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ASK THE EXPERT: Is bigger really better?

The benefits of investing in one large property versus buying two smaller apartments is a hot topic amongst investors. Australian property tax and expatriate tax expert Steve Douglas explains the pros and cons to both purchases.

Most people feel safe buying property of lesser value; psychologically, property bearing a larger value may seem intimidating. However, there really is no reason to worry. Whether you invest in one larger property or two smaller ones, the value, the risks and the benefits are similar. Here are a few factors to consider when making your decision:

 

1. ENTRY COST STAMP DUTY

Stamp duty applies when you enter a contract to purchase a home is valid and is charged by every state government in Australia. The rate of duty increases with the value of the property; so while the stamp duty on a larger home may be higher than on two smaller homes, it eventually boils up to the same amount.

 

2. INITIAL OUTLAY

When you acquire an investment property in Australia, a 20 percent deposit is required, with the balance funded by a quality lender. There is also the Stamp Duty cost to be factored into the equation – approximately five percent – so you need around 25 percent of your intended purchase as either a cash contribution or as available equity on any other Australian property you may have.

 

3. GROWTH PROSPECTS VERSUS RENTAL

The key advantage of two smaller properties is the likelihood that the combined rental income will be higher as compared to that obtained from a larger property. On the other hand, it’s more likely the larger property will be in a better suburb or of a better style, which can result in higher growth. This trade-off needs to be considered based on your personal cash flow and investment budget. And it’s important to quantify this rather than guess, as the benefit is usually lower than you think. As a guide, it usually works out to be a difference of about 0.5 percent to one percent per year more net rent on the smaller property. So if you feel the larger property will not grow on average by an additional one percent each year over the smaller ones, then you may as well proceed with the property that holds smaller value.

 

4. FUTURE USE

In Australia, when you live in your own property, there is no tax allowance for interest paid on the mortgage, so it is critical the mortgage is at the lowest possible level when you do start living in the property. As such, if you can lower the entry costs, you then have a better chance of achieving a low- or no-mortgage environment when you move in. This is especially true when you consider that if you chose to opt for two smaller properties that may be sold later to fund your eventual home, you will be required to pay Stamp Duty again, and you will have selling expenses and you might have Capital Gains Tax on the sale of the properties.

 

The table below is a cost breakdown, assuming you have bought a property in New South Wales for A$1,260,000, which would buy you a reasonable house or a nice apartment as compared to having two smaller apartments of half the value each

 

 

Acquire larger home for A$1,260,000

Acquire two investment properties for A$630,000 each

Stamp Duty & Legal Fees

A$56,790

A$51,680

Selling Expenses

NA

A$25,200

Provision for CGT on sale

NA

A$120,000

Stamp Duty & legal fees on eventual home purchase

NA

A$126,090

Annual rent adjustment
(seven years)

NA

A$36,400

Total acquisition costs

A$56,790

A$286,570

 

In the table, you can see that purchasing a larger property first, rather than buying smaller properties first and then selling them later to acquire your eventual home, bears a significantly lower entry cost, even after allowing for greater rental income from the smaller properties. This saving of A$229,780 would mean a much smaller mortgage for you to pay out or manage.

Regardless of what property you are considering to acquire or what budget you have, it is most important you strongly believe you have chosen a good property capable of attracting a quality tenant and giving you the best opportunity for growth in value for the amount you intend to spend. When it comes to property, quality is a great protector, so always choose the best you can afford. If it happens to be something you can live in later, that will be a great reward.

 

Australian Taxation Services
10 Jalan Besar #17-01 Sim Lim Tower, Singapore 208787
Tel: 6293 3858

Steve Douglas is the Co-Founder and Managing Director of Australasian Taxation Services (ATS). ATS provides specialist taxation services for anyone looking to invest in Australian property, including Australian expatriates living overseas. Areas of specialisation include the Australian taxation aspects of property investment, as well as expatriate and migration planning.

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