An Architect on one of my current construction projects, who knows how passionate I am about all things investing, recently (and when I say recently, I mean 3 months ago when I started writing this entry!) asked me if I had ever heard of NRAS. I admitted that I hadn’t but was obviously curious to learn more about something he personally was interested in pursuing as a first time investor. He explained to me that the Commonwealth & State Governments have implemented an initiative in which they encourage investors to provide affordable rental properties in exchange for tax free offsets and incentives subsequently providing the potential to turn negatively geared properties into cash flow positive properties.

What is NRAS?

NRAS is short for the National Rental Affordability Scheme and it was legislated by the Government in 2008 in an effort to provide affordable rental properties for low to middle-income households. With the population of Australia growing at such a rapid rate, and the prices of homes out of reach of most Australians, there has been an increased demand for rental properties which is consequently creating a shortfall between available properties and those wishing to rent them. The Commonwealth and State Governments have acknowledged this as a serious issue and as such are aiming to provide, through NRAS, 50,000 new affordable rental properties by June 2012. There is speculation presently about whether the initiative will continue past this point, however, regardless of whether it does or not those investors who have opted to participate in the NRAS initiative will continue to receive the benefits for the next 10 years.

You’re probably wondering at this point (as I did) how something as significant as NRAS has managed to fly under the radar. The main reason is that to implement an initiative such as this takes time and resources but furthermore the main target of NRAS was initially larger development companies who could buy and provide rental properties in bulk. It is only recently that smaller and individual developers/investors have been targeted to participate in the initiative.

How will NRAS support the Australian Community and what are the benefits for Investors:

NRAS will provide rental properties that are 25% below the market value. This means that investors who have a property that could be rented out for $400pw, at market value, are now faced with a property that will return $300pw to be eligible for the tax offsets.

Why would anyone in their right mind do this? Well, besides having a social conscious, investors  now have the potential to turn a negatively geared property into a positively geared property through the use of tax offsets (sometimes referred to as rebates) which work as a direct reduction in tax payable. In other words for each dollar of tax offset investors are eligible for their tax payable will be reduced by a dollar, regardless of their taxable income. For example, under NRAS investors will be eligible for approx. $10,000 in tax offsets per annum which means each investor’s tax payable will be reduced by $10,000 per annum.

In most cases tax offsets can only reduce the amount of tax paid to zero which means that investors generally don’t get a refund if the offsets are greater than the tax that is payable, however in this instance the Australian Tax Office (ATO) has nominated NRAS as a refundable tax offset which means that it can reduce the amount being paid to LESS than zero which results in a refundable amount and subsequently provides a positive return on the investment.

Investors also have the advantage of still being able to claim property expenses, deductions and allowances just like any other investment property as well as having the added bonus of applying these deductions against a lower assessable rental income which increases the benefit of negative gearing. This is what people like to call having your cake and eating it too.

Crunching the numbers and costs involved:

Costs are as per all investment properties and will include interest payable on the loan, maintenance costs, rates, insurance, capital gains tax (when/if the property is sold), insurance etc.

An audit process is also undertaken every 12 months which ensures that the property is being rented out in accordance with NRAS guidelines and policies. This will cost approx. $700 per annum but will vary from incentive to incentive. There is also a 10% management fee which compared to the usual 6-8% seems high, however, as part of the management fee there is a guarantee that the property will not be vacant for more than 2 weeks at time which offers peace of mind.

As for returns, currently the Commonwealth government initiative is indexed for 10 years (as per an average of 3.9% based on an annual average CPI for rent) and provides tax offsets of $6,855 per dwelling per year as a refundable tax offset or payment. The state government is providing a tax free incentive indexed for 10 years and currently $2,285 per dwelling per year. Taking all this into consideration the current incentive indexed at 3.9% over ten years equates to $109,228.

Who is eligible to rent the property?

There has been a lot of discussion surrounding the calibre of potential tenants considering NRAS is targeted towards middle-to-low income earners. Whilst it is a generalisation that low income earners don’t make great tenants, especially those going into brand new properties, it is a concern for most investors when looking at NRAS. Having said that, the normal parameters for any tenant still apply; the only difference is those who are now eligible to rent the property. The below table courtesy of Queensland Affordable Housing Consortium outlines the basic income requirements for those eligible to rent NRAS properties.

Any other requirements:

NRAS properties must be close to transport, schools, shops etc. making them desirable for tenants. There are also specified guidelines for the management of NRAS properties, namely that the manager is responsible for ensuring that the tenants meet the income criteria and that they are reviewed against the criteria every two years. If it is found, at any time, that the tenants residing in the property do not meet the strict NRAS criteria investors will forfeit any right to tax offsets and will have to pay back any money accumulated through the tax offsets to the government. This will also occur if investors have been found to not have been reducing the rental costs by the required 25% as per the NRAS agreement. The option to self-manage the property is available, however, the risk of not adhering to strict guidelines is very risky and probably very likely.

The Negatives:

Finding negatives for NRAS seemed daunting at first until I stumbled across some of the more popular property investing forums where I found endless amounts of information on why people think NRAS is not a good investment opportunity, regardless of the endless supposed benefits.

The main topics of conversation circulated around lending and finance. Lending in the current market is getting increasingly difficult and most banks will not lend against NRAS properties. For those that do a larger deposit (at least 20%) is generally required making it extremely difficult for every day Australians to purchase an NRAS property. Whilst NRAS was initially targeted towards developers and larger investment companies the fact that it is now available to the general public goes to the show that the initiative has not been as successful as the Government first anticipated.

Another downfall for NRAS investors is that if at any point in time during the 10 years they should need to opt out of the agreement they can, however, only on the proviso that another NRAS property is available. This means that investors will either need to sell their NRAS property to someone willing to take on the remainder of the agreement OR they will need someone to purchase another NRAS property to fill the gap. Whilst for most investors this isn’t a problem, mainly because they tend to hold for the long term, if something should happen and the investor needed to sell the property it creates more headaches than it is worth.

The majority of NRAS properties, if not all, are bought off the plan which generally means that there is an increased up front sale cost because the property is brand new, a high risker of damage and the capital growth is never guaranteed. In fact one of the biggest arguments against NRAS properties is that while you may be achieving tax incentives for 10 years (and only 10 years) the capital growth will be negligible when compared to non-NRAS properties. How people can know this with the initiative only having been around for 4 years, I don’t know, I can only assume it is due to the stigma attached to NRAS properties. It will be interesting to see the stats on sale values once some of these properties start selling both during and after the 10 year agreement.

Higher admin fees for property management, the complicated tenant process and strict requirements were also seen as negatives by many and whilst these, and the aforementioned are all valid points, my main quandary with the whole process is as follows:

What happens to the tenants renting out these properties when the 10 year agreement expires? Surely once the tax incentives run out investors are not going to continue to rent out their properties for 25% below market value? Whilst the initiative seems good at first glance, it hardly seems thought through for the long term.

Emma