Example 1(b) – Investing in an established investment property

Property details:

Let us consider a similar property to that of Example 1 except that rather than being brand new, it is 10 years old. It is a Queensland property (three bedroom brick residence on large block) that is for sale for $870,000 and is to be rented for $870 per week. Apart from standard rental management and letting fees, rental expenses will include rates ($2250), insurance ($1150), maintenance ($1200), pest control ($250) and other costs totalling $250. The original building construction cost (10 years ago) was $280,000 and the purchase price includes $46,000 worth of fixtures and fittings. The purchase costs include normal State Government stamp duty and transfer fees and $1850 solicitor’s fees to cover the conveyancing.

Loan details:

Principal and interest finance can be arranged at 6.4% over 30 years to cover all costs, including purchase and loan costs. The total loan costs ($2,232) include a fixed establishment fee of $500, no mortgagee insurance, and the remainder of the loan costs are as per the program defaults.

Investor details:

The investor’s current annual taxable income is $125,000 per year, his spouse’s is $50,000 and they wish to purchase the property in joint names. They currently own their own home and have estimated annual living expenses to be $45,000 per year.

What if:

If they use their own home as collateral and borrow the entire amount for the investment property, what sort of a return (IRR) can they expect over a ten-year period if the annual growth rate is 5% and the annual inflation rate is 2%.

What are the steps?

  1. As in Example 1: Starting with a default spreadsheet template, choose investment analysis (Menu: View/Investment Analysis).
  2. As in Example 1: Property price: $870,000. Use the left mouse button to click on the property value field in the input column and overwrite the current value with 870k. Hit the Enter key and the value will change to $870,000 and the entire spreadsheet will be updated. Click on the “Property value” row title with the left mouse button and the Property Value dialog will appear. Note that the property price is showing as 870,000. If you wish, you can specify the property address and description for later reference (these items would then appear on any reports that you generate from the spreadsheet). If there were to be any initial renovations or if the property is to be rented fully furnished, the cost of the renovations and the furniture package could also be specified within this dialog. Click on OK (or Cancel) to return to the main spreadsheet with (or without) any changes you may have made in the dialog.

  1. As in Example 1: Rent: $870 per week. Click the rent field in the input column and overwrite the current value with 870. When you hit the Enter key, the entire spreadsheet will once again be updated. Click on the “Gross rent /wk /yr” row title and the Rent dialog will appear. Note that the rent is showing 870 per week and that a vacancy rate of 2% (1 week vacant per year) is assumed. The item chosen in the rent preferences section should be “per week”. The “per year” option (used mainly for commercial property) would have the effect of showing the initial potential annual rent (i.e. with no vacancies) in the main spreadsheet input column rather than weekly rent. The “Holiday Letting” option obviously pertains to situations where the property is available for holiday letting and the vacancy rate (or alternatively, the occupancy rate) varies seasonally. If the latter preference is chosen, the seasonal rents, periods and occupancy rates can be specified and the item in the main spreadsheet input column would reflect the potential annual rent. Click on cancel to return to the spreadsheet without any changes.

  1. As in Example 1: Purchase costs: Click on the “Purchase costs” row title and the Purchase Costs dialog will appear. Change the conveyancing costs to $1850 and ensure that the spreadsheet is using the current Queensland scales to calculate stamp duty (click on the Reset Scales button to change them) and transfer of title fees. Click OK to return to the spreadsheet. Ensure that the Tax Status is specified as “Capital cost” as these are considered capital costs and are generally only taken in account for tax purposes if the property is sold. An exception to this is in the A.C.T. where they are considered a “Revenue cost” and are a tax deduction in the first year of the investment (probably because land there is leasehold).

  1. As in Example 1: Investments: Change any current amount in the Investments input column to zero to indicate that there is no initial cash deposit and that all costs are to be borrowed (i.e. the investor is using equity in another property as supplementary collateral for the loan and does not have to put any initial cash deposit into the investment).
  2. As in Example 1: Loan: Click on the “Loan amount” row title to bring up the Loan amount dialog. Note that there are no cash outlays and that the total loan reflects the total of all costs associated with acquiring the property. Click on the Loan Costs button to bring up the Loan Costs dialog. Change the current establishment fees to $500, the mortgage insurance to zero, remove the registration fees for a 2nd mortgage and hit the Enter key. Note that this item will now show as a flat fee rather than a fixed percentage of the loan amount. Note also that items such as search fees and registration of the title are included here in loan costs because they were a condition of gaining the loan. Click on the OK button to return to the Loan dialog with the updated loan costs and note the change to the loan amount. While still in the Loan dialog, click on the Loan Type button to bring up the Loan Interest & Type dialog. Choose Principal & Interest loan type and change the term from 25 years to 30 years and the interest rate to 6.4%. Click OK to return to the Loan dialog and click OK again to return to the main spreadsheet. Note that the “Interest” row title will now have the suffix “(P&I)” to indicate the principal and interest loan type. Note also that the “Investments” row title will have changed to “Investments/principal” and the following columns will show the annual amounts paid off the loan principal.

  1. As in Example 1: Rental expenses: Click on the “Rental expenses” row title to bring up the Rental Expenses dialog. Change the costs of rates ($2,250), insurance ($1,150), maintenance ($1,200) , pest control ($250) and other costs ($250). Click OK.

  1. Building depreciation: Click on the “Deprec. of building” row title to bring up the dialog. The building was constructed 10 years earlier for $280,000 so change the building costs to 280k and subtract 10 from the current year shown and hit the Enter key. Note that, by default, any building depreciation claimed as a tax deduction will be taken into account in calculating any capital gains tax liability if the property were to be sold. Building depreciation claims will be at the fixed rate of 2.5% until they are written off (in this case, another 30 years). Click OK to return to the main spreadsheet.

  1. Fixtures and fittings: Click on the “Deprec. of fittings” row title to bring up the dialog. As this property is an established one, we will change the default values of General fittings and the Low-value pool to zero and hit enter. (Note: From 1 July 2017, if the property was already established and the fittings are those of the previous owner, they are assumed by the ATO as already being written off and no claims can be made). Click OK to return to the main spreadsheet.

  1. As in Example 1: Taxable income: Choose Personal Details (Investor menu) and enter the investors names, their current work-related incomes and deductions. Change the investor’s taxable income to 125k and the partner’s taxable income to $50k and click OK.

  1. Click on the “Tax credits” row title to bring up the Tax Credits dialog. Note that the method for tax credit calculation will be using taxable income rather than simply assuming that all tax credits accrue at a specified marginal rate. As this is an established property, rental losses can only be claimed against other rental income. As there is no other rental income, the losses must be quarantined. The losses are carried forward until such time as there is a surplus of rental income or the property is sold, at which time the losses can be offset against any capital gain. Under Property Details click on Quarantine losses and choose “Joint names” and click OK to return to the main spreadsheet. Note that the row title will have changed to “Tax credit (joint)” and the input column will show $175,000 (i.e. 125,000 + 50,000) rather than the program default.

  1. To see the impact on Tax credits, choose Tax Benefits from under the Investor menu. Note that with the rental losses (31,575) quarantined, there are no tax savings to be had and that the tax credits are zero.

12.  As in Example 1: Capital growth and inflation rates: Click on the capital growth field in the input column and if necessary, change the value to 5%. Likewise, choose the inflation rate field and change the value to 3%. Hit the Enter key and the entire spreadsheet will be recalculated.

What’s the bottom line?

The estimated after-tax internal rate of return should show 14.38% (compared to 22.46% in example 1).  (This assumes that they are calculated using the 2026/27 Australian tax scales).  Their contribution in the first year is $34,294 (compared to $21,447 in example 1) or a cost of about $660 per week. The equity built up in the property after ten years is estimated to be $645,901 (compared to $647,846 in example 1).

Spreadsheet from this example.

Spreadsheet from example 1

Can they afford it?

Click on the Investment Capacity item in the Investor Menu and set Home loan payments to zero (in this case they are assumed to own their own home) and set their total living expenses to $45,000. Note that they can still easily afford the investment. Their combined total net income (including the rent from the investment property) is $219,335 compared to total expenses of $160,419 leaving them with net surplus of $58,916.  Clearly, the difference to that of the investment property in Example 1 ($71,763) is largely due to the lack of any tax credits in the case of the established property.

What if they were to sell the property after 10 years?

Selling the property will incur disposal costs (sales commission and solicitor’s fees) as well as possible Capital Gains Tax liability. Click on Selling costs under the Settings menu. Sales commission is usually a negotiable item these days but usually work out between 2.5% - 3%, depending on the property price. For simplicity we will use the default scale for Qld properties and solicitors fees of 0.50%.

Capital Gains Tax is shown as 2,033. Click on the Capital Gains Tax button which shows the default method of calculating CGT is the Discount Method.  As this is an established property, under legislation introduced in 2026, the Indexed method must be used. Likewise, there is Minimum tax rate of 30% to be applied if necessary. Building depreciation claims must also be written back when calculating the taxable gain, though in this example they are not claimed as they form part of the quarantined tax losses..

.  

Click OK to return to the Selling Costs dialog which now shows a Capital Gains Tax of zero.

To see where the CGT of $0 comes from, you can open the Capital Gains Tax calculator (Calculator menu). The default parameter values in the calculator will be those of the current property under review. The Indexed capital gain is 151,000 which is more than offset by the quarantined losses (225,885) leaving a Taxable capital gain of zero and a remaining 74,883 of tax losses to be carried forward and used on another property.

Choose the Discount Method results in a Discounted capital gain of 231,550 which when offset by the quarantined losses of 225,885 still leaves a Taxable capital gain of 5,666 and a Capital Gains Tax of 2,033. So in this case the Indexed Method would be preferable, though there is no choice. Click close.

.  As in Example 1: At his stage there are a number of reports that can be generated:

1.     Choose Capital Gains Tax Report (Report menu) to provide a detailed assessment of how it the CGT was calculated.

2.     Choose Cash Flow Analysis Report (Report menu) for a detail assessment of how an $870,000 property will cost them $660 per week

3.     Choose the Investment Analysis Report (Report menu) for detailed assessment of potential investment returns for the specified finance options and assumptions made.