Converting your Owner Occupied Property to an Investment.
Home or business owners often face a common question when upsizing to a new property to live in or occupy. Should I sell my current property or keep it and convert it into an investment property?
An understanding of the emotional and practical variables involved can assist in guiding astute decision-making.
Reasons to Keep Your Current Property
Head v Heart
When buying a home to live in, there are going to be a number of emotional drivers. At the time of buying, there will be several lifestyle decisions driving the decision to purchase. It may be that the history of the property or your experiences living there were positive ones, and you are not ready to disconnect entirely from those memories.
However, the characteristics of an ideal investment property need broader financial analysis. The key metrics include the economic fundamentals of the area now and its prospect for capital growth and rental yield.
Uncommitted Relocation
Keeping your property and changing its status to an investment property may be appropriate when relocating for work where the change may not be permanent or, in a similar vein, to test a lifestyle change.
Converting your current home to an investment while buying or renting in the new location allows you to try different scenarios. With this knowledge, you can keep the option open to return to the property at some point in the future.
Financial Considerations
Tax Implications
If you keep your existing home as an investment and buy a new one, the tax treatment of your loans may change. The interest on the existing home loan, (now an investment property) becomes tax-deductible, while the new owner-occupied loan may not be. This scenario requires sound pre-planning.
Your existing family home is usually exempt from capital gains tax if you sell it, and this is an important factor to discuss with your accountant when considering keeping it as an investment.
Another consideration is being aware of changes to other state property taxes, including land tax. These have become very material, especially in Victoria, as outlined in our property taxes blog. Ensure you factor in these changes.
New Revenue & Costs
If you are able to lease out your existing property, this will generate a new income stream. As a first step, consider if it is viable to find and sustain tenancy.
Make sure you understand the Gross & Net Rental Yield that you will get on your property. Simply put, the Gross Yield looks like the following:
Gross Yield % = (Annual Rental Income/Property Value) x 100
As an example, the average Gross yield on residential property in Australia is under 4%. However, you should compare and benchmark your property with similar properties in your area.
The Net Rental Yield includes expenses such as:
- Insurance
- Strata fees (If applicable)
- Vacancy costs
- Repairs & Maintenance
- Legal & Accounting Fees
- Building inspection fees
- Agent or Management Fees
- New Taxes
To calculate the Net Rental Yield, use the same formula above, less your anticipated expenses.
Many people often don’t consider the inverse relationship between rental yield and capital growth. The better the property, the more prospects it generally has for capital growth and indirectly, this means a lower yield/rental for the owner. For many people, the higher yield is critical, while other investors will absorb a shortfall in the hope of future capital gains.
Reasons to Sell Your Current Property
In our experience, the key theme in these and perhaps other financial decisions is your Opportunity Cost. By making a decision to keep or sell what do you forego? This cost is both quantitative and qualitative.
Quantitative is the return you will get from directing the sale proceeds into an alternative decision. An obvious one is the repayment of a non-deductable home loan debt. Take this example:
Suppose I use the proceeds to pay off non-deductable home loan debt, which is currently at 6%. Keep in mind that this is an after-tax return, as the debt is not deductible. Using an average tax rate of 30%, if this is “Grossed up” as a pre-tax return, it is effectively 8.5%.
Can you get a better return on investment over your horizon?
Qualitative is often forgotten. How much extra time will you spend managing the property? Do you enjoy doing that? Perhaps you are “handy” and enjoy doing the maintenance and upkeep on the property, as well as dealing with tenants.
When deciding whether to keep or sell your property:
- Seek professional advice, including your accountant
- Be realistic about the property's future returns
- Remove emotional sentiment
- Understand the concept of Opportunity Cost
Once you have weighed up these four factors, then you will be in a better place to make an objective and informed decision that also feels right and makes sense for you.