Hi there. My name is Ben Everingham and I’m the director here at Pumped On Property and in today’s video, I’m going to talk about how you can work out a holding costs and cash flow position on an investment property.
Good day. My name’s Ben Everingham and I’m the director here at Pumped On Property and we’re a buyer’s agent with offices based in Sydney and the Sunshine Coast in Queensland and in today’s video, we’re going to talk about, or I’m going to talk about, how you can work out the cash flow/holding costs associated with any property that you’re seriously considering buying.
I supposed I’d kick off today’s video the same way I kick off with all the videos and that’s why is actually understanding the cash flow position on a property important?
You can kind of say that it might not be hugely important in a marketplace where interest rates, with an interest only loan of three and a half to four percent and so in most instances, the property that you buy rent is going to cover the holding costs associated with the property, so it’s neutrally, or could even be positively geared, but today’s interest rates are the lowest they’ve ever been.
I’m shooting this video in 2017 when rates are very low, so just because they’re low now doesn’t mean they’re going to be low forever and I think it’s really, really important to understand and remember that just because things are good now doesn’t mean they’re not going to be different in the future. Understanding what the rainy day or the worst case scenario day is going to look like is very, very important to me as an investor, my clients as investors, and I think it should be important for you as well.
I think it’s a case of, working out the holding costs on a property, it’s not rocket science. It’s simply looking at the total income that’s coming in associated with the property and then the total outgoing expenses as well and looking at the pre-tax and the post-tax positions.
I’m not a registered financial planner or accountant. I can’t talk about the post-tax position in today’s video, but we can definitely show you how to work out the pre-tax position on the property.
There’s a number of things that affect the income side associated with the property, so I suppose there’s the rent and sometimes we collect additional money off our tenants which might be water, it might be something else, etc. It might be something that they’ve given you to add value to the property in some sort of way that does suit them if they’re a long term tenant.
The income’s very, very simple to work out. How many weeks a year is your property going to be rented, what’s the weekly rent, and then you can forecast that figure, which is very easy. Let’s say it’s 400 bucks a week rent times 50 weeks a year. $20,000 a year is your income from the property and then you’ve got your expenses, which are made up of different things which I’ll go through now.
The biggest expense, if you’re not paying cash for a property, is generally the interest associated with holding the property. There’s interest only loans where you just pay the interest and then there’s interest and principal loans where you’re paying the interest that you own the bank plus you’re actively paying the debt down on the property over time and so obviously, the intention long, long term should be to own properties outright thereby you’re not affected by the movements in the market as much and if things go south, you’ve still got a passive income stream coming in.
You don’t need a job to survive, but obviously it’s a process of paying down properties and we’re not going to get into that in today’s video, but we’ve got some amazing other videos on how to create a 10/15 year plan, how to create financial independence over that time. Maybe jump through our library of videos on www.PumpedOnProperty.com, under blog, and have a look there or alternatively, if you’re on YouTube now, have a bit of a look there.
Interest is important. Interest, again, is very simple to calculate. You just work out how much you owe on the property, or are going to owe on the property, after you pay your deposit and closing costs and if it’s an interest only loan, let’s say you owe $400,000 and you manage to secure a five percent interest rate with the bank, then the interest only costs associated with holding that property are going to be just above $20,000 for a 12 month period. If you’ve got 20 grand of income and 20 grand worth of interest expenses, then you can see that with the other costs associated with holding the property, it’s going to be negatively geared before tax.
There’s obviously the management fee associated with the property which generally includes one week’s worth of rent for the property, it might include an advertising or an administration fee, and generally the rates associated with management, depending on where you are in Australia, are between four and a half and ten percent of the total rent received from the property on a weekly or a monthly basis.
Management is one of those things that I never personally sacrifice, so you need a good manager to take care of your investment. Sometimes I pay a slightly higher rate to get a much better service and to be able to sleep at night to know that everything’s covered and if anything does come up, my manager’s going to alert me early and I can act on that.
There’s also the maintenance costs associated with the property. The newer the property, generally the rule of thumb is the lower the maintenance. If you’re buying a unit or a townhouse, maintenance on the outside of the property is covered by the body corporate phase, but if you’re buying a house obviously you’ve got to look after the internal and external maintenance.
Generally, I just have rule of thumb. For a 400K property, I put $1,000 a year away for maintenance. Some people like to put more than that, some people don’t budget it at all, but over a 10 year period, you can guarantee that things are going to come up on whatever it is that you own right now.
There’s insurance as well. Generally, insurance, again, is an area that I can’t speak about much, but as a property owner, myself, who’s bought a lot of property and continues to hold some property, insurances vary greatly depending on the company. The excess, and how much you’re prepared to, I suppose, risk in terms of that upfront fee, if anything does go wrong with the property and the type of coverage.
There’s building, there’s contents, there’s landlords. It’s definitely something worth considering and so I suppose it’s a case of shopping the marketplace a little bit and seeing what’s out there and what’s right for you.
Generally, I don’t like to spend more than a thousand bucks a year on any properties insurances, but some of the more expensive properties that you can own, obviously, insurances can get up there, especially if your excess is lower.
Rates are another important consideration and cost to take into account and when I’m talking about rates, I’m talking about the rates that accounts will charge you for the land component of your property.
Rates vary dramatically depending on the value of the land and the local council area. I’ve seen areas where there’s one council here, for example Brisbane City and Moreton Bay there, and Moreton Bay’s charging, for no particular reason, 50 percent more in rates for the exact same land component, so it really is all dependent on the local area and what the value of the property is worth, but you’ve got to remember as the value of your land increases, your rates increase, so you’ve got to take that into consideration with your future cash flow position.
There’s a water cost. There can sometimes be an electricity cost associated with holding a property as well. They are important to take into consideration.
As is land tax, which is something most people don’t factor into account. Now, land tax varies dramatically. I suggest to look at land tax for a property, you type in whichever state in Australia that you’re looking to buy a property and then type “land tax calculator” in. Land tax, again, like council rates varies depending on the value of the land. It also varies depending on the ownership structure that you’re buying in, so it might be different for an owner occupied property versus an investment in your own name versus an investment in some sort of entity set up by an accountant or a solicitor, but it is something that once took me by surprise.
I hadn’t thought about land tax before and then all of a sudden, in New South Wales, I was over the threshold of a certain amount of property and I got stung for three years of land tax, which my accountant hadn’t factored into account or even told us about. Needless to say, I sacked that accountant straight away, but I still had to come up with that $6,000 out of my pocket or two grand per year for this one property that had taken us over the threshold, so it’s really important to consider that.
Then I suppose if you’re buying a unit or a townhouse, there can be an extra cost, which is STRATA, or body corporate, on top of all of the other things that I’ve just suggested and so again, that varies largely. I personally don’t like to invest in anything that has a STRATA or body corporate fee above $35 per week and that’s extremely low.
There can also be one off contributions associated with living with other people and in groups of units, townhouses, and apartments. Again, before you buy, it’s really important to do your due diligence. Not just on the property, the building and pests, but also to have a look at the notes from the body corporate, have a look at the sinking fund, and have a look at what’s planned for the future so that unlike me, because I’ve made a lot of mistakes myself obviously trying to learn as I was younger and doing things myself, that I started off with a body corporate fee of about $2,000 per year on a unit in the Southland Shore in Sydney. By the time I sold that property, they were trying to collect about $7,000 to $10,000 per year in extra contributions to do some work that should have been done honestly 10 to 30 years ago, but poor management and poor use of those sinking fund phase meant that it hadn’t been done and so they were trying to collect as much money as they could to do the work that needed to be done and these were old lifts, old glass, etc. which can be very, very expensive.
I hope you’ve got some value out of today’s video. We’ve talked about some of the costs associated with holding a property that you should be thinking about and obviously the income side of things. It’s very important to remember that just because things are really simple right now and very stable doesn’t mean that the global economy is going to be stable long term and you’ve got to be thinking today about what happens if interest rates rise, if we go through a recession, and the property price halves in value or if you lose your job and you don’t have a buffer in place to protect yourself.
In terms of the last part I wanted to touch on, obviously there’s a pre-tax position, but there’s a lot of benefits associated with buying a property in Australia from a tax perspective, which are worth exploring with your accountant. I always personally get a tax depreciation report on my properties that I give to my accountant. I also collect all of my invoices associated with the property, I provide my accountant with a very detailed spreadsheet of all the costs and all of the income associated with the property, and hand deliver that to them, so that instead of spending time going through my receipts, they can spend time strategically working on how they can save me the most money and how we can plan this year, previous years, and future years.
I use BMT for my tax depreciation reports. I know Washington Browne’s another big player in the Australian market. Costs vary depending. Just make sure you’re getting value.
I really appreciate you staying through this whole video. I know we talked about a lot very quickly. I really appreciate your time and until next time, stay hungry. Thank you.