How long are you prepared to wait for a return?
In our last blog post, we looked at the differences between negatively gearing and positively gearing a property, and how it can affect ROI.
In this blog we show you how two different investment styles — holding an investment property or flipping it — and determine of the two examples, which will deliver the better return on investment.
Our case study centres on a four-bedroom home in Edgeworth, a few hours north of Sydney. The home is valued at $400,000 and generates $450 per week in rental, according to realestate.com.au. That’s a return of 5.85 percent per annum.
In this scenario, you buy the Edgeworth property by putting down a 20 percent deposit and borrowing $320,000. Interest on an investment loan is 6 percent per annum and general maintenance costs total $5,000 per year.
The buy-and-hold approach
Property in Edgeworth, according to realestate.com.au, appreciates at a rate of 4.1 percent per annum. Without spending any additional money on the property, aside from general maintenance costs, in five years time, the property would be worth $482,000. Your mortgage would now be worth 66 percent of the property’s value.
You may choose to refinance your loan to access the equity, which you can leverage for another investment, or you may choose to sell the property. If you choose to sell the property, you will pay capital gains tax (CGT).
Because you’ve held the property for more than 12 months, you can reduce the amount of CGT you pay, by applying the 50 percent CGT discount, meaning you will only pay tax on $41,000 from the sale of the property. This $41,000 will be added to your total taxable income for that year.
The buy-and-flip approach
Instead of renting the Edgeworth property, you decide to renovate it substantially. The property has an original kitchen and bathroom, and a large backyard. You renovate the kitchen and bathroom, at a total cost of $30,000. You also build a granny flat in the backyard, which costs $200,000.
At the end of 12 months, the property has increased in value to $650,000. You sell the property and, after your expenses, have made a total gain of $30,000. Because you’ve held the property more than 12 months, you can apply the CGT discount, so you only pay CGT on $15,000. That $15,000 is added to your total taxable income.
Flipping may deliver ROI
To determine which scenario truly delivers the greatest ROI, we need to consider how much the person will pay in tax. Assuming the person who bought and held the property for five years, earns $70,000 per year, their property actually made a loss of $540 each year (using the same method to calculate costs against income and tax as we did in a previous post).
Although, you can’t claim this loss, it does ultimately reduce your ROI by $2,700 over the period to $38,300, or $7,660 each year. In this case, if you have the capital (equity you can leverage from another investment), buying and flipping a property, may deliver greater ROI.
Carefully consider all of your investment options, before deciding on a course of action.
Could you invest right now using equity from your family home?
Disclaimer: Please note that all information contained in this blog is purely general and should be regarded as advice only. We recommend that you always seek professional advice before making property decisions.
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