The first principle of property investing is that land appreciates while buildings depreciate. That is why I recommend a house and land package, not an apartment or unit.
The land itself isn’t deteriorating or becoming less usable; however, the house that sits on the land is deteriorating a little every day and costing money to maintain.
Key Point: In a 25 year snapshot, capital city house prices had risen 394% and regional prices by 420%. However, land values had risen much more steeply. According to property research group RP Data, from 1990 to 2014, the cost of land per square metre increased 710% in capital cities and 742% in regional areas.
The price of land on its own has increased at around double the rate of the price of house and land combined. This is to be expected, because the value of land will always be determined by supply and demand. It will go up and down depending on the demand for the land and how much is available.
If you build a brand new house today, with a construction cost of $200,000, 50 years from now it won’t be worth $200,000. In fact, it might be completely worthless and may be ready to be demolished. That is when people refer to land with an old house on it as ‘just land value’.
The exception to this is when the price to build increases faster than the rate at which the value of the building itself falls. At which time, you may get the benefit of land and building price appreciation.
The point of investing in property is to own land, which, as the statistics show, is consistently rising in value.
Perhaps land value doesn’t rise every single year, but it historically has risen over any 10-15 year period, and you can be confident that it will rise as long as Australia sees an increasing population. That is one reason why I recommend having at least a 15-year investment outlook.
It is important to maximise the tax effectiveness of your property investment. This is one reason I recommend building your own house and land package, rather than buying an older, established property.
You might be asking yourself: ‘Why don’t I just buy land?’
It seems logical that you don’t want to buy an asset that is falling in value the moment you buy it. Well, the main reason to have a house on the land is that the house gives you an income in the form of rent, which goes towards your costs of owning the land and should pay a lot more than the building cost of the house alone.
However, you still face the falling value of the house. Thankfully, the tax office recognises this, which is a bonus for you known as ‘depreciation’.
Depreciation is an important concept for property investors to understand. It can dramatically improve the cash flow from your property and it can get you positively geared faster.
Depreciation is simply saying that you have an asset that earns you an income but it is losing value.
Don’t get too worried about the specifics of this. In practice, all you need to do is to get a Property Depreciation report, which usually costs a few hundred dollars. It will specify the tax deductions allowed for your property, which you (or your accountant) will use when preparing your tax return each year.
Example: depreciation helps your cash flow
To give you an idea of what it means for your cash flow, let’s say that on an entry-level 4 bedroom home the total depreciation was $8,000 per year. If you are in the 37% tax bracket, this means you will get an additional tax refund of $2,960 each year.
You can even get that tax refund calculated into your regular pay, so you don’t need to wait until the end of the year to receive it. In our example, being out of pocket $100 per week, you are now only out of pocket $43.08 per week.
Depreciation is higher when the property is newer. Older properties do benefit from depreciation, but not as much. After 40 years, the property is considered to have completely depreciated.