Finance Matters…

I was listening to some investment info the other night which I feel is relevant to  the world economies and Australia. We apparently are in the best position as they see it, in case of a global slowdown which will happen via USA. According to them we will suffer slow property devaluation similar to what Japan has experienced (before you laugh these guys are members of Harry S Dent's team and are advisors to him. So they have and he has demographic credibility.) If potentially we do go through this, what would be the best finance protection aspect if properties could potentially fall by half? Hypothetically if you have a property current value 500k, you have a line on credit on this at 80% of the value of your property, property drops by half, my house is now worth say 250K, the bank loan is still for $500k does the bank reduce my LOC?

Regards
Warren Marks

Assuming that you hold properties for the long term then interim value fluctuations should not concern you. The banks are in the business of lending money. They gain nothing from forcing a client to reduce debt or sell assets. Therefore, as long as you can still make the required repayments on a timely basis, then it's highly unlikely the bank will do anything. Generally, if property values fall by half then rental income would probably also decrease which might put pressure on affordability. This might cause people to default and then the bank will look a little closer at your situation.

In terms of what financial protections are available, I would just make sure you are in a strong financial position to service debt. If you can still make the repayments on loans if your rental income halved then that's good. Also, making sure you have the appropriate insurances (i.e. rental insurance, income protection, etc.) in place is also important. Finally, having a buffer built into your loan is a good idea so that you can draw on additional monies to help service debt if need be.

Regards
Stuart Wemyss
Director – ProSolution www.prosolution.com.au

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My husband and I own two properties in Mount Isa 400k / 500p.w. & 300k / 300 p.w. respectively.  We have one mortgage over the two of 386k interest only.

Subsequently we have purchased a 2 brm cottage in inner-city Townsville for 321k. We are in the process of moving the house to the back of the block in order to complete a subdivision est. cost $140k. End value approx 400k / 400 p.w.

We have just purchased our "first home" a 4 bedroom Queenslander on 1012m2 which we intend to move to the front of the block to complete the subdivision. Currently the house and land is 430k. Once the first sub-division is completed we intend to develop the second block.

Our challenge is that we intend to have the bank finance the subdivision, however they will only do so once it has been substantively completed. We need approx 80k worth of work done for the bank to finance the subdivision; however we only have 40k in cash.

Val	Finance
Mt Isa	700 000	386 000
Development Block	320 000	320 000
Home	430 000	410 000

Cost to complete Devlopment	140 000
Cash	40 000
Min costs to reach level bank will extend development loan	80 000

We are looking for a way to bridge the 80k worth of work with our 40k in cash without having to liquidate one of our first two properties.

Any suggestions?

I assume that the bank wants you to substantially complete the subdivision so that they can revalue the property and lend against its higher (improved) value while still maintaining the loan to value ratio at below 80% so mortgage insurance does not apply? If this is the case then there are a few options. There are two lenders (Westpac and ING) that lend up to 85% without mortgage insurance. Therefore, approaching a different lender may give you a higher borrowing capacity.

Another option, assuming the sub-division doesn't take long, is to use a personal loan. You could then repay the personal loan with the increased mortgage monies once the subdivision has been completed.

Lastly, you might consider paying for mortgage insurance. However, this doesn't seem to make sense in my opinion.

Regards
Stuart Wemyss
Director – ProSolution www.prosolution.com.au

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I was forwarded your e-newsletter from my wife.  We have both been involved in buying property in Australia for the past 4 years and have found it an interesting and absorbing hobby/ past time while both working full time.  We realise we do not know a great deal about property investing despite attending a few seminars/ reading books.  We are at a point where we are planning to have children and wanted to ask your panel/ readership of experts their advice on our situation:

We live in our own older house in North Manly, purchased in Aug 05 valued at $800K with a $620K mortgage on it ($560K fixed till Aug 08 and $60K variable with ~$25K in an offset account). We are mid way through renovating.  We have put $10K a year each year off the fixed portion on the mortgage, as allowed within the terms of our mortgage agreement.  We put aside ~$2K/ month each from our salaries into the mortgage repayments & offset account for our house. We bought our house using equity release through remortgaging from an investment of 3 town houses in East Maitland purchased in 2003 (we both like the board game Monopoly so figured we'd start investing with a strip of 3 houses, planning to put a hotel on it once we'd passed "Go" a few times).  These properties are valued at $580K total with a consistent 80% LVR on the interest only mortgage.  We plan to keep using the equity from the investment properties to fund other property purchases/ improvements.  We've purchased a property in Cairns in July 07 with a long term guaranteed rental agreement (12 yrs) valued at $480K.  The Maitland investment properties pretty much fund themselves now, and the Cairns property is negatively geared.  All properties are in our name not a trust - we have recently learned the benefits of being in a hybrid trust, however the cost of setting up a hybrid trust/ maintaining a hybrid trust now seem prohibitive).

Q1. When my wife has our 1st child and stops working how best could we structure our mortgage to minimise this impact of loosing this income stream?  

Q2. Is it better for us to keep buying investment properties with equity gained from investments, or to pay down our home loan?  We are getting conflicting advise from financial advisors.

Q3. Is it worth moving our investments/ and home into a trust structure at this point? 

Q4. In this current housing climate is it better to consolidate our existing position or expose ourselves further?  We have a good opportunity for a duplex in QLD we are currently looking at and want some advise on whether to move on it.

Thank you for your newsletter - we are enjoying learning from others experiences and the articles. Hope you may be able to help us with our queries.

Warm regards
Dominic

My answers are as follows:

1.Any mortgage restructuring will need to be completed prior to your wife ceasing work. There are a couple of things you can do. Some lenders allow a repayment holiday which allows you to reduce (or stop) your loan repayments for a period of time whilst your wife is on maternity leave. Another option is to increase your lending so that you can draw on funds to assist with repayments (i.e. capitalising interest). Its best to do this with your investment loans and you need to ensure you have the correct products to conform with tax legislation/rulings. If your wife is going to take a lengthy break from paid employment then you may have to review your lending exposure with a view to reducing it.

2.That depends on the quality of property. If you are aiming for a 10% compounding growth rate (which I think people should), then you are better off purchasing investment properties. If your investment properties are not performing well, then you are definitely better off reducing your home loan. You could look at the strategy of capitalising interest on your investment loans so that you can use all your income to reduce non-deductible debt. This is a very powerful strategy and gives you the best of both worlds.

3.Unlikely. Changing the ownership of property is rarely worthwhile. You will probably have to pay for stamp duty and you will lose the capital gains tax exemption on your home. However, you might want to seek advice from your accountant on this matter as there's a lot to consider.

4.I think that it's good for people to continue to acquire high quality assets when it's safe and sensible to do so. There are two things to focus on. Firstly, purchased the highest quality asset. That is, you want a good quality property because that will maximise your chances of strong capital growth. Secondly, I think people should continue to purchase property when they can afford to do so. I don't think you should get too caught up in strategy or timing the market. If you have a long term view and you are buying good quality property, then it will work out.

Regards
Stuart Wemyss
Director – ProSolution www.prosolution.com.au

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Compound growth

My question is simple. We all understand compound growth. The thing with compound growth is that in the first few years there's not that much exciting difference in the capital, but as the years progress, the growth becomes astronomical.

So, as property is compounding, the price of property will become astronomical and beyond the markets reach - at which time demand drops off because no-one can afford the price, thereby increasing the time necessary for property to double.

If a property started out at 100K, then became 200K, then 400K, then 800K, then 1.6M, then 3.2 Mil, then 6.4 Mil, then 12.8 Mil - at 10 year cycles, the incomes necessary to keep these properties within demand will not follow at the same extent of the growth, unless wages are compounding at the same rate. The 'real' amount of increase in property price with each cycle is larger each time.

What am I missing here? If I buy a house today worth 300K, everyone can afford it. In 10 years and at 600K, everyone will still probably be able to afford it, 10 years later at 1.2 Mil, it would seem to me that less people would be able to afford it, and at 10 years later at 2.4 mil, hardly any could afford it? Of course, what I might be missing is wages growth - but look at Sydney now. Unaffordable. I earn in the top 5% in the country and cannot afford to live on the lower north shore, where anything decent for a family is over 1.2Mil and what you'd really like to live in is 2.2 Mil. We rent an unrenovated house for $675 per week in Cremorne, and it's valued at 2.2. Mil.

My thinking leads me to believe that property will not continue to double every 10 years simply because compounding will put property out of reach of most people, thereby reducing demand until wages grow. Am I looking at only half of the equation?

Nic

Nic

Thanks for the great question. I understand your logic – at some time property values will become unaffordable if prices keep doubling.

Firstly let me refer you to an article in the archive section of the Property Update website. I think this should make interesting reading for you. Check out this artcile How long does it take to double your money?

But back to your question – "will property values continue to increase at the rate they have been in the past?"

History in Australia would suggest the answer is yes – that's the way property works here due to the way we want to live and our tax system.

The house my parents bought in 1968 for $25,000 is worth $1,000,000 today.

Back in 1968 as a couple with 2 children, my parents couldn't afford $25,000. They put in their small deposit (the proceeds of selling their previous house), took a 25year loan for the maximum they could and still had a shortfall of $2,000 which they took as a 2^nd mortgage form the vendor.

Very little has been done to this house over the years. My mother sold it 2 years ago for $600,000 (a record price at the time); but with the property boom in Melbourne it is now worth $1,000,000 (I know because I bought it off her.)

Today surrounding similar houses are being bought by young families who are having similar affordability issues as my parents had 40 years ago. The cycle moves on.

What makes it easier for couples today is that the multitude of lenders and plethora of loan products means that it is easier for families to get loans for properties – for their own homes and for investments.

A University study I recently read showed that property investment showed a returned averaging 14.8% per annum since 1920. This amounted to about an average capital growth of 10% and a yield of 5% per annum.

Having said all that I understand your question – when will all this end?

You are partly correct – as cities become more mature, more densely populated and more highly sought after to live in, the do become relatively unaffordable. New York and London are great examples of this and as you suggest, Sydney is becoming unaffordable to a large portion of the population.

This does not stop these cities from being great places to invest - as fewer people can afford to live in New York, London or Sydney more people will rent pushing up yields. This will mean Sydney real estate will still be attractive to some investors – those who can afford it. They will still chase the relatively smaller amount of property available and keep pushing up prices.

It all falls back to supply and demand. Despite the relative unaffordability of our major capital cities, more and more people want to live in them. And this is boosted by our as surging immigration. Most of our overseas migrants move to Melbourne, Brisbane and Sydney.

One change that we will notice in the future in response to the increase in property values is that more of us will live in smaller, medium density dwellings – townhouses or apartments. Another likely change is the percentage of owner occupiers (which has remained at about70% of the population for many years) is likely to drop.

The average person doesn't like to hear this – but it's really a case of the rich getting richer. Those who own the right type of property can look forward to steady capital gains and increasing yields in the foreseeable future.

Regards
Michael Yardney
Director – Metropole Property www.metropole.com.au

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Investment dilemma…

I bought my first house in a cheaper out eastern suburb in Melbourne six years ago, it has nearly doubled in that time; ie Hampton Park.

My question is should I sell and use that equity to buy into a suburb that is considered a blue ribbon suburb ie Glen Waverley or should I follow the train of thought that says buy and never hold.

My Hampton Park house has performed well but if I had of bought in Glen or Mount Waverley at the same time I bought my house I would have been further ahead.

Regards
Stephen

Stephen,
Thanks for the question.

You've obviously done well with your property in Hampton Park, but I understand your dilemma.

Would you be better off putting your money in an area which will perform better?

As you know, I prefer not to sell properties, but I'm not against selling if you are missing out on better opportunities elsewhere.

The problem is that when you sell you need to pay capital gains tax, agent's commission, and legal costs. When you buy you will need to pay stamp duty and legal fees again. All this means you are up to 15% behind just by selling

One alternative you could consider is not selling but refinancing your existing property and using the extra loan you get form this as a deposit on your next property in a better performing area.

That way you will have 2 properties working for you.
Regards
Michael Yardney
Director – Metropole Property www.metropole.com.au

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Finding the right balance…

My name is Clare & my husband & I just started investing this year. We hope to have purchased our fourth property by the end of the year, all in NZ. (We're currently based in Singapore, I'm a Kiwi & he's an Aussie).

My query relates to the equity balance and what is a good ratio to maintain. We currently have everything at 20% which is the minimum for overseas investors, and on interest only terms. We plan to try & expand as aggressively as we can afford for the next 2 to 3 years.

After that though, at what point do we start raising the equity percentage of our properties. I've heard one tactic is to pay off 3 to support a larger capital gain property and keep them in 'units' like this. Is it worth ever paying off properties? Are you shooting yourself in the foot by putting 'dead money' into paying off principle? Should we pay off just enough to make it a positive cashflow? Currently in every property we still have to make up the mortgage because interest rates are so high, isn't this dead money also?

What have you found that works that would be a rough guide to go by.

Thanks very much.
Clare

Clare

To put it simply there is no correct answer to your question.

It depends on your investment strategy, how big you want to grow your portfolio, your risk profile and your time frame.

I have outlined my strategy in detail in my book – How to Grow a Multi Million Dollar Property Portfolio – in your spare time.

I think I answer all your questions in detail in this book as they are the common questions many property investors ask. Rather than go though them one by one her, I'm going to be cheeky and recommend you buy my book. You can read a free chapter or buy it on line by clicking here.

Taxing questions…

Hello,

Our question is in regard to vacant land we purchased 3 yrs ago with the intention of constructing a rental property when resources allow.  We haven't been claiming expenses on this property since purchase due to our understanding that expenses on vacant land are unclaimable.  Are expenses claimable on vacant land where there is intention to develop that land?

Hope you can help us
Thanks Trevor & Louise

Yes indeed expenses on vacant land is not deductible. However expenses on vacant land is deductible if there is an intention to build. There are no actual guidelines as to what time frame is expected however 3 years would be too long. The expenses are however "capitalised" onto the cost base so that capital gains tax is reduced later when the property is sold.

Regards
Edward Chan
Chairman – Chan & Naylor Australia www.chan-naylor.com.au

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I have a  question I would liked answered, a short and sweet (ok laymans terms) understandable answer.
If I sell an investment property and after deducting the purchase and all other relevant costs am left with $100,000 profit, then 50% (I have owned the property for over 12 months) or $50,000 is subject to Capital Gains Tax.
Now this tax is calculated at the tax rate of my annual income (correct?). If I have not worked that financial year what tax rate do I pay. Also if I also sell a second property in the same financial year, and lets say the CGT is also $50,000. then what rate of CGT tax do I pay on the first and second properties.

Kind regards
Tina

All capital gain and other income is added together to determine what your taxable income is in that particular tax year and the appropriate tax rate is than applied. For example if all capital gains and income adds up to $6000 and that is below the tax threshold than no tax is payable. However if it totals above $120,000 than its taxed at 46.5% tax rate. You simply apply the income tax rate appropriate to the level of total taxable income/capital gain in that particular year.

Regards
Edward Chan
Chairman – Chan & Naylor Australia www.chan-naylor.com.au

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I have 1 rental property which was originally my own home.  We moved out as it was too small and are now renting.  I haven't yet done a depreciation schedule as I am uncertain about capital gains for this property as I've been told I can still nominate it as my principle place of residence and not have to pay capital gains tax. 

I will most likely never sell it or move back into it. I bought it in 2001 but didn't rent it out properly until 2006.  It is also in our personal names.  Would I be better off moving it into a Trust now (cause I shouldn't have to pay CGT but will have to pay stamp duty) so I can claim depreciation at a higher rate? (value is now 370000, bought it at 138000).  I have plenty of equity to start moving ahead in my portfolio but want to make sure this one is set up correctly first.

Thank you
Deni Truss

You can continue to nominate it as your Principle Place of Residence for up to 6 years after you move out and you should get a depreciation schedule as soon as possible.

You are correct in stating that there is no CGT but there is stamp Duty on moving it to a Trust. However whether you should transfer it to a Trust or not depends on what you are trying to achieve. Have you got Asset Protection concerns, or do you need more flexibility with the income distribution etc, etc.  

We find that 7 out of 10 clients have need for a Trust depending on their circumstances and the other 30% needed a different solution to their problems. We need to identify the type of problem first before being able to offer the correct solution.

For example if you are concerned with Asset Protection we could transfer the properties through a Life Interest which has no stamp duty (except Queensland). If your properties are in Queensland than we have a different solution etc, etc.

If your concerns are flexibility of distribution of taxable income and minimising your taxes than our Property Investors Trust Deed™ will help balance out the flexibility concerns. However we cannot determine this until we have carried out a Financial Health Check on you. An Accountant from Chan & Naylor can do this which can take up to 2 hours .

Just like a Doctor cannot prescribe medication without assessing your health first we need to look at your circumstances holistically before being able to prescribe the right "medication". There are no problems in real estate that we have not found a solution to, but we need to assess your circumstances appropriately before being able to tell you what the best cause of action is.

Regards
Edward Chan
Chairman – Chan & Naylor Australia www.chan-naylor.com.au

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The right strategy…

I have received pre-approval to purchase my first investment property, and in my research I have stumbled across your website, and found it to be extremely helpful.
As part of my reading and research over the past few months, I have found that there is a fair amount of conflicting opinions on the 'right' strategy to take.
I would really appreciate some thoughts or advice on the pros and cons of the following 2 approaches.
(A) Purchase a lower cost property - e.g. a 1 Bedroom Apartment, using only part of the deposit I have saved, thus allowing me to invest the remainder in shares etc, or put towards a second property as soon as possible.
or
(B) Purchase one property e.g. Unit/Townhouse at a higher value Any feedback would be greatly appreciated.
Kind regards
Vanessa

Vanessa
Thanks for the question.
Firstly you are correct in saying that there are a number of conflicting investment strategies.
As you probably have gathered – my strategy is to by the best property you can afford – and to buy well located properties that will increase in value over time.
I suggest you time your purchase judiciously by selecting a state that is in the upturn stage of it's property cycle (which currently incudes most states other than Perth or Darwin). Then invest in capital cities rather than regional properties.
Further I fine tune this strategy by recommending you only buy your investment in a suburb that has always exhibited above average capital growth. And within that suburb I chose areas or localities that have greater amenity and greater appeal. I the chose a street that has more ambience – some streets are more "liveable" than others.
I avoid main roads and secondary main roads. I like wide streets with a mix of nice properties in it. Then in that street I look for the type of property that will have enduring appeal – a property that will be sought after by both owner occupiers and tenants.
And finally I look for a property with a "twist" - with something extra or special. For example one to which I can add value through refurbishment or renovation.
Then I old this property in the long term and in time leverage off its increased equity to purchase further properties.
This strategy works well for me – it has for over 30 years - and it has worked well for many other wealthy property investors.
Of course there are other strategies such as buying high cash flow and therefore low growth properties, and I guess they all have a place. Mine is not the only way to make money out of property – but when I look at the seriously successful property investors they have all followed a similar strategy.
Back to our question- should you buy a cheaper property and end up with 2 properties later or should you buy a more expensive property now.
If you subscribe to my investment philosophy, the more property you own, the more the "system works for you." You have the combined factors of leverage and compounding working for you growing your wealth.
So my initial though is to buy the best property you can comfortably afford. But if this is your first investment I can understand that their may be some concerns about buying a more expensive property. Worries about the size of your debt or can you afford to service the loan.
Remember fear is what holds back many investors, but with time and knowledge you should be able to overcome some of your concerns.
Good luck with your fist investment!