Room for Debate: Do NRAS properties make good investments?
Xavier Perronnet of iProperty Plan argues:
The federal government’s National Rental Affordability Scheme (NRAS) is being used as a marketing tool to sell property. The scheme was introduced in 2008 and is designed to help meet the social need for affordable rental housing by encouraging investment in residential property through attractive tax incentives.
The scheme provides a substantial financial incentive of a minimum of $9,524 tax-free per house annually to investors who rent approved houses at 20% or more below current market rates to eligible tenants.
However, NRAS is not an investment scheme per se, it is a housing scheme. It aims to provide affordable accommodation and underpins the government’s drive to privatise public housing.
My concern with the scheme is the regulated choice investors have. Asset selection is limited to new approved developments in areas where there is a need for affordable housing. It aims to supply 50,000 new dwellings, and because these are in defined areas where approval is granted, there is a risk of clusters of NRAS properties throughout the market. This has the potential to cause oversupply issues down the track.
Further, these developments tend to be in areas where land is available at low cost, which is generally the case when there is limited demand in the area. However a key characteristic for capital growth is a high land value and limited supply.
The popularity of NRAS properties is growing as financial planners find ways to market the incentives and make money through their referrals and recommendations. Investors need to be aware that large kickbacks of 5% to 10% of the purchase price are being paid to the advisor who is making the recommendation to purchase, and that these kickbacks are simply built into the purchase price of the investment.
I have come across a number of people promoting these schemes, and the alarm bells have been ringing. In one example an investor was offered a unit backed by the scheme for $356,000. On paper the investment cashflows looked great but when subjected to greater scrutiny, the property was found to have a market value of closer to $300,000.
Investment schemes that are heavily marketed off the back of cash incentives and tax benefits are nothing new. In recent times we have seen a number of investments that have been sold with a focus on up front benefits only to be a disaster down the track.
In the early 2000s a wave of off-the-plan properties were sold around the country. The lure of stamp duty savings and depreciation benefits were used to attract buyers. Fast-forward five years and many of these properties have been resold at a loss. In one example a Docklands property was purchased in 2001 for $582,000 only to be sold in 2006 for $455,000.
Further, the investment time bombs are not limited to the property market. In 2008 many investors got stung investing in agribusiness managed investment schemes such as Timbercorp and Great Southern. Once again these investments were sold with the enticement of upfront tax deductions. However when the dust settled the Australian Securities and Investments Commission (ASIC) was reported to have identified issues with inadequate disclosure of information to potential investors and poor performance of the investments. Once again these investments were sold through financial planning channels where commissions of around 10% were paid.
It is important to point out I am not criticising the NRAS scheme itself, however investors need to understand the true motivations of the scheme. They should be wary of the marketing machine that uses the scheme to make an investment product look good.
Upfront cash benefits are great, but they must be viewed as a bonus. The quality of an asset should be assessed in isolation of any incentives. If the investment asset does not grow in value, or worse has the potential to lose money, then why bother? In some cases keeping your money and just going on a nice holiday is a better option.
Xavier Perronnet is a director of iProperty Plan, which provides independent analysis and tailored advice to investors and home buyers.
Michael Sloan of The Successful Investor counters:
There’s an easy trap to fall into when you’re a property commentator or you work in the industry: the lure of the blanket statements. As more and more of our lives get reduced to soundbites, it’s easy to release lines like “only buy houses” or “don’t touch it if it is more than 10 kilometres from the CBD”, then sit back and relax.
Of course, in property investing, like everywhere else, there are many shades of grey to each argument. Your skill and attention as a property investor should be focused on ensuring that you make the right decision for you and your personal circumstances, while our job as industry leaders should be to provide you with enough factual information to make that decision an informed one.
Unfortunately there has been a lot of misinformation from some property commentators or financial planners telling investors to stay away from properties in the National Rental Affordability Scheme.
While I’m obviously in favour of investing in the NRAS system, I should point out from the start that this is not a blanket statement. There are good NRAS investments and bad ones – it’s your job to make sure that you choose an investment that is best for you.
If you are new to NRAS let me explain it very simply:
• You buy an investment property.
• You provide a discount on the rent
• You get tax-free money from the state and federal governments
The scheme is in place to provide affordable rental properties for middle- to low-income earners. However the income threshold is not as low as you may think. For example, tenants qualify with an income below $45,496 for a single person and $93,079 for a couple. If the couple has two children, the eligible income can increase by 25% with no penalty, which takes the threshold to more than $116,000 per year – a figure most would consider as well off.
According to the Australian Department of Families, Housing, Community Services and Indigenous Affairs, which is responsible for administering NRAS, properties in the scheme are typically indistinguishable from other middle-market dwellings. Rigorous criteria is applied to the location, design and amenity of approved dwellings, and investors can expect to benefit from the annual NRAS Incentive, rental yields and capital gain.
If you are a potential property investor what does this mean to you? Let’s say the normal rent is $400 a week. Under the NRAS program you rent it at $300 a week.
This means you lose $5,200 in income each year ($100 per week), although this income would have been taxable, so your actual loss is about $3,800. But you get $9,981 tax free!
As a comparison, we recently sold units in an Essendon North development where some were under the NRAS allocation and others were sold to either owner-occupiers or investors who did not wish to participate in the scheme. For those investors, the cashflow was negative $90 a week in year one, $66 in year two and it took 10 years to become positive. But as an NRAS property, it was positive cashflow $54 a week in year one $81 in year two and $239 by year 10. Over the first 10 years this property is cashflow positive by more than $70,000. These figures are based on an income of $65,000 and a 6.5% interest rate.
This money can be used to reduce personal debt, to pay off the investment property or, yes, to have a holiday.
Critics of NRAS are quick to dismiss its tax benefits by likening it to other schemes with so-called ‘tax benefits’ such as timber plantations and olive groves. Of course, the two have nothing to do with each other. The stock-market based tax dodges were marketed for their tax breaks alone, whereas investors in the NRAS scheme have the security of owning quality properties in good locations.
Others have linked it to negative experiences purchasing off the plan properties in large-scale developments such as Melbourne’s Docklands. Once again, the commentators are attempting to use guilt by association. It would be like a stockbroker warning you not to invest in a particular stock because four years ago an investment in a completely different stock performed badly.
A final criticism is levelled at direct sales companies selling NRAS properties, because of the high commissions they receive. They suggest the commission is being added to the price and the properties sold above their real value. Does that happen? Sure, but it happens with non-NRAS properties as well, so to dismiss all NRAS properties because of it is short sighted.
Besides, it is easy to find out if this is happening: just mystery shop the builder/developer and see if you save money by going direct. If so then drop the marketing group like a hot potato.
So why is the blanket statement “Don’t buy any NRAS property” wrong? Effectively these commentators are saying there is not one single NRAS property worth buying in the whole country. In fact a recent article on this site suggested that NRAS properties were so bad you would be better spending your money on a holiday. Really?! Come on!
Why would these commentators make these negative comments about NRAS? More often than not, these commentators often promote inner-city high-capital-growth properties as the only way to invest. They really can’t understand why an investor would buy an apartment off the plan instead of an older inner-city apartment in a block of 12, or a single-fronted terrace or any other of those beautiful properties.
If buying a property that you can brag about is your main reason to invest, or if money is no object then you should buy one of these properties. But these properties are out of reach of the average investor; typically they will cost $300 a week or more after tax. How many investors can afford that? And for those that can afford it, you need to ask the question: what else could you do with a spare $300 a week?
The choice between these two mindsets (the pro-NRAS and anti-NRAS) can be reduced to this. You could buy a normal investment property and put money towards it every week or buy an NRAS property and enjoy the tax breaks where the tenant not only buys the property for you but also gives you a profit.
One thing is for sure, the cashflow on these properties can be outstanding. A client of mine on a high income recently purchased an NRAS property and it is positive cashflow by more than $100,000 in the first 10 years.
When this scheme finishes I doubt we will ever see cashflow figures like this again without investing in mining areas.
Just before you think I have broken my own rule about making blanket statements, I want to make something clear.
Not all NRAS properties are good investments, just like in the regular investment market some are terrific and some are shockers. Each NRAS property needs to be treated on its merits, instead of dismissing all NRAS properties. What’s the solution to avoiding a bad NRAS property? Don’t buy one.
Also, a word of warning about the risks of allowing a company that is selling you an NRAS property to also arrange the loan (in a one-stop-shop type arrangement). Potentially the property will undervalue, and they won’t tell you (especially if you have plenty of equity, as you’ll find the bank will lend you the money without telling you about the poor valuation).
How do you deal with this issue? Firstly, you should be aware that there is a cost for the builder/developer to get an NRAS allocation and they will usually pass that on to you (the cost is generally around $10,000 to $16,000). While some might baulk at this, you should remember that it’s similar to paying extra for ducted heating so you get higher rent. If you want to check the valuation, make your offer subject to a satisfactory valuation, then make an allowance for the NRAS loading and decide if it is reasonable. The key is to make sure the broker or lender tells you what the property values at.
Lastly, one more warning: for most investors interested in NRAS, it is now or never. Why? Because it is unclear how much longer the scheme will last for. For an investor who plans to buy a few investment properties, buy the NRAS-approved property first, because by the time you’re back in the property market the scheme will likely be at an end.
So remember: keep an open mind about the National Rental Affordability Scheme. Don’t buy a property just because it is has an NRAS allocation. And don’t listen to commentators telling you to stay away from every NRAS investment.
Michael Sloan is the founder of The Successful Investor. He regularly writes for NAB about property investing – for further information about NRAS visit https://moneybasics.nab.com.au/michael-sloan.