Property Investing Terms Can Be Confusing
We often get calls or emails from people asking about the meaning of terms used on the MRD website or in our posts and articles. Some terminology may be confusing to novices or those who are not Australian residents.
The following definitions may assist you with some of the more commonly used investment jargon.
A term generally used for units in high-rise or higher density housing.
A body corporate is the English legal term for a corporation. It is distinct from a person, although it has many of the same legal rights. In strata title situations, the body corporate manages common areas such as swimming pools and foyers. Body corporate fees are the levies paid by each unit owner for the upkeep, management and maintenance of the property.
Commonly, the body corporate also insure the structure of the building, units or townhouses (the owner generally has landlord insurance). The individual owners are all represented on the body corporate and all have a vote. Owners can be elected to join the body corporate committee. This group will make decisions regarding common areas, landscaping, gardens, facilities etc.
Body corporate fees for investment properties are tax deductible against income in Australia. Some investors avoid properties with a body corporate (virtually all strata title units) because they see it as an additional expense. Experience has shown us however that these complexes, with their extra facilities, pools etc, can attract better tenants, higher rents and can experience better capital growth.
Capital Gains Tax
In Australia, Capital Gains Tax (CGT) is applied to the profit made on the sale of investment properties, it does not apply to a property in which you actually reside. CGT now only applies to 50% of the profit made (as long as the property is held for more than one year), also, tax credits are accrued for all maintenance, council and water rate expenditure on investment property and can be offset against CGT or other taxable sources of income.
Conveyancing is the act of transferring the ownership of a property from one person to another and is generally performed by solicitors or specific conveyancers. The buyer needs to ensure that he or she gets good ‘title’ to the land; i.e., that the person selling the house actually has the right to sell it. The system of conveyancing is designed to ensure that the buyer gets the land (together with all the rights that go with it) and knows about any restrictions in advance. As part of the process, searches are generally done to check with government departments to see, for example, that they don’t intend to demolish the building in the future to build a new highway, or that the land is not contaminated etc.
Council rates are levies payable to local government to cover the costs of services, like collecting garbage, and infrastructure, such as public facilities. The rates are generally calculated on the basis of the unimproved land value of the property. Council rates for investment properties are tax deductible against income in Australia.
Deposit bonds are another option for 'off the plan' purchases where settlement times can be 6-18 months. A deposit bond is a guarantee issued by an insurance company to the vendor. It acts as a substitute for the cash deposit between signing a contract and settlement of the property. However, at settlement the purchaser is required to pay the full purchase price including the deposit.
Deposit bonds can be issued for all or part of the deposit amount required, up to 10% of the purchase price. Acceptance of the deposit bonds in lieu of a cash deposit is at the sole discretion of the vendor and some developers will not accept them on certain projects because of the limitations placed on them by their lenders... so don’t just assume that bonds are OK.
Should the purchaser default under the contract of sale, the vendor can claim the amount guaranteed from the insurer. The insurance company will then seek to recover this amount from the purchaser.
Deposit bonds are available from several companies and generally include:
- Short Term Guarantee- with an expiry date of 6 months
- Long Term Guarantee- for purchase contracts where the Sunset Clause is between 6 and 36 months.
As a guide, a six-month deposit bond representing a $30,000 deposit would cost a once-only fee of around $360 (including any applicable stamp duty). Your broker should be able to arrange this all for you and it can generally be done in 7-10 days.
A duplex is a house divided into two living units or residences, usually having separate entrances, similar to two joined villas sharing a common wall.
In Australia over the last few years, a large number of mortgage and finance brokers have entered the market. Mortgage brokers aim to assist borrowers by comparing the huge number of loan products in the marketplace offered by a multitude of different banks and non-bank lenders. A broker can look at the borrower's specific needs and match them with a specific product, regardless of the bank providing the product. This saves the client a lot of time and effort approaching individual banks, who will of course only offer the products in their own portfolio.
Goods and Services Tax. A tax in Australia, similar to VAT in UK, on all goods and services (there is no GST on rent for residential properties).
House and Land
A system where you settle the land and then build a free-standing house on the block. This is the most common way to purchase free-standing houses.
Land Tax in Australia varies from state to state. It is levied on the unimproved land value. The family home is generally exempt and most states have a tax-free threshold. Land Tax generally only becomes an issue on larger portfolios of investment property. For example in Queensland, an individual may be liable for Land Tax if the total unimproved value of the freehold land owned by that person as at 30 June 2005 is equal to or greater than $450,000. Check http://www.osr.qld.gov.au/taxes/land/ for details.
Commercially available insurance to cover property contents (carpets, blinds, kitchen appliances etc.), malicious damage by tenants, the risk of tenants breaking the lease etc. These do not cover normal vacancy and the items and amounts covered vary from company to company. Premiums, around $AU240 per year, are tax deductible. We strongly recommend you take out Landlord Insurance. In situations where the body corporate insure the structure, this is often the only insurance required by most investors.
LMI – Lenders Mortgage Insurance
When you borrow more than 80% LVR, the lenders will generally charge you Lenders Mortgage Insurance. This is a one-off charge that you pay to protect the lenders extra risk (it does not insure you – it insures the bank). Going to a 90% or even 97% loan-to-value ratio can conserve a lot of equity and can enable some investors to purchase that extra property that they could not on an 80% lend. The cost is tax-deductible and often does not have a real impact on cash flow. Many experienced investors will use this as part of their strategy.
LVR – Loan-to-Value ratio
LVR is short for ‘loan-to-value ratio’ and is the maximum percentage of a property’s value that an institution will lend. Check with the lender for any special conditions. Many, for example, may require you take out mortgage insurance if the LVR is over a certain level. There may also be other restrictions, such as lending for apartments under 50m2 which can mean a much lower LVR.
The median house price is the price at which there are as many sales below that price as above. Generally a more useful measure for comparison of growth in real estate prices than an average price.
Off the Plan
‘Off the plan’ is a common way of buying property, generally units, often with some price advantage. ‘Off the plan’ means exactly that, you are buying something from what you see on the plan and a schedule of finishes. You can inspect the site and visit similar construction by the same builder and decide based on that. You will have a schedule of finishes saying which cook top, dishwasher, floor coverings etc, will be used and the builder is held to that. Construction time can vary from several months to years. The aim generally of buying ‘off the plan’ is to achieve capital gain based on the fixed price even before the property settles.
Common to larger complexes, a manger who lives onsite and collects rents for the owners, handles maintenance, gardening etc. They complete periodic inspections of the property and collect a fee from the owner as a percentage of rent, generally around 10% (inc. GST). Good onsite managers can help increase the value of the property.
A quantity surveyor is a person licensed to estimate the construction costs of buildings. For our interest, this relates to the depreciation allowed by the Australian Tax Office on investment properties, building, plant and equipment. Quantity surveyors will complete 40 years (generally) of depreciation schedules and this is accepted by the Australian Tax Office.
In our experiences, this is an area that many investors miss out on because they just don’t have the experience or information. Done properly, this can deduct tens of thousands of dollars from your taxable income in Australia.
Rental Agent or Manager
Often a local real estate agent, they will collect the rent and mange the property, conduct inspections, help arrange maintenance etc. They collect a fee from the owner as a percentage of rent, generally around 10% (inc. GST). In larger complexes this role is filled by ‘onsite’ managers.
In the past few years secure complexes have become desirable. Generally, they consist of gated groups of ten or more apartments, units or townhouses, where access is gained only via a key or access code. Often they include shared facilities like swimming pools, spas, gymnasiums, club rooms etc.
Strata Title is a form of ownership devised for multi-level apartment blocks, which have apartments at different levels or 'strata'. It also applies to many unit and townhouse complexes.
The sinking fund is sum set apart periodically to allow for future maintenance of common areas in strata title units or townhouses. Generally, these levies are collected as part of the body corporate fees. For example, when maintenance is required on a common item like a swimming pool, it is paid for by the sinking fund rather than the individual owners. The sinking fund amounts only become tax deductible when they are actually used for maintenance, not when they are collected.
Similar to a villa (see below) but generally of a two-storey construction.
Can be from one to three bedroom residences, generally located in a building occupied by more than one household. They usually have more than one level. More recently, townhouses and villas are also being referred to as home units.
A small single-storey house, generally on a small block of land or in a strata title complex.