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If you have decided to start your real estate investment journey or want to add to your portfolio, you have two options: buy an existing property or build a new one.
Buying an existing property is the most common option among investors, but some investors choose to build a brand new property for a variety of reasons, namely tax minimization.
If you're curious about building an investment property, here are the pros and cons you need to know first.
Advantages of building over buying
Tax minimization
When you build a new property, you can claim depreciation on interior fixtures and fittings, which can reduce your taxable income.
You will almost certainly save on stamp duty, as this is usually only payable on the value of the land because the property does not yet exist.
Any home loan interest payments made during construction may also be tax deductible at your marginal income tax rate. It is always recommended to speak with your accountant to see how you could minimize your tax liability when building an investment property.
Building could be cheaper than buying an existing property
If you manage to get a good deal on the land and building, it might actually be cheaper to build the property than to buy an existing one. Building a new property is time consuming and most people are not willing to put in the effort so they will pay more for an existing property.
Building to meet market demand
If you're building an investment property from the ground up, you have a unique opportunity to speak with real estate agents and find out what types of properties are in demand right now, then build your own to meet them.
A perfect example of this is the current trend towards working from home. Many tenants are looking for properties that have built-in study nooks or a multi-purpose room that could be converted into office space. Finding out what qualities tenants are looking for in a rental can go a long way in securing a long-term tenant.
Instant Equity Potential
Instant equity means that after building the property, you can go back to the lender and have it reassessed. If you got a good deal on the land and the building, and you did a great job on the building, you can add value instantly and get instant capital, which could be used for your next real estate purchase.
Disadvantages of building versus buying
It involves a lot of work
Building a brand new property is a lot of work, which is why most people don't do it. You have to talk with architects, builders, plumbers, electricians, painters, etc. There can also be delays which can impact the budget which leads to the following point:
It may not always be the cheapest option
If you've ever seen an episode of Grand Designs or The Block, you'll know there can be delays and budget meltdowns. It is very rare for a build to go 100% to plan. Materials and labor can sometimes be more expensive than expected, some materials can be scarce, it can rain for weeks meaning no work can be done, and so on .
This is why it is wise to have a fixed contract from your builders so that you pay a fixed amount for the construction, which means you are somewhat protected. However, problems can always arise and there will always be things beyond your control.
In addition, you repay interest and receive no rental income from the property while it is being built.
Other developments may affect the value of your property
If there is a brand new apartment/townhouse complex being built, or if you are buying in a new land release area that has potential for future land releases, this could hinder the growth of your property because there is too much competition around you.
Property operates on a supply and demand model. If there is an abundant supply of land or new properties in your area, it will be more difficult for your property to appreciate in value.
You are more limited in locations
Chances are you want to buy vacant land, instead of buying land with a property already on it and then demolishing it to build a new one. However, vacant lots are rare in many areas. If you find one in a good neighborhood, there will be demand. Of course, there are always some places with new land releases, but it's important to keep in mind that buying in an area like this could hamper the growth of your property's value. property.
No rental income until the property is completed
As no one can inhabit the property until it is completed, you will not receive any rental income during the construction period. This means that you will pay your own mortgage or rent, as well as other costs if you own other investment properties.
If you have other rental income from other investment properties, this could help you pay off each stage of the project. Either way, you should prepare for a period of around 6-12 months or more where you will have all the expenses of an investment property with no rental income.
How does building an investment property work?
The first step is to get a construction loan. A construction loan is a type of short-term loan that is used to finance the cost of building a property. Construction loans usually last about as long as it takes for the house to be fully built. When the term of the loan expires, the loan is converted into a regular mortgage product set by the lender.
Construction loans provide six-step financing for the building process, including:
Deposit
Slab down
Full frame
Locking
Fixation
Convenient completion
How do construction loans work?
Construction loan repayments are usually interest only before reverting to a principal and interest loan at the end (unless otherwise agreed).
Construction loans cover the expenses you incur as they arise. We use a six-step process with our investment construction loan:
Step
Typical components
Deposit
Paid to builder to start work
Base
Concrete slab finished or footings and base masonry finished
Frame
Framing of the house complete and approved by the inspector
Lock
Windows/doors, roofing, masonry, insulation
Fixing
Plaster, kitchen cupboards, appliances, bathroom, toilet, laundry/tile, heating, fixing/interior doors, etc., plumbing, electrical, painting
Practical Completion
Closing, site cleanup, final payment to builder
The payment is made to the builder after each stage of construction is completed, usually referred to as an installment payment. You are only charged interest based on the amount you use for each progress payment.
How to apply for a construction loan
You will need all the usual items required for any home loan application, including:
Identification
Job Information
Pay slips and pay statements
Lists of assets and liabilities
A Savings Story
In addition to all of this, you will need to submit professional plans for the property, including an expected appraisal. Having a larger deposit can also help.
If you are interested in building a new home, speak with one of our loan specialists today to get pre-approved for a construction loan.
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Marie Mortimer is Managing Director of loans.com.au, one of Australia's largest online lenders. Since Marie started the business over 10 years ago, Marie has grown loans.com.au into a business with $6 billion in home and car loans. Marie is dedicated to improving the financial literacy of all Australians and is passionate about the FinTech industry in Australia. When not at work, she enjoys spending time with her husband and two young children.
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