Should I turn my home into an investment property? Ask Margaret

Hi Margaret,  

I am an international student who has just graduated and I am planning to move back for good.

My parents are considering selling their apartment in Bondi Junction.

In your opinion, do you think we should sell?

Or would you recommend that instead of selling we keep the apartment and rent it out instead?  

Thank you for any information and advice you may be able to provide, it is very much appreciated.  

Kind regards,

Irene

Margaret's answer on the next page. Please click below. 

Hi Irene,

The decision about whether to keep a former owner occupied property, or instead rent it out, involves a lot more considerations than just whether the time is right or if it will make a good investment, although these two matters are definitely part of the analysis.  

It’s hard to know exactly where to start and so the following information is not necessarily in order of how the considerations need to be made, but all of them must be considered:  

• A principal place of residence is capital gains tax free as long as it’s sold within the allowable period.  Your parents can move out of the apartment and keep it CGT free up to six years, as long as they do not have another property on which they claim the principal place of residence exemption.  If they do move out and buy another property, they can have a strict six month period of overlap where they can have two exemptions, but if this is missed by even one day (that is, the property is not sold) then they are liable for CGT on one of the properties right back to when they first moved out.

• This is important because if instead they sell and take the tax free gain, they can use this to buy another owner occupied property with low or no debt.  If they wish, they can borrow against the equity in that new owner occupied property and invest elsewhere, with a fully tax deductible debt.

• If they keep the Bondi apartment and rent it out, only the property's current debt can be claimed as a tax deduction.  Even if they use that property as security for further funds to buy another home of their own, that debt is not a deductible one as it is the purpose for the loan, not what secures it, which determines tax deductibility.  In some cases people doing this end up a little upside down – they have a large debt on a house they live in (with no deductions allowed) and a small one on an investment.

• People often keep a former home because they think it will make a ‘good investment’, and this is based on emotion rather than any researched facts to support Whether or not it is a good place to invest.

The first thing to consider is Whether or not this area has the capacity to deliver as good as, or better, growth and yield than any other area. 

Keeping it may prevent your parents from investing in an area with a better capacity to grow in the coming few years and a higher rental yield, giving an all- round better performance. 

Usually, areas which have already become ‘blue chip’ have their best period of performance behind them, and unless there is some major development or infrastructure project on the way, such an area is more than likely to grow with only a lacklustre result. 

For sound investing and a return better than bank savings interest rates, you need to find an area on the cusp of its best period of growth (as in a pre- blue chip area) and you are not likely to find that in the upmarket, favoured suburbs of our capital cities. 

Great investing opportunities are usually in formerly remote suburbs or newer suburbs catering to families – the kind with major infrastructure projects ahead of them and burgeoning populations which drive year- in, year- out growth in value and rental yield.  

It’s rarely the right thing to keep a former home and make it into an investment. 

Your parents need some good advice from a qualified property investment adviser, one whose best interests are not served by selling them a property, to ascertain their bottom line financial position in relation to any debt on this property and any they may move to and to establish just what will be the most appropriate strategy for this time in their lives.

Have a property question? Ask Margaret!

This article was first published on Property Observer in July 2013.