Investor Alert: Reality Bites

There’s no doubting Australia’s love affair with renovating, a fact which producers of reality renovation TV shows have jumped on.  While these types of shows offer great entertainment and possibly help reignite interest in the property market, the reality is that they don’t get down to the details when it comes to profiting from the exercise.

As a viewer, you’re in dangerous territory if you think it’s easy to make money renovating because what these shows promote is not quite reality. At the conclusion of each of these shows, even though some properties appeared to turn a profit, it’s extremely unlikely that any of the properties actually made a real ‘on-paper’ profit. That is, if you or I were in their exact same shoes as a private investor and did the sums at the end of the day, we’d be walking away with a loss.

It may sound like I’m against renovations, but that’s far from the truth. However, I do believe that if you are going to incorporate renovating into your investment strategy, then you need to know what you’re doing or you’ll end up in the same boat as these contestants. These shows don’t communicate the real costs and underlying fundamentals of renovating property for a profit.

They tend to gloss over other costs involved such as stamp duty, selling agents commission, interest and other holding costs and capital gains tax. Not to mention, many of the contestants on these shows won prizes such as a pool or appliances package or had the help of free labour, which wouldn’t have factored into the bottom line either when a supposed ‘break-even’ point was quoted for the properties. If these very real costs were taken into account, the financial outcome would be even worse.

Renovating successfully is also about more than just the sweat and tears of turning an ugly duckling into a swan which is what these shows focus on. In the real world, not every run-down house is a good renovation candidate and it all comes down to accurately crunching the numbers before you even think about getting out your cheque book. Seasoned renovators know that there are three numbers that must stack up – (1) the purchase price, (2) the total cost of renovating and (3) the projected sales price. If any one of these figures is off the mark, any potential profit will quickly dwindle away.  

In the case of these renovation shows, the lackluster sale results are most likely due to mistakes in one or more of these three areas. If too much was paid for the properties (note: they don’t need to be overvalued, even market price can be too much for a renovation project), then even if they got the other two aspects right they would probably still be up for a loss. This information is something we aren’t usually privy to when it comes to reality TV so we can only guess whether this was a contributing factor.

I believe many of the properties went wrong by spending too much and overcapitalising on their renovations. As an investor, you should spend what you need to spend to meet the market’s needs and turn a profit, not to meet a pre-determined budget. In some cases, the contestants may have found that spending less and doing a more pared back renovation without the expensive structural changes could have made some of these properties profitable.

The last area that worked against some of the contestants was their final sales price estimations. It became clear that many of them had over-ambitious expectations, with some even predicting their house would break records for the area (a risky strategy at the best of times, let alone in today’s market). This is a sure sign the contestants started becoming emotionally involved with their project, a big no-no. You will only ever receive what the market is willing to pay and in virtually all cases it was nowhere near their estimations. This doesn’t just leak away your profit, but the belief leads you to overspend further on your renovations which can make the situation worse.

If these renovation shows got you excited about starting your own project, then that’s great. But remember that renovating property successfully is not as easy as picking up any old tired property, slapping some fresh paint on the walls, transforming it into a modern masterpiece, and then selling it off for a profit.  Reality TV is about entertainment not education so get your inspiration, but make sure you mix it with a good dose of ‘real’ reality.

Acquisitions:  Winning Auction Strategies

With auctions not being particularly popular in WA, many investors are inexperienced when it comes to participating in auctions and securing the best property deal. This can lead to investors either overpaying at auction or even skipping the auction altogether and missing out on a good property investment simply because of fear of the unknown.

Firstly, you must be absolutely certain about the property before bidding at an auction. Standard auctions don’t allow for a cooling off period or for conditions such as finance approval or pest inspections. You will also need to be prepared to pay a deposit on the day should you win the auction.  

Bargain properties can certainly be found at auctions but the emotion and intensity often leads people to dramatically overpay. Here are four key rules to ensure you secure a good buy:

1. Keep your cards close to your chest

Don’t tell the agent what you think the property is worth or how much you’re willing to pay. Play down your interest in the property as this information will be conveyed to the seller when it’s time to consider the reserve price they set. The less an agent knows and the fewer interested bidders they’re aware of, the less the reserve may be, especially if the vendor is anxious about selling the property.

2. Set your limit and stick to it

There may come a time when agents will push you to go just that little bit higher with the temptation that it might secure you the property. One $1000 bid more might not seem a lot, but where do you draw the line? These extra bids quickly add up and before you realise how much you have bid you have stretched your limit often by at least $10,000. If you don’t think you can stick to your limit, send someone else you trust such as a friend or buyers’ agent to bid on your behalf. Successful investors know it’s all about the numbers so if you can’t secure the property at the price you set, you should just walk away.  

3. Wait until the reserve is met

There’s no real point bidding before the property is on the market as it does nothing except play into the hands of the seller by pushing up the price. Be aware that in WA, auctioneers are also allowed to place vendor bids which are bids on behalf of the seller (auctioneers must openly disclose these to the crowd). These cannot be made after the reserve has been met. And even though dummy bids are illegal (false bids used to artificially inflate the price and not made by a genuine buyer or disclosed by the auctioneer), that’s not to say they don’t still happen. These just bump up the price further and give other bidders the impression of more competition pressuring them to bid higher. The less activity that occurs by bidders, the better it is for the potential buyer as the vendor will be feeling the pressure and be less resolute in sticking to their original price expectations, whether that’s during the auction or afterwards should it be passed in.

4. Be in control

Position yourself close up at the front or side of the auction to give you the opportunity to watch the crowd as much as the auctioneer. This will help you assess the competition. Portray a cool, calm and collected exterior regardless of how you really feel on the inside and bid with total confidence. Bid immediately after another person has bid to intimidate your competitor who may assume by your actions that you have plenty of money to spend and will secure the property at all costs. 

Property Development:  Doing a Pre-Acquisition Feasibility Study – Part 2

The analysis of Place involves assessing the physical location of the property. It requires a two-fold process investigating the property firstly from a ‘macro’ point of view and secondly from a ‘micro’ level. 

The ‘macro’ analysis involves looking at the potential development’s location from a wider and more general perspective. Ask yourself this basic question – “is this the right place for the project?”. You need to look at fundamental supply and demand issues and work out if the area you have chosen is going to provide long term growth or high rents depending on your goals.  For example, history has shown that properties along coastal areas experience higher growth than those in inland locations.

When assessing from a macro perspective, also take notice of what big businesses, large developers, retailers and councils are doing. Is there a major shopping centre undergoing a large redevelopment? Where are big commercial projects being built? Are more and more swanky cafes and restaurants opening up in a certain area? What suburban renewal programs are local councils thinking about for the future? These organisations spend significant sums of money researching the market before investing, and if you can tap into this knowledge early you just might be onto a winner.

Secondly, you need to look at your project from a micro perspective. This involves assessing your development at ground level and investigating its immediate surrounds. Do some digging and find out whether there is any state housing surrounding the property. What is the streetscape like? Will it appeal to the type of buyers for your property? What types of homeowners are positioned around your property – are they a positive or negative factor? What features would attract buyers to this property’s location – is it walking distance to a school or shopping precinct, is there easy access to public transport, etc? Even consider if this property is well located from a solar aspect. Does it get plenty of natural light? Is it protected from strong coastal winds? This micro analysis will help you ascertain if this individual property is ripe for development, or whether you should move on to look at others in your chosen areas.

The last P that needs to be assessed is that of Promotion. The importance of Promotion will depend on whether you are developing to sell or developing to hold. If you are planning to hold then naturally your focus is longer term and your interest is on renting it out.  But if you are selling, then you need to have a marketing strategy in mind before you purchase the property (depending on the scale of your development). Consider how much money you will need to budget to adequately promote your development. Will you need materials like signage and brochures? What about a website? How much is advertising going to cost?  Will you be using a sales agent – who will you use and how much will their services set you back? And don’t forget about the importance of naming your development – a name should suit your development and appeal to the emotions of prospective buyers.

A thorough market analysis that includes completion of a Real Estate Market Analysis covering the ‘4 P’s of marketing’, is one of the most critical stages involved in property development. Get it right and you could be just one step closer to your retirement, but get it wrong and you could end up knee deep in debt.

WA to Prop Up Entire Nation’s Growth

By 2015-16, the report predicts that the value of WA’s exports will almost double. Average weekly earnings and population growth are also expected to outshine all other states as the west continues to benefit from the insatiable demand of China which is managing to offset slowdowns in Europe and America. The strength of the WA economy and its resources sector appears to be poorly understood nationally despite Deloitte’s analysts suggesting the state is heading towards a boom like the one experienced in 2007 and 2008.

“The rest of the economy could pack up and go home and the announced capacity expansion pipeline could still keep growth going for the better part of a year,” it says.

The volume of investment projects either underway or planned is “simply staggering” according to the report, underpinned by two major LNG projects backed by Chevron. One of these, the Wheatstone project valued at $29 billion, was just approved in September 2011.

The strength of the resources sectors continues to grow with BHP Billiton reporting its West Australian iron ore shipments have jumped by 28 per cent to a record 173 million tonnes a year. Fortescue Metals Group also posted a record quarterly export figure for the September quarter, of 12.36 million tonnes, an increase of almost 21% on the same period last year. Even the retail sector in WA is on the up with 9% growth over the past year, five times the national rate.

Any worries of a renewed global financial crisis have simply shaved some growth expectations off both WA and China which Deloitte’s believe is a welcome relief. They anticipate the slight slowdown will enable both China and WA to stay closer to their supply side potential and manage a more sustainable level of growth over coming years.

“Earlier outlooks for both China and WA were too strong for our liking, leading us to warn of rising inflation and skill shortages in both regions.

“Now China and its best global supplier – WA – are set to grow at more sustainable rates in the next year or two”.

Current Property News:  Market Commentary

Strength of economy supported by latest jobless figures:

The economy has once again defied gloomy forecasts by posting a decrease in the national unemployment rate for the first time since February this year.

Jobless figures released by the Australian Bureau of Statistics show the national unemployment rate fell from a 10 month high to 5.2% in September 2011. 20,400 jobs were added to the economy in September, more than double what economists were predicting.

The figures also show that Western Australia has again managed to retain its title of the lowest unemployment rate of all states, with the rate falling to just 4.3% for September.  Almost 14,000 extra full-time jobs were created and the total number of females in full-time work grew by almost 10,000. Experts are anticipating that WA’s unemployment rate will fall below 4.0% by next year courtesy of the burgeoning resources sector.

Some other states didn’t fare so well. In New South Wales, the jobless rate rose to 5.5%, Victoria rose to 5.3% and South Australia also rose to 5.6%.

Australia continues to do well in relation to many other developed nations around the world. In comparison, Britain’s unemployment rate stands at 8.1% for September, up from 7.9%.

Hot Property

Overview:

Buyers’ Agents don’t just come in handy for investors. Our client had previously used our service to find an investment property and was now looking to upgrade their home and chose to call on our help once again. The client did the legwork in locating properties throughout key areas south of Perth, and used our Buyers’ Agents to help research and evaluate potential opportunities and negotiate the eventual purchase.

After evaluating a number of properties our Buyers’ Agents recommended a modern street-front townhouse in Mount Pleasant. The suburb offered good value compared to nearby areas, with a number of newer homes being built and an enjoyable lifestyle for the client. The selected property also featured higher land value, was elevated with river glimpses, and was surrounded by better quality homes which made it superior to other opportunities considered.

Our Buyers’ Agents commenced negotiations to bring the price down from a listed price of “mid-900’s”. After six weeks of tough negotiations, the property was finally secured for $870,000, under estimated market value. The new owners have decided to rent out the property for now (renting at $150 more per week than anticipated by our Property Wealth Management Division by negotiating on special conditions) while they ride out the market to sell their current home. This strategy ensures they receive a good discount on their buy in the present market, while being able to hold out for a higher price on their current home to close the financial gap of upgrading. 

Result:

Purchase of a street front 3×2 plus study brick and tile townhouse in Mount Pleasant, 9km from Perth CBD.

Purchase price: $870,000

Estimated market value at time of purchase: $880,000 – $900,000

Savings: $10,000 – $30,000

Finance:  Using Credit Subsidy 3 – The Tax Payers

Successful investors know that capital gains are the way to true wealth. Firstly you do not pay the tax until you sell the asset. No sale, no tax. The capital gains tax system reflects the fact that investors must be rewarded for risk, not punished by excessive taxation. Capital gains taxes for individuals are taxed at only half the rate for assets held for greater than twelve months.

Successful investors know that there is a tremendous tax advantage for borrowing for investment. They know the tax disparity that exists between the taxation of interest deductions and capital gains. They know interest is deductible at full taxable rates while capital gains are taxed at only half the taxable rates if the asset is held for twelve months or more. I cannot stress enough how important this is to wealth creation.

For example let’s assume we purchase a property that costs us $400,000 after all settlement costs and stamp duty. Assume we are able to borrow the entire amount because we have sufficient equity in our home. Let’s assume we get rent of 5% net yield after expenses (rates etc). This would equal a net yield of approximately $20,000. Our interest expense is 7.5% (i.e. $30,000) paid interest only. I will ignore non-cash deductions (depreciation) for the purpose of this illustration. Let’s assume that just after twelve months and one day we sell the property and we net $410,000 after sales fees and settlement costs. On a pre-tax basis, what has been the change in our net worth? It has been zero. We made a gain on the sale of the property of $10,000 but our interest costs exceeded our net rent by $10,000, resulting in no net gain on a pre-tax basis.

However the tax treatment of interest expenses and capital gains results in a different change in our net worth on an after tax basis.

I will assume for this example we are in the top tax bracket of 46.5% (45% plus 1.5% Medicare Levy). If we make a loss on our rental activities we are able to deduct the $10,000 net operating loss against our other income. By deducting $10,000 against our other income we are able to get a refund from the ATO of $4,650, meaning our after tax operating loss is $5,350.

We are also required to pay tax on the capital gain. Because we held the asset for greater that twelve months we only include half the gain in our income. We therefore include a total of $5,000 in our income. On the top rate of 46.5%, our tax payable is $2,325.

While on a pre-tax basis there was no net gain or loss, the ability to deduct borrowing expenses at full tax rates while only paying capital gains tax on half the gains highlights the tremendous benefits available to those who borrow for capital investment. The taxpayers help subsidise your activities.

With all the tremendous subsidies available to borrowers it is surprising that more people do not use finance to invest. Fortunately for those who want to use finance to create wealth few people understand the game, leaving the huge subsidies to those people that do.

Property Management:  Are Rent Increases Legal?

Landlords cannot simply increase the rent because the market has moved. The Residential Tenancies Acts in each State and Territory encompass strict legislation that needs to be adhered to or landlords can face hefty penalties.

The Acts basically state that if your tenants are on a fixed-term lease agreement the rent cannot be increased unless a legally compliant  rent review clause is written into the lease agreement. If the clause is in place, the tenant needs to be given usually 60 days notice. The rise cannot usually occur within 6 months of the tenant moving into the property or be increased within a 6 month period of a previous rent increase.

If your tenants are on a periodic lease agreement, the rent may be increased but the above conditions also apply.

We ensure that rent reviews are a standard clause in our tenancy agreements allowing flexibility for owners should the rental market shift. Rent review clauses are not standard in most leases and self-managers should be particularly careful in ensuring that the clauses they insert are legally compliant and excercised in accordance with the relevant States Act. 

Under-renting properties is also an issue for property investors. We see many examples of this when we take on new property managements where properties are grossly under-rented by $100 per week or more, including one that was being rented at half of its market value. The property was tenanted by the same tenants for 3 years who never received a rent increase during that time despite the property being under professional management, the market shifting, and the tenants being on a periodic lease agreement.

Unfortunately we have seen this situation many times. Some property managers have too many properties on their books to give individual properties the attention they deserve. Many property managers don’t own a property let alone an investment property and can fail to understand the needs of investors.  This situation can also occur in self-managed properties. Owners can become ‘emotionally involved’ and don’t want to offend or risk losing their tenants if they increase the rent.

As a result of these situations properties may be under-rented leaving owners with a loss in income. Make sure you are dealing with a property management firm who keeps their average portfolio per property manager low so your property manager can keep up to date with market rents and maximise your return. 

Wealth Protection:  Mental Health – Talking About the Silent Illness

Did you know?

• Around one million Australian adults have depression and two million have anxiety disorders.*
• One in five women and one in eight men will experience depression in their lifetime.^
• Depression and anxiety are the most common mental disorders experienced by Australians – depression alone is predicted to be one of the world’s biggest health problems by 2020. #

Depression can be linked to:

• Family conflict
• Isolation or loneliness
• Unemployment
• A serious medical illness, and
• Drug and alcohol abuse

Depression is an illness, not a weakness – you shouldn’t be ashamed to seek help. And you deserve to be free of financial worries while you are receiving treatment.

The importance of income insurance
Income insurance can help protect lifestyles and support people through the financial stress depression can cause.

• A three-tier total disability definition is an important feature of Income Insurance Plans eligible for most clients with the bulk of most occupations. This means you can be assessed on a duties, hours or income basis, allowing more flexibility when it comes to claim time.
•  A waiver of premium benefit is built in to some income insurance plans. If you are receiving a total or partial benefit (except Nursing care), they don’t need to pay the premium for this or any other life, TPD or trauma plan shown on the same schedule.

Taking out tax-deductible income insurance can give you peace of mind, knowing your families are financially protected if you cannot work.

Justin McManus is a representative of AXA Financial Planning Limited, ABN 21 0005 799 977 AFSL 234663. This information has been prepared without taking account of your objectives, financial situation or needs. Before acting on this information you should consider its appropriateness, having regard to your objectives, financial situation and needs.

*www beyondblue.org.au

^Australian Bureau of Statistics, 2008

#The Global Burden of Disease: A Comprehensive Assessment of Mortality and Disability, Injuries, and Risk Factors in 1990 and Projected to 2020, World Bank, Harvard School of Public Health, Geneva, 1996

Additional Article Source  – AXA