Depreciation can be a useful property investment tool: Mark Armstrong

I was driving in my car the other day when I heard a radio ad from a group that sells brand new property. The ad said the group only recommended properties in areas that have shown growth that is double that of Melbourne’s growth rate.

The statement got me thinking that just because you buy in a suburb that has had strong growth, it does not mean all property in that area will be a solid investment.   

Take a look at the properties below.

These apartment blocks are located in the blue-chip suburb of Prahran. They each have a similar number of units and sit on similarly sized blocks of land. The only difference is that one was built in the 1960s and the other in 2000.   

Two-bedroom apartments in the 1960s block were selling for less than $200,000 in the year 2000. Conversely, the similarly sized apartments in the new block were fetching over $400,000. Investors who purchased one of the new apartments were paying a premium because they were new.

Today, the older apartments are worth about $550,000 and have been growing by about 10% each year relative to their purchase price. Conversely, the new ones have been growing by closer to 5% per annum and are worth approximately $600,000.   

So why has one grown by $350,000 and the other by $200,000 over the same time frame?  

It is because when you buy something brand new, it begins to depreciate - or lose value - the minute it is used.

A new car, for example, starts to depreciate as soon as you drive it out of the dealership.

Residential property is no different. The building itself, along with fittings and fixtures like floor coverings, stoves and hot water systems (to name but a few) loses value over time.

By contrast, the land underneath the building appreciates or increases in value. This is because buildings, fittings and fixtures are replaceable, while land is not.

The ATO recognises that depreciation is part of the cost of holding an investment property, along with expenses like municipal rates, insurance and interest on the loan. Hence, it allows you to claim depreciation as a tax deduction.

In the case of a building, depreciation is claimed over 40 years. For most fittings and fixtures, it’s claimed over five to ten years.