THE
NINE DEADLY
SINS
OF
PROPERTY INVESTMENT
MISTAKE NO. 1
NOT HAVING A FINANCIAL PLAN
This plan should contain as a bare minimum:
1.
2.
3.
4.
5.
6.
Your clearly defined investment objectives
The research tools, market knowledge and capital required to achieve these goals
Your funding strategy (cash, super fund, borrowed, credit lines etc.)
Ownership structure (company, trust, nominees etc.)
Risk management strategy
Asset Management strategy
MISTAKE No. 2
BUYING IN YOUR OWN BACKYARD
Many property investors buy as close to home as
possible…
WHY?
Because they know the local prices, rents and in general are familiar with the area
They also like the region because they live there or holiday there
They can keep an eye on it – in case something goes wrong
MISTAKE No. 3
Emotion - Logic
Your particular taste in property
Proximity to friends / relations
Personal choices , colour. decor etc
Other lifestyle features – holiday region
OR
Demand drivers – shortage of product, underlying demand,
pent-up demand, infrastructure, migration trends, generic
population growth, rental yields, qualitative research
Heart Strings
We tend to fall in love with our properties and
it is perfectly normal to do so, however as
property investors we must learn how to put
aside our emotions and be guided by
independent research and not subjective,
emotive gut-feel.
If a property doesn’t pass the stress-test, it’s
time to move on and look for something that
does.
Emotions do influence investment decisions
and it’s not easy to put them aside! When we
buy with our emotions we are often letting our
feelings rule instead of looking at what the
market is doing.
It’s better to let the numbers make the
decisions for us rather than our emotions!
If we see a property that we simply must have,
before doing anything, get the advice of a third
party - someone who is not in love with it and
is completely non-biased and knowledgeable
about investing in property
Holiday home ~ investment or not..?
The illusion that any beach area is a great investment is fundamentally flawed. Many of us
choose these spots because they are wonderful lifestyle areas, yet most lack the simple
community infrastructure that creates growth.
As such they have no real market drivers. Often they are actually retirement and small tourism
communities which have little prospect for long-term performance.
The assumption that every water way is the next Hedges Avenue in Surfers or Rose Bay in
Sydney is wrong.
Many new property investors or homebuyers that choose this option to enter the property
market find themselves trapped in a non-performing asset for many years. That isn’t to say that
all waterfront areas are poor but unless these areas have an economic underbelly rather than a
speculative hope of change you will be disappointed with the investment performance.
The holiday house
Typically, lifestyle locations tend to have little
or no local industry that creates growth
through employment.
Instead they tend to have a surplus in supply,
which always drives down rental yields and
house values.
Many coastal areas are dependent upon highly
cyclical industries or activities which are
heavily dependent upon external economic
factors such as tourism and retail outlets.
Many banks also have lending restrictions or
just won’t lend on coastal area properties.
MISTAKE No. 4
Relying on AGENTS or others who are selling a product for your research
• Fastest growing area in Australia
• The Renovators Dream
• Buying off the plan at today’s prices
• Flips, wraps and other get-rich quick schemes
Renovations
What is best area to look for
renovation opportunities and
are they easy to do?
Can you create equity out of
thin air?
First and foremost the reno plan needs to offer a profit opportunity – otherwise why would you
do it.? Never do a reno in an area where there is little opportunity to add value
If there is only a small value difference
between renovated and un-renovated
properties in the area you are probably picking
the wrong location.
This usually means that while the suburb is
probably a highly sought after location, some
of the properties in the area might be in need
of an upgrade.
A good reno suburb needs to have a large
price variation between properties that are
sold on the market. An ideal scenario would be
where there is a wide range of prices for
properties that are of similar size and age.
The last critical requirement for an area to fit
the grade of a great renovation suburb is that
it needs to be changing. Renovated properties
tend to be popular when the local resident
base is getting wealthier and the suburb is
being viewed as a more desirable place to live.
This ongoing gentrification process usually
creates a big appetite for renovated
properties.
Another sign of an excellent location to search
for a good renovation opportunity is if the area
is an older suburb that’s close to the CBD of a
capital city or major regional centre.
Queensland - Coorparoo
(4km southeast of the Brisbane CBD)
❚ Median house price:………........................$667,500
Dale Street: for maximum reno potential: Houses
priced around $525,000–$1.04m offer the best reno
❚ 12-month capital growth:………. ....................1.04% profit
❚ Capital growth forecast over 8 years: ……….7% pa
Property count: 25
❚ Rental yield: ……............................................4.18%
Number of properties in that price range: 7–21
Best renovation opportunities
Properties to avoid: Houses priced at over $1.5m
Welwyn Crescent; maximum reno potential: Houses due to high capitalisation.
priced around $636,000–$1.1m offer the best reno
profit
Property count: 29
Number of properties in that price range: 5–15
Properties to avoid: Houses priced at over $1.5m
due to high capitalisation
Coorparoo
Coorparoo enjoys evergreen demand from renters and buyers for the sheer fact that it is conveniently
located. Getting to and from work by public transport is a breeze from Coorparoo Train Station, while the
suburb’s arterial roads connect it with all of the city’s major thoroughfares.
This alone would make the suburb a handy place to consider for picking up a property to renovate, but
other Coorparoo characteristics turn a strong offering into a compelling one. Many of the houses are dated
weatherboard homes, some in the Queenslander style, but because the area tends to attract a middleincome demographic, where owner-occupiers outnumber renters, most properties have been well looked
after.
Owing to the fact that investors can purchase properties with good, solid bones, but that need something of
a modern revamp, the area has become a haven for renovators of late, and sales figures show that there is a
large gap between houses selling at the bottom of the market and those selling at the top. Roughly one in
eight listed properties tends to sell for between $400,000 and $500,000, while just over half sell between
$500,000 and $700,000. The remainder of properties are priced between $800,000 and $2m.
Total number of properties: 4,617 Sales in past 12 months: 183 Current stock on market: 64
Renovating for profit
You need to know the approximate price of what things cost to fix. It means then that you won’t
be fazed by problems that might scare other buyers off, like concrete cancer or a total rewire
job, because you can estimate the cost of repair and factor that in. Having a good idea of costs
means that you can do a rough crunch of the numbers as you are walking through a property
and know by the time you finish whether there’s a profit potential in renovating it.
Think resale all the time - the big no-no’s: buying on a main road or beside a railway line, or a
house that sits below street level… these are what we call “major buyer objections” and there
are a plenty of them. No renovation will ever fix them. Move on.
Is there sufficient scope for improvement. If you can’t substantially improve a property and
uplift its value, whether through a cosmetic facelift or significant structural changes, then it’s not
worth bothering with.
Renovating for profit
Older properties can offer the best pickings for structurals, as there’s obviously more work to be
done. Whereas cosmetic renos are well suited to properties of a certain age and style. You need
to be familiar with what type of renovation works for the particular style of property you’re
looking at, whether it’s a timber cottage, federation terrace or brick semi.
Do your due diligence on property prices in that suburb, you must know what price you need to
get that property for to make a decent return on investment. If when you have factored in all
project costs there’s insufficient profit - walk away. There’s no better way to erode your profit
than pay too much for a property to start with.
Confine your property purchases to a couple of suburbs, so you become a real estate expert in
those areas. Know the best and worst streets, where heritage restrictions apply, where high and
low price pockets are and what style of home that buyers want in the suburbs.
Introduction
Renovating a property can be both stressful and rewarding. It’s a time
when you realize your dreams and bring to life new features in the
property that not only add value but in the case of your own home –
meeting the changing needs of your family for the foreseeable future...
An improvement to real estate can help increase a property’s market
value. This increase however will not necessarily be the same as the
dollars spent on the improvement.
An improvement contribution to the market value is measured by its
affect on the value of the entire property rather than the intrinsic cost of
the improvement.
Remember - it is possible to over capitalize on a property..!!
Most Renovators Over-spend
Types of Renovations
Likely Recovery Cost (%)
1.
Room addition
2.
Major kitchen remodel
85-100
3.
Minor kitchen remodel
75-100
4.
New bath
75-100
5.
Bathroom remodel
60-75
6.
En-Suite
100
7.
Roofing
10-30
8.
Cellar
30-45
9.
Garage
30-50
10. Windows/Doors
100
25-50
18
Types of Renovations
Chance of cost recovery (%)
11. Insulation
0-25
12. Heating system
50-75
13. Decks
75-100
14. Pergola
50-75
15. Pool
50-75
16. Skylight
75-100
17. Ext. painting
75-100
18. Int. painting
75-100
19. Landscaping
50-75
20. Fireplace
75-90
19
Renovating for profit

Buy a property that is suitable for both
resale and long-term holding for rental.
This gives you flexibility in a changing
market.

Always buy properties in good locations –
well located properties still sell in bad
markets while poorly located properties
may not.

Buy at a price that assures you at least a
20% return on your investment after
costs – this not only gives a fair return,
but protects against a fall in the market

Get a flexible finance package – things go
wrong, builders finish late, people lose
their jobs etc.

Don’t rush into the first property you see
– take your time to find the right
property. The more you look, the better
you will get to know the market, the
better your judgement becomes. If it
takes a year to find the right property,
then give it the whole year.
Top 10 Renovation Ideas
Adding an en-suite: best way to increase
a home’s capital value.
More windows and skylights: creating
more natural light.
Refurbishing kitchens and bathrooms:
these rooms age the fastest.
Creation of a home office: more people
are working from home and this area
should occupy one of the best spots.
Repositioning of the kitchen can create
an open plan living area.
Low maintenance improvements are also
popular.
Indoor/outdoor living areas: connecting
the garden with indoors by using glass bifold doors.
Rumpus room: creation of a leisure area
near the children’s bedrooms.
Improved site orientation: opening up the
home to its best aspect.
Parents retreat: near master bedroom,
capable of being used as a guest room.
Cost effective renovations - bathroom, options: paint tiles, builders line
taps, resurface the bath
Cost effective renovations - kitchen
• Cupboards – condition of the
carcasses
• Bench tops – generally well worth
replacing, good dollar return
• Taps – flick mixer
• Sink – a $190 sink looks the same as
a $350 sink
• Tiles – shop around
Cost effective renovations - lounge & dining
• Ornate cornices and
ceiling roses –
centre-piece
• Painting – feature
walls
• Floor sanding and
polishing
• Lighting – LED
Cost effective renovations – decks
•
Wide stairs - % dollar return is high
•
Treated cypress pine
Roofing
Pre-wiring at frame stage & cost effective materials
• Internet
• Pay TV
• Outdoor and indoor speakers
• VJ paneling
• Cypress pine structural timber
• Treated pine handrails
• Steel stair stringers
• Zincalume
Before & After
Before & After
Off the Plan – good or
bad strategy..??
Dark clouds continue to loom over apartment re-sales in
central Melbourne as new research suggests capital growth in
the secondary market looks increasingly gloomy.
Charter’s research director, Robert Papaleo, said most re-sales
experienced stagnant prices and few, if any, had capital
growth above inflation.
The figures indicated that the capital growth of more than
3,000 apartments resold since 1992, after inflation,
represented an annual average increase of just 1.3% over the
holding area
Source – Australian Financial Review
Understand the market cycle for future growth.
Do this by considering the six market drivers
(population, economics, demographics,
infrastructure, yield variation and supply and
demand).
Choose low-density, boutique properties.
Always buy in stage one of a development
because it will be at the best price. Never
consider any other stage. Developers withhold
further stage releases in order to make
additional profits and sell the properties at a
high rate of return.
Buy a property at least 18 months off the plan,
which will allow the property price to increase
and, with just a deposit down, you should secure
100% cash on cash return.
The Swiss have a saying that ‘buying cheap is buying expensive”
Always have the “plan” valued at the
commencement of the contract process. You
need to buy at the plan’s value at the
beginning and not the value at the end.
Valuers call this method “valuation
summation” which involves the cost of land
and the building.
Don’t get in over your head. Buy properties
under $600,000 as they appeal to the entire
market should you be required to sell.
Always plan to settle. Never buy to sell
midway through the project’s construction.
You should always confirm your borrowing
capacity first before entering into an off-theplan contract.
Brisbane Inner-City (Queensland )
Despite the “aura of safety and
respectability” surrounding CBD apartment
markets, Brisbane’s CBD residential
market hasn’t performed well historically.
The city has 69 apartment developments,
of 100 or more units each, scheduled for
the next five years, which “suggests the
situation will get worse before it gets
better.
Off the Plan – Brisbane, Melbourne & Perth apartment markets
• Development costs are high
• Surplus of stock – particularly at the top end
• Small infill projects are the best performing
• Significant increase in supply of sites – medium to high density
Brisbane Development
Hot-Spots
One factor is
the oversupply
of properties
that is looming,
and that’s why
I’d be very very
careful to avoid
buying
properties in or
close to the
CBD.
Another issue
is the standard
of some of
these
buildings, with
reports of
many small
apartments
with windows
that are not
openable, nor
having
particularly
good views.
FORGET the property spikes of recent times, the Perth market is set to
cool in the next 18 months.
Independent
property
analyst’s say
the Perth
housing
market will
“only be for
the brave”.
Low rates will
help keep
people buying
and investors
looking, but
won’t spur on
the market on
its own
Wraps & Flips
A “Wrap” is a term often used to describe a sale on vendors terms to someone who wouldn’t normally
qualify for traditional finance…
A “Flip” is where you on-sell a property before your contract expires and you have to settle the
transaction.
Vendor terms (Wraps)
A vendor terms contract (also known as a
terms sale contract), is a method of buying
and selling real estate where the purchaser
pays the purchase price to the vendor in
instalments, rather than paying the full
amount of the purchase price by way of a
home loan secured by a mortgage over the
property.
The vendor retains the title to the property
until the full amount of the purchase price is
paid, which may be some 25 years after the
contract is signed.
Vendor terms contracts have become more
common recently, especially in the rural
property market, where low-income earners
who are unable to qualify for finance from a
mainstream lender are targeted by property
sales companies offering the chance to own
their own home.
Unfortunately, some unscrupulous companies
are using high pressure sales tactics to
persuade consumers to enter into vendor
terms contracts for the sale of properties not
fit for habitation, at up to three times the price
for which they were purchased by the vendor.
Flipping
Property flipping is an investing strategy where
you sign a contract to buy a property and then
sell your interest to a third party before having
to settle or close on the deal.
Example
Investor 1 finds an absolute bargain of an investment property - he knows that it is worth about
$400,000 – but the seller only wants $320,000 for a quick sale; she needs some quick cash to
settle some urgent debts.
Investor 1 doesn’t have the cash to settle on the property but he does know that he could sell
the deal to someone else who does. He completes a full due diligence before signing the
contract on a 30 day settlement with a deposit of $5,000.
Investor 2 is a property investor with significant means behind her. She offers Investor 1
$390,000 which is accepted. They arrange the dates so that there is a simultaneous settlement
between Investor 1 and Investor 2.
Both feel it’s a win-win outcome..... Investor 2 gets an investment property that fits her wealth
creation strategy and Investor 1 has made a lot of money ($70k) for simply brokering a deal.
Considerations
1. Finding undervalued properties
Capital Gains
2. Finding someone to flip to
Contract sell price:
$390,000
3. Affordability - if you can’t flip the property
before settlement date then you’ll have to buy
it.
Less Contract purchase price:
$320,000
Less Legals:
$ 2,500
4. Stamp Duty
Less Stamp Duty:
$ 14,860
5. Licensing Issues - because you are selling a
property that you don’t technically own and
making a profit as a result, it’s likely that you
are going to need to be a licensed real estate
agent to complete a flip
Less Agent’s fee:
$ 3,000
Capital gain:$49,640Capital gains tax @
48.5%=$24,076(assuming top marginal income tax
rate)
After tax profit:
$ 25,564
Lunch Break
Finance, valuations & ownership structures
Kev Pardella
LTG Goldrock Mortgage Broking Service
Kevin Pardella – has been providing lending
solutions for 35 years. He is a full member of
the Mortgage and Finance Association of
Australia (MFAA) and a founding member of
the Finance Brokers Association of Australia
(FBAA).
Kevin holds a Diploma of Financial Services
(Financial Planning), a Diploma of Mortgage
Lending and a Certificate IV in Financial
Services (Finance/Mortgage Broking). He is
also the holder of Australian Credit Licence
No: 383434.”
He is also a Senior Associate of the Financial
Services Institute of Australia (FINSIA) and an
Affiliate Member of the Financial Planning
Association of Australia (FPA).
Through his membership of Australian
Finance Group (AFG), Kevin currently holds
accreditations with over 25 lending institutions
including all major Australian Banks and many
Building Societies, Credit Unions and Non Bank
lending institutions, in order to provide a wide
range of competitive products for his Clients.
MISTAKE No. 5
Paying above market price:
$400k
($30k)
$430k
That extra $30k if it is borrowed money this will cost you an extra $100k in interest over 25 years.
Most property investors rely on the selling agent to determine the purchase price instead of commissioning and
independent appraisal
Property Values & Valuations
Source: Propell National Valuers)
Most property investors use borrowed
funds when investing in residential
property – irrespective of whether we are
buying for a long term hold or short term
renovation, when you borrow the Lender
will invariably request an independent
valuation for the property...........in this
session we look at the process and
highlight the main considerations. It’s
inevitable that novice investors – and even
many experienced ones – will make
mistakes. The challenge for us all is to limit
the mistakes and where possible learn
from others who have travelled the road
before us...
No.1 Fundamental
Banks will lend on the LOWER of the valuation
figure or the contract purchase price.
The valuation figure on a purchase will not
always be the purchase price. A variance of
more than 10% should be critically examined.
Banks will lend on the LOWER of the valuation
figure or the contract purchase price.
The valuation figure on a purchase will not
always be the purchase price.
“A bank valuation will be conservative”
A bank will engage an external valuer to
provide an unbiased valuation on the
property. Valuers must act independently and
should not be influenced by the party seeking
the valuation or concerned with the reasons
why a valuation has been requested.
A valuation report can be challenged in court
and must be backed by comparative market
data, therefore a valuer must be able to justify
their valuation figure by providing evidence of
comparable sales in an area.
In compiling a valuation report, valuers must
adhere to a strict process heavily reliant on
factual data and appropriate methodology.
"Market value is the same as sale price"
Market value is an estimate of the price a
property would likely attract in a rational and
competitive market place. Sale price is the
actual figure a property is sold for.
The reason for disparity between a valuation
and sale price could result from human factors
relating to the sale. A buyer may feel a
personal connection with a property and
happily pay above market value, or
alternatively, a seller may have personal
circumstances which compel them to sell
quickly and accept an offer below market
value.
“The Valuer didn’t spend enough time in a home to give a
reasonable valuation”
Before visiting a property a valuer will
undertake extensive background research on
the local market. Valuers have access to
software and data which allows them to check
recent sales data in your area and will have
knowledge of comparable properties.
When the valuer arrives at the property they
will have a very specific checklist of items they
are looking for and may only require 20-30
minutes at your property to compile this
information. The additional research the
valuer has undertaken will be evident in the
valuation report.
“The valuation doesn’t reflect the recent makeover”
Buyers have very personal preferences
when decorating and will often use
extreme / loud colours or products for their
improvements.
These won’t appeal to all and Valuers do
consider current design trends....for this
reason neutral colours present best.
Exotic colours and furnishings can have a
negative impact on valuations.
Remember that you rarely recover the cost
of the “gold taps”
“Extra bedrooms = extra value”
Many property owners make the mistake of
believing their property is worth more than
another in their area because it has more
bedrooms.
Thirty years ago this certainly was a
consideration when home design was less
sophisticated and family sizes on average were
larger. In today’s market, property owners
often choose to convert a spare bedroom into
a study or office, home theatre or storage
room
There’s a trend to convert garages to
bedrooms to accommodate older teens and
adult children with personal space away from
the main living area. When comparing two
properties, especially units, total floor area
may be a better indication of value rather than
the number of bedrooms in a dwelling.
Valuers also consider location-based factors
such as street appeal, street access and views
when comparing properties
“Swimming pools don’t add value”
This is a generalisation which cannot be
applied to all properties. In some areas there
is evidence that buyers are prepared to pay
more for a pool, however in other areas this
may not be the case.
Prestige homes or suburbs catering to families
may see the added value in pools, whereas
inner city or coastal properties may not.
If there is one it should be well maintained
and landscaped to maximise value.
“Property prices never go backwards"
This view is often held by young investors who have only experienced strong market conditions.
Many parts of Australia were fortunate during the 2000's to experience an unprecedented boom in
property prices that seemed like it might continue forever. While in the long run property markets tend
to go forward due to scarcity of land and increasing population, they tend to be cyclical in nature and
often go backwards in the interim as experienced in late 2008 into 2010.
Economic factors both domestically and internationally can have a rapid and damaging impact on local
property markets. A severe economic downturn in China, for instance, could see a decrease in demand
for Australia’s resources. In some mining communities that would likely result in a decrease in property
prices and rental yields.
I saw six men kicking and punching the mother-in-law.
My neighbour said ‘Are you going to help?’ I said ‘No, six should be
enough.’
Billy Connolly
MISTAKE No. 6
Incorrectly structuring the Ownership
Tax deductions for expenses and depreciation
schedules are critical to the overall
performance of the package
Plus….
Capital gains tax should be minimized through
appropriate ownership.
OWNERSHIP STRUCTURES
Individual - Joint - Tenants in Common
Trusts
Companies
Super Funds
Each of these structures has a differing
effect on personal tax, CGT and
asset protection.
Individual Ownership
1. Owned and controlled by one person
2. Any net income/loss assessed at the owner’s
marginal tax rate.
3. A CGT concession of 50% of the capital gain
applies on disposal.
4. Assets are fair game for libelous action.
5. Property forms part of the individual’s estate
on death.
66
Individual Ownership
A large taxable capital gain may push an
investor into a higher tax bracket.
The investor could plan to dispose of the
property at a time when he/she can manage
to reduce the marginal rate of tax say, just
after retirement.
The adjusted capital gain will now be taxed at
a lower rate hence reducing the tax liability.
67
Joint Ownership
Two or more individuals own equal shares.
All income/losses distributed to the owners in
accordance with their holding.
Each other’s assets are still at risk.
On disposal, CGT is attributed proportionately.
If one owner dies, their share is distributed equally
to the other owners.
For CGT purposes, surviving owners deemed to
acquire their portion at the date of death.
68
Tenants in Common
Two or more individuals own predetermined
portions of the asset.
All income/losses distributed to the owners in
accordance with their holding.
Assets are still at risk.
On disposal, CGT is attributed proportionately.
69
Tenants in Common
Individuals have the ability to sell their interest
to others.
If one owner dies, their share passes to their
estate.
For CGT purposes, the estate is deemed to
acquire that portion at the date of death
70
Trusts
A trust is a legal entity created to hold assets
on behalf of beneficiaries.
It has its own set of rules called a Trust Deed
and is controlled by a trustee/s.
Trustee/s may be two or more individuals or a
corporation (company trustee) controlled by
one or more directors.
There are different types of trusts….
71
Trusts….
Trusts cannot distribute losses to
beneficiaries. The loss is carried forward and
offset against future income.
The CGT concession applies to gains
distributed to individuals.
Assets are quarantined and protected from
any litigation against the trustee or
beneficiaries.
Any funds remaining in the trust attract tax at
the top marginal rate
72
Family Discretionary Trusts
Used mainly for Tax and Asset protection.
Trustee holds assets and conducts business on
behalf of the trust.
May have any number and class of beneficiary.
Beneficiaries have no claim over the assets in
the trust.
73
Family Discretionary Trusts
The trustee controls the regular distribution of
income generated in the trust and eventual
distribution of assets.
The distribution may vary from year to year as the
trustee decides.
Trust distributions are taxable in the hands of the
beneficiary.
74
Fixed Unit Trusts
Distributions are in accordance with the
number and class of units held and cannot be
altered from year to year.
Suitable structure for unrelated parties.
On disposal, asset gains are also distributed
according to shareholding.
Units may be sold. This may activate a CGT
event with possible stamp duty liability.
75
Hybrid Trusts
A combination of a Discretionary Trust and a
Unit Trust.
Gives the trustee/s the ultimate flexibility in
distributions.
Although beneficiaries hold units, the trustee
can vary the income distribution year by year.
Can overcome some of the capital gains
distribution problems.
76
Plan to tax trusts is doomed
Long-term plans to tax trusts as companies are all but dead after the Board of
Taxation yesterday recommended against any major reform of the sector.
Source: Australian Financial Review
77
Companies
One or more Directors.
Can pay franked dividends.
No distribution flexibility.
Company owns property in its own right.
No CGT relief available.
Complex estate planning issues.
Not a desirable form of property ownership.
78
Politicians understand the value of negative gearing…
The Sydney Morning Herald reports Australia’s
politicians are among the country’s most
enthusiastic real estate investors.
Federal politicians on average own 2.5 properties
each, or an estimated $300 million worth of land
holdings.
Only 13, or 6 per cent, of Parliament’s 226 members
own no real estate.
National’s senator Barry O’Sullivan is Parliament’s
biggest property owner with a 50-strong investment
portfolio and National’s member David Gillespie
owns 17 holdings
Tax Office statistics show nearly one in every seven Australian taxpayers owns investment property and one in every
10 is negatively geared
Billionaire Clive Palmer is also high on the property
investor list, with 12 properties to his name.
Independent South Australian senator Nick
Xenophon owns 8 investment properties, and
Liberal Communications Minister Malcolm Turnbull
also owns 8 properties.
Victoria’s politicians are also keen property
investors, but fall short when compared with their
federal counterparts.
The state’s 128 MPs own, on average, 1.8 properties
each, with a combined value of about $146.5
million.
MISTAKE No. 7
Selecting the incorrect finance package:
Cost of funds
Split account
Administration
Mortgage Reduction Plans
Understand the ATO Rules
For many years , the No.1 strategy when
arranging residential investment property
finance was to capitalise interest on a taxdeductible loan and to accelerate repayment
of non-deductible debt. Using the rental
receipts from an investment property to pay
off the family home.
This arrangement effectively stripped years off
the repayment period for the loan – 10 to 15
years commonplace. For obvious reasons this
scheme proved immensely popular and was
subsequently mass marketed by the finance
broking profession and property marketing
groups.
In June 2011, the ATO issued a draft ruling
stating that it could apply Part 4A to any
“scheme” relating to the financing of
investment properties whose primary purpose
is to reduce tax liabilities or “to pay off your
home loan sooner.” Whether it would attempt
to do so will depend on the circumstances of
each individual case. Since ANY arrangements
to finance the purchase of an investment
property are effectively “a scheme,” the ATO
are clearly trying to cast a wide net.
But what the ATO is in fact saying is that it
doesn’t like the capitalisation of interest on
deductible loans at all.
Capitalisation of Interest
Clearly, the ATO cannot proscribe this.
Otherwise, every business overdraft operated
by any company for the last 100 years would
need to be unwound.
But it is actively on the lookout for anything
that looks sufficiently like a split loan
arrangement that it can be said to be primarily
for tax minimization and therefore subject to
rejection under Part 4a.
There has never been any question that the
legitimate expenses of owning an investment
property could be charged to the deductible
loan account.
These expenses include management fees,
strata levies, insurance premiums, repairs, etc.
Because of this ruling there is now a huge
amount of ‘grey area” between what is and
what is not allowed - in terms of finance
structuring for investment property
acquisitions.
Structuring investment finance is not a
simplistic exercise and the task should only be
given to experienced and trusted
professionals.
Cross securitising
Cross-securitisation occurs when a lender takes all of your
properties as collateral when giving you finance. In other
words, all of your properties are under one or more blanket
loans with one lender.
Most banks have clauses in their home loan documents that
entitle them to review any one of your home loans with them
at any time and ask for additional funds. This can happen if
the bank believes that the value has decreased or that your
debt has climbed too high.
This clause also entitles them to force you to use any other of
your properties as security in order to provide the bank with
the additional funds necessary to re-secure the loan in
question.
In other words, all properties are security for all loans. This
can severely limit your investing future.
Separate funding = independence
Your ability to borrow is tied down if all of your properties are financed with one lender. If, for
example, you want to borrow more than 80% the premium for the LMI is calculated on all of the
money you have with that lender, not just the amount you’re currently seeking. This can add
thousands to your borrowing costs.
If you want to sell off one of your properties and keep the equity you’ve earned, the lender
could require that you use all of the money you gained from the sale to repay your debt rather
than allow you to only pay off the portion that was secured by the property you sold.
The “all monies” clause (which most loans have) gives your lender the option to re-assess the
risk you present to their interests at any time, e.g. you want to borrow to purchase a new
property. The “all monies” clause gives the lender the ability to revalue all of your properties,
risking the possibility of properties with lower valuations offsetting those that are higher,
resulting in a significant reduction in your available equity.
Better Strategy
Spread your loans among a variety of lending
institutions.
This gives you much more flexibility in handling
your finances.
You’ll have the ability to choose which
properties you want to strip equity from which
can be put towards continuing to grow your
portfolio.
How would you like to be able to borrow more
money.?
Perhaps enough to buy a nice investment
property or even two properties instead of
one.?
In this session we consider the case for using
Lenders Mortgage Insurance as a tool to help
build your property portfolio
Show me the money..!!
What makes property a good investment.?
Residential property is a stable investment that
produces strong long term capital growth.
Russell investments recently reported that
Australian residential real estate grew by an
average by 9.95% per annum over the last 20
years, significantly outperforming shares.
Residential real estate is the only asset class
dominated by non-investors (home owners)
which makes it a more stable market underpinned by the fact that 70% of Australians
own their own home and half of these don’t
have a mortgage on it.
What makes property a good investment.?
Another distinct advantage with residential
property is that you can gear up (borrow)
more than any other asset class.
Banks simply won’t lend you more than 50%
against shares but they may lend you up to
95% of the value of a well located property.
As we all understand gearing up can magnify
your capital gains - but if you get it wrong it
can also magnifies your losses!!
Greater leverage – why?
In simple terms the banking industry see
property as a less volatile investment and
because they have been lending against real
estate for hundred’s of years their experience
confirms it as a low risk lend.
How do we take advantage of this?
If your credit record shows you as a financially
responsible person and your risk profile is
good, you can accelerate the growth of your
property portfolio using leverage – and put
less of your own money into the deposit and
use more of the bank’s funds.
Lenders Mortgage Insurance (LMI)
If you buy with less than a 20% deposit the
banks will usually need to insure the loan –
this is called Lenders Mortgage Insures (LMI)
Lender’s Mortgage Insurance protects lenders
(the bank) from the risk of the borrower (you)
defaulting on their loan repayments.
You pay a once-only insurance premium at the
start of the loan – this varies depending on the If you default on the loan the security property
size of the loan, the loan type and the amount
may have to be sold as a result of that default.
of your deposit.
If the net proceeds of the sale don’t cover the
The cost of this insurance premium is often
full balance outstanding on your loan, then the
added to the loan amount so you don’t have
insurance company pays the shortfall to the
to come up with additional cash over and
bank – after which, they will come to you to
above your deposit.
recover the full extent of their losses.
Why consider LMI.??
Mortgage insured loans can be used effectively to create financial leverage’- e.g. you own a home worth
$550,000 and to still owe $250,000 and you want to take advantage of this equity.
A typical conservative gearing strategy would be to apply a 80% Loan to Value Ratio (LVR) and release a
deposit of $190,000 ($550,000 x 80%= $440,000 less your existing mortgage of $250,000 = $190,000)
This represents a 20% deposit for a property valued at $950,000 (also an 80% LVR.)
However with a 90% LVR strategy (a much more aggressive gearing strategy) the equity available in your
home would increase to $245,000, which allows the purchase of properties with a value of well over $2
million at 90% LVR.
The missing link of course is your ability to service the loans and purchase costs etc. We are simply
illustrating the point that the ability to borrow at a higher LVR substantially increases your purchasing
power.
First time investors
LMI can be a great way for first time investors
to get into the market sooner rather than later.
As many property markets are currently rising
faster than some beginners can save a 20%
deposit - the ability to buy your first
investment property with just 10% or some
times even 5% deposit may make the
difference between having your foot on the
property ladder or not.
For most, it’s just another cost of doing
business and you can actually claim the
premium as a tax deduction.
The deposit gap
Should I or shouldn’t I...?
There are some mixed views on the merits of
taking out a low deposit loan. On the plus side,
it helps buyers enter the market sooner and
enables them to enjoy the upside of
subsequent price increases.
These benefits include building their equity as
property prices go up and not falling victim to
a widening deposit gap which increases as
prices increase.
Another benefit is that most low deposit loan
products come with the same features as
mainstream loans so borrowers aren’t
disadvantaged as far as choice is concerned
On the negative side though, these
types of loans tend to be more
expensive (interest rate, fees and
Lenders Mortgage Insurance plus a
tighter underwriting criteria, especially
for the self-employed...
So - should you take out a low deposit loan.??
Is taking out a low deposit loan a good thing? In an ideal world the answer is probably no.
However - we live in the real world and so the answer is a qualified yes, providing the following
is met:
1. The loan is affordable
2. The lender is reputable and understands and has experience with low deposit borrowers .
3. Loan terms and features are identical to those available to borrowers with larger deposits.
4. The interest rate and other costs are comparable to mainstream loans, albeit they may be
slightly higher – but they should not be unreasonably higher. As soon as you can demonstrate a
good repayment track record and build up equity you should look to renegotiate your interest
rate or refinance, if you’re paying above standard rates.
Funding your purchase (understanding the options)
1. Understand the lending process
2. Understand the valuation process
3. Evaluate and select the correct type of loan
4. Consider the loan structuring options
5. Consider the taxation options
6. Be aware of the potential problems
7. Consider the ownership options
Early Mortgage Payment Strategies
In simple terms – make extra payments
On a loan of $300,000 (@7%) an extra payment of $100 per
month will save you $68,795 in interest or 4 years and 4 months
in payments.
Pay fortnightly – pay half your monthly payment each fortnight:
On a loan of $300,000 (@ 7%) you will save $102,789 in interest
or 6 years and 3 months in payments.
Use an offset account:
$5,000 in an offset account will save you $32,922 in interest. If
you combine this with a fortnightly payment plan you will save
$122,738.
MISTAKE No. 8
Buying the wrong type of product.
Land is critical to capital growth
Units - low maintenance but low capital growth unless there is a stand-out feature.
KANGAROO POINT:
$100,000 invested in 1981 in units
= $300,000 today
$100,000 invested in house and land = $975,000 today
HOUSES ~ PRODUCE INCOME
LAND ~ PRODUCES CAPITAL GROWTH
Growth & Income Equation…
High growth usually means low income and
vice versa.
For example: Over a ten year period….
Yield
CG
Total
Paddington
3%
12%
15%
Blackwater
9%
3%
12%
Capital Growth or Rental Yield
Strong capital growth is usually the No.1
choice because of the potential to generate
long-term capital profit.
However, rental yields on high growth
properties tend to be low which means these
properties are almost always negatively geared
(that is, expenses (like mortgage interest and
other costs) exceed the rent earned).
Whilst this provides the investor with some
useful tax breaks (under current tax
legislation) it still means you will be out of
pocket each month until the property is sold.
Conversely, properties with a higher rental
yield , usually provide for a positively geared
investment property (that is, where the rent
exceeds all costs) meaning the investment
pays for itself.
It also means the property is generating cash
reserves which can be used to pay down the
loan or for any other purpose.
The downside is that when it comes time to
sell, the capital gain is likely to be substantially
less than that of the strong capital growth
property.
High Growth Strategy
What is a realistic expectation.?
Good suburbs have historically registered
growth rates of inflation plus 4% - 5% pa over
the long term. So it is reasonable to project
growth at between 6.5% to 7.5%.
The inherent risk with a growth strategy is that
you’ll likely be out of pocket while you hold
the investment and as such you will be subject
to interest rate risk.
Increases in mortgage rates can be painful,
and you need to consider the “lag-factor” for
rent increases.
There are of course, ways to minimize this risk,
such as taking out a fixed rate loan.
A strong capital growth strategy places all your
eggs in the one basket insofar as all the profit
will be made sometime in future when the
property is sold.
In the meantime, investors will typically run at
a loss and with negative cash flow.
High Rental Yield Strategy
A high rental yield strategy is all about
generating positive cash flows which help
protect you from interest rate shocks and
significantly reduce the potential need for
ongoing cash injections.
This is a less risky investment strategy and as
result, the overall return (due to the lower
capital growth) is normally not as great. There
may also be the need to pay tax if the taxable
income is greater than the allowable expenses
(including depreciation) thereby reducing cash
flows to the investor.
Rental yields can vary but yields considered
high are usually in the vicinity of 8 per cent
to 10 per cent whereas for high capital
growth properties rental yield is typically
anywhere between 4%-5.5% (even lower in
some cases).
Growth Vs Income Comparison
To illustrate the point let’s assume we have a
choice of two properties both costing
$400,000.
Property A has an expected capital growth rate
of 7% pa plus a rental yield of 4%
Property B has a capital growth rate of 4% and
a rental yield of 7%.
Acquisition, finance and holding costs are the
same. The following table illustrates what the
financial situation might look like after fifteen
years.
Property A’s value after 15 years is substantially greater than Property B’s (almost 50 % more),
Property B would generate significantly more cash during the course of the investment.
Note that the rent differential narrows after fifteen years on the basis of the superior capital growth .
Capital Growth or Rental Yields
Can you have a property that delivers strong
capital growth and a high rental yield at the
same time.??
The answer is yes – however it is an extremely
rare occurrence and more often than not you
have to decide between one or the other
when formulating your property investment
strategy.
By and large the choice will be driven by your
own personal and financial circumstances.
Summary
So which is the best option? Both strategies
provide for good overall returns and a profit
but they do represent quite different
strategies with different financial rewards and
risks. The answer boils down to individual
needs and objectives and this is best
determined by a detailed financial analysis.
If you are running a portfolio of properties it
might make sense to include some high
yielding ones and use the surplus cash to cover
net outgoings for low yielding properties. This
would help you balance your portfolio.
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