Example 5 – Investing in an NRAS property

This example is designed to help understand how to use PIA to analyse the scenario of buying an investment property that has been built as part of the National Rental Affordability Scheme (NRAS).

NRAS is a long term commitment by the Australian Government in partnership with the States and Territories, to invest in affordable rental housing.  The Scheme began in 2008 aiming to reduce the shortage of affordable rental housing by offering tax incentives to build and rent dwellings to disadvantaged households at a discount rate (at least 20 per cent below the market value). The annual incentives are offered for a period of 10 years. The incentive comprises:

• a Federal Government contribution in the form of a refundable tax offset or payment to the value of $7,996 per dwelling per year in 2014-15
• a state or territory contribution in the form of direct financial support or an in-kind contribution to the value of at least $2,665 per dwelling per year in 2014-15.

The incentive is indexed in line with the rental component of the consumer price index.

Property details:

Let us begin with a new $320k townhouse built in Queensland as part of a development approved under NRAS. The market rent was assessed at $330 per week and would rent under the NRAS discount (20%) at $264 per week. The normal rental expenses include standard rental management (8.25% of market rent) and letting fees (1 weeks rent), rates ($1000), insurance ($650), body corporate fees ($500) and maintenance ($500).  In this example the rental management fees are the same whether the rent is discounted or not. However, under NRAS, there is an addition fee to cover NRAS compliance ($900).  Let us also suppose the estimated vacancy rate is 2% under normal conditions, but is just 1% under NRAS (more demand for the lower rent).

The State Government’s component of the tax incentive is classified as non-assessable non-exempt income and, while this may be subject to debate, in this example, we will take it into account in apportioning rental expenses as tax deductions in this example.

As the NRAS compliance costs are necessary to the non-assessable non-exempt State income, these will not be tax deductible and for the purposes of this analysis, will be deducted from the NRAS subsidy.

The building construction cost was $220,000 and the purchase price included $20,000 worth of fixtures and fittings. The purchase costs included normal State Government stamp duty and $1250 solicitor’s fees to cover the conveyancing.

Loan details:

After a cash deposit of 100,000, an interest-only loan was arranged at 7.0% to cover all remaining costs, including purchase and loan costs. The total loan costs include a fixed establishment fee of $500, no mortgagee insurance, and the remainder of the loan costs are as per the program defaults.

Investor details:

The investor’s annual salary was $85,000 per year, his spouse’s was $35,000 and they wish to purchase the property in the name of their Self-Managed Super Fund (SMSF) into which they make an annual contribution of 9.5% ($11,400) of their combined salaries.

What if:

The annual growth rate for the property was 5% and the annual inflation rate 2%.  

1. What will be the cost per week under NRAS compared to non-NRAS?
2. Is it possible to repay the loan using the surplus in the fund?

What are the steps?

1. Open a new spreadsheet and define the property as if it were not purchased under NRAS.  These changes to the default values can be completed under either Data Entry Check List or by clicking on the corresponding row titles in the Investment Analysis spreadsheet.
• Set the property price to 320k (Property Value dialog).
• Set the conveyancing fees (Purchase costs dialog) to 1250.
• Set the Rent (Rental Income dialog) to 330 per week and the vacancy rate to 2%.
• Set the normal rental expenses (Rental Expenses dialog) as per the specifications above (total of 4,367/yr).
• Set the construction cost (Depreciation of Building dialog) to be 220k.
• Set the value of general fittings and the pool of low value fittings (Depreciation of Fittings dialog) to each be 10k.
• Under the Finance tab, set the cash invested to be 100k (Loan Amount dialog).
• Set the loan type to I/O and the interest rate to 7% (Loan Interest & Type dialog).
• Set the establishment fee to 500 and the mortgage insurance to zero (Loan Costs dialog).
• Under the Investor tab, choose investor type (Investor Details dialog) to be Super Fund and the fund contributions to 11,400 per year.
• Under the What If tab, set the inflation rate (Inflation Rate dialog) to 2% and the growth rate (Investment Property Growth dialog) to 5%.



2. Choose the investment analysis spreadsheet (click the Spreadsheet button or from the View menu, choose Investment Analysis). Note that the row title for the Tax Credit row denotes “super” as the tax scale used in its calculation.





3. Under the Setting menu, choose NRAS Options. Note that the default NRAS Tax incentive is 10,661 (2014/2015) Federal and State components combined) and the rental discount rate is 20%. In this example we will assume there are no additional purchase costs associated with purchasing the property under NRAS, but we do need to specify additional $900 non-deductible compliance costs under NRAS and a vacancy rate of 1%.  Then click on the checkbox to apply the NRAS settings to the property.


 


Now before clicking OK, click on the NRAS Tax Incentive button to bring up the dialog and ensure the checkbox to apportion the deductions to be claimed in accordance with the proportion of the income derived from the State component (NANE income).





Then click OK to return to the NRAS Options dialog.
4. Rather than clicking OK to return to the Investment Analysis spreadsheet, click on the Cash Flow Comparison button to generate a report showing a comparison of the first year cash flows under non-NRAS and NRAS.
   
   
   This report quickly shows that the property will cost an average $42 per week in the first year and an average of $22 per week over 10 years whereas under NRAS, the weekly cash flow is a positive cash flow of $85 per week in the first year and $117 per week over 10 years.
   
5. The Investment Analysis spreadsheet should now look like this…
   
   
   
   
6. Now select Preferences under the Settings menu and choose “Annual cash surplus” as the bottom line of the spreadsheet. This shows a surplus of 14,127 in the first year.
   
   
   
   
7. To direct any surplus cash into the loan repayments, choose Credit Line (Settings menu). The 14,127 will now appear in the Investments/payments row of the spreadsheet.
   
   
   
   If we click on the figure 14,127, we can see the derivation of the new total loan payments. 
   
   
   
   
8. As the loan is being repaid monthly, the interest bill for the year drops and so the actual cash surplus does not necessarily drop to zero even though we used the projected cash surplus as repayments. By scrolling across the years, we can see that the investment loan is fully repaid before the end of the 11th year. At which time the cash surplus will rise dramatically with the full investor contributions and the net rent all remaining in the fund.