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If you’ve decided you want to start your property investing 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 opt to build a brand new property for a range of reasons, namely tax minimisation.
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
When you build a new property, you can claim depreciation on the internal fixtures and fittings which can reduce your taxable income.
You’ll almost certainly save on stamp duty, as this is usually only payable on the land value because the property doesn’t exist yet.
Any home loan interest payments made during construction can also be tax-deductible at your marginal income tax rate. It’s always recommended to speak with your accountant to see how you could minimise your tax obligations 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 the build, it could actually work out to be cheaper to construct the property than to purchase an existing one. Building a new property takes a lot of time and most people aren’t prepared to put the effort in, so will pay more for an existing property.
Build to meet market demand
If you’re building an investment property from scratch, you have a unique opportunity to talk with real estate agents and find out what kinds of properties are in demand right now, and then build yours to accommodate that.
A perfect example of this is the current move towards working from home. Many renters are looking for properties that have built-in study nooks or a multi-purpose room that could be transformed into an office space. Finding out what qualities tenants are looking for in a rental can go a long way towards securing a long-term tenant.
Potential for instant equity
Instant equity means that after you’ve built the property, you can go back to the lender and get it revalued. If you scored a good deal on the land and the build, and you’ve done a great job on the build, you could add value instantly and get instant equity, which could be put towards your next property purchase.
Disadvantages of building over buying
It involves a lot of work
Building a brand new property takes a lot of work, which is why most people don’t do it. You have to speak with architects, builders, plumbers, electricians, painters, etc. There can also be delays that may impact the budget which leads to the next point:
It may not always be the cheaper option
If you’ve ever seen an episode of Grand Designs or The Block then you’ll know that there can be delays and budget blowouts. It’s very rare that a build will go 100% according to plan. Materials and labour can sometimes be more expensive than first thought, certain materials may be in short supply, it may rain for weeks on end which means no work can get done, and so on.
This is why it’s wise to have a fixed contract from your builders so you pay a fixed amount of money for construction, which means you’re somewhat protected. However, issues can still arise and there will always be things that are outside of your control.
Additionally, you’re making interest repayments and you’re not getting any rental income from the property while it’s being built.
Other developments can harm your property value
If there’s a brand new apartment/townhouse complex going up, or you’re purchasing in a new land release area that has potential for future land releases, that could hinder the growth of your property because there’s too much competition around you.
Property works on a supply and demand model. If there’s a plentiful supply of land or brand new properties in your area, it’s going to make it harder for your property to grow in value.
You’re more limited in locations
Chances are you’re probably going to want to buy a vacant block of land, as opposed to buying a block of land with a property already on it and then demolishing it to build a new one. However, vacant blocks of land are scarce in many areas. If you do find one in a good area, there will be demand for it. Of course, there are always certain spots with new land releases, but it’s important to be mindful of how buying in an area like that could hinder growth in your property value.
No rental income until the property is complete
As nobody can live in the property until it’s been completed, you won’t be receiving any rental income during the construction period. This means you will be paying your own mortgage or rent, as well as other costs if you own other investment properties.
If you do have other rental income coming in from other investment properties, this could help with paying off each stage of the project. Regardless, you should prepare for a period of about 6-12 months or more where you will have all the expenses of an investment property without any rental income.
How does building an investment property work?
The first step is to secure a construction loan. A construction loan is a type of short-term loan which is used to fund the cost of building a property. Construction loans generally last for about as long as it takes for the home to be completely constructed. When the loan term is up, the loan is converted to a regular mortgage product set by the lender.
Construction loans provide finance across six steps of the construction process, including:
- Slab down
- Frame up complete
- Practical completion
How do construction loans work?
Construction loan repayments are usually interest-only before reverting to a principal and interest loan upon completion (unless otherwise agreed).
Construction loans cover the expenses you incur as they occur. We use a six-stage process with our investment construction loan:
Paid to the builder to commence work
Concrete slab complete or footings and base brickwork complete
House frame complete and approved by inspector
Windows/doors, roofing, brickwork, insulation
Plaster, kitchen cupboards, appliances, bathroom, toilet, laundry fittings/tiling, heating, fixing/internal doors, etc., plumbing, electrical, painting
Fencing, site clean-up, final payment to builder
Payment is made to the builder after each stage of construction is complete, typically referred to as progress payments. You are only charged interest based on the amount you use for each progress payment.
How to apply for a construction loan
You'll need all the usual items required for any home loan application, including:
- Employment information
- Payslips and pay summaries
- Lists of assets and liabilities
- A savings history
In addition to all of this, you'll need to present professional plans for the property, including an expected valuation. Having a bigger deposit can help too.
If you’re interested in building a new home, chat with one of our lending specialists today to get pre-approved for a construction loan.
Marie Mortimer is Managing Director of loans.com.au, one of Australia's largest online lenders. Since Marie started the business more than 10 years ago, Marie has grown loans.com.au into a company with $6 billion worth of home and car loans. Marie is dedicated to improving financial literacy for all Australians and is passionate about the FinTech industry in Australia. When she isn't at work, she loves to spend time with her husband and two young children.
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