If we were to put a percentage value on it, the selection of an individual city will generally account for approximately 80 percent of the performance outcome from a property investment decision. The other 20 percent is the specific property selection. In the majority of cases, property investors have the order of importance out of whack and focus 80 percent of their energy on the later.
One of several driving forces behind this back-the-front decision-making process is a fixation that some investors have with new (or near-new) properties. They prioritise high taxation benefits (depreciation) and they have a perception of ‘new’ meaning limited maintenance expenses.
To shed some light on this matter, we’ve reached out to one of Australia’s most respected quantity surveyors and depreciation experts, MCG Quantity Surveyors. Managing Director, Mike Mortlock, was kind enough to share the below insights with Propertyology.
Mike said, a question that I get asked quite often is ‘… I’m about to invest and want to know which investment property will give me the best tax depreciation deductions…’
Depreciation is a taxation benefit, not a property investment strategy.
I’m frequently asked by well-meaning investors: ‘what is the best property to buy for depreciation deductions’.
There are two key ingredients for maximum depreciation deductions:
- A high construction cost per square metre, with a high standard of finish; and
- Extensive common areas with a long list of amenities.
As for what sort of investment best fits that description… It would most likely be a 1-bed apartment in a block of say 600.
The block would be a high rise of 30+ levels, include 8 levels of basements and a marbled and extensively furnished foyer. Multiple swimming pools, a gym packed with equipment, 6-lifts and a cinema would also be ideal.
Apartments typically cost more per square metre, because there’s less open space per square metre than a house and more wet areas.
Highrise tend to cost more to build, as there are extra construction costs involved for traffic management, hoarding, cranes, scaffolding and the list goes on.
As for extensive common areas, when you buy an apartment in a block of 600, you will roughly own one-six-hundredth of the common areas (1/600).
In the experience of MCG Quantity Surveyors, one lift in a high-rise building generally costs $1 million or more, they have a 30-year effective life and depreciate at 6.67 percent per year.
If you owned 1/600 of a building with 6-lifts worth a combined $6 million, you’d be able to claim $667 in year one – just on the lifts!
That’s the upside.
The downside? You’re paying to maintain them, too. And the strata fees will blow the enamel off your teeth!
When expressed as a share of the purchase price, apartments are great for taxation deductions, because the land component is small.
You’ve probably heard the adage ‘buildings depreciate and land appreciates’?
Land is a non-depreciable asset so if you’re wanting to maximise your deductions, ideally you buy as little of it as you can.
Depreciation can be a curious thing and it differs starkly from ‘market value’.
Consider two apartments in a building that are identical in size and quality. One has a view of Sydney harbour, the other overlooks a carpark. The purchase price could differ by hundreds of thousands, but the deductions won’t.
I remember a repeat client purchasing an $8 million house in Vaucluse as an investment, only for me to tell him that there were not enough deductions to justify him paying me for a depreciation schedule. It was built in the 1960s and had NEVER been touched!
Getting back to the person that asked me ‘what to buy for maximum deductions?’
After I explain the type of property, in the massive block, with all the common property, the response I then generally get is “But Mike, that sounds like a terrible investment!”
And you know what? History has proven that to be true.
Related article: House versus apartment performance
In fact, I did a quick Google search and found an article on the places in Sydney you can buy in 2022 for than less 2016 prices. What those suburbs all have in common is a high proportion of high-rise units. Locations such as North Ryde, Haymarket, Ultimo, Parramatta & Haymarket. Each major city has their own version of these suburbs.
All properties will likely have some depreciation deductions available, and you really MUST get in touch with your friendly quantity surveyor for a free estimate as part of the process.
But please remember that, whilst nobody likes paying tax, nobody likes losing money either – those two things can certainly go hand in hand.
I use this example in the hope of illustrating that deprecation is a bonus, never a strategy.
I want people to understand that using depreciation as a primary investment strategy is like trying to win a weight loss competition by cutting your arms and legs off.
Sure, you’ll get some impressive results, but is it going to be worth it in the long run?
CASE STUDY
In the middle of the (then) Sydney and Melbourne property boom in 2014, the widespread consensus of the Australian public and all of the so-called ‘experts’ was that Brisbane would be the next city to boom.
Propertyology Managing Director, Simon Pressley, lives in Brisbane so, given the confirmation bias within all humans, it would have been very easy for Simon to justify buying an investment property in his hometown.
For the small outlay of $280,000, Simon could have purchased a brand new, 1-bedroom apartment, just 2-kilometre from the Brisbane CBD, a major university precinct and city’s largest hospital. Depreciation deductions would have been significant.
Brisbane’s property market ended up being flat for much of the 8-years post-2014 and, even with the recent COVID boom, an apartment like the one in question would today be valued at only 15 percent more than the initial purchase price.
Instead, Simon used $280,000 to purchase the 3-bedroom house featured in photos in this blog. It happened to be 104-years old (that’s not a typo).
8-years later, the property is worth $650,000 (130 percent capital growth).
Simon has not spent any money on renovations, yet the rental income has increased significantly. The current $28,000 annual rental income is $12,000 more than annual expenses.
Critical to vastly different outcomes of the two aforementioned scenarios was Simon not obsessing about the age of the property he invested in and, most importantly, not paying attention to what others called ‘research’ (aka ‘Group Think’). His own objective analysis of the fundamentals of each of Australia’s 400 individual townships pointed to Hobart.
With great understanding that capital growth makes a significantly bigger contribution to future retirement lifestyles than tax deductions, instead of fixating on real estate ‘birth certificates’ he focused on selecting a low maintenance, structurally sound house in a middle-ring pocket where his research indicated opportunity.
As a professional property investor, Simon is adamant that city selection is the most important decision for property investment performance.
There are a few key priorities for selecting the right property, but ‘age’ is not one of them.
Simon encourages investors to purchase a depreciation schedule for every property, regardless of when it was built.
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