Some Common Investment Terms Explained: part two

In our last blog post we shared some helpful investment terms with you, and we thought we’d do the same again. Investing can be a daunting process, and it’s good to have an understanding of the basic terms so that you can understand the smaller details. In this blog post, we wanted to share some useful definitions of common investing terms with you.

DEPRECIATION

Depreciation is a way of tracking how much value something loses over time. If you’ve purchased a property that you hope will increase (appreciate) in value over time, then you may think that this doesn’t apply to you. It’s important to remember, however, that many of the fixtures and fittings, and also appliances, in your property will in fact decrease in value over time. This includes things like carpets and curtains, appliances like hot water services and heaters, and also any furniture etc. that may be provided with the property. As such, depreciation is a way of claiming the ‘wear and tear’ on certain items as a loss against your personal finances.

Because not all of these things may depreciate at the same rate, you may need to speak to a quantity surveyor about a depreciation schedule for your property. This schedule will let you know how long these depreciating assets will ‘last’, which will let you know how much depreciation you can claim on them. Once an item’s effective value is reduced to zero, you can no longer claim depreciation on it. They’ll also let you know if you can actually claim depreciation on the items, as there are some rules, such as whether you can claim depreciation on used (i.e. not new) items. How much you can claim, or whether you can claim particular items at all, will depend on when your property was built and how long you’ve owned the property for.

Not only does a comprehensive depreciation schedule help you plan ahead by knowing when these assets should be replaced in your property, but it also lets you know how much you can claim back on your tax. As depreciation on an investment property is tax deductible, it’s worth making sure that you’re claiming your losses to your full advantage. Your depreciation schedule will likely be broken down into two parts: the first will cover the building itself, and the second will cover the items that have been discussed here. Please note that your property does not depreciate, even if you do not renovate. Its equivalent of depreciation is CAPITAL GAINS ALLOWANCE.

CAPITAL GAINS ALLOWANCE or CAPITAL WORKS ALLOWANCE

Capital works allowance is a certain percentage of a property’s value that can be claimed as a sort of ‘wear and tear’ loss. While property doesn’t depreciate in the same way as other assets (and indeed maintained properties often increase in relative value over time), owners are still entitled to deductions that recognise that buildings require maintenance.

For investment properties, owners can typically claim 2.5 per cent of the building’s construction costs each year (note that this is connected to what it cost to build the property, not what the current market value is). Also, if work was commenced after 1992, investors can claim 2.5 per cent of alteration costs, which includes things like kitchen and bathroom renovations and other major internal works, or external works such as fences.

CAPITAL GROWTH

Capital growth refers to the increase in value of an asset (typically a property) over time. While this can be calculated and reported over any period of time, particularly year on year, it is most important when discussing the difference in value between when the property was purchased, and when the property is sold.

Understanding capital growth rates is important because understanding how values have risen or fallen in a particular area over a given period of time may inform whether or not investment in a particular area is a good idea or not.

Understanding the capital growth is an important part of property ownership, especially when it comes to selling your property. This is because you will be liable for capital gains tax on the profit you make on the sale (i.e. the difference between purchase and sale price). Fortunately there are many ways to offset this with the costs incurred as part of property ownership.

BODY CORPORATE/STRATA TITLES

Some properties may come with a body corporate or strata title attached, typically if there are shared facilities in the complex/estate. These may be relatively simple, such as shared driveways or garden space, or they may be more complicated, such as in apartment buildings with function spaces and/or commercial properties.

While there a few different terms for these managing bodies, each with their own subtle differences, the impacts on you as a property owner are likely to be relatively similar.

While you may not need an in-depth understanding of the day-to-day running of the property, it’s important to understand that there are some limitations on how your property can be changed or managed. For example, there may be different processes for managing renovations or maintenance than there would be for a freestanding property. It may also mean that there are fees and expenses associated with the management of the property that you wouldn’t normally have with a freestanding property as well. How much those fees are will depend on the property and managing body, so be sure to ask the question if you’re considering buying a property that is managed by one of these bodies. It’s also important to clarify details specific to your property, such as whether any mentioned insurance covers your property, or whether it only covers the common areas in the complex. 

Generally, however, paying into these fees will also give property owners the right to vote on various issues relating to the management of the property. Please note that many contracts will state that if you are late in paying your fees, you lose your right to vote.

It is also important to know that while there will be an annual fee associated with managing your property, sometimes there will be other expenses that aren’t covered by those annual fees. These ‘special expenses’ are usually one-off payments required for unforeseen expenses, such as repairs beyond simple maintenance, or other expenses such as legal fees. While many management bodies will try and keep a pool of money for these expenses out of the annual fee (this ’emergency fund’ is known as a ‘sinking fund’), if that sinking fund cannot cover expenses, the property owners will need to stump up. Please also note that these management fees are different to your council rates — there will also be council rates on top of these expenses.

The specific requirements and expenses associated with a management body of this kind will depend on a number of factors, including state-specific legislation. If this all sounds complicated, it is, but it also saves you a lot of hassle in terms of negotiating payment rates and insurance plans with every other property owner in the complex.

Hopefully these blog posts have helped to explain and demystify some of the terms used by property investors. If you’d like to know more about property investment, why not check out some of our blog posts? There’s no end to the amount that you can learn about property investment, but having a good grasp of the basics will help you understand the more complicated concepts, and hopefully assist you with making stronger investing decisions.