It’s a dirty secret for many, but there are few more effective ways of generating a negative return on your investment than by buying a property “off the plan” from a developer. This largely stems from the fact that developers exist for the pure purpose of generating a profit and will generally do whatever it takes to ensure that they receive the maximum return on their investment.
Leading developers, such as Mirvac or Central Equity will often tempt investors with short-term “rental guarantees”, which, when coupled with stamp duty concessions served to create an artificially high return. In many inner-city developments, as much as half of the available stock will be sold to wealthy, yet unsophisticated foreign investors, while the remaining half needs to be sold to owner-occupiers or local punters.
The Sunday Age, which produces a property wrap section, is littered with colourful advertisements for new apartment buildings much like that produced on Sunday by boutique apartment developer, Ubertas for its Rhapsody development on Melbourne’s St Kilda Road. The advertising feature (which largely resembles an article, but features a small note at the top stating that it is actually an advertisement) stated that:
… calculations by John Hopkins, executive chairman of the John Hopkins Group [a property advisory company], show that for some investors, or owner occupiers, the bottom line after-tax weekly deficit in the first year of buying the apartment would $1,186, or $22.81 a week.
The calculations also appear on Rhapsody’s website.
The advertisement continues:
The rosy scenario is based on buying a single bedroom apartment in Rhapsody, a luxury residential project at 568 St.Kilda Road. Musician James Morrison is among those who have already bought into the project and plan to live there.
At this stage, potential investors must be thinking, “only $22 per week and a famous neighbor” — what could go wrong? Well, that is until Ubertas and John Hopkins explained how they came up with their figures. The advertisement noted that the scenario assumes rental income of $428.00 per week (which is reasonable), plus tax benefits of $9562, less interest and ownership costs, leaving a “deficit” of only $1186 per year.
There are two major problems with the claim. First, the calculations treat the $9562 “tax benefit” in the same manner as rental income. Second, the calculation disregards maintenance costs to the apartment and the building itself (which are likely to average at least several thousand dollars annually over the life of the property).
In reality, even for those paying a marginal 41.5% rate of tax, the real value of the tax benefit is less than $9562, That is because the calculation does not account for “time value” of the tax benefit — that is because the costs relating to the property (such as interest or body corporate fees) are paid monthly or quarterly, whereas the tax saving is reaped far later (in most cases in the following year when the owner’s return is completed).
Further, the benefit only applies when the owner is paying at least 41.5% tax, if the owner loses their job or has their income level reduced, the apartment starts “costing” a lot more than $22.00 per week. The most dubious claim however was that “for some investors or owner-occupiers the bottom line … would be $1186”. Given that the $1186 figure relies on the tax advantages of “negative gearing” (which is not applicable for owner-occupiers), it appears that the statement is misleading.
Crikey contacted Ubertas to seek an explanation for their claims, however, a spokesperson for the company claimed that all advertising and marketing was outsourced to a third party called HSJ Advertising. Crikey contacted HSJ but the advertiser did not reply prior to publication.
In Ubertas’ defense, such selling tactics are hardly unusual for developers seeking to maximise their returns, effectively turning the property market into a kind of Ponzi scheme, where the property, in the ordinary course of events, loses money for its owner. The only way most investors are able to profit from such acquisitions is by selling the property to another purchaser for an even higher price.
That is becoming ever the more difficult with increasing unemployment and announcements like that made yesterday by the Federal Government, when it stated that skilled immigration would be reduced by 14% in the coming years.
Who can argue with the wisdom of this advice? Certainly not me- I have an intense aversion to buying off the plan and real estate developers!
Adam I may have misread the point in the article about the time value of the tax benefit, and you may already know this, but the tax benefit can be paid to you throughout the year by the ATO. You submit an Income Tax Withholding Tax Variation to the ATO as early as possible in the tax year- its an online form.
http://www.ato.gov.au/businesses/content.asp?doc=/Content/6650.htm.
This reduces the tax you pay each pay period based on your estimate of your net return from the investment. The downside is you have to be pretty accurate or the ATO might penalise you.
But I am no expert- its imperative that you get independent advice from your own accountant before you enter into any investment. Cheers