If you’re thinking about starting your property investment journey or adding to your existing portfolio, one of the key decisions you'll need to make is whether to buy an existing property or build a new one. While buying an established property is often the more common path, building a new property has its own unique set of benefits and challenges. In this blog, we’ll explore the pros and cons of building an investment property in Australia to help you decide if it’s the right move for you.

Advantages of Building an Investment Property

When you consider building a new investment property, there are several potential advantages that could make this option very appealing. From tax benefits to customisation opportunities, here’s what you need to know about the pros of building your investment property.

1. Tax Benefits

One of the biggest advantages of building a new property is the potential for tax savings. In Australia, when you build a new property, you can claim depreciation on the building itself, as well as on the internal fixtures and fittings. Depreciation is a non-cash deduction, which means it doesn’t require you to spend any additional money to benefit from it. Instead, you simply claim a portion of the cost of your building and its fittings as a tax deduction each year, which can significantly reduce your taxable income.

For example, let’s say you build a new property and the total cost of the construction is $500,000. The Australian Taxation Office (ATO) allows you to claim depreciation on both the building (capital works deductions) and on the plant and equipment within the property, like appliances and carpets. Over the first few years, these deductions can add up, reducing your tax bill and improving your cash flow.

Additionally, you’ll likely save on stamp duty, which is another significant cost when purchasing property. When you buy an established property, you pay stamp duty on the total purchase price, including the value of the land and the building. However, if you’re building a new property, you generally only pay stamp duty on the value of the land since the building doesn’t exist yet. This can save you thousands of dollars upfront, making it a more affordable option to get started in property investment.

Another tax advantage comes during the construction phase. Any interest payments you make on your construction loan are usually tax-deductible at your marginal income tax rate. This can help offset some of the costs of the build and reduce your overall financial burden during the construction period. However, it’s always a good idea to speak with your accountant or financial advisor to see how you can best structure your finances and minimise your tax obligations when building an investment property.

2. Potential Cost Savings

Building a property from scratch can sometimes be more cost-effective than purchasing an existing property, particularly if you can secure a good deal on the land and the construction costs. This is partly because new builds can be more energy-efficient and require less maintenance, meaning you could save money on repairs and utility bills over the long term.

In some cases, buying an existing property might come with hidden costs. For instance, an older property may require extensive renovations or repairs to make it suitable for tenants, which could eat into your profits. When you build a new property, you have more control over the quality of the construction and can ensure that everything meets modern building standards. This means fewer surprises down the line and potentially lower ongoing maintenance costs.

Moreover, building a new property can sometimes mean getting better value for your money, especially if the property market is competitive. When demand is high, the prices for existing properties can be driven up, making it harder to find a good deal. On the other hand, building allows you to potentially save on purchase costs by negotiating with builders and suppliers, especially if you’re able to manage the project efficiently and keep a close eye on your budget.

3. Customisation to Meet Market Demand

One of the most significant benefits of building an investment property is the ability to tailor it to the current market demand. When you buy an existing property, you’re limited by what’s already there. But when you build, you can design the property to meet the specific needs and preferences of potential tenants, which can help attract a higher quality tenant and secure a longer lease.

For example, in recent years, the rise of remote work has led to an increased demand for properties that include dedicated home office spaces. By including features like a study nook, a spare room that can be used as an office, or even high-speed internet connectivity as a selling point, you can make your property more appealing to tenants who work from home.

You can also choose to build in energy-efficient features, like solar panels or water-saving devices, which not only appeal to environmentally conscious tenants but can also reduce the property’s operating costs. These kinds of upgrades can make your property stand out in a crowded rental market, increasing its appeal and potentially allowing you to charge a premium rent.

By working closely with real estate agents and doing your research, you can identify what tenants in your target market are looking for and build your property to meet those demands. This level of customisation is something you simply can’t get with an existing property, and it can give you a significant competitive advantage.

4. Potential for Instant Equity

Another advantage of building is the potential to create instant equity once the property is completed. Instant equity occurs when the value of the property is higher than the cost to build it. This can happen if you’re able to secure a good deal on the land and construction costs, and if the property market in the area appreciates during the construction period.

For instance, if you purchase a block of land for $200,000 and spend $300,000 on the construction, but the completed property is valued at $600,000, you’ve created $100,000 in equity. This equity can then be used to leverage further investments, either by refinancing the property to access the funds or by using it as collateral for another loan.

Creating instant equity can be a powerful tool for building your property portfolio quickly. It allows you to build wealth faster and gives you more flexibility to take advantage of other investment opportunities as they arise. However, it’s important to note that not every build will result in instant equity, and market conditions can change, so it’s essential to do your homework and manage the project carefully.

Disadvantages of Building an Investment Property

While building an investment property has its advantages, it’s not without its challenges. It’s important to be aware of the potential drawbacks before deciding to go down this path. Here are some of the main disadvantages of building an investment property.

1. Time and Effort Involved

Building a property from scratch is a complex process that requires a significant amount of time and effort if you’re not working with a Property Adviser of Project Manager. Unlike purchasing an existing property, where you can move quickly from offer to settlement, building a new property involves multiple stages of planning, approvals, and construction, each of which can take weeks or even months to complete.

You’ll need to work with a variety of professionals, including architects, builders, plumbers, electricians, and more, to bring your vision to life. Coordinating all of these parties and managing the project timeline can be a full-time job in itself, especially if issues arise along the way.

For instance, delays in getting council approvals, unexpected weather conditions, or supply chain disruptions can all push back your completion date, potentially costing you more in interest payments and delaying your rental income. It’s important to be prepared for these challenges and to have a contingency plan in place to deal with any setbacks.

Additionally, if you’re new to property development, the learning curve can be steep. You’ll need to familiarise yourself with building regulations, contract management, and construction processes, all of which can be overwhelming if you don’t have prior experience. This is why many investors choose to stick with buying existing properties, as it’s often seen as a more straightforward and less risky option.

2. Risk of Cost Overruns

One of the biggest risks associated with building a new property is the potential for cost overruns. While you might start with a fixed budget, it’s not uncommon for building projects to go over budget due to unexpected expenses. This could be due to a variety of factors, such as rising material costs, labour shortages, or changes to the building plans.

Even with a fixed-price contract, which is designed to protect you from price increases, there can still be additional costs that weren’t accounted for in the initial budget. For example, if you decide to upgrade certain fixtures or finishes during the build, or if there are issues with the land that require additional work, these can all add to your overall costs.

It’s also worth noting that while construction is underway, you’ll be making interest payments on your loan without receiving any rental income. This can put a strain on your cash flow, especially if the project is delayed or goes over budget. To mitigate these risks, it’s crucial to have a well-defined budget and to include a contingency fund for any unexpected expenses that may arise during the build.

Furthermore, building a property involves taking on more risk compared to buying an existing one, as you’re betting on the fact that the property market will remain stable or improve by the time your property is completed. If market conditions change during the construction period, you could end up with a property that’s worth less than what you spent to build it, making it harder to achieve a positive return on your investment.

3. Market Competition and Location Limitations

In some cases, one of the drawbacks of building a new investment property is the potential impact of market competition, especially in areas where there is a high supply of new developments. Property values are heavily influenced by the basic economic principle of supply and demand. If you build in an area where there are numerous other new properties being developed simultaneously, the sheer volume of available properties can dilute demand, making it harder for your property to appreciate in value.

For example, if you purchase land in a newly released estate where multiple homes are being constructed at the same time, you might find that your property struggles to stand out. Tenants and buyers have a lot of choices, which can drive down rental prices or slow the growth of your property's value. Even if your build is high quality, the competition can still impact your returns.

Additionally, finding a vacant block of land in a desirable location can be a challenge. Prime locations, such as those close to city centres, beaches, or major amenities, are often fully developed, leaving limited opportunities to build. If you do find vacant land in a sought-after area, it’s likely to be in high demand, which can drive up the cost and reduce the potential for profit. Alternatively, if you opt for land in a less developed area, you might face challenges with slower property value growth or a smaller pool of potential tenants.

Another factor to consider is future developments in the area. If there’s a possibility of more land releases or new apartment complexes being built nearby, this could further saturate the market, making it difficult for your property to stand out or appreciate in value. It’s essential to do thorough research on the area and understand the local property market before committing to building.

4. No Immediate Rental Income

One of the more challenging aspects of building an investment property is the fact that you won’t generate any rental income until the property is fully completed and tenanted. Depending on the size and complexity of the build, this could mean going without rental income for six months to a year, or even longer. During this period, you’ll still need to cover your mortgage repayments, as well as any other costs associated with owning the land, such as council rates and insurance.

This lack of income can put a strain on your finances, especially if you’re relying on the rental income to help cover your costs. It’s important to have a solid financial plan in place and to ensure you have enough savings or other sources of income to cover your expenses during the construction period. If you own other investment properties, their rental income might help offset some of these costs, but you’ll still need to prepare for a period where your investment property is essentially a financial drain.

It’s crucial to factor in these risks when deciding whether to build an investment property. Ensuring you have a financial buffer and being realistic about the potential for delays can help you manage the period of no rental income more effectively.

The Process of Building an Investment Property

If, after weighing the pros and cons, you decide that building an investment property is the right choice for you, it’s important to understand the process involved. Building a property is quite different from buying an existing one, and it comes with its own set of steps and requirements. Here’s a general overview of how building an investment property works.

1. Securing a Construction Loan

The first step in building an investment property is securing a construction loan. Unlike a standard home loan, a construction loan is designed specifically to finance the construction of a property. Construction loans are usually short-term loans that cover the cost of the build, and they typically convert to a standard mortgage once the construction is complete.

Construction loans are structured differently from regular home loans. Instead of receiving the full loan amount upfront, the funds are released in stages as the construction progresses. These stages are usually:

• Deposit: This is the initial payment made to the builder to commence work.
• Slab Down: The stage where the foundation is laid, including the concrete slab or footings.
• Frame Up: This stage covers the completion of the house frame, which includes the walls and roof structure.
• Lock-Up: At this stage, the external structure is completed, including windows, doors, and roofing.
• Fixing: This involves the installation of internal fittings, such as plastering, kitchen cabinets, and electrical fittings.
• Practical Completion: The final stage where the finishing touches are applied, and the property is made ready for occupation.

As each stage is completed, you’ll need to provide the lender with evidence, such as a builder’s invoice or a progress report, before they release the next portion of the loan. During the construction phase, your loan repayments are usually interest-only, based on the amount that has been drawn down. This can help keep your repayments lower during the build, but it also means you won’t be reducing the principal of the loan during this time.

2. The Application Process

Applying for a construction loan is similar to applying for a regular home loan, but there are a few additional requirements. In addition to providing standard documentation, such as identification, employment information, payslips, and a list of assets and liabilities, you’ll also need to present detailed plans for the property you intend to build.

These plans should include:

• Architectural Plans: Detailed drawings of the property, including floor plans and elevations.
• Builder’s Contract: A fixed-price contract with your builder, outlining the cost of construction and the timeline for completion.
• Specifications and Inclusions: A list of materials, fixtures, and finishes that will be used in the construction.
• Expected Valuation: An estimate of the property’s value once construction is complete, often provided by a qualified valuer.

Having a larger deposit can also be advantageous when applying for a construction loan, as it demonstrates to the lender that you have a solid financial foundation and reduces their risk. Keep in mind that lenders will also assess the builder’s credentials and financial stability before approving the loan, so it’s important to work with a reputable builder who has a strong track record.

3. Managing the Build

Once your loan is approved and construction begins, managing the build is one of the most critical aspects of the process. Good communication with your builder is key to ensuring that the project stays on track and within budget. Regular site visits and progress checks can help you stay informed about the build’s progress and address any issues as they arise.

It’s also important to stay organized and keep detailed records of all transactions, correspondence, and changes to the build. This will not only help you manage the project effectively but will also be essential if any disputes arise with the builder or other contractors.

Finally, be prepared for the unexpected. Even with the best planning, construction projects can encounter unforeseen challenges. Whether it’s a delay in the delivery of materials, a sudden increase in costs, or a change in weather conditions, being flexible and ready to adapt is crucial to ensuring the successful completion of your investment property.

Final Considerations

Building an investment property in Australia can be a rewarding venture, offering opportunities for tax savings, customization, and potential equity creation. However, it’s not without its challenges. The process requires significant time, effort, and financial resources, and it comes with risks that you need to carefully consider.

Before deciding to build, make sure you have a clear understanding of the costs involved, the potential risks, and the time commitment required. It’s also essential to consult with professionals, such as financial advisors, accountants, and real estate agents, to ensure you’re making the best decision for your investment goals.

If you’re willing to put in the work and manage the risks, building an investment property could be a great way to grow your portfolio and achieve long-term financial success. But if the process feels too daunting or if the risks outweigh the potential benefits, buying an existing property might be the better option for you.

Ultimately, the decision comes down to your individual circumstances, investment strategy, and risk tolerance. By carefully weighing the pros and cons and seeking professional advice, you can make an informed decision that aligns with your financial goals and sets you on the path to success in property investment.

Ally Home Loans Pty Ltd is your ally in finance for all of your home loan, investment property, business and commercial financing needs. With our wide range of lending solutions, expertise in financial planning and investment strategies, and extensive experience in working with both Australian residents and Australian expats, we are your partners for your lending needs.

Book an obligation-free, complimentary consultation here today.

Ally Home Loans Pty Ltd is an Authorised Credit Representative (Credit Representative Number – 494608) of My Local Broker (Australian Credit License – 481374). Important Disclaimer: Your complete financial situation will need to be assessed before acceptance of any proposal or product.