Build the house or buy the investment

As at today, there are currently five houses in my street either getting extensions or a full knock-down and rebuild. Come to think of it, there are probably only 5 houses on my street that haven’t had a pool, granny flat, extension, reno done in the last few years. At some point in your household life-cycle you too may feel the urge to improve your property, or should you think about making a financial investment instead? From a financial return perspective, should you up-grade the family home or purchase an investment property?

In most cases the family home (main residence) is generally capital gains tax free, however your interest on borrowed money isn’t tax deductible. On the other-hand interest on your investment property is generally tax deductible, however you will most likely be paying tax on any capital gains. Which one gives you the better return?
Here’s the Scenario: You home is now worth $1m and you have no mortgage – congratulations. A bank is happy to lend you $500,000. Your choices are to either invest the funds in a residential investment property worth $500,000 or up-grade to a new home worth $1.5m.

I’m using a property yield of 3.5%, interest rate of 6.5%, capital appreciation of 5% p.a. and an after-tax household cash flow to service the debt of $40,000.

Assuming you value your wealth in 10 years’ time by liquidating all your assets. I’ve calculated that the combined residence and investment property is greater than the new family home value by more than $300,000. Why? Simply because the value of the additional rental cash flow overtime, outweighs the capital gains free benefit of the main residence. So next time you have money to invest, have a think about the potential cash flow it could generate.

The above scenario is not tax advice or personal financial advice. It is of a generic nature and has not considered your financial situation or additional costs associated with investing in property (such as land tax or stamp duty). Investments can go up or down in value and tax laws can change. If you are going to rush out and buy an investment property tomorrow and forego your planned renovations, please speak to your partner first and your financial professionals second.