46 – Holiday Homes Make Poor Investments

We spent last weekend five hours South of Perth in Albany, WA. With the kids in tow, we rented a cutesy old cottage for they duration so they’d have their own rooms and space to run around.

Being away in this context soon got me thinking about the many reasons why we veered away from holiday homes/apartments as an investment. With family frequently visiting from intrastate and overseas, a property that could be rented out is when not in use was hugely appealing to us at first glance but many reasons led us to reconsider.

When we first started looking seriously at property investment, one of my first thoughts was to purchase a holiday apartment. I figured something with a few bedrooms in nearby Scarborough might not cost too much and “Scarbs” is an increasingly vibrant area in Perth. It’s also a good spot for visiting tourists with its expansive beaches and nearby amenities. I’ll note this was before I came to prefer land (i.e. a house on a block of land) over apartments and decided to invest for long-term growth rather than cash flow—in short, don’t buy an apartment because the land content ratio is too low…). In general, you’ll likely pay a premium to buy in a holiday location—which may not relate to long-term capital growth. In other words, are you better off buying into a highly-priced holiday location or doing your research to buy into a cheaper suburb that’s likely to grow faster and produce a better return on investment in the long run?

We also had to ask ourselves whether we buy something local for the sake of the visiting relies or choose something further afield in a more interesting (to us) location—either out of town or in another state. If we wanted to make use of the property ourselves, would a “holiday at home” (er, a property in Perth, where we live) be all that desirable?

Regardless of location, the ability to produce an income will always be at the mercy of the local short-term rental market and tourism conditions. Although I’m no expert in this area, I’ll hazard a guess that sites like Air BnB are eating into the traditional short stay markets.

With a normal rental, you have the surety (in a way) of a guaranteed weekly rent for the term of the lease. With a holiday home, you might have a higher nightly rate but the uncertainty of whether the property will be full one night and vacant the next—which, on average, may or may not equate to the same income as a regular rental. Averages are useful but may hide seasonal ups and downs and corresponding cash flow troughs throughout the financial year.

Unlike a typical suburban house rental where we’re renting a property to a tenant as a place to live, as their home, with a holiday home we’re dealing with a different set of variables. How closely are holiday makers vetted? How do we insure the property? Will neighbours object to the comings and goings of visitors at unusual hours? What happens if China crashes and the Chinese tourists suddenly dry up? We had a global recession not all that long ago; are the Yanks still flying in to little old Perth at the same rate they were before the dot com and housing market crashes?

At the very least, you’ll need to estimate vacancy, affix a nightly rental price tag that fits the market and attracts the right kind of holiday makers or travellers, and then consider marketing costs (for your online listing, membership with the local tourism body or visitor centre, etc) and cleaning costs. Of course the property will also need to be furnished with not only furniture and appliances but linens, cookware, books/DVDs, artwork, etc. Other running costs will include electricity, water, gardening, and possibly cable and internet, as well as the usual rates and insurances.

Don’t forget, if you want to use the property yourself, the ATO will require you to exclude the period when the property was not available for rent as a percentage of any deductions you might want to claim (i.e. negative gearing). On the upside, you may be able to claim a higher rate of depreciation (4% p.a. over 25 years instead of 2.5% p.a. over 40 years).

If you want to use the property yourself during peak periods, then you’ll likely have to forego any income the property would otherwise generate during that time.

The property we rented in Albany, although lovely in an historic kind of way and very practical for our young family, has zero appeal to me from a practical and maintenance standpoint. Although the main house felt sturdy and sound, the back extension (these places always have a back extension, right?!?) had a definite lilt to it despite being the newer construction.

Then my wife plugged in the kettle for her morning tea but it wouldn’t switch on because she’d unwittingly tripped the circuit. Of course we just thought the kettle was a dud—until it came time for a shower and we had no hot water from the instant gas system with its electric ignition. It took a very upset wife and a call to the neighbouring manager, at 8:30am on a Sunday morning, to sort that one out.

We’ve been living in a relatively new house in Perth for going on a decade now and although it’s been a pretty easy run there are always things to deal with—we’ve already had to replace the hot water tank, for example. I cannot begin to imagine the countless number of ongoing issues to be found with an older house. On the one hand, it’s established and “bedded in” but how soon until the roof needs replacing or the foundation restumping? Insects and damp or mould may be problematic in older houses and the electrics may be shady.

Although I’d love to have a nearby holiday home for the relatives or a beach shack down south that we can use periodically, as an investment we’ll be sticking with suburban houses for now and fork out for a week or two in that holiday rental when we want to get away.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

23 – Progress Update: Fixing Stage Complete

On Monday came the “enclosed” invoice for a not-insignificant chunk of cash; today the “fixing” stage invoice arrived for about half that amount again. Apparently the builder was hanging on to invoices around the end of financial year period.

If nothing else, it seems like progress is moving quickly now (quicker than it really is!). In either case, we’re now nearing the end of the construction phase with “practical completion” the last outstanding invoice.

Stacey, our Client Liason Manager at Open Wealth, called this morning to let me know the fixing stage invoice would be sent through and we also spoke briefly about inspections, insurance, and property management. Notably, the real estate agency recommended by Open Wealth will send us an updated rental appraisal. The initial appraisal we received late last year was (a conservative) $380/week and I’m curious to see whether this has moved up or down (Open Wealth suggested the actual rental income on many of their builds in this estate is closer to the $410/week mark—I based my forecasts on the $380 figure). As more new product becomes available in this estate, and on the back the health of the national economy, I’ll be interested to see where we land—hopefully above the $380 benchmark and also in relation to the higher $410 figure.

It’s hard to believe we’re already nearing the point when a tenant will move in and the property will become income generating. Although I’d obviously prefer to be on the ground supervising the details of the build and feeling in-tune with this aspect of the process, I’m also comfortable knowing we don’t need to be there—that we’ve put our trust in Open Wealth and paid them to stand in our place while we undertake more productive activities.

With this stage complete, items like the plastering, tiling, kitchen, and laundry have been ticked off. With the next milestone, tap ware, sinks, shower screen, light fittings, air conditioners, blinds, and kitchen appliances go in, the carpet will be laid and the house painted, feature walls will be rendered and the driveway poured, the letterbox will be built, and the house will be cleaned.

Meanwhile, the property manager will be rounding up potential tenants for short-listing by Open Wealth and, ultimately, selection by us. The builder will have two weeks to address any issues found during inspection (following the practical completion milestone) and it may be possible (I’d guess likely—given the rental guarantee) there will be a few pre-handover inspections before any formal open for inspections take place after handover.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

21 – Tax Time

I’ve spent the last few days (on and off) gathering together everything needed by our accountant to complete our tax returns. This year’s tax return is more involved than normal because we have the purchase of our first investment property to consider and my wife’s life insurance—part of which may be tax deductible.

We’ve had an accountant prepare our tax returns for many years now—initially because it all seemed a little complicated and now because it is a little complicated.

Back then we had income from one or two employers, bank interest, HECS debts, and deductions like professional memberships and insurances, training, mobile phones, internet, stationary, uniforms, and depreciation of office equipment and furniture. I wasn’t sure how my income and tax returns related to my wife’s and vice versa.

These days, we’ve got more of the same plus private health insurance, life insurance, the investment property establishment costs (any IP is an interesting mess in its own right when it comes to taxation), dependent children, and the occasional minor offset to me as a non-earning stay-at-home parent. And of course the tax laws are always changing in many of these areas, making it hard to keep on top of what we can and cannot do, legally. Next year we’ll have the IP income or loss, interest and running costs to deduct, building and fittings depreciation, and so on.

The first accountant we worked with claimed he would be able to to cover his costs and we always found that to be the case… in other words, he was able to include valid deductions that we probably wouldn’t have considered (plus he didn’t charge us much). 

That first year our intention was to use his return as a template for subsequent years but it seemed just as easy to go back to him and so we did.

Although I wouldn’t recommend using your accountant as your financial adviser, our first accountant was the only financial professional we relied on at that point in time and he was able to offer some useful tips. For example, he highlighted the benefits of having private health insurance instead of paying roughly the same amount for the Medicare Levy (of course our insurance premiums increased as we started planning a family and it seems like the Medicare Levy doubled at some point along the way too…).

Now days our accountant is a key member of our broader financial team and we’ve “upgraded” to an accounting firm that deals regularly with clients who own investment properties (WSC Group—I’ve written about them before in the context of financial advice and insurance). WSC were recommended to us by Open Wealth and they’ve offered an outstanding service thus far—note they’re not directly affiliated with Open Wealth.

We pay for the expertise of an accountant but did you know accounting costs can be deducted the following year? Our first accountant also claimed he’d never had the ATO question a return he submitted (I assume tax return audits are fairly random but having a professional submit your return can’t hurt). While I probably could do our taxes, I’d prefer to know the return is correct and, more importantly, that I’ve claimed all of the deductions I can to reduce our taxable income.

If you’re considering the purchase of an investment property, or hold an investment property today, do you know how your quantity surveyor’s report relates to the depreciation of your building and fittings—and therefore you tax return? I’m estimating those two deductions alone will be worth nearly $10,000 in the first year. Don’t know what a quantity surveyor’s report is? Ask your accountant!

I forwarded 7MBs of PDFs to our accountant this morning so that’s my job done for now, hopefully.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

14 - Progress Update: Plans Approved

We received a quick note from Open Wealth today noting the builder has confirmed building plans and permits have been approved. The start date for construction—preparation for the slab pour—is next Monday!

I’m certainly ready to see this house built so we can get tenants in and start recouping costs. The holding costs have been minimal to date but now that we’ve settled on the land we’re accruing interest on the mortgage for that component and our first interest payment of nearly $700 came due just this week. That amount is paid from our line of credit and capitalised as interest during construction so it’s no problem from a cash flow perspective—and was budgeted for—it’s just a bit scary seeing it all start to happen for real now.

In contrast to our new build, Gemma’s father recently popped into town (they live south of Perth) with the intention of buying a second residence to accommodate them when they come up. They located an existing house in one day, put in an offer that equals the asking price, and settlement is due in the next few weeks. In effect, they’ll be able to move in soon and the time between their offer being accepted and move in day will be less than a month (if everything goes smoothly).

Two of the reasons why Open Wealth advocates building over buying is to take advantage of depreciation as a non-cash tax benefit and to avoid paying stamp duty on the building component of the purchase (i.e. the house). With a new build, we’ll pay GST to the builder (10%) and while the depreciation will be a substantial bonus, we’ll be accruing interest for many months before the house is tenant ready (again, assuming the build goes smoothly). I haven’t done my figures to determine which is the most cost-effective route but I imagine it would be close.

Note building new also brings builder’s and structural warranties, greater tenant appeal, of course, and potentially a greater valuation so you can leverage the equity and do it all again.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael