Property Management:  Want more growth plus high rental returns?  The answer may be outside.

A large block can help an investor build wealth, but tenants are typically unwilling to pay more to live on a large block. So, is there a way to make the outdoor space more valuable to tenants and therefore increase rental returns? 

A small property on a large block can be an investor’s dream. It can deliver strong capital growth as well as the opportunity to add value through developing the property in the future. But while a large block can help an investor build wealth, tenants are typically unwilling to pay more to live on a large block, resulting in lower rental yields for this type of property.

So, is there a way to make the outdoor space more valuable to tenants and therefore increase rental returns? I believe so. Although the size and quality of a property’s indoor space plays a large role in determining what tenants are willing to pay, the outdoor space offers excellent opportunities to boost the rental value.   

In fact, recent research and trends suggest that desirable outdoor spaces are one of the few characteristics that a tenant would be willing to pay more for. And in a place like Perth with long, hot summers and alfresco lifestyle, outdoor space is probably more important than in any other city around Australia.

But not all spaces are created equal. Properties with large outdoor areas can put off tenants because of the effort and costs associate with maintaining the outdoor area. Some tenants might discount a property entirely because of a high-maintenance outdoor area.

What’s clear is that tenants don’t want to open the back door to a sparse landscape of endless grass, an old Hills Hoist, and meters of bland fencing. Nor do they appreciate an overgrown jungle. The truth is many of them aren’t motivated to look after an outdoor area that they just don’t use.

Unfortunately though, this scenario is all too common as many investors place little importance on the outdoor areas of their investment property, focusing instead on the presentation of the interior. When the outdoor spaces do receive attention, it is usually the front garden that gets most of it. While this is valuable for street appeal, it might not be enough for tenants if the back area is poor and unusable.

So, what do tenants want in an outdoor area and how can you make your investment property more desirable to them (which will improve your rental yield and help you rent your property faster)?

What tenants ultimately want is an area where they can entertain guests, a relaxing environment where they can unwind after work, and green gardens that are attractive but require minimal maintenance. 

Here are some key features and ideas you may like to consider for your property:

BBQ area

Just about every tenant would want a space where they can place a table to entertain guests by the BBQ. A simple paved area or small deck would be ideal, or even a gravel area with stepping stone pavers would do. If there’s existing ugly concrete, consider painting it or laying do-it-yourself decking tiles over the top for an inexpensive update.

Sun coverage

To make the space more usable and complete it as an ‘outdoor room’, consider some sort of shade structure. This could be as expensive as a covered pergola or as cheap as an open pergola with a vine or some shade sails. 

Hardy plants

A bit of greenery will never go astray, but choose plants that are hardy, slow growing and need virtually no maintenance. Visit markets and discount nurseries to pick up some bargains and make your dollar go further. There’s no need to go overboard; using plants as borders around hard areas (like paving) and in a few feature beds is all that’s necessary. 

Partitioning

Sometimes the size of the yard can make it too big a job to improve and too expensive. In this case, consider partitioning or screening off a part of the yard and instead focus on just improving a smaller, more usable area nearby the house.  

Of course, when it comes to improving the outdoor space of your property, the exact specifications of what is desired will vary from area to area.  For example, properties in family areas may need to have grass for the kids, while in other areas tenants may prefer no grass at all but prefer a large shed with plenty of storage.  It’s worth doing some research by looking at other competitive properties on the rental market to see what you’re up against and what the outdoor areas are like of properties that appear to be most in demand.

Don’t forget that improving the outdoor spaces isn’t just about attracting tenants; it also adds value to your property. For buy-and-hold investors, it can be worth spending a bit more on the outdoor areas. For those looking to redevelop in the near future, it doesn’t make sense to spend too much if it’s only going to be torn apart, however some small, inexpensive changes can make the world of difference for the short term.

Speak to your Momentum Wealth Property Manager first about updating the outside of your property. They can give you an idea of the market expectations and what potential value an update may add to your property.

Finance:  Helping your kids get on the property ladder

These days more and more kids are relying on their parents to help them buy their first home or investment. And most parents are happy to help if they can. So as a parent, what options do you actually have?

With property prices climbing year on year, it’s not always that easy for the next generation to jump onto the property ladder. It’s no wonder then that these days many mums and dads are willing to put their hands in their own pockets to help their kids kick-start their future.  Some of the options could be:

Provide cash for a deposit

If you are in a position to do so, you could provide all or part of the money to put towards a deposit. If you don’t have cash but have equity in your property, you could refinance your property to pull out the cash although you will now have repayments to make on this new loan. Providing a deposit can be made as a non-repayable gift or as a repayable loan. If it’s provided as a loan, some lenders may require a formal contract to be signed. If you are close to retirement, also bear in mind there are social security consequences with gifting that need to be considered.

Buy the property jointly

In this scenario, you buy the home as ‘tenants in common’ with your child. This allows you and your child to treat your share in the property separately, and to split ownership however you wish – for example, 40% ownership to your child, 60% ownership to you. 

Act as guarantor

If you have equity in your own property (ies), you may be able to use this as security for your child’s purchase. Your child will still need to borrow the full amount, but may avoid lenders mortgage insurance if the sum you put forward as security allows their loan-to-value ratio to come down to 80% or less. With this option, you do not have to physically dip into your pocket at all – you are simply just making a promise to the bank that you will support the loan (in full or in part) if your child defaults. While you may think this is unlikely, you must be prepared for the risk of this outcome as it does happen and shouldn’t be taken lightly. Once your child’s house has grown enough in value, you will be able to be released from their loan.

If you don’t have the financial capacity to help your children, don’t be dejected. The best thing you can do for your child is to help them become financially savvy themselves as early as possible. There are many ways to do this – for example, if you are able to have them stay at home longer, help them to save through paying you board which goes into an interest-bearing account in their name and then put towards a house deposit when they are ready. Learning to save, recognising the importance of long-term goals, and understanding the fundamentals of investing in property wisely is worth just as much, if not more, than money itself.

If you are looking at assisting your child financially with the purchase of a property, speak to a Momentum Wealth broker. Different lenders have varying requirements, and with the recently implemented NCCP legislation, your broker can advise the best options that are suitable for you.

Hot Property

In this month’s Hot Property section, we highlight a house in the suburb of Rivervale that was purchased by Buyers’ Agent Mark Casey on behalf of his client who was looking for a future development site. 

Overview:

With two properties already under their belt, our clients were looking to acquire their third investment. Buyers’ Agent Mark Casey was put on the case to find them a high performing future development site, that would also generate a good rental return for the short term. The client was looking for a property located close to the city and proposed football stadium to be built in Burswood.

The final property chosen was a 1960’s brick and tile home in Rivervale which is close to the city, within the client’s desired search area, and with strong growth potential.  Mark’s superior knowledge of the area enabled him to widen his search as he was aware the particular location and street selected has only recently been rezoned to higher density. 

Located on a triplex potential site, the selected property perfectly matched the client’s needs and Mark was able to acquire it well under the estimated market value and approximately $50,000 under the advertised price.  Today, it is also achieving an excellent rental yield of 4.4%.

Result:

Purchase of a 3×1 brick and tile house in Rivervale, 5km from Perth CBD.

Purchase price: $499,000

Estimated market value at time of purchase: $520,000 – $540,000

Savings: $21,000 – $41,000

Suburb Snapshot:  Hamilton Hill

Our bi-monthly Suburb Snapshot section shares our tips on the best suburbs to keep a watchful eye on for your next investment purchase. In this month’s issue, we’re going to profile the southern suburb of Hamilton Hill. 

Hamilton Hill is a large established suburb located approximately 16km south-west of the Perth CBD.

Situated near the coast, it is just a short drive to Fremantle and is surrounded by the suburbs of Spearwood, North Coogee, South Fremantle, and Beaconsfield.  The suburb is easily accessed via the key transportation routes of Leach Highway, Stock Road, and South Street and is convenient to a number of amenities including Cockburn Gateway Shopping Centre, Murdoch University, St John of God Hospital, and Murdoch train station.

It is home to a number of primary and high schools, both within the suburb and just beyond, and enjoys the benefit of a number of parks and reserves including Manning Lake wetlands and surrounding natural bushland. Additionally, homes on the west side of the suburb are ideally situated within a ten minute walk of popular South Beach.

Hamilton Hill has a number of features which make it a potentially sound investment. Many parts of the suburb are undergoing transformation and thanks to the Department of Housing´s Urban Renewal Program, the number of state housing projects has diminished with the advent of newer re-developed estates such as Phoenix Rise.

The suburb will benefit from the approved Phoenix Central Revitalisation which includes a number of areas for rezoning and rejuvenation of the Phoenix town centre. It will also feel the effects of the proposed Cockburn Coast District Structure Plan for the beach-side and old industrial area alongside it which are set to transform into a cosmopolitan hub of activity. The area was just recently rezoned from Industrial to Urban by the Metropolitan Region Scheme and is now out for public comment. It’s expected these plans will bring more young professionals to the area.

Properties in the suburb offer good value for money and are quite affordable in light of the future potential of the area. Properties around Manning Park and west of Carrington Street tend to be most popular and command a more premium price accordingly. Houses are a mix of both old and new, and include everything from apartments and villas to family homes and large plots ripe for development.

Prices in the area typically start in the low $200,000 – $300,000 which will buy an apartment or small parcel of subdivided land. Three bedroom villas or duplex’s are available from the low-mid $300,000’s although better properties usually fetch more than this. Larger plots of vacant land are mostly in the high $300,000’s. Houses start from $400,000 with more desirable properties in the high $400,000’s and larger family homes and potential development sites starting in the low $500,000’s up to as much as $850,000. Rents range from around $275 to $500 per week depending on the property. 

Key Statistics

Source: REIWA.com.au, January 2012 

Wealth Protection:  Prostate Cancer & Trauma Insurance

Prostate cancer is the most common cancer for Australian men. After lung cancer, it is also the second most common cause of cancer deaths for Australian men. Each day about 32 men learn they have prostate cancer and tragically, every three hours one man loses his battle against this disease.

Trauma Insurance and the Trauma Insurance Plus Plan provides valuable cover, should the policy holder suffer from prostate cancer. It can provide financial support at a time when they need it most. It can be used to obtain specialist medical attention not covered by health insurance, or cover financial commitments.

Key features of the Trauma insurance plus plan

Trauma insurance is about protecting the policy holders lifestyle and supporting them through the financial stress a traumatic condition like prostate cancer can bring to an individual and their loved ones.

Some Trauma Insurance Plus Plans will make a 100 per cent benefit payment if a prostate tumour is classified under the TNM (or equivalent) classification system as:

·         T1c or above, or

·         T1a or T1b with a Gleason Score of 6 or above, or

·         T1a or T1b and is considered untreatable or if the person insured is required to undertake major    interventionist therapy.

A partial payment (the greater of 20 per cent of the benefit, or $10,000, up to a maximum of $100,000) will be made for prostate tumours classified as T1a or T1b under the TNM (or equivalent) classification system with either a Gleason score less than 6, or where major interventionist therapy is not required. Please refer to the Insurance product disclosure statement for the full definitions.

Trauma reinstatement option

Some trauma reinstatement options enables clients, who have been paid a claim, to reinstate their trauma policy 12 months after the insurer receives their claim form. Without this option, it is unlikely they will be able to repurchase trauma insurance.

Most other insurers would typically exclude the original event the client claimed on when their trauma insurance is reinstated, and the new trauma policy issued. There is only one Insurer who has industry leading trauma reinstatement option allowing a client to claim again on cancer and heart attack eventsrelated to their original claim. A partial benefit of the lower of $50,000, or 10 per cent of the benefit amount under the new plan will be made.  

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.

Acquisitions:  Real Estate Contracts – What you should know when purchasing a property

In the excitement of buying property, many investors overlook the importance of including sufficient contract clauses to protect themselves. As Kent Cliffe explains, it is not the Sales Agent’s job to represent the best interests of the buyer.

I have come across a number of people who have purchased property through a sales agent and have been badly burned by not seeking representation when purchasing the property. It is the Sales Agent’s job to represent the seller. Therefore, they are naturally aiming to get the seller the best price and use contract clauses that most favour the seller.

When purchasing a property, it is crucial that buyers are aware of the potential pitfalls when it comes to real estate sales contracts. These contracts are legally binding documents – once accepted and signed by both parties (purchaser and seller) you are obligated to uphold its terms and conditions.

Contracts for the sale of property do vary from state to state so advice is recommended before you place offers to ensure that you are adequately protected and not in breach of any legal requirements.

At Momentum Wealth, we always add our own clauses to contracts to protect clients from concealed or unforseen circumstances.

Researching properties for purchase can be a time-consuming process, especially when looking at multiple properties. There may also be some issues that weren’t attended to before placing an offer on the property. This is why we always use a sufficient “get-out” clause to protect clients in these instances.

I am still surprised at the number of people who believe the use of a finance clause will protect them should they change their mind about purchasing the property or find some problem with the property that they were not aware of. Typically finance clauses state that the purchase of the property is subject to you the purchaser obtaining finance within a particular time period.

Anyone using this clause on its own is taking quite a risk. If you discover something that may affect your purchase decision, (for example a development next door, or structural problems with the house) then you may find yourself in breach of the contract if you walk away from the sale.

We always ensure that we use other clauses or sufficient “get-out” clauses to cover our clients. This provides them with an option to walk-away if something arises that we were unaware of when making the offer on the property.

The Real Cost of Buying the Wrong Property

It’s no secret that the Perth property market has suffered over the short-term since our 2006 boom. However, with the resources boom fuelling a two-speed economy, property in Perth has been viewed by many (and myself included) to make a “recovery” more so than its national counterparts.

With increasing rents, low interest rates and the ability to purchase property at competitive prices, there is currently an excellent window of opportunity for investors.

It’s at this time of rising confidence that investors need to be savvy, cautious and selective with their purchases. Not all properties grow at the same rate – and the cost of buying the wrong property could be higher than you think.

What’s the worst that could happen?

Property is a popular investment vehicle for many Australians because it appears safe and stable. It’s widely believed that all properties will grow in value, and that the “worst case scenario” is simply a lower rate of capital growth.

Sadly, this is not the case. Recently we have been contacted by owners of properties that have significantly dropped in value, severely undermining their owners’ investment goals. Other properties have stayed stagnant and are likely to continue in this vein for a number of years to come. Unfortunately none of these people used Momentum Wealth to find their property and they have suffered as a result.

Here’s some examples:

Townhouse, QLD :        Purchased for $384,900            Re-valued at $238,000

Apartment, WA:           Purchased for $349,000            Re-valued at $310,000

Apartment, WA:           Purchased for $1.2 million        Re-valued at $850,000

Townhouse, VIC:          Purchased for $510,000            Re-valued at $380,000

Why did these investment properties fail?

Every property is different, and there’s no perfect matrix of investment factors that will always produce the same result. However, we noticed a few common factors between these examples that contributed to their poor performance:

Too much supply: Property, like the wider economy, is a game of supply and demand. Large quantities of new supply, such as new apartments and new house & land packages, hold back the capital growth of established properties in the area. While there is ample supply of brand new properties, there is no incentive for established property prices to rise. Not only this, but when developers are under pressure to sell more properties (as they have been in most cities in Australia over the last 3-5 years), they offer discounts and incentives on their brand new properties which effectively discounts your property as well!

New property supply is not evenly distributed across Australia’s capital cities; in every city, there are regions that have significant supply of new property (with more supply still to come), and suburbs which are tightly held. Investors who buy in these over-supplied locations can find themselves waiting for years for “the next boom” instead of enjoying the steady capital growth they expected.

Inflated purchase prices: Another reason that some properties have not increased in value is because of commissions loaded into the price of some of the projects by developers. Our finance division has been flooded with requests for assistance where investors have realised they have lost significant value in their properties. The problem is, many of these properties were never worth the contract purchase price. Commissions in property marketers can be significant and can add up to 10% to the property sale price – putting the investor on the back foot before they’ve even begun.

Investor-targeted marketing: All the properties listed above were marketed by “Property Investment Companies” as great investment properties. The problem is, when a development project is marketed primarily at investors, it can hide the real state of the market. 

Exercise caution

We’ve said this before, but I will say it again. Be careful who you trust as your property advisor.  A few things for investors to consider are:

• If an “advisor” is offering to help you with acquiring an investment property without it costing you a cent, that’s a serious alarm bell. You need to ask the question, how are they getting paid if you’re not paying them? More often than not, they will be paid a handsome commission from a developer for selling their property to you. In that case, are they really acting in your best interests and providing you with unbiased investment information? Stick with property firms who don’t take any commissions from developers and instead get their payment directly from you. It may appear to cost you more upfront, but it will easily pay itself off in a great investment.

• If you are looking to buy an investment property, be wary of businesses that help you acquire the property but that also sell property. This could be directly, as in they also function as regular real estate agents, or indirectly, in that they have “relationships” with developers and the like. This presents a real conflict of interest as it is in their best interests to try and sell you the properties they promote, rather than other (perhaps better) investments on the market for which they don’t make a cut on. Only a Buyers’ Agent can truly represent the buyer in a property purchase.

• Be cautious about businesses that will only sell you very specific projects. Typically these projects are branded developments that are heavily marketed. You can usually spot them because they are packaged and promoted under a name that sounds rather glamorous. These projects in most cases are brand new off-the-plan apartments or house and land packages in outer suburban growth corridor areas. In some cases these types of projects may be an okay investment, but more often than not you can do much better elsewhere. Generally they are fully priced, full of fat including sales commissions and GST, in areas with below-average growth prospects. Not a wise investment in my books.

• If anyone tries to tell you investing in real estate is a guaranteed investment, they’re lying. Very few things in this world are guaranteed. Although property has generally been relatively stable and profitable for many over the last 100 years, real estate is still a risk like any other investment. If they tell you it’s easy to become a millionaire in next to no time, without of taking a reasonable level of risk, they’re also lying. You can become a millionaire through property investing but it requires time, patience and most importantly smart investing.

Too many people don’t understand enough about investing in property and rely fully on the advice provided to them, often via just one source. In these current market conditions, it remains crucial that investors choose properties selectively. The wrong property purchase could leave the purchaser waiting for another Perth “boom” – while the right purchase will benefit from the tightening market conditions to provide excellent returns to its purchaser in the next 1, 3, and 10 years.

Momentum Wealth and its affiliated entities are not Accountants or Financial Planners. While all information is provided in good faith, you should seek your own independent advice in relation to all matters regarding investing, taxation and superannuation.

The Property Newsletter will return in March 2012.

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 

Investor Alert: Is it wise to put all your eggs in one basket?

Some investors are lucky enough to afford a fairly substantial investment property. Perhaps it’s a property around the $800,000 mark or even as high as $1 million. Whatever the exact figure, these investors are naturally excited at the prospect of being able to buy something a bit more glamorous than a run of the mill investment property. But the question is, is it better to put all your money towards this one property or spread it out across a number of cheaper properties?

Personally, I am a firm believer in buying multiple cheaper properties instead of one expensive property. The caveat to this however is that the cheaper properties must still be ‘investment grade’ properties, otherwise you negate any advantages in pursuing this strategy. Generally speaking for Perth, you will find most of these types of properties around the median house price of $400,000 – $500,000 (although that’s not to say that they don’t pop up occasionally below and above this mark). So in the earlier scenario, that could mean purchasing two properties instead of just the one.

There are a number of reasons why I support this strategy and most of them relate to risk.

Firstly, there’s less risk from rental vacancies. Should one property become vacant, the weekly income loss would be far less than if the same situation arose with your more expensive – and only – investment property. With multiple properties, you have a safety net in that your other properties will continue to bring in rental income while you find a replacement tenant for the vacant property. There’s no safety net, however, if your million-dollar investment sits vacant.

Secondly, having multiple properties is better from a liquidity point of view. Even if you invest with a buy and hold mentality, sometimes you may be forced to liquidate your assets despite your best laid plans. With multiple properties, you give yourself more options in that you may only need to sell off one or two assets and be able to retain others, keeping your foot in the market. With just one expensive investment property though, you may be forced to liquidate it and go back to the drawing board.

Thirdly, there’s protection if an area or property you choose doesn’t perform as well as expected or is negatively impacted by some activity or event. You will still have other properties in your portfolio that may continue to flourish which will help you in continuing to grow and leverage off your asset base. The economy is one such factor which can affect properties differently depending on their location and their value. In the economic climate of late, in Perth and throughout the nation, lower-to-mid priced properties have been far less affected than those in higher price brackets. If you had bought a single million-dollar investment property in Perth prior to the GFC, you would be in far more financial pain than if you had spread your funds across multiple median-priced properties.

Aside from risk, there are other reasons why multiple cheaper properties can be a better investment decision. At the median price, rental yields are typically quite good and superior to those achieved by higher value properties. With multiple properties, you also afford yourself more freedom to take greater calculated risks that could pay off handsomely, such as buying one property in an up-and-coming area or an area that could be rezoned. With just one substantially-valued investment property, however, you may be more reluctant to take that chance.

Diversification is important to any investor. Most think that diversification means to spread your money across different asset classes such as property and shares, but as you can see the concept equally applies within one asset class such as property. Buying multiple properties in different areas, in a price bracket that continues to attract demand and minimises your risk even in flatter economic times such as now, is wiser than putting all your eggs in one more expensive basket. 

Land vs building – what’s the right balance?

Most people would be familiar with the phrase ‘land appreciates, buildings depreciate’. While this is a little simplistic, the statement generally holds true. It is surprising then how many investors, armed with this knowledge, still manage to get it wrong.

Real capital growth is derived from the appreciation of land. This is because land is a commodity that is in limited supply and always in demand. Buildings, however, lose value over time because the physical materials deteriorate and the appeal of their style and function diminishes as buyers’ tastes change.

Some people argue that the cost to build rises each year meaning replacement of the same building would cost more in today’s dollars, thus buildings appreciate. Yes, the cost to build increases with inflation but this is irrelevant. If you were to sell a once new property in 10 years, the fact is a buyer is buying the land with a 10 year old depreciated home on it – not buying land with a home on it valued at the replacement cost of building it today. That is why you find many old properties selling at practically land value. To think today’s costs are relevant is no different than trying to argue that your 10 year old Toyota Carolla is valued at the same price as the current year model! Having said all that, it is possible to retain some value in the building if you regularly maintain and update it. However, this obviously costs money and does not simply come about with time. 

Many assume therefore that the message from all this is that the more land you have, the more capital growth you will be rewarded with. While there’s some truth here, this is where many investors tend to become unstuck. Let’s use an example to explain. Do you think the value of 500sqm of land in the heart of a major metropolitan city is the same as 500sqm of land in a small country town? Or even 1000sqm in the country town? Of course not.

Land is valued at a different rate per square meter depending on its location. Therefore the lesson is if you’re after strong capital growth, don’t base your buying decision on where you get the largest quantity of land for your money. Instead, focus on the proportion of value that the land component contributes to the overall purchase price of a property.  This is what is sometimes called the land-to-asset ratio. Good purchases tend to be those that have a high land-to-asset ratio, that is, ones in which the land accounts for most of the property’s value.  Although in many instances this directs investors towards older dilapidated houses in established areas close to the city, if you’re on a budget or need stronger rental income do not discount strata-title properties. If you do your homework and purchase carefully, you can find strata properties with a high land-to-asset ratio that perform just as well. 

Tax Office set to change rules for SMSF investors

 A new draft ruling released by the Australian Tax Office (ATO) has relaxed rules for those buying properties in their self-managed superannuation fund (SMSF).

Previously SMSF investors were allowed to maintain their properties but were restricted from making improvements to them. This stance had discouraged some investors from dabbling in property investment through their SMSF because of the strict regulations. 

It is expected that this long-awaited change will have the most impact on cheaper properties in need of some TLC. These properties are now more appealing because SMSF investors would be able to conduct renovations to add value and improve the rental return.

While improvements are now permissible, they will only be able to be conducted if they are funded by cash resources in the SMSF and not borrowings. There are also restrictions on the types of improvements that can be made. Examples of allowable improvements include extensions and bigger kitchens, but the key is that improvements must not “fundamentally change” the property.

The ATO has also taken this opportunity to clarify other grey areas regarding property investment and SMSFs. They confirmed that unlike improvements, SMSFs may borrow funds to undertake repairs provided the repairs do not change the character of the dwelling. 

Hot Property

Overview:

Looking for a high growth investment property in Perth, our clients enlisted the help of Momentum Wealth and its buyers’ agents to do the hard yards.

Given the client’s requirements, we immediately focused on the sometimes overlooked suburb of Craigie in the northern suburbs of Perth. Being a tightly held suburb (both for resale and rental) it tends to achieve good property price growth and also has the benefit of providing plenty of value-add opportunities.

When the right property came on the market, our buyers’ agents kicked into gear immediately. Being familiar with the area from a property investment point of view, we were instantly able to assess the potential and value of the property and place an offer. The property was ideal being an average 1970’s home (yet still achieving reasonable rent) and was situated on a flat corner block in a proposed rezoning area. We secured the investment property for our client within three days of it being listed beating other buyers to the punch.

Despite the competitive nature of securing properties in Craigie, Perth, we still managed to acquire the property under market value, but most importantly, secured an investment property for our client that has potential for great gains in future.

Result:

Purchase of a street front 3×1 brick and tile home in Craigie, 22km from Perth CBD.

Purchase price: $420,000

Estimated market value at time of purchase: $430,000

Savings: $10,000

Suburb Snapshot: Redcliffe

Redcliffe is an established suburb in Perth located approximately 10km east of the Perth CBD.

It’s situated near the suburbs of Belmont, Ascot and Cloverdale and enjoys excellent proximity to the city and airport, as well as being just minutes from the Swan River. The suburb is serviced by key transportation routes such as Great Eastern Highway, Tonkin Highway and the Graham Farmer Freeway, and is ideally located by short drive to commercial and industrial areas in Kewdale and Welshpool for employment. Redcliffe also has access to a variety of amenities such as local primary and high schools, parks, a cinema, and major shopping centre, Belmont Forum.

Over the past 10-15 years Redcliffe has undergone quite a transformation, with a number of developments changing what was once a suburb dominated by tired public housing into a desirable and well-maintained community. Popular estates such as ‘Flemington Chase’ and ‘Ascot Gardens’ were developed, and today much of the older parts are continuing to undergo rejuvenation with a few property development opportunities still available. Redcliffe tends to be popular with property investors, both for development opportunities as well as good rental yields (thanks in part to the consistent demand from fly-in fly-out workers who prefer a property close to the airport). It is also an area that is traditionally blue-collar; however with its proximity to the CBD and Swan River that is slowly changing with an increase in demand from young professionals and families.   

Properties in Redcliffe generally fall into one of three categories – older undeveloped or partly renovated properties towards the northern end of the suburb (typically 50’s/60’s style on large land), newer strata-titled villas in the older northern end of the suburb (created from private subdivision), and newer homes and villas through the southern part built in the 90’s and 2000’s which are located in the developed estates.

Prices start from the low $300,000’s for small units and homes in less desired pockets. Between $350,000 – $400,000 are 3×1 properties on blocks under 500sqm (generally villas/units), while in the low $400,000’s are a mix of good size 3×2 properties and the occasional smaller 4×2 property. Most 4×2’s, depending on their location, age and land size, are generally priced from $450,000 – $550,000, as are older properties suitable for redevelopment.  A handful of properties are found above $550,000 which include new and near new properties, larger homes, and larger development opportunities.  Rents generally fall between $400 – $500 per week.

Key Statistics

 Source: REIWA.com.au, September 2011.

SPECIAL FEATURE: Momentum Wealth’s Rising Stars

You might think that after buying and selling around 13 properties, you’d be an old hand at property investing. Not so for this young couple which is why they reached out to Momentum Wealth to give them the help they needed.

Trisha Fulton and her husband Ryan have so far turned over more properties in their short lifetime than most people. However, it was always their principal residence that was the subject and not once had the idea of “property investment” entered their minds. Buying and selling was simply a result of their personal circumstances. In fact, due to Trisha’s job, she’s moved in and out of 65 company owned properties in the past 7 years.

When the young couple needed to relocate to Perth from Brisbane back in 2009, they spoke with buyers’ agent Ray Chua at Momentum Wealth to help them find the right home. Although things didn’t work out at the time, buyers’ agent Ray kept in touch and when it came time to take the plunge and buy an investment property in Perth, they knew exactly who to call.

Trisha and Ryan picked up the phone and enlisted the help of Ray and Momentum Wealth to give them guidance and help them make the right decision for their needs.

“Being our first investment property, there’s a different set of criteria than when you’re buying for your own home and you need to make a really intelligent decision based on returns and all that analytical information”, says Trisha.

“(Ray) opened up our minds to a lot of different opportunities that we probably wouldn’t have considered”.

The couple’s primary strategy is to buy properties with future development potential over a 7-10 year timeframe. With a strict 2 week deadline and other equally difficult criteria set by Trisha, Ray begun the search and located them a prime investment property in Rivervale, Perth in July this year. Purchased for $552,000, the property came with a shabby 2×1 property on a duplex sized block. However with buyers’ agent Ray’s insider knowledge and astute research, what really made the property special is its future potential.

“It’s got potential for a triplex development in the future. We wouldn’t have known these things without his help”, comments Trisha.

This determined pair are certainly not short of energy or ambition. With a number of goals set over the coming 10 years, the couple’s next plans are to acquire another 4 properties over the next 2 years across both Western Australia and Queensland. Once these properties double in value, they will start to subdivide and develop them. In 10 years time, they are hoping that they will be in position to not necessarily retire, but choose their work rather than be forced to work.

Although the couple started out as novice property investors, over the last 6 months Trisha has done a lot of her own research to educate herself about investing in property, and has had the help of a property advisor like Momentum Wealth. One piece of advice she decided to take on was to treat property investing as a business, not a hobby. Since starting their investment journey, she’s found this advice invaluable and highly recommends that other property investors do the same.

She also insists that in order to create this business mindset, investors need a good team of people to support them and that to get the most from them, you should treat them as you would expect to be treated yourself.

“If all the right people are in the right place and you look after them and they look after you, you’ve just simply got a good formula for success”.

Using Credit: Subsidy 2 – Low Level Borrowers

For many varied reasons, there will be many people in society who have no debt at all. Perhaps they are in their 50’s and have paid off their home and have no leveraged investments. There will also be people who have low levels of debt relative to their asset levels. There will be some people who have a relatively high level of debt compared to their asset levels. A bank or financial institution will have loans out to the entire spectrum of borrowers.

Assume a person owns their home worth approximately $500,000 and they have a loan of $50,000.  What risk do you think the bank or financial institution is at of not getting their money back on this loan? Almost nil I’d suggest. If someone owned a property worth $500,000 and they had a loan of $250,000, what risk do you think they are to the bank or financial institution? Very little I would suggest. If they stopped the repayments the bank or financial institution has enough of an equity buffer in the secured asset that even in the event of a fire sale the property would have sufficient funds to cover the repayment of the loan.

If someone owned a property worth $500,000 and they had a loan of $400,000 what risk do you think they are to the bank or financial institution? There is some risk to the lender. If they stopped paying the loan and let the property go to ruin it is quite possible that the lender could lose some money. If you were lending money, wouldn’t you much prefer to lend to the person who owes $50,000 on the $500,000 home rather than the $400,000? Wouldn’t you be expecting a higher rate of interest on the higher level of borrowings to compensate for the extra risk?

While there is a larger risk to the lender by lending $400,000 versus $50,000 against a $500,000 asset, the financial institutions rarely charge different interest rates to different borrowers. The lender knows that across the board they will have a range of people at different levels of debt and in order to be able to offer a competitive interest rate they typically offer one interest rate across the board (except to high net worth borrowers who often get discounted interest rates). They know that if the economy went into a severe recession and property prices went down, there are enough borrowers who have low levels of borrowing that the lenders potential bad debts would not become too significant.

What do you think would happen if everyone borrowed up to 80% of the property value and kept it at that level? Suddenly the lenders would have a much riskier portfolio on their hands and they would have to increase interest rates to compensate for the risk. If the economy went into recession there is a chance that a high percentage of loans could go into default and the banks may lose significant amounts of money.

Those who borrow to a lower level relative to their assets should really be getting a cheaper interest rate than those who borrow to a higher level. Lenders have never been able to figure out a way to effectively price the different risk on property loans. They typically use the arbitrary figure of 80% loan to value as the point where loans become more risky. They don’t differentiate between 5% borrowings and 79%. Fortunately for highly leveraged borrowers, not everyone borrows to their maximum. Those who borrow to lower levels relative to their assets are effectively subsidising those borrowers who take higher risks and borrow towards the maximum.

Property Tax Tips: When are interest expenses deductible?

Generally interest is deductible if it is incurred when the borrowed money is used for income producing purposes. If the borrowed money is used for some or all private purposes then the interest on the private portion is non deductible.

For example, if you borrowed $300,000 from the bank and $200,000 was put into a property investment to generate income and the other $100,000 to purchase a home to live in, then 2/3rds of the interest would be deductible (being $200,000 / $300,000).

This is referred to as the “use” test or “tracing” test which generally means that:

(a) When borrowed money is used solely to purchase investment property then the interest will be deductible (while the property is rented or available for rent)

(b) Where borrowed money is partly used for investment purposes and partly for private purposes, the interest will be deductible to the extent it is used for investment purposes.

Many people believe that if they use an investment property as security for a loan than the interest on that loan is tax deductible regardless of what the money is used for. This can be a costly mistake. The deductibility of interest has nothing to do to with the security used to borrow the funds. You can use your own house, a car or a boat or anything. What matters is what the borrowed funds are used for.

Property Management: Case Study

Bianca started managing the properties and found the following:

Upon inspecting the properties, she discovered over $10,000 of urgent repairs that needed to be completed. She organised quotes, agreed on prices and negotiated payment plans with contractors. This meant the tenants were safe and the client could have all repairs completed at once without stress or financial strain.

Three of the leases had expired exposing the owner to the potential of an unexpected vacancy. New leases were signed  with the tenants with the expiry dates staggered at different times in the year so no two properties would be vacant at once, protecting the owner’s cashflow in the event of a vacancy.

Four of the tenants were in arrears – one was 5 weeks behind.  Bianca spoke with the tenants about their arrears and negotiated payment plans which has now led to all of the tenants paying their rent two weeks in advance.

Bianca has now spoken with the owner and his accountant and formulated a maintenance plan for the upkeep and refurbishment of all of the properties. This has given the client and his advisers a clear picture of when works are to be completed, what will be done and how much this is likely to cost.