To figure out what it will really cost you to buy an investment property we need to split the holding cost into the pre-tax cash flow (what it costs out of your pocket) and the post tax (what it costs you after you claim everything back from the tax man). You should always calculate your affordability based on the pre-tax cash flow.
Pre – Tax cost of an investment property = rent – less mortgage repayments – property expenses. If the answer is negative, than it is negatively geared property. If it is positive than it is a positively geared property.
The post tax calculation takes into account the depreciation you receive on the building and also the fixtures and fittings. For the building deprecation, you can claim 2.5% of the cost of the building for the first 40 years. The fixtures and fittings can be claimed over the first ten years. This means, the newer the property the higher the amount of depreciation you will receive. The other factor will be your Marginal Tax Rate, the higher your tax the bigger your tax benefit (or bill of it is positively geared).
Property expenses = Strata, council rates, gas, electricity, water, insurance and Property Management Fees
Here is an example using numbers;
Purchase Price: $500,000
Loan Amount: $474,000 (we have assumed a 10% deposit which means the loan is 90% of the purchase price plus stamp stamp duty in NSW)
Interest Rate: 5% (variable)
Interest Amount: $23,700
Rental Amount: $500 per week = $26,000
Property Expenses = $5,980
Marginal Tax Rate: 34%
Pre Tax cash flow = $26,000 – $23,700 – $5,980 = -$3,395
This means the property is negatively geared by $3,395 per annum
Post Tax cash flow = -$3,395 + $6,679 (tax credit) = $3,285
This means your property is positively geared after tax.
By having a clear understanding of these numbers – it will allow you to make calculated decisions on whether you can afford the property or not.
Please note: These calculations do not take into account lenders mortgage insurance (LMI). This is the insurance you need to pay the bank if your loan is greater than 80%. of the value of the property. The higher this percentage gets, the higher the LMI becomes. We explain more about LMI in the strategies section.