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The Experts

Margaret Lomas
Expert
+ About Margaret Lomas
Founder and Director of Destiny Financial Solutions
Past chair of Property Investment Professionals of Australia (PIPA)
Author and Television Host

3 risks of investing in property

Monday, December 24, 2018

Many spruikers or other property commentators may like to suggest that property investing is low risk but this isn’t always true.   All investing carries risk and property no less than any other investment.  There is the market risk (the sector won’t do as well as other investing sectors), the specific risk (the property chosen won’t do as well as other properties may do), and of course, the pure risk (investing anywhere is not as good as keeping your money in a jar in the kitchen!)  

Where property is concerned, and to help you to decide if it’s a risk worth taking, let’s take a look at some of the more common risks that people worry about when they do buy property:

1. Will property fall in value?

If we considered the property market in Australia as one market, then this is a question I would have to answer with a ‘yes’.  If we combined the value of all property in Australia today, the value of that combined figure certainly may indeed be lower next year than it is right now. This will be due to the fact that our two largest markets, Sydney and Melbourne, have hit their peak and will now either stabilise, or in some cases, fall in value.  Depending on when you bought into those markets, this fact will either mean that your property does indeed fall in value (if you purchase at the tail end of the boom), or you still end up with a property worth more than you paid for it (if you bought any time up until around early 2017). We saw frenzied buying and prices paid way over the true underlying value of some properties.  Now as we come to the end of this, we can expect a period of adjustment in that market. 

But, just like the highest rung in the ladder has the greatest height to fall from and the greatest chance of pain when you do fall, so it goes that properties at the peak of their market, if that market overheated, have the greatest chance of a fall. And because of the high values of these properties, their value decreases will provide a big impact to the overall reading and, in fact, skew the results.

Having said this, at the present moment, we are seeing a ramp up of confidence and interest in many other markets, such as Adelaide and Brisbane. This improvement to the value doesn’t register when measured in the one ‘Australian Property category (due to the drag of those falling markets), but when considered alone will grow in value. Many of these markets show a severe undersupply of housing, and more people pouring into the rental markets than we have had for many years.  I expect upward movements in these markets for some years to come and that properties in some of the lower price ranges in highly populated areas will do well. 

2. Will property perform less well than other assets?

The debate has long raged about which has the better long- term outcome: shares or property? I don’t know which one will ultimately perform better over the long term but I do know that it is important that, whatever asset you choose, you become educated about it first.  In the share market, or the property market, you can suffer poor performance, if you buy a poorly performing asset, buy at the wrong time or in the wrong market.  On the other hand, you can certainly go a long way to ensuring that, whatever asset you choose, it will perform well if you stick to the fundamentals and learn how to research before you buy. Not all property goes up and down. Not all property follows a cycle. And not all property exists in areas that are rich in growth drivers. Learn what those growth drivers are and how to uncover them, and you will most certainly improve the performance on any property you buy, as you are less likely to buy property that was never going to perform in the first place.

3.  Are there times when it’s better not to invest anywhere, including property?

If you keep your money, or the equity in your property, uninvested, then you do have a guarantee: the guarantee that you will lose nothing but you will also gain nothing. If instead you choose to invest now, and improve the potential outcome of that property investing by learning how to pick markets most likely to either grow, or withstand any economic turmoil, then you can only do the same, or better than you would have, had you not invested at all. I have been investing in property, and advising others how to do it well, for 25 years now. In all that time, while I have seen many cycles, I have never seen a period of time where all property in every market in Australia performs badly. There are markets within markets, and it is possible for you to be able to pick a market that will grow in value, even while other markets are falling.

Investing does carry risk – but don’t think that if you do not invest at all that you are avoiding risk. There is, in my opinion, just as big a risk doing nothing as there is taking the chance and investing carefully.

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How to get rid of a dud property

Thursday, December 20, 2018

One of the greatest fears that most property investors have is that they will buy a property that will be a complete lemon, and in doing so they’ll become financially ruined. When I meet investors for the first time, it’s most likely that they will state this fear as being the number one reason they’ve not invested.  It’s such a big barrier for many that they won’t invest at all, for fear that everything they have worked so hard to achieve up until this point will be forever lost on the dud property investment. 

I’m not going to say that you will never buy a dud investment – it can definitely occur even when you have used your best endeavours to research well. Unexpected events can occur, planned infrastructure may become unviable, large employers can close down – there’s a host of unforeseen circumstances that could leave you holding a lemon. The point is, if you’ve purchased a property that isn’t performing, you need to address it and take action. It’s no use allowing it to just sit in your portfolio. If it’s truly a bad property, it will only get worse, and every day you hold it will only lead to a compounding of the loss.  

First, though, you need to know if you truly do have a lemon.  Some sure fire signs are:

You have high and consistent vacancy.

You have a constant flow of really bad tenants who keep damaging the property and diminishing your asset.

The property now has a value that is less than you paid for it, which is still going backwards AND a very low cash flow, or

It is situated in an ugly duckling suburb that didn’t get better – much of the planned future improvements failed to occur.

What is notably excluded from the list above are properties that aren’t growing and those with low or negative cash flow. Lack of growth and negative cash flow only become an issue if they in some way prevent you from adding to your portfolio. It’s perfectly acceptable to have in your portfolio a property or two that’s not performing at the present time, as long as they still show characteristics that point to economic vibrancy.  If this is your property, you should go back to it again.  If the answers are still positive, it could be just your timing that’s out, and the property should come good.

On the other hand, if you think you may have a lemon, here’s what to do:

1. Assess the true financial impact of that property upon you today 

If the property is creating a lot of real, personal financial hardship, and you are prevented from enjoying your life now because your money is being poured into this non performing asset, or if the existence of that property in your portfolio limits your capacity to borrow again to buy something else in an area with a better prognosis, you must sell. Don’t hang on to it hoping for that elusive capital gain, or because you believe that you have to try to recoup your losses. Although property markets do go in cycles, these cycles are measured and expressed as an average only. This means that within these cycles, a property in any one area can still stay in a trough indefinitely and behave very differently to the average. 

You will most likely make a loss, but you will be able to carry forward this loss indefinitely to offset any future capital gains,  and selling now will halt further loss. 

2. Consider keeping it a while longer 

If the reason you consider it to be a lemon is because it is suffering from value losses, but its cash flow is still positive or at a minimal negative amount, you may want to keep it for a while longer. You should only do this if owning it does not mean you cannot qualify for further lending to buy more property, and so you are not able to build your portfolio further while-ever you own it. 

Be aware that many properties that seem to be losing value are doing so because too much was paid for them in the first place. Make sure that’s not your situation. Did you pay market value, or, if you bought from a developer, might there have been commissions that boosted the purchase price over market value? Before selling due to a loss in value, examine the economic landscape – you don’t want to sell out of a property that subsequently performs well unless there is no other choice.  

3. Sell now and get straight back into the market 

If you’re experiencing a crippling negative cash flow, and the area shows distinct signs that growth is light-years away, you may be best to sell now and get straight back into the market with a property purchased in an area with greater economic potential, and better rental yields.

Likewise, if you have a property that attracts unsavoury tenants and your landlord’s insurance policy has reached its maximum allowable claims, this may again be a good reason to sell and cut your losses. Where one property takes up the bulk of your time and energies, it may be better out of your portfolio.

Remember that while ‘buy and hold’ is a sound strategy, it doesn’t also mean you hang on till the death knell on a property that you made a mistake buying.  Learn how to see the writing on the wall, and exit from bad investments before they get the chance to get worse.

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Peanut butter & jam sandwiches

Friday, December 07, 2018

Have you ever wondered how new food combinations like peanut butter and jam sandwiches came about? I imagine they came from people breaking traditional thinking, trying something new and forging an untested path – often in the face of criticism and humiliation.

Sometimes, two things which were previously thought to be incompatible can be brought together with great success.

For many years, ‘experts’ claimed that you had to be either a growth investor or a cash flow investor. They declared that growth and cash flow were mutually exclusive, incompatible – like peanut butter and jam on sandwiches together!

If you already invest in property, you will know, as I do, that “ideal properties” with affordable cash flows and good capital growth are out there. I own many of them. You can find them too.

Finding the ideal investment property for you

If you have read any of my work, you already know and understand my 20 Must Ask Questions®.  Following these questions will ensure you select the right investment property for your needs. Now I would like to introduce the concept of “cash flow affordability” and how it impacts investors.

Before explaining cash flow affordability, let’s briefly revisit the concepts of capital growth and cash flow.

Capital growth

Assuming your objective is to generate the highest capital gain possible, you may think that investing in capital cities and coastal locations is the key.  We now know that this is not correct, as recent studies have shown that there are many areas outside of capital cities that have delivered some amazing growth.  

Since capital growth is directly linked to supply and demand, it is reasonable to expect that those areas with a population growth faster than the national average will experience greater levels of demand, possibly higher than supply, and so drive up property prices.  This can happen both in cities and in larger regional areas.

Cash flow

Investors seeking positive cash flow properties are typically drawn to locations where the demand for rentals are highest, and this can occur in regional areas and the outer suburbs of some capital cities.

To ensure a minimum injection of ongoing funds, cash flow investors look for properties that ‘pay for themselves’, without a need to support a negative cash flow. Finding property that also has a high amount of building depreciation can also contribute to the inward flow of funds, and so boost the after tax cash flow.

The possible downfall with this approach is the temptation to chase cash flow at any cost, leading you to consider single-industry towns, for example, with slim long-term prospects for sustained capital growth.

The key, of course, is going to lie in discovering properties offering the best possible growth for the highest possible cash flow, and ones which suit your personal short-term needs for either cash flow or growth.

Introducing cash flow affordability

Cash flow affordability is the equilibrium between cash flow and capital growth. It is that balancing point between achieving and acceptable capital growth and being able to support the property’s costs while this appreciation in value occurs. This point of equilibrium will be different for every investor.

Let’s consider two investor scenarios to explain the concept in greater detail.

First story

Wayne is a single man who lives at home with his elderly parents. His living expenses are extraordinarily low and he spends his money very carefully. His total annual living expenses are only $40,000. Wayne earns $215,000 per year as an engineer. Wayne has a high cash flow affordability and so he can target properties with high potential for capital growth even though they may come with negative cash flows. Having said that, Wayne’s objective is still to make these properties into positive cash flow properties in as short a timeframe as possible.

This is achievable as Wayne’s substantial surplus (the difference between his income and expenses) when combined with rapid mortgage reduction principles will reduce his debt, and therefore his interest cost, quickly. This reduction in interest over time (hopefully combined with increasing rents) will create a positive cash flow.

Second story

Mark and Sarah are a married couple with 3 young children struggling to get ahead. Mark earns $90,000 per year and Sarah works part-time on $25,000. Their household expenses are $100,000 per year; leaving a surplus of $15,000. For Mark and Sarah, cash flow is key consideration when investing. In total, they can only afford $288 per week (assuming they use their entire surplus to fund the holding costs of the properties, which doesn’t appear to be a smart option given their circumstances – unless they have other cash reserves).

Mark and Sarah really need to acquire properties with cash flow of say, no more than around $30-$50 per week negative.

Other things that need to be considered are time till retirement and risk profile.  An investor with less available time needs growth more quickly, and one with a low risk profile will need to buy in areas with less speculation.  All investors have different needs which must be considered when making choices about where and what to buy.

Always remember that the ultimate aim is to buy a property with the greatest chance of capital growth for the highest cash flow possible.  Cash flow keeps us in the market, while growth allows us to get out, or at least acquire the assets needed to make choices about our retirement. If you do your research well, you can achieve both of these things.  However, due to the nature of how values and rental (yield) growth initially may occur in opposition to each other, the first few years of a property investment may require that you choose the one which is the most important to you, and knowing more about your personal needs for cash flow or growth may help you decide which is the right property for you now. After those first years, a well-chosen property should be delivering both yield growth and values growth.

Investors need to be realistic when searching for properties, because it is better to purchase an ‘almost perfect’ property now, than wait for years hoping that the ‘perfect property’ will pop-up. They rarely do.

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10 key lessons to grow rich through property

Thursday, November 29, 2018

In the day and age where everything is not only complex but must be executed at the speed of light to keep up with busy lifestyles, it can be great to reflect on some of the more fundamental property investing lessons.  Here are the 10 of the most important ones that never change, regardless of what is happening in the property market!

1. Understand that property will provide a different return for you than other asset classes.

In the end, you’re looking for cash flow to keep you in the market, and growth to get you out!  You must learn how to calculate property returns, taking into consideration any personal tax benefits to establish the true return on any property, which is a combination of the rent return and the yearly growth, with any tax refunds added in there! It’s not as straight forward as just knowing what the rental yield is.

2. The debate between cash flow investors and growth investors will rage eternally, but it’s largely baseless.

I get callers on my show all the time saying ‘I’d like to find a property that will have capital growth’. Of course they do!  No one ever says ‘I’d like to find property that won’t grow’! Growth and cash flow are equally important, and it’s simply not true that you have to forego one to get the other. Failure to consider cash flow can lead to an inability to stay in the market, just as failure to consider growth leads to an inability to create a strong net worth position.

3. Once you have put together a portfolio of properties, your work doesn’t end.

Your portfolio must be managed on an ongoing basis. Monitor your properties individually and your portfolio as a whole to be sure that it continues to meet your goals. Identify when a property has served its purpose and establish those properties that may need early liquidation. Be sure that eventual liquidation of your portfolio is managed to occur at a time most financially viable in terms of income and tax. Get a good professional property manager who knows how to best look after your asset.

4. Don’t be afraid to set an upper limit that sits comfortably for you in terms of price.

You don’t have to spend a large amount of money on each purchase to obtain properties that will perform well for you. More important is your own comfort and willingness to continue to increase the number of properties you hold, within your risk profile. There’s also no truth in the rumour that the more you pay for a property, the better it performs – in fact the reverse can be true, and many high-end properties might be nice to live in but fail to perform well over time. Those same properties usually have a lower yield, since rents do not have as big a variation as values do.  

5. Successful property investing will only occur where the choosing of property has been carried out diligently.

You have a responsibility to ensure you carry out your own research and increase the chance of successful investing. Know the questions to ask when buying any property and be sure they are asked of the right people. Explore any management arrangements and fully understand any agreements that may be attached to property. Research the area and the future plans of council. Know the population movements and the extent of demand for rentals and sales. At all times maintain a commercial approach to your investing—there is no place for emotions in this process.

6. Become smarter than your accountant when it comes to accessing your tax benefits.

Use any tax benefits to help you minimise debt as quickly as you can, so that periods of slow capital gain will not impact so heavily on you. Remember that you are personally responsible for the preparation of your own tax return—even when you use a professional to assist you. Having said that, you should never buy property as an investment just for the tax benefits, and any property you buy should be a good investment, regardless of any tax benefits it provides to you.

7. Be careful when you use any unusual or comprehensive purchasing structure.

If your property investment involves a ‘buy and hold’ strategy, you can’t afford to put in place a structure that will not remain efficient for the term of your investment. Project ahead 10 or 20 years and do the sums to be sure that any structure you choose continues to work for you. Company and trust structures do not automatically protect you, nor are they often the best and most profitable way to buy property. When choosing in whose name to buy, consider whether that person will remain in their current income position for the life of the investment.

8. Just because you choose to have a professional agent manage your property does not absolve you of your responsibility as a landlord.

You remain responsible at all times and severe penalties can be applied if you do not carry out these responsibilities with care. Know what the state in which your property is situated will require of you, by visiting Fair Trading and Real Estate Institute websites. Be sure that your landlord’s insurance policy is adequate and current.

9. Be careful of undertaking any risky strategies which may be suggested at high priced seminars or by rags-to-riches gurus.

There really is no such thing as a free lunch and most of these strategies may well have a very steep downside. I have yet to see strategies or properties sold at these seminars that have turned out to be good investments and appropriate for the person buying them. Seminars and unusual strategies usually benefit the spruiker far more than they benefit the investor.

10. Be sure to always work on debt minimisation, but where your loan is a line of credit, beware of the traps of using rapid mortgage reduction.

Capitalising your loan is also a no-no from the tax office’s point of view, and the way you draw back funds from lines of credit must be managed in accordance with tax office rulings.  The best position for you as a property investor is one where you have minimal debt, so work on ways to always be reducing what you owe, regardless of whether this means you have diminishing tax benefits.

In the end, it’s all pretty much common-sense. Trust your own judgement and ask yourself whether you’ll still be able to sleep at night after you take on any potential strategy. Investing is really meant to be fun, invigorating and profitable. I’ve been encouraged by the great number of people all over Australia who write to me to advise me of their own investing success. These are everyday people like you and I who don’t necessarily take great risks, but who commit to being sure that they take the responsibility for their own future firmly in their hands.  Block out all that white noise that you hear about changing government policies and booming and busting markets and just follow the fundamentals – and over time, your property investing will pay off!

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Procrastination is the thief of time

Thursday, November 08, 2018

I get the chance to speak to a lot of property investors all the time, and I think I know how many of them tick.  Often it’s at a seminar that I meet them, and they leave so full of excitement and determination – ready to go and get started straight away!

You might identify with this. Most likely you’ve been to a seminar or read a great property investing book and started planning what to do next.  Some people make a firm commitment to get right into it and finally start investing, others plan on how they can expand their existing portfolio. All in all there’s usually excitement in the air and a conviction that action will follow. 

The next day at work the excitement continues, at least until morning tea time.  Colleagues are apprised of the situation, the great seminar that had provided the motivation to take the future by the horns.

By noon, it becomes apparent that enough time has been spent on excitedly imagining the future as a die-hard property investor and work needs to become the focus.  By this time, you might have even looked at real estate websites and considered hotspots.

Friday night and the exhaustion of working so hard kicks in and all you want is a glass of red and to sit in front of the heater watching The Voice. Tomorrow you’ll get into it.

Saturday dawns and you have things to attend to first – clean the house, mow the lawn, get the kids to and from sport, go shopping, call your mother, put on a load of washing.  By afternoon you haven’t stopped, so it’s time to sit for a little bit, you’ll switch on the computer later and get started on the big dream of owning a swag of investment properties.  There’s plenty of time.  You can even start tomorrow.

Sunday arrives and – well it’s Sunday and it’s your only real day off so you’re not even going to go near the computer. Instead, you read the paper – there’s news that interest rates might rise and that the property market looks set to be affected.  Mmmm. That’s Ok, it’s only one report, but probably lucky you haven’t done too much work yet.  Monday morning and someone enquires whether you have bought a property yet, referring to that latest news.  When you say ‘no, I was busy on the weekend’ they say ‘maybe a good thing’. None of the agents have gotten back to you about your enquiries anyway, it just shows how hard this whole thing is going to be if you can’t even trust those in the industry.  The ball is in their court now anyway – what can you do but wait until they phone you?

Deep inside your mind that little voice (the one you call reason, but which in fact is really called roadblock) comforts you with comments like ‘you’re not really ready yet’, and ‘it’s a big step and you’re not really equipped, you should wait until you know more’ and ‘I could lose big time here so I really should wait until the news is better/the property market is booming/ I have more money/ pigs fly/ hell freezes over’.  Yes, that feels better – you’ve made a decision and you’re sticking to it.

Until next year, when you go to a seminar again and you get fired up again, only by then you also kick yourself for not taking action sooner, because you can see the bargains you missed and the people who went home after the seminar and, tired as they were got on the internet that night and found their first, or next property and, despite being busy/tired/overworked, killed themselves making it happen because they did not want to be in your position next year!

Does this sound like you?  Which person are you?  Are you the person who, despite an impossible workload, too many commitments, lack of knowledge and the uncertainty that still exists decides that now is the time and you will not stop until you own a property?

Or, will I see you next year, head hung a little as you tell me how excited you were last year but how life got in the way and you just couldn’t take action.  The time wasn’t right.  The planets just didn’t align.

It’s so easy to find an excuse not to get started, but much harder to find an opportunity to get into it.  Your first (or next) investment property isn’t going to come knocking on your door, and building a portfolio isn’t going to come without challenges, drawbacks and risks.  But retirement will be on your doorstep in the blink of an eye and by then it will be too late.

So, what are you going to be doing this Saturday?

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Frozen with fear

Thursday, October 25, 2018

The time seems right.  The indicators are all there, telling you that now may be the right time to start, or to continue, your portfolio.  You are feeling financially secure, but want to improve your potential future income.  You know that the capacity for the government to provide for your retirement needs is limited, and that you must do something for yourself.

But you can’t do it. 

Something within is throwing up all manner of challenges for you, and you simply cannot bring yourself to hold your breath and take that leap.  And, as you procrastinate, the years keep rolling on and you know, without doubt, that you will look back and regret that you didn’t take the chance when you could have.

In all the years I have been assisting people to buy property, I have discovered that all the knowledge in the world can still do very little for some people – it is the psychological factors that become the barriers that prevent many people from investing success.  Knowing what these factors are, and then identifying your own personal psychological barriers so that you can remove them, is the most important first step to take as an investor. Here are a number of them:

1. Fear of losing your money

When investing in property, the most common thing people worry about is that they will lose everything. Since we usually do not use any of our own cash when we buy investment property, this can be translated into worrying that you will lose the house in which you live. Mostly, this is completely unfounded, provided that you do not become overexposed.

To deal with this fear, work out the worst-case scenario and ask yourself if you can afford that outcome from your existing cash flows – think about what might happen during periods of vacancy and whether you can afford the mortgage during these times.  If not, then you should not buy, but it is more likely that the worst thing to come out of a failed property investment is an increased personal debt that you probably can manage.  And remember, the actual likelihood of this result is very small anyway.

2. Fear that you will not be able to afford to repay the debt if the property is vacant

When people first begin to consider this possibility, they imagine that there will possibly be months in which no income is being achieved and they will be required to meet the mortgage repayments from their own pocket during that time.  In fact, unless your property is damaged so that it cannot be occupied, and landlord’s insurance can cover this event.

In terms of going weeks and months with no tenant, it’s more likely that a small reduction in rent can attract a tenant in most markets.  You simply need to be sure that you have your property at, or just below market rent, and that the property you buy is appropriate to the demand – that is, the right property type for the demographics.  There’s always a sweet spot at which you will be able to find a tenant in most areas, so be sure you quickly get to that spot so that you don’t suffer vacancy for too long. 

3. Fear of making the wrong choice

Buying a property involves making a large purchase.  Even if you borrow all of the money and use little or none of your own, your commitment is a big one.  Why is it, then, that people so carelessly choose property, using all manner of emotional reasons to buy?   Investors mistakenly believe they can use a ‘gut feeling’ about property, or base their choices around what they would personally like to live in.  Worse still, they follow the crowds, take advice from their unqualified friends, buy a property in their dream location near the beach and largely put faith in people who have a vested interest in their purchase – such as the person selling the property to them!  It’s no wonder so many bad choices are made.

You can never remove all of the risk when you invest in property, but you can manage it and increase the chances that what you buy will work out well.  However, you can only do this by becoming educated first. The reason I developed the 20 Must Ask Questions® was to provide a benchmark, which becomes the minimum criteria that a property and area must display before it becomes likely to perform well.  If your fear is that you will choose badly, then leave your emotions at home, learn how to invest well and arm yourself with the 20 Must Ask Questions®.  Then, commit to only buying property that can satisfy them.

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Negative gearing: the latest political whipping boy

Wednesday, September 05, 2018

Whenever there is any kind of economic strife within the country, or when governments begin to discuss budgets, negative gearing becomes the whipping boy on which almost everything is blamed.  There’s a lot of emotion around the discussion about negative gearing, with the opponents claiming it is a rort for the wealthy, while the proponents claim that it continues to prop up many otherwise lacklustre property markets.

Before you begin to invest in property, or take part in any debate about negative gearing, you must first know what the term means.  Too many people lack real knowledge about this area, yet form an opinion about it anyway. To understand this, let’s start with the second part of the term – gearing. 

What is gearing?

Gearing is the term used to describe the process of increasing the size of your investment through borrowing.  Typically, when you gear an investment, you use that investment as security to access more funds, which in turn buy more of the assets.  When you gear an investment, the results can be that you either receive a negative outcome - negative gearing, or a positive outcome - positive gearing.  It is important to note that both outcomes are based on borrowing and both outcomes are based on the amount of tax that you pay as an individual, and so the amount of tax break you can receive.

What is negative gearing?

Many people believe that negative gearing is a strategy that explains how people on high incomes get back more of their tax.  But it is not a strategy at all – it is a tax outcome. In fact, the definition of negative gearing is:

‘Gearing your investment so that the cost to maintain it (loan repayments, yearly investment costs and expenses) outweigh the income produced by the investment, leading to a reduction in taxable income.’

In other words, negative gearing happens where the total yearly costs of any investment outweigh the total income, and you’re allowed to claim a loss against income earned elsewhere.  But, you can never get more than 45% of the loss back, and you’ll always have to pay the other 55% yourself.  The pay-off for meeting this commitment is considered to be the hope that the asset you purchased increases in value over time by more than the amount of money you lost as a result of holding it!

What’s positive gearing?

If negative gearing is an outcome whereby the costs exceed the expenses, then positive gearing is the opposite, and results where the income on an asset you invest in exceeds the expenses.  For property, this would occur if you purchased a property that had a high yield for your purchase price.  With interest rates low and remaining that way, reducing the yearly costs of holding an investment property, and rents coming under pressure in many areas and so increasing, more incidences of positive gearing are being seen and some people, who initially negatively geared, are seeing these properties now returning a positive income.  

What’s positive cash flow?

While both positive and negative gearing are fairly straight forward, and are the result of a simple equation of taking expenses away from income and assessing the result, the real confusion comes with the third tax outcome - positive cash flow.  This is a tax outcome that always happens when you positively gear – the fact that the income is higher than the expenses will always mean that you end up with money left over, even if some is lost in tax. However, even a negatively geared property can have a positive cash flow, if the on-paper deductions provide enough additional tax back to close up the gap.  

What are on-paper deductions?

On-paper deductions are those deductions an investor can claim where money hasn’t been actually paid out as an expense – but part of the asset has lost value.  They are the deductions that result from the perceived yearly loss in value of the building, and in some cases, the plant and equipment inside that building.  In a nutshell, for each one dollar of reducing value of the claimable part of the asset, you can receive as a refund your marginal rate of tax.  So, for example, if the building declined in value by $5,000 each year, you receive up to $2,250 in tax back, with nowhere to spend this money, as it is an on-paper, rather than an actual expense.  If that same property had good rents that were close to covering the expenses, then this additional sum of tax back could close that gap and result in a positive cash flow.  

And so, you can see that, even when you ‘negatively gear’ you may not end up with a negative cash flow, and it is very important to understand that negative gearing or positive gearing is actually not the most important factor for you as a property investor – it is the final result, or bottom line cash flow (after all your tax claims are made) that governs your ability to hold an investment over the long term, even when growth is low. 

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Which capital city is the best to invest in, right now?

Thursday, August 23, 2018

It’s no secret that buying an investment property in Sydney is now so 2016, and if you weren’t quite into it then, it’s too late to suddenly decide that you are now.  It’s not like you weren’t warned – not only did I issue warning after warning as the fire under the property market that was Sydney began to lose heat, so did virtually every other expert out there.  It wasn’t that the ‘boom’ had gone on too long, or that the ‘cycle’ told us the end was nigh – it was more about that fact that the median price had finally reached a point that was way above what the average income earner could afford.  There is only one single thing that makes a property market grow, and that’s demand.  When demand is taken away because price ultimately takes buyers out of any market, then it becomes a waiting game for wages to catch up again.

If you’re thinking that this means that you need to now wait to get an investment property under your belt, think again.  Savvy investors know that the theory that you should only buy property in a market where you live, or close to where you live, is a dangerous one.  The mistaken belief that you ‘know’ the market where you personally reside is one of the biggest traps for property investors.  This is because what you ‘know’ about where you live has nothing to do with whether the area is one that will give you the best investment return.  What you know about your area relates to lifestyle, not economics, and it is economics that will determine whether any area will grow well and deliver a suitable rental return.

And so, if not Sydney, then where?  Melbourne is close behind Sydney in terms of its point in the cycle, and it’s a fast closing window.  Hobart has been performing well, but its small population and low population growth usually means it has a stellar year or two and then nothing for many more years. Perth is likely at the bottom, but being at the bottom doesn’t mean that you’re headed up any time soon.  And even when an area at the bottom does head upwards, it can take years and the climb can be painfully slow, especially when there is an absence of strong economic drivers.

My money’s on Brisbane, and it’s all pure economics.

Firstly, the average house in Brisbane is still well below what the average income earner can afford. Even without wages growth, interest rates could go up, and property prices could increase, and the average wage earner could still afford to buy property there.  Since demand is the major driver of growth, there is no immediate impediment to demand, except, of course, oversupply.  This is an easy one to tackle – just don’t buy in an area with impending oversupply!

Secondly, changes to the age profile of the population in Brisbane over the next 10 years are expected to see those aged 20 to 34 move on to the next stage in life and look at buying a home of their own, according to Angie Zigomanis from BIS. He said the emerging trend would underpin demand for new housing on Brisbane’s suburban fringe and established housing in the inner-city region. These people will mostly qualify for the first home owner grant of $15,000 (and stamp duty concessions) which is available on many of the houses on the market, due to the high $750,000 cut off for the grant.  That wouldn’t even get you an apartment in Sydney, but it buys an awful lot in Brisbane.

Then of course we have infrastructure – tons of it.  New University campuses, major medical developments in both north and south suburbs, and main roads, tons of them, making the commute around all parts of Brisbane easier and easier.  There’s also the Queens Wharf Precinct, Brisbane Airport Redevelopment, Brisbane Live Entertainment Arena, Northshore Hamilton and a new International Cruise Terminal, to name a few.

It’s no surprise to see strong jobs growth in Brisbane in both the education and medical sectors, and also improving employment figures after a few years of poor results.  Things seem to be looking up in this area, but remember, in Brisbane wages growth isn’t as important for keeping a floor under what is already a highly affordable property market as it is in Sydney or Melbourne.

Strong inward migration will contribute, with the population expanding from not only overseas but interstate migration.  Why wouldn’t you want to live in a state which is beautiful one day, perfect the next? In addition, over the next 15 years, the population of Brisbane is set to double. In 2015, Brisbane’s population was approximately 2.2 million, and is expected to grow to 4.6 million by 2031. This means that the city will require 40% more homes than it had in 2006, according to government estimates, with a focus on building up, not out.

Finally, Brisbane is on track to become Australia’s next New World City by 2022.  Since 2000 it has consistently ranked within the top 30 per cent of the world’s fastest growing cities, and has been particularly noted for job creation.

It’s an investor’s dream , just waiting to be grabbed.  Just be careful what you buy.  Apartments in the city are not the best choice, nor are high-end properties where demand is subdued.  Think families, millennials and migrants, and find the kind of property that they are most likely to demand.

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How much should a property investor borrow?

Thursday, August 09, 2018

I am often asked what Loan-to-Valuation Ratio (LVR) I recommend, and, unless I know the complete financial story of the person asking me, I can’t really say. There’s no ideal or recommended LVR for the general investor – rather each investor has a specific debt level which suits their own needs for income, growth and risk.

The term ‘gearing’ relates to the process of borrowing to apply a leveraging effect to your own funds to invest in a greater number, or wider range of assets.  The higher you gear an investment portfolio, the more you multiply the risk of loss, as well as the return.

Understanding how gearing impacts on risk and return is important for all investors, so that you can match your own needs and risk profile to suitable levels of gearing. An investor with a long time till retirement, a good income and sufficient excess funds has more appetite for risk, and so can probably afford to more highly gear, while an investor who may need the funds sooner and who has little chance of replacing lost funds, should adopt a lower gearing strategy.

Let’s take a look at a number of different gearing levels which an investor might choose and explore the type of investor that these levels might suit.

Borrow 80%

A borrower who is borrowing 80% or more of the total property they own is one who shows an appetite for risk. It means that you only have a small margin for value swings.  If your property falls in value by 20%, you will own nothing. You should not borrow to these levels if you are nearing retirement, have job instability or if you currently have no capacity to save or invest in additional assets besides the property you are borrowing for.

Borrow 60 – 80%

An investor with a medium time frame in which to invest, relative job security and an income which can facilitate additional debt repayment or additional investing, as well as a mid range attitude to risk, can choose an LVR within this range.  A fall in value of the security property is unlikely to result in total loss of personal wealth, and at these levels of gearing there is still a good amount of leveraging which enables the purchase of more assets, and so the exposure to higher levels of growth and wealth creation. 

Borrow less than 60%

An investor with a short time till retirement, a limited amount of years available to work and a small amount of savings is well advised to keep their gearing levels below 60%.  At this level, a good margin is built in to ensure that family home assets are not likely to be at risk and that, should property values fall, a nest egg in the form of remaining equity would still exist.  This nest egg could then be used to undertake an alternative investing strategy to compensate for any losses which may have been incurred through a poor choice of property investment or through market value decreases. 

My advice to all investors is to treat any advice or invitation to invest using high levels of gearing with the utmost care and consideration, and know your personal appetite for risk.

Wise investors usually maximise their gearing levels at 80%, and attack debt reduction with vigour and commitment to reduce this quickly.  Remember that for every $1 of property you own, that’s $5 more you can buy with leveraging, so constant debt repayment and acquisition of equity is a crucial part of every property investment strategy!

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Property management for 'niche' market property

Tuesday, July 10, 2018

If you are a property investor, chances are that you intend to buy more than one property.  You most likely want to build an entire portfolio of them. If this is the case, there’s a chance that, at some time in your property investing period, you might consider acquiring what I call a ‘niche market property’.

As I have explained in a previous article, a niche market property is one which is designed to cater to a specialty market.  Included in niche market properties are Holiday Houses and Apartments, Serviced Apartments, Student Accommodation and the fast growing area of Seniors Accommodation. 

Buying any of these kinds of property not only requires extra research and attention to detail, but it means that they are more than likely going to be managed differently.  Having a sound understanding of the different kinds of potential management arrangement is critical – as with any property, poor management can impact on not only the return, but the ultimate value of your investment.

Here are a couple of the more common forms of niche market property management arrangements.

Management agreements

The first one is known as a management agreement. This most likely involves an on-site manager already in place, who may have been retained under a range of different arrangements. A management agreement refers to a written contract between the owner(s) of property (often as a body corporate) and an experienced operator. It will consist of a list of requirements of this manager, along with a schedule of remuneration for his or her services, typically expressed as a percentage of gross or net revenue.

Where a manager has been retained via a management agreement, and there is no associated granting of real estate or retail rights, it’s usually fairly simple to terminate his or her services if the grounds are just. Make sure you’re familiar with the exit clause and that there is not a large cost to terminate a poorly performing manager.

Management rights

Management rights are similar to management agreements, however they’re usually ‘purchased’ by the manager and involve the acquisition of some of the real estate. Typically, management rights will be sold by the developer prior to completion of the project for several million dollars, and may include an apartment in the complex plus rights over any restaurant, bar and reception area.

Terminating a poorly performing manager who has purchased these rights can be fraught with problems, and very often these types of management rights are bought by couples with little or no hotel management experience. This could have dire consequences for the success of your property investment, and you should ensure that you have an appropriate risk profile, plus money to lose, before buying a property under an arrangement such as this one.

Leasebacks

Finally, Leasebacks differ from other management agreements in that they involve a manager actually signing a lease with each individual property owner, in order to then on- rent the property.  Some investors feel more comfortable with this type of arrangement because it means that rent is going to be received even when there is no one occupying the property. That lease can be negotiated to include a clause requiring the lessee to pay all outgoings, such as rates and electricity, from the gross rent they receive.  This way, the property owner knows exactly how much they are likely to receive each month.

This can be false security, though, as the ability of the manager to pay the lease is linked directly to his or her success in running a profitable venture. Where the venture returns less than needed to honour the lease agreement and all it’s included clauses, the manager has to provide top up funds from other sources (such as the restaurant and bar that are a part of the complex your property is in, or even another establishment) or, if there is no other source, the lease will not be honoured.

Niche market properties tend to have an added layer of risk which ultimately impacts on the overall value of the property and the short- term performance.  I always recommend that, where an investor believes that any niche market property may be a suitable addition to their portfolio, they seek sound and independent financial and legal advice, and ensure that their entire investment strategy, including non- property investments, is taken into account. 

Many niche market properties have an exceptionally poor track record, which is rarely discussed by the property spruiker selling the property, and when it comes to this type of property, the term ‘Caveat Emptor’ (let the buyer beware) is never more appropriate.

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The high yield property trap and what to avoid

The difference between men and women in property

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The next property markets to boom

Picking the bottom

6 reasons to get landlord insurance

It’s time for property investors to think like disruptors

How the Budget will affect property investors

When it comes to property, are you a leader or a follower?

Investing in property for income and growth

Property growth drivers

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The rise of the ‘rentvestor’

3 tips for buying interstate

Be wary of property advice

7 reasons why negative gearing should not go

5 property traps to avoid in 2016

9 gems for your property portfolio

Property Investing – keep it simple, stupid

What’s yours is mine

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