Martin Hawes: Don't be at a loss with rental property investment

In my last column I stressed the importance of keeping yield in mind while investing in residential rental properties.

This prompted a reader to ask whether yield should be only the calculation of rental income divided by the cost of the property or, if the property is negatively geared (ie the income does not cover the property costs), whether tax refunds should also be taken into account.

Investors should be trying to make as much money as they can rather than lose money for tax purposes. One of the first principles of investment is to analyse the investment before tax or gearing are taken into account.

That means in the case of property, to get the yield, the rental income is divided by the cost of the property and then multiplied by 100 to give a percentage. No other items such as tax refunds are considered until you have assessed the worth of the investment and its intrinsic desirability.

An investment must stack up in its own right before tax. The fact that it turns out to be tax efficient should be regarded as a bonus rather than a reason to go into it.

Tax is a political construct and even though property investment does not have special tax rules - it is taxed the same as any other business - there will be increasing agitation to change how it is treated. One day a government is going to cave in.

In fact, much of the problem with property investment at the moment is that most "investors" are going into it with the expectation of losing money.

This is never a good idea. Sure, the loss will mean less tax to pay on your other income which is something of an offset - but you still have a loss. And good investors don't like losses.

It may seem wonderful to get a tax refund but it is better to make money and pay some tax; after all, Inland Revenue does not take all of your profits. The thing that I do not like about residential property at the moment is that it is hard to make a decent cash profit because yields are so low.

If you go into a property investment making an income loss you will no doubt be hoping to make up that loss by way of capital gain. That will probably work out in the long term but may not be so in the next few years. Investment 101 says that you should aim to make money, pay some tax and the capital gain will follow along as a very welcome extra.

* Martin Hawes is a financial adviser. His disclosure statement can be found at www.martinhawes.com