• Category Archives General Property Investing
  • Inflated Property Returns

    I was talking to someone recently about our property in Florida, and was saying how the expenses were higher than we first imagined, and in turn our return is a bit less than what we were hoping for. Initially I was hoping for a net yield of around 8.00%, I thought this might be a bit optimistic but going through the numbers before purchasing a property, it seemed like a realistic value.

    But after obtaining our property in Florida and seeing first hand the expenses, it seems that despite being fairly conservative in our initial assumptions, the return is still less than what we initially hoped for. However, if you rearrange the numbers a little, the investment looks better and perhaps even a bit more realistic as well. See below for the initial and subsequent calculations which show net yield returns.

    Initial Calculations

    The Net Yield of 0.56% is less than desirable, and if we were told we would be getting this return then I don’t know if we would have taken the leap to invest in the US as the hassle would just not be worth it. Although I did not include any capital gains on the property (as our plan is for cash flow) this can be  disregarded as the cash flow target simply has not been met.

    But by making some adjustments to the calculations, like shifting some of the expenses to the capital (moving the cost of the A/C unit and the whitegoods under capital expenditure), the numbers start to look much better. This is realistic as these expenses are not a yearly expense and you would hope that a new A/C unit would last a few years at least, the same with the white goods. Further, you can remove the cost of PI  insurance (as this expense is not dedicated to this single property and will cover all properties under the LLC) and include it as part of the LLC’s general overheads.

    Adjusted Calculations

    As you can see by adjusting the calculations to perhaps more realistic figures, we have now obtained our 8.00% Net Yield that we were hoping. It is important to note that both situations are essentially identical with all expenses included in both examples (with the exception of PI Insurance), yet it is simply a different way of
    calculating that gives you a very different result.

    I think this is a good sign to be careful when seeing advertisements purporting unbelievable returns. You should always look through the numbers yourself and satisfy yourself that what is being advertised is achievable. You should also always check whether the returns are ‘gross’ or ‘net’ yield and what expenses have been considered.


  • The Business of Property Investing in 2013

    With a new year under way, now is the best time to organise your financials and plan for a prosperous year ahead. These four tips will assist you in making 2013 your strongest investing year yet.

    Number 1 – Set goals

    You’ve probably heard this one a bunch of times, each time brushing it off as unnecessary or something to look at later. It took me quite a few years of doing just that before I finally realised the benefits of setting goals at the start of each year.

    Setting goals will help you focus your energy and give you some direction throughout the year. It doesn’t need to be an onerous exercise but each goal does need to be actionable and measurable. For example, ‘purchase another investment property’ or ‘increase passive income to $500/week’ provide clear benchmarks to aim for. ‘Get rich’, on the other hand, won’t really do.

    Make sure that each goal:

    • can be achieved within a year
    • is something that you can measure your progress against
    • is, most importantly, something that you’re passionate about achieving.

    The goals that you set at the start of the year can be amended and updated as things change.

    Number 2 – Undertake an end-of-year review

    An end-of-year review is something everyone should do, regardless if you set any specific goals the previous year or not. When you treat your investments as a ‘business’, your overall results will improve.

    Undertaking a review doesn’t need to be too complicated. Start off by asking yourself simple questions such as, ‘Am I happy with what I achieved this year?’ and ‘What area could I have improved in?’.

    Next, list your achievements for the year (this doesn’t need to be limited to your financials) and areas where you lost a bit of focus (for example, sticking to a budget).

    The final step is to review all of your current investments to see how they are travelling.

    Number 3 – Set a budget

    Budgeting ties in nicely with the first two tips. Once you’ve set your yearly goals and undertaken a review of the previous year, you’ll be in a much better position to move forward with all of your financial pursuits.

    Find a basic budgeting spreadsheet on the internet and fill it in as accurately as possible. If you’re unsure about any numbers, make an educated guess, but do try to be as comprehensive as possible.

    With your budget complete, you will be able to see exactly where your money is going on a weekly or monthly basis. This will also assist you when you undertake your next end-of-year review.

    Deposit a portion of any excess income into a high-yielding online savings account where it can stay until the next deal comes along.

    Number 4 – Keep good records

    Start each year with a relatively clean slate when it comes to records. It’s easy to be overrun with too many emails, RSS feeds and ‘to-do’ lists. Give your inbox a thorough clean-out and try to keep it clear by archiving old emails. Keep one ‘to-do’ list (preferably one that you can access everywhere, for example, with Evernote), then write down each day’s actions on a Post-It note.

    Lastly, file everything (electronically and hard-copy) that is important using a clear folder structure.


  • Interest rates: are your investment decisions sending you to an early grave?

    On the first Tuesday of every month something happens that gets every property investor and commentator curious.

    I am talking about the meeting that the Reserve Bank of Australia (RBA) has every month to talk about all things interest rates.

    It may seem insignificant to change interest rates by 0.25%, but 0.25% means millions of dollars for banks and financial institutions. If property owners are treading that fine line of only just being able to service their loans, then one rate change in the wrong direction could leave them struggling to make ends meet, and a couple rate changes could leave them close to having to sell their home or even facing bankruptcy.

    This is why it is so important that people take into consideration the potential consequences of rate changes before they sign up to a new loan. A property loan is a long-term deal. Even with refinancing you could still be locked in for up to three years – and facing 30 potential rate changes in that period.

    It’s a matter of needing to hope for the best but plan for the worst.

    I still remember when I got my first home loan … the standard variable rate at the time was about 5.80% per annum and with that rate I was comfortable making the repayments, even being able to manage some extra repayments. But before I finally signed off on the contract, I wanted to make sure that changes to the interest rate wouldn’t leave me bankrupt. Having done the sums, I would have still been able to make the repayments if the interest rate rose to 10.00% per annum.

    A simple way to check is to add 3.00% to the current standard rate and see if you are still able to make repayments. If you can then you should have no problems servicing the loan.

    It’s interesting to note that most financial institutions don’t advise you to carry out this sort of simple, yet very important, check. I was given pre-approval for a loan amount way out of my limit. Add to that a few rate changes in the wrong direction and I would have been on the brink of not being able to service the loan.

    In my opinion, this is just pure greed on the part of financial institutions and is plain negligent. A lot of people will take the pre-approval amount and start looking for properties up to this price range, completely unaware of the precarious position they are putting themselves in. Add to this the tendency for Australians (at least in the past) to live way above their means and you have a perfect recipe for disaster.

    At the end of the day, however, people still need to take accountability for their own actions and should take a greater interest in their finances. Getting finance is the most powerful tool property investors have in regards to building wealth, but, like most things, it is a double-edged sword. You need to take stock of your current situation and plan for the different circumstances that could arise in the future.

    I have watched my parents worry about bills as they come in and get stressed at the increases to grocery prices. One of the things that they did do right was to pay off their home loan as fast as they could. Couple that with a large deposit and they didn’t need to wait for RBA’s monthly interest rate announcement with sweaty palms.

    It is this mentality that I have emulated. When I see the interest rates change, I know my large buffer will keep me going before things get tight. As I increase my investment property portfolio, I make sure that I use these ideals in every investment decision. The last thing that I want is to be watching the news once a month, praying that the RBA does not increase interest rates, knowing that if they do, it would lead to financial catastrophe.

    Investing is about growing wealth, not about growing stress.

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    Disclaimer: By viewing this website, you acknowledge that it is for informational purposes only and does not imply any contractual agreement, promises of returns or legal expertise. All investors should consult with legal representation and appropriate accountants before making any investment and should ensure that individual due diligence is done. Any information provided here is for educational purposes only and should not be taken as financial advice.


  • The Myth of Negative Gearing

    I remember when I was younger, asking my mum what Negative Gearing was. I had seen it advertised everywhere, from free seminars on television to articles in magazines and newspapers, it seemed to be the buzz phrase of the day. My mum explained that negative gearing was when you buy a house and rent it out to a family and let the rent pay for the mortgage. I guess she kept it simplified because I was not even a teenager at that stage but even still, it sounded like a good idea to me, you basically get a house for free! So what could possibly go wrong?

     

    A few years later, when I really started to look into investing, I began to see the “negative” part of negative gearing. I guess the answer was always in the name, if something is called negative, then it is never going to be a good thing, right?

     

    So, what is negative gearing? Put simply, negative gearing is purchasing a property as an investment, where the money coming in (rent) does not cover the money coming out (loan repayments, maintenance, agent’s fees etc.) and you are forced to use your own income to cover the difference.

     

    But so many people have made so much money out of negative gearing, “how can it be a bad thing?” I hear you ask. Well to make money out of a negatively geared property, the value of the property needs to rise consistently over the medium to long term of the loan. Back when negative gearing was really popular, this was the case but in the not-so-flash property market of today, you need to give things a second and third look before jumping in. In a rapidly rising market like Australia had during the 2000s, it was next to impossible to lose money investing in property. In the end, all these people who invested in negatively geared property were able to still make money despite an unsustainable investment strategy.

     

    So, what makes it so unsustainable? Well it is a fact that the majority of property investors own 2 or less properties, I cannot remember the exact percentage, but I believe it is something like 90% of property investors ‘only’ own 1 or 2 properties. The reason for this is simple, the majority of properties are negatively geared; they cannot afford to hold any more. 


    As an example, let’s say you have $1,000 extra cash flow a month. Because a negatively geared property is taking money out of your pocket, assume it costs you $500 per month to maintain the loan (cover the difference between the rent and the loan repayments). Already you can see that you are only able to cover 2 properties, as after that, you are out of extra cash flow.

     

    So why do people negatively gear into property? Well again, the answer is simple. They have to. They want to invest in property because according to a lot of people, it is a great way to invest, just about risk free, just about a guarantee to make a return and the saying “safe as houses” does come from somewhere after all. 


    As it stands now, if you want to invest in property as part of your portfolio, you will see that almost all of the available properties are negatively geared. This is mainly due to the extremely high house prices in Australia, particularly in the major cities. House prices rose dramatically over recent times, and the increase in rent simply did not keep up. I remember when I was renting back in 2009; we paid $550.00 per week for a 3 bedroom house in Sydney. Looking at comparative sales nearby, the house would have been easily worth about $800,000. Assuming an interest rate of 7.00% per annum, that gives a weekly interest repayment of $1,076.00. Repayments at this level don’t even begin to “eat” away at the principal amount as the rent is nowhere near the amount needed to service the loan. This is the situation across most of Australia, rent prices just do not come close to the loan repayments and all the properties have to be negatively geared.

     

    Another reason that people invest in negatively geared property is to reduce their tax bill. People are under the illusion that they can end out better off because they’re paying less in tax. Of course it is true that you can claim expenses on the house on your tax return, but this is offset by the money out
    of your pocket to service the loan, so you still end up out of pocket. Let me show you an example:

    Your initial taxable income is $150,000 per year

    Tax rate of 45%

    Rent collected of $600 per week

    Interest repayments of $1,100 per week

    Other deductions of $5,000 per year (property maintenance, fees etc)

     

    Option 1 – Not investing in property

    Taxable Income = $150,000

    Tax Paid = $150,000 – [$150,000 x (1 – 0.45)] 
                   = $67,500 (approximately)

    Net Income = $150,000 – $67,500
    = $82,500

    Option 2 – Investing in property

     

    Taxable Income = $150,000 + $600 x 52 – $1,100 x 52 – $5,000
                             = $119,000

     

    Tax Paid = $53,550

     

    Net Income = $119,000 – $53,550 
                       = $65,450

     

    So as you can see, your net income is almost $20,000 less in this example, so just to break even with a negatively geared property, you need to ensure there is at least $20,000 in capital gains over the course of a year. Now as I said earlier, when the property market was going well, this was fine, but without the large rises, negative geared property should be heavily scrutinised before committing to buy.

     

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    Disclaimer: By viewing this website, you acknowledge that it is for informational purposes only and does not imply any contractual agreement, promises of returns or legal expertise. All investors should consult with legal representation and appropriate accountants before making any investment and should ensure that individual due diligence is done. Any information provided here is for educational purposes only and should not be taken as financial advice.