National Rental Affordability Scheme NRAS and Mistakes to AVOID!
CONTENTS Contents...1 Introduction... 2 Brief Over view of NRAS...3 Key Facts About NRAS...5 NRAS Incentives... 7 NRAS and Mistakes To Avoid!...... 8 Looking seriously at NRAS......8 Don t Become Blinded by the Cashflow Potential of NRAS......9 Do Your Due Diligence......10 Assessing the Balance between Purchase Price and your Tax Rate......11 Not Assessing the Level of Rental Discount... 12 Considering the Timing of Incentives....13 Considering Financing Restrictions......14 Understanding Head Lease vs. Direct Tenancy Structures......15 Considering Termination Provisions......16 Considering the Eligible Tenant Pool in the Area......17 Obtain Professional Advice!......18 Contact us... 18 Our contact details:... 18 No Advice Warning... 19 1
INTRODUCTION We are delighted to provide you with a copy of our Information Guide on the National Rental Affordability Scheme (also referred to as NRAS). NRAS is a Federal and State Government initiative that can provide property investors with exceptional outcomes, potential property investors should consider NRAS before making any investment decision. In reviewing NRAS however many investors are making mistakes that can and should be avoided. Our purpose in providing this NRAS Information Guide is to help you understand those potential mistakes in the hope that you will avoid them. We trust that what you read in this Information Guide is beneficial to you and assists you in considering whether an NRAS investment is right for you. Increasingly, property investors are looking to NRAS as a way of adding cash flow positive properties to their investment portfolio. Like with any investment, there are potential risks to consider and mistakes that can be made. Both experienced and inexperienced property investors are at the same risk of making mistakes when considering an NRAS investment. As always we encourage you to seek advice from suitably qualified professionals prior to making any investment decision. This NRAS Information Guide is designed to help you avoid making these Mistakes! 2
A Brief Over View of NRAS: NRAS is a joint initiative of the Federal and State governments, created by the Council of Australian Governments (COAG) as part of a strategy to delivery 50,000 affordability rental dwellings throughout Australia. NRAS has been established to: Increase the supply in affordable rental dwellings. Reduce rental costs for working rental households. Encourage large-scale investment in affordable housing. The scheme aims to facilitate the delivery of new affordable rental properties through the provision of significant incentives to property investors over a period of ten (10) years. It should be noted, however, that: NRAS is not a public housing program; It is a tax / cash incentive to encourage more private investment in the affordable price range of the residential construction market. NRAS approvals are more likely to be granted for residential developments for the following reasons: Within close proximity to services education, retail, medical, transport, etc. Close to employment and industry. Located in an area that has an undersupply of affordable housing. The scheme is open to a range of household types on low and moderate incomes. Under the scheme, NRAS dwellings must be rented to Eligible Tenants who meet the NRAS income thresholds. It is very important to note that NRAS dwellings must be rented out at a rate that is at least 20% below the prevailing market rates and in the case of certain types of properties (generally inner-city apartments) at 30% below market rates. Income limits are intended to include key and essential service workers such as childcare workers, nurses, police officers and fire-fighters. 3
The current initial income limit for a single adult is $44,128 per annum, increasing to $104,913 per annum for a couple with three children. This assessment is made on the income for the 12 months prior to occupation. NRAS then allows for tenant salary increases of 25% above the income limits. For example, with the income increase allowance, a couple, with three children, could earn up to $131,141 for up to two years before they become ineligible for the discounted rent, or up to $55,160 in the case of a single person household. See Table below: Household Type Entry income level ($) Upper income level to maintain eligibility ($) Single person 44,128 55,160 Two adults 61,006 76,258 Sole parent with 1 child 61,049 76,312 Sole parent with 2 children 75,685 94,606 Couple with 1 child 75,641 94,553 Couple with 2 children 90,277 112,847 Couple with 3 children 104,913 131,141 4
KEY FACTS ABOUT NRAS: The following points should prove useful to in providing an overview and to dispel some myths and misconceptions about NRAS property investments: NRAS dwellings are private owned property, just like your family home or other residential property. The Australian Government has made a 10 year commitment to NRAS. The Scheme is managed and regulated under the legislative framework provided through the National Rental Affordability Scheme Act 2008. NRAS properties cost no more to purchase than the equivalent non NRAS property. Operating agreements between the scheme operator and individual investors can vary considerably. Investors should familiarise themselves with the specific provisions of the scheme operator agreement (and seek professional advice) before deciding on a particular investment. Some key differences from scheme-to-scheme are as follows: Some schemes operate on a head-lease structure where the scheme operator leases the property from the investor for a 10-year period and in turn sub-leases it to a qualifying tenant. Under this structure the investor has little or no control over the selection of tenants or the selection of the property manager (with the scheme operator generally taking care of both). Other schemes provide for the investor to select their own property manager and in turn enter into direct residential tenancy agreements with their tenants (and involve themselves in tenant selection). The type of properties included in each scheme can vary considerably, with some scheme operators targeting suburban three-four bedroom house & land packages, medium density properties and others focus on inner-city and urban apartments. 5
The ability to terminate the agreement with the scheme operator during the 10-year NRAS Incentive period can vary, with some schemes being very restrictive and others providing greater flexibility. NRAS was designed to stimulate the building of new affordable rental dwellings. Therefore, strict limits are in place as to the types of properties that would be eligible for incentives under the scheme. Although there are limited exceptions, generally a dwelling must be brand new. NRAS homes can be bundled with non-nras properties: for example, there may be only a minority of NRAS properties in a multi-storey development, with other properties sold offthe-plan to homebuyers and individual investors. NRAS dwellings can generally be sold without penalty during the 10 year holding period in the following circumstances: The dwelling is sold to another investor who undertakes to comply with NRAS obligations; or An equivalent dwelling is offered as a substitute dwelling for the remaining part of the 10-year period; or Where the agreement with the scheme operator provides for early termination (generally with some form of pre-agreed penalty needing to be paid). At the end of the NRAS 10 year period, the investor has no ongoing obligations to the scheme operator or the Australian Government. Where dwellings are approved under NRAS, investors should be aware that this does not mean that the Australian Government endorses, guarantees, or secures the investment in any way. 6
NRAS INCENTIVES It is worth repeating that the NRAS is not a public housing scheme. It is, rather, a tax incentive to induce more private investment in the lower price range of the residential market. The financial incentive, payable either as a grant or refundable tax offset, is paid annually for up to 10 years. To remain eligible to receive the NRAS incentive, the investor must rent their property to low and moderate income households at a rate that is at least 20% below prevailing market rates. The Scheme offers annual incentives for ten years. Investors wishing to receive the incentives need to ensure that they have applied correctly using the appropriate forms and procedures. Incentives are currently set at the following rates (although this will increase on a year-to-year basis in line with the residential rental component of the CPI figures): Commonwealth Government Incentive currently of $7,143 per dwelling per year as a refundable tax offset. State or Territory Government Incentive currently $2,381 per dwelling per year in direct or in kind financial support. This means that incentives total $9,524 for the current financial year. 7
NRAS and Mistakes TO AVOID! Now that you have read the brief overview of NRAS, let s look at the Mistakes that (in our opinion) investors can make when reviewing an NRAS investment, we hope we can help you avoid them. LOOK seriously at NRAS DO NOT avoid looking seriously at NRAS because you think it is government housing. NRAS is a scheme devised by the government to provide incentives for investors to invest in new dwellings that can be rented to lower to middle income earners because of what is emerging as a chronic shortage of supply of affordable rental accommodation in particular in and around our capital cities. NRAS is not government or social housing Eligible Tenants can be gainfully-employed hardworking singles and families in all sorts of professions and trades. They are nurses, police officers, and government employees, child care workers, chefs and carpenters, business graduates and many others either starting their careers or building their families. They are single or married and with or without children. They are from all walks of life. Of course considering your potential tenant pool within the area and price range of a specific investment is as critical with an NRAS investment as it is with any property investment. 8
Don t Become Blinded By The Cashflow Potential Of NRAS Becoming blinded by the cashflow potential of NRAS without properly considering the area for capital growth and Tenant Pool is one of investors BIGGEST mistakes. The cashflow numbers speak for themselves when investing in an NRAS property, the higher your tax rate, the more attractive the cashflow benefits can be. For Example: On a $335,000 investment with a tax rate of 45% and 100% financing, a non-nras investment property will be cash negative by around $32 per week after tax. The same value property in NRAS would be more than $130 per week after tax cash positive! But don t fall in love with the cashflow too soon. And don t get caught buying just any NRAS property, in any location, without considering a myriad of issues including a proper assessment of the capital growth prospects of the suburb, city and state. If like most property investors you are looking to accumulate wealth through capital growth over time it is essential that the property is an attractive investment from a growth perspective whether or not it is included in NRAS. Ask yourself, without these great cashflow incentives would I buy THIS property anyway. If the answer is NO WAY or PROBABLY NOT then forget it. They may not be easy to find but high-quality NRAS properties in high-growth areas do exist and this is what you should be looking for! 9
Do Your Due Diligence Failing to do proper due diligence on a development, the market or the specific developer is another common mistake. Don t fall into the trap of believing that because the Federal and State governments provide NRAS incentives and approve NRAS operators that somehow they endorse or have completed due diligence on specific developments, markets or developers. In any property development, it is essential that you do your due diligence on the market, the development and most critically the developer. Look for new landmark projects being built by names that you know and who have a proven track record of success in completing quality projects that get sold, get rented and have healthy re-sales and re-letting rates. Again, when looking for NRAS properties these may be few and far between but they do exist. Some of Australia s leading developers with strong track records are participating in NRAS, so make sure you find them! 10
Assessing the Balance between Purchase Price and your Tax Rate Not properly assessing how the balance between the property purchase price and your tax rate can impact the effectiveness of NRAS incentives. Your marginal tax rate will have a big impact on whether or not your new NRAS property is cash positive (on 100% financing). For example, on a marginal rate of 45% a $335,000 NRAS property could be cash positive by around $124 per week after tax. This changes to $79 per week cash positive after tax on a 37% tax rate and further changes to $39 per week after tax on a 30% rate. Outside of NRAS the same $335,000 investment would likely be around $90 per week cash negative after tax on a 30% rate. NRAS investments can be effective inside SMSFs as well; even though the tax rate drops to 15%. With a SMSF you are going to need to contribute at least a 20%deposit to gain bank financing. NRAS can make sense inside your SMSF, particularly when considering the capital gains tax benefits that normally apply when selling a SMSF asset. As a general rule, on the same tax rate, the higher the value of the property in NRAS, the less the cashflow benefit tends to be. For example, on a 37% tax rate as in the example mentioned above a $335,000 NRAS property might be $79 per week cash positive after tax, whilst a $425,000 property drops to being $34 per week cash positive. Move up the scale to $550,000 and the equation goes to negative $8 per week. This is not to say you may not still be attracted to investing in a higher value property to gain control of a higher valued asset that has the potential to present greater capital gains over time BUT you do need to consider the purchase price versus cashflow benefit equation properly before investing. 11
Not Assessing the Level of Rental Discount Another mistake that we see people make is to not assess the level of discount that the specific investment will have to be offered at and not realising that different NRAS properties are required to be rented at different discounts to Market Rental Valuation. In assessing an NRAS investment don t make the mistake of thinking that all NRAS properties are required to be rented at a 20% discount to Market Rental Valuation. In some cases the required discount to market will be up to 30%. This is because an assessment needs to be made by the NRAS operator as to the ultimate affordability of the rental for Eligible Tenants in the locality. Generally, more expensive inner-city properties will be required to be discounted by higher rates (25% or 30%) because otherwise Eligible Tenants would still not be able to properly afford to rent them. Don t make the mistake of thinking that properties that must be rented at say a 30% discount should be avoided however as these are quite possibly high-quality properties such as inner-city apartments with strong capital growth prospects. 12
Not Considering the Timing of Incentives Not considering the timing of incentives and costs from a monthly cashflow perspective is yet another mistake. As with any form of investment, in particular a financed property investment, you need to consider the timing of cash flow. Your annual NRAS incentive (currently $9,524) will represent a significant portion of your annual inflows. But if cashflow is tight (whether inside or outside SMSF) your incentive won t be much help if you need to wait a year to collect it and need to fund your financing and other costs in the mean time. You need to seek professional tax and accounting advice to consider if you can claim your incentive during the year through a withholding variation. Some restrictions may apply so make sure you understand these BEFORE committing to your NRAS investment. Also, withholding variations will not apply for SMSFs and are not much use unless you are a PAYG tax payer either. 13
Considering Financing Restrictions Making the mistake of not considering financing restrictions that may apply when financing an NRAS investment. Firstly, the most important thing to check is whether the particular NRAS operator is APPROVED BY YOUR PREFERRED LENDER. That s right. All lenders have a list of NRAS operators that they have approved and will not finance property investments that are in NRAS schemes that are not on their list! If an operator is not on a specific lenders approved list it may just be a case of the lender having not yet completed due diligence on that particular operator and other lenders may have them on their approved list. But if you intend to use a specific lender (say your existing home mortgage provider to keep it simple when using your home as security) you must ensure that the operator is approved on your lender s list BEFORE SIGNING A CONTRACT. Many lenders limit the LVR (loan to value ratio) for NRAS properties. This may mean that you need a larger deposit, or that you need a higher percentage of equity in your home or other properties if you intend to use them as security in a 100% financing scenario. Most significantly, some lenders do not consider the NRAS incentives when assessing your ability to service the loan on an NRAS property. This can negatively impact your DSR (debt servicing ratio). Consider this, if we use the example of, 100% financed negative gearing scenario outside of NRAS which requires the borrower to be able to comfortably service a negative cashflow. The same property inside of NRAS is cash positive, however if the lender excludes the NRAS incentives from their calculations the base cashflow negative. Make sure you understand fully whether your proposed lender will include none, part or all of the NRAS incentives in assessing your ability to service. 14
Understanding Head Lease Vs. Direct Tenancy Structures It is CRITICAL that you know and understand the differences between head lease and direct residential tenancy agreement structures and the costs associated with each. Many NRAS operators utilise a head-lease structure. In effect this means that you are leasing your property for the NRAS term (10 years) to the NRAS operator and in turn they sub-lease it to an Eligible Tenant. In such cases you will have limited or no control over the selection of either the managing agent (generally head-lease operators are the managing agent) and little or no control over the selection or approval of the tenant. In fact, you will generally not be a party to the tenancy agreement so will have limited legal standing at the tenancy agreement level. In our opinion these structures are to be avoided in most circumstances. Other NRAS operators allow you to appoint a managing agent of your choice and in doing so, provide you with the opportunity and right to participate in tenant selection. (subject to eligibility criteria). In these cases you are a party to both the agency agreement and residential tenancy agreement and the NRAS operator has little or no legal standing in either. In our opinion if you are investing in an NRAS property you should insist on this latter type of structure as in effect it mirrors normal residential property investment arrangements. 15
Considering Termination Provisions To invest without properly considering termination provisions or restrictions is a mistake that you should not make. NRAS agreements are for a 10 year period. Whilst we believe that all property investments should be considered with a 7-10 year outlook, 10 years is a long time in anyone s language. As such you should not make the mistake of not properly understanding your rights, restrictions and opportunities if circumstances arise whereby you wish to terminate the NRAS agreement. Many NRAS operators have restrictive termination provisions, particular under head-lease structures. Others have more flexible termination provisions with as little as two month s notice being required and no reason for termination needing to be provided. Under such structures generally a nominal termination penalty is applied, normally at a rate of around $300 pa for each remaining NRAS year. Of course any termination of your NRAS agreement needs to also consider the underlying tenancy agreement termination provisions and the tenant s rights. This is another reason to prefer NRAS operators that do not use a head-lease structure. When you are not on the head lease structure you will generally be using a standard residential tenancy agreement as you would with any non-nras investment and will be aware of (and in control of) the tenancy termination provisions. 16
Considering the Eligible Tenant Pool in the Area Don t make the mistake of not considering the type and size of the Eligible Tenant pool in the area for the specific type of property you are investing in. What type of property are you investing in? Is it a one-bedroom inner-city apartment suitable for occupation by a single person? Or is it a three or four-bedroom house or townhouse in the suburbs designed for a family? Don t make the mistake of jumping into an NRAS investment without properly assessing whether the property meets the local market demand or without properly considering how many Eligible Tenants you might have to choose from in the local area. This is the same assessment that you would make with any non-nras investment but it becomes even more important in the case of NRAS because you will be looking for high-quality tenants that fall within the Eligibility criteria. 17
Obtain Professional Advice! NRAS is an exciting program that can offer outstanding cashflow and exciting capital growth prospects for investors. At the same time there are many issues to consider and many mistakes that can be made if you do not research the scheme and the specific investment opportunities within it and obtain sound advice from legal, financial and tax and accounting specialists. Be sure to consult one or more of your professional advisors prior to making a final decision to invest in an NRAS property! CONTACT US You can make an appointment or call and ask any questions you like! Contact Tony Freese 0432 326 622 Direct Line: 07 4630 3817 tony.freese@harcourts.com.au 18
NO ADVICE WARNING This NRAS Information Guide contains general information only. It has been prepared without taking into account your personal objectives, financial situation or needs. You should consider any advice in this NRAS Information Guide in light of your personal objectives, financial situation or needs before acting on it. You may wish to consult a licensed financial adviser to do this. The information in this NRAS Information Guide is no substitute for financial advice. If you are considering acquiring a financial product you should obtain a Product Disclosure Statement and consider its contents before making any decisions. 19