Investment Property in Australia: What is an investment property?

What Is an Investment Property?

An investment property is a property that you buy mainly to make money, rather than to live in yourself. Most commonly, you buy a house, apartment, townhouse or unit and rent it to tenants. The tenants pay you rent, which gives you an income from the property.

For example, imagine you buy a house for $800,000 and rent it out for $700 per week. The house is an investment property because you are not buying it as your own home. Instead, you are hoping to earn rental income and potentially make money if the property increases in value.

How Does an Investment Property Make Money?

There are two main ways an investment property can make money: rental income and capital growth.

Rental income is the money you receive from your tenants. If your property is rented for $700 per week, you receive $36,400 in rent over a year, assuming it is occupied for the whole year.

Capital growth means that the property becomes more valuable over time. For example, if you buy a property for $800,000 and several years later it is worth $1 million, the property has increased in value by $200,000. You would generally realise this gain when you sell the property.

What Does It Cost to Own an Investment Property?

The rent you receive is not all profit. Owning a property comes with many expenses.

These can include mortgage interest, council rates, strata fees, insurance, property management fees, repairs and maintenance. You may also have periods when the property is empty and you receive no rent. This is called vacancy.

For example, if you receive $36,400 in rent but spend $40,000 on the property's expenses during the year, the property has cost you more money than it generated in rent. However, this does not necessarily mean the investment is unsuccessful, because the property may have increased in value.

What Is Negative Gearing?

Negative gearing is an important concept in Australian property investment. It generally occurs when the property's deductible expenses are greater than the rental income it produces.

For example, suppose you receive $30,000 in rental income but have $40,000 of deductible expenses. You have a $10,000 rental loss. Under Australian tax rules, this loss may be able to reduce your taxable income from other sources, subject to the relevant rules.

This means that some investors are willing to accept a rental loss because they expect the property to increase in value over time. However, negative gearing does not mean the government simply gives you the $10,000 back. The tax benefit is only a reduction in tax based on the applicable rules.

What Taxes and Other Costs Are Involved?

There are costs when you buy, own and sell an investment property.

When buying, you may have to pay stamp duty, conveyancing or legal fees, inspections and other purchasing costs. If you borrow money, there may also be costs associated with the loan.

While you own the property, you generally need to declare the rental income for tax purposes. Some expenses related to earning that income may be deductible.

When you sell the property, you may have selling costs, such as an agent's commission. If the property has increased in value, you may also have to pay capital gains tax (CGT) on the taxable capital gain. The amount of CGT is not simply a percentage of the entire sale price. It depends on factors such as your purchase price, eligible costs, ownership period and tax circumstances.

Why Do People Buy Investment Properties?

People buy investment properties for different reasons, but a common goal is to build wealth over the long term.

An investor might accept that the property costs them some money each year after rent and expenses because they believe the property will become significantly more valuable in the future. Another investor might focus more on rental income and look for a property where the rent covers most or all of the property's expenses.

So, an investment property is really a combination of income and growth. The investor needs to consider how much they pay for the property, how much rent it generates, how much it costs to own, how much they borrow, the tax consequences, and how the property's value might change over time.