• Category Archives 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.

  • 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.

    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.

  • Does US Tax Make Sense?

    Realising that we are going to have to start filing a US tax return at the end of the year (the US financial year runs from January to December), I started to look into how the tax system works and what forms we need to fill.

    I have not figured out all the complexities of their system but I believe we are going to change the classification on our LLC so that it is classed as a corporationn(C Corp) for tax purposes.

    I remember seeing C Corp and S Corp when we were first setting up the LLC, but did not know the repercussions of each class, so we ended up going for the default partnership arrangement. Unfortunately, if we leave it as this, it means that both us will need to apply for an ITIN and file individual tax returns. Essentially each tax return will declare 50% of the income and deductions and you also have to file a tax return for the LLC.

    While I was looking at the rate of tax paid in the US system, it made me realise that the way Australian tax is done is a lot simpler and seems to make a lot more sense. What I mean by this is the amount of tax paid is linear, as you earn more, you pay more tax. Whereas, in the US system, it is has big steps between the brackets. I will show you what I mean:

    10% on taxable income from to $8,700, plus

    15% on taxable income over $8,700 to $35,350, plus

    25% on taxable income over $35,350 to $85,650, plus

    28% on taxable income over $85,650 to $178,650, plus

    33% on taxable income over $178,650 to $388,350, plus

    35% on taxable income over $388,350

    You can see that there is no tax free threshold like there is in Australia (currently $16,000), and there is no marginal rate for amounts over a certain amount. What does this mean? Let’s look at the following situation:

    Person A earns $35,300 in annual income – pays a rate of 15% tax, so net income becomes $30,005

    Person B earns $35,400 in annual income – pays a rate of 25% tax, so net income becomes $26,550

    It is amazing isn’t it, Person B earns more income, yet because of how the US tax system is setup, it forces him to be taxed more and end up with a lower net income! It really does not make sense. I am tempted to ask my US accountant if this is true. It would make me want to ask my boss for a “de-raise” if I was close to one of the brackets or look at what tax deductions I could claim to lower my taxable income. What do you think?

  • Turning your PPOR into an Investment!

    Recently I wrote an article about the comparison of Renting vs Buying. That article was for the initial choice between buying a house compared to renting a place to live and investing the assumed extra cash flow that comes with it. A question was asked of us recently on the benefit of moving out of your PPOR and renting a place, while renting out your PPOR in the meantime.

    I remember reading an article a couple years ago about the benefit of purchasing a place that you want to live in some time in the future, basically the typical 4 bedroom suburban home to raise a family in, while you are single and young, live where you want to. The benefits seemed to make sense and this is exactly the situation I was asked about. I now seem to find myself in the same situation. I have been living in my PPOR for the last two and a half years but I am relatively far from the city, not close to many of my friends and not in the most desirable area to live in.

    The decision to move out has already been made in my mind; I feel for me at this time, it is a better lifestyle choice. Since I have already balanced the emotional side of the decision, I now just had to convince myself of the financial benefits. I was able to develop a fairly routine spreadsheet to show the financial implications of making such a decision.

    Basically, I would be able to rent out the property for $400 per week and to rent out a place that I would like, I would be able to find a property for $250 a week. Already it is easy to see a benefit of $150 per week. However it is important to note there is a lot of additional expenses that will need to be covered when you become a landlord. Landlord insurance is required to ensure your tenants do not take you to the cleaners, contents insurance is also a good thing to have when you are renting. Property management fees will also need to be taken into consideration.

    After taking all of the above into consideration, I found out that I would be approximately $100 per month better off if I moved out of my PPOR and rented it out. It should be noted that I did not take into account the tax implications of turning my PPOR into an investment. I realise you would be able to deduct a fair bit due to having the investment property, but this would most likely be offset by the added income due to the rental returns. So in the end, I did not take into account the tax implications, it would have made the spreadsheet a lot more complicated, and I do not believe it would have added anything extra.

    If you would like a free copy of this spreadsheet, please click this link Spreadsheets

    I have also read about the benefits of exchanging the title of the property into a trust to be able to fully deduct the interest repayments with your tax return; however I have not looked into this in great detail and unfortunately cannot provide any extra information. However if you have paid down the principal significantly (in which case there is minimal interest to claim), then it may not be worth it. As stamp duty will have to be paid when you transfer the title to a trust.