Sometime investors are too quick to judge whether a holding is ‘successful’ and end up making the wrong decision about whether to hold or sell.
Now, I admit I’m not immune to the occasional bad decision. More than once I’ve reflected on what possessed me as a 20-something to make dubious shirt selections for those evenings out on the town.
But unlike choosing a metallic-print short sleeve button up for the public bar, bad investment decisions have substantial, far-reaching implications for you and your family.
If you draw the wrong conclusion about how robust a particular property holding is based on incomplete information, you could end up with one the most common investor regrets – selling too soon.
I think the problem stems from a lack of understanding about the proper measure of investment return, and the strategies you can employ to boost your position.
In fact, there’s one very simple move that can transform your asset from a money sucking black hole to a wellspring of income – and it’s not negative gearing.
Let’s take a look.
The true measure of return
To understand what constitutes investment success, we need to discuss how return is measured and what you’re trying to achieve with your portfolio.
Most buyers look at a property and weigh up capital growth potential and rental yield.
For many, the gold standard is to have an asset that can be held in a neutral or positive cashflow position, while providing excellent prospects for long-term capital gains.
This delivers a true set-and-forget investment.
If you are making enough income from the property to covers its borrowing, operating, holding and maintenance costs, then it will sit invisibly within your portfolio, taking care of itself until you want to access the equity through sale or redraw.
But all too often, investors do a self-audit of their portfolio and are delivered a shock. They run the numbers and discover their cashflow is going backward each year. They see the bottom line and think, “This thing is draining me dry. Time to exit!”
This, my friends, is a grave mistake because you are ignoring the space your property occupies as part of your overall investment landscape.
A fast fix to negative cashflow
Let me give a rudimentary example of how not understanding the holistic role of real estate can have you offloading too soon.
Let’s say you purchased an investment property in a great coastal location.
It costs you $500,000 to buy and delivers a gross yield of 4.0 per cent, or $20,000 per year in rent.
The combined annual cost of interest on your loan, maintenance, government charges and management fees come in at approximately $25,000 a year.
While you are looking forward to capital growth over the next 12 years, you also note the property costs you $5000 a year to operate and maintain.
That’s going to be $60,000 over the coming 12 years. Life’s too short to be throwing that sort of money away! Best offload that home pronto.
But hang on tiger, here’s the thing – assets don’t work in isolation of your household cashflow, and while they might show an annual loss on paper, they also provide tax breaks.
This means, your investment could be reducing your taxable income by thousands of dollars each year with the outcome being a huge boost to your annual tax return.
So, in the above example, if you can find approximately $15,000 in deductions each year at a minimum, the property moves from being an anchor dragging your plans, to a motor driving your financial success.
The upside of depreciation
So, where can you find these deductions?
Firstly, there are the well-known tax breaks. Your loan’s interest charges are tax deductable, as are many of your running and maintenance costs. Depending on your income these alone may generate a positive tax return each year.
But there’s also depreciation – the unsung hero of tax boosters.
Depreciation is a very cost-effective way of helping move your negative annual cashflow position into positive territory.
I’ve run the numbers, and they’re compelling.
By spending a few hundred dollars on a depreciation report, the average Australian investor generates tax breaks of around $9,250* in their first year alone.
If you’re earning $100,000 a year, according to the ATO tax calculator, this means a boost to your tax return of $3,423 – even more depending on what sort of property you have.
In fact, not getting a depreciation schedule is costing you far more than you might realise, and sometime when those dollars are gone, they disappear forever.
A little while back, I conducted a survey of our client base and discovered the average amount of lost time for investors who failed to commission a depreciation schedule quickly enough was 3.58 years.
In that time, the average investor without a schedule had potentially forgone around $20,537 in depreciable benefits.
I even found one client who waited almost 18 years to do a schedule and lost $41,000 in tax breaks as a result.
So – turn around you’re thinking and start looking at how you can easily utilise the laws of the land to turn that real estate investment dud into a diamond asset. One that boosts your households overall cash position each year and keeps you on your wealth-building path.
Source: MCG 1000 Assets Report
Mike Mortlock is a Quantity Surveyor and Managing Director of MCG Quantity Surveyors. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating. You can visit them at www.mcgqs.com.au Mike Mortlock is a Tax Depreciation expert, Quantity Surveyor and Managing Director of MCG Quantity Surveyors. He is a regular speaker and commentator having been featured in the Financial Review and Sky Business. MCG Specialise in Tax Depreciation Schedules and Construction Cost Estimating for investors. You can visit them at https://www.mcgqs.com.au