1. Not treating the investment property like a business
If your investment property is occupied by a family member you’re helping out, then your investment goals might be a little different. However, for most investors they’re in the business of owning a property to make money. There are often times when investors make decisions based on emotions, whether it is paying too much for a property or basing decisions on their personal tastes. Whilst you might like to purchase a new property with tiled floors because it looks appealing, a new property with carpet will return greater tax deductions each year. Under the diminishing value method, $2,500 of carpet will return $500 worth of deductions in the first full year, whereas tiles will return only $62.50 in the first full year. The difference to a tenant might be minimal, but the difference to the tax office is that carpet is a plant and equipment item depreciable at 20% (Division 40) whereas a tiled floor is considered as capital works (Division 43) depreciable at 2.5%.
Treating a property like a business also means charging market rent. Whilst a good tenant is worth holding on to, it’s important to think of charging less than market rent as handing over your money to someone else each week. Your property manager should be on top of comparable properties and managing your rental reviews. Rental increases need to be reasonable and in line with the market. Don’t make the mistake of charging less than market rent waiting for your lease term to expire, and always remember that your decisions should be based on investing rather than personal preferences. Some of the best investment properties might exist in places or properties where you’d never wish to live yourself.
2. Not maximising tax deductions
Most property investors are aware that they can claim their property managers’ fees, interest expenses, repairs and the like, however it’s important to know everything you can claim, and at the same time maximise those claims. An accountant that is experienced with property deductions should be the first port of call, they will make sure that everything that can be claimed is being claimed. The next step is contacting a Quantity Surveyor to undertake a capital allowance & tax depreciation report. Many investors either don’t know they’re entitled to claim tax depreciation deductions on their investment property, or have been convinced that the property is too old to be worthwhile paying for a report. Even a property constructed prior to the qualifying date for capital works deductions (for residential, properties built after 17 July 1985) should have significant deductions available 95% of the time. This might consist of capital improvements prior to your purchase (concreting, painting, renovations), or simply the residual value of the plant and equipment items within the property. This includes things like air conditioning, blinds, carpets, cooktops, curtains, hot water systems and much more. If you’re renovating a property, there are also significant deductions available when you’re throwing away or ‘scrapping’ assets. The residual value of assets thrown in the bin can often help to finance the renovation itself!
I’ve been fortunate enough to convince investors to have a report prepared and been able to identify many thousands of dollars worth of deductions in the current financial year and often even more in back claims. The difference between tax depreciation reports can quite often be vast. Be sure you’re dealing with a registered tax agent, and that the report includes a low value/low cost pooling schedule. You might save a few dollars on a report prepared by a Quantity Surveyor inexperienced in tax depreciation, but considering the fee is tax-deductible and you might be missing out on thousands of dollars worth of claim, it’s worth doing your homework.
3. Not having adequate Property Insurance
Property insurance can be broken into two major components; Landlords and Replacement Cost Insurance.
With Replacement Cost Insurance, many investors might be able to estimate a construction cost, but there are additional costs that are quite often neglected. A replacement cost estimate prepared by a Quantity Surveyor shows the actual cost to reinstate a building in today’s economic climate and to today’s building standards. This often results in additional costs such as compliance costs, demolition of the existing structure, site clearing, professional fees and costs associated with the time it takes for reconstruction (including design and documentation).
Investors wary of their cash flow need to consider whether a small saving on their premium is worth not being covered for the full cost of reinstating a property if it was damaged or destroyed.
Cash flow is also a consideration when it comes to landlord insurance. It might feel like it’s just another expense you can do without, but you need to decide how you’d fair should the worst happen. Can you afford for a vacancy period, or a tenant in arrears moving out with a cleaning bill that won’t be covered by the bond? What about malicious damage to the property? It’s ok to take on risk, so long as you’re confident you have a strategy to deal with it. With the majority of landlords having only one investment property, most investors don’t have much wiggle room when it comes to cash flow. Common features of landlord insurance include;
- Malicious or intentional damage to the property by the tenant or their guests
- Loss of rent if the tenant defaults on their payments
- Liability, including for a claim against you by the tenant, and
- Legal expenses incurred in taking action against a tenant
Not all products are created equal; some insurance is designed to be taken out in addition to general home insurance, whereas others are more all-encompassing.
4. Poor Tenant Selection and Tenant Relationship
Many investors make the mistake of not undertaking proper screening of their tenants such as checking references and other documentation; this is really a mandatory way to ensure to the best of your ability that you’re going to have a cooperative tenant. If you’re working with a property manager, ensure that you’re confident with their selection process and ask any questions you might have about their rental history and references. Selecting a tenant should not be merely based on whoever is prepared to pay the most for your property. If your price is too high, you risk attracting less quality applicants. Your relationship with your tenant is an important one, and it’s important that once you have a good tenant, you’re living up to your side of the bargain. Repairs are one of the major reasons that tenants won’t extend the lease on their current property.
Landlords aren’t the only ones with tenancy horror stories; tenants have plenty of experience with snooty property managers not returning their calls, legitimate repairs being ignored and surprise appearances at their doorstop. Ensure you have properly screened your tenants, be upfront about the responsibilities and expectations of both parties, and wherever possible always attend the property inspections.
5. Not understanding Repair Costs
Repair costs are part and parcel of property ownership and won’t necessarily exceed fair wear and tear. However a major repair can be very costly and may require the property to be vacated. Not only do you need to understand your legal obligations to undertake urgent repairs, you also need to consider the cost implications. Many investors don’t set aside enough money to cover urgent repairs or stay on top of minor problems that have the capacity to escalate if not managed properly. Sometimes the quick fix works fine, but often it’s delaying a problem that’s going to cost more money in the long run. Any areas that come in contact with water such as bathrooms, kitchens, windows and weatherproofing can potentially result in damage that is difficult to detect but eventually very expensive to repair. It’s always a good idea to take plenty of time inspecting the property, and engaging the services of a qualified building inspector is often worth it in the long run. Strata titled properties have a sinking fund that forecasts the requirements for repairs and the associated costs, preparing a similar plan and setting the money aside is an easy way to ensure you’re able to cope with any surprises.
Mike Mortlock is a Director of MCG Quantity Surveyors, property commentator and expert on tax depreciation. MCG helps investors maximise their tax depreciation deductions and ensure their building insurance adequately covers current replacement costs.