it could save you thousands," Sheppard says.



Being a landlord



If you plan to rent out your property, there are plenty of specialists who can take care of the management, including advertising, selecting tenants, collecting rent and ensuring the property is maintained.

For this they will charge a fee, which can be claimed as a tax deduction. If you decide to manage the property yourself, learn about the responsibilities and legal obligations you have as a landlord.



Case study

 

In three years, Troy Harris has gone from property investor to developer. The former toy shop owner entered the property market with the idea that he and his partner would find rundown properties to renovate and then sell.



"We were finding that we were so hands-on with renovation we didn't have time to find the next property, so we moved into development," Troy says.



Three- or four- unit developments at the low end of the market or for first-home buyers are their project of choice. They have invested in about 20 units and completed a couple of renovations.



"A nice new unit without anything too expensive is always going to be a hot property," Troy says.  His tip for the would-be property investor is to "do your numbers and don't guess on valuations".



"Never factor in property growth for something you are going to sell. Do your sums on today's price, never tomorrow's," he says.

Doing the sums

Income from salary  $55,000

Rental return            $8000

Total income          $63,000



Less interest on        $8400

investment loan

Other outgoings        $2000

(eg rates, repairs)

Estimated taxable income    $52,600