• Category Archives Real Estate
  • 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.


  • Lithgow Properties

    Having a quick look on www.realestate.com.au you will see there are several properties that can provide you with neutral/positive gearing. Have a look below at a list of properties with their figures and gross yields for each of them. These are all simple calculations and using a spreadsheet was able to take only a minute to generate them. Note these are all free standing houses so have no strata associated with them.

    House Cost Rent Per Week Gross Yield Interest Weekly Profit
    $143,000.00 $165.00 6.00% $151.25 $13.75
    $155,000.00 $175.00 5.87% $163.94 $11.06
    $185,000.00 $210.00 5.90% $195.67 $14.33
    $209,000.00 $225.00 5.60% $221.06 $3.94
    $235,000.00 $265.00 5.86% $248.56 $16.44
    $180,000.00 $195.00 5.63% $190.38 $4.62
    $199,000.00 $225.00 5.88% $210.48 $14.52
    $160,000.00 $180.00 5.85% $169.23 $10.77
    $165,000.00 $185.00 5.83% $174.52 $10.48
    $160,000.00 $175.00 5.69% $169.23 $5.77
    $249,500.00 $350.00 7.29% $263.89 $86.11
    $229,000.00 $300.00 6.81% $242.21 $57.79
    $169,500.00 $250.00 7.67% $179.28 $70.72
    $235,000.00 $265.00 5.86% $248.56 $16.44
    $240,000.00 $375.00 8.13% $253.85 $121.15
    $245,000.00 $300.00 6.37% $259.13 $40.87
    $189,000.00 $210.00 5.78% $199.90 $10.10
    $150,000.00 $175.00 6.07% $158.65 $16.35

    The interest is assumed to be 5.50% per annum.

    As you can see, just having a quick look there are plenty of properties which can offer you positive returns. Now I understand that I have only done gross yield, and there are plenty of expenses that have to be accounted for that will severly reduce the overall yield, but hopefully even without some of these expenses the properties should be at least neutrally yielding.

    It is also important to note that it is not always the best to go purely off yield as a figure, but sometimes a figure like weekly profit would also be a good test. In the above table, a higher yield does not always correspond to a higher weekly profit. And at the end of the day that is what is really important, getting that money in your pocket!

    A cash on cash return is also a good way to check and compare properties, the following table does a cash on cash return with a couple extra assumptions. Assumes a deposit of 20%, additional purchasing costs of 5% (stamp duty, lawyer fees etc). And additional expenses such as property manager fees, insurances, rates etc of 2% of property value.

    House Cost Total Purchasing Costs Loan Size Interest Expenses Gross Rent Yearly Profit Cash on Cash Return
    $143,000.00 $35,750.00 $114,400.00 $6,292.00 $2,860.00 $8,580.00 -$572.00 -1.60%
    $155,000.00 $38,750.00 $124,000.00 $6,820.00 $3,100.00 $9,100.00 -$820.00 -2.12%
    $185,000.00 $46,250.00 $148,000.00 $8,140.00 $3,700.00 $10,920.00 -$920.00 -1.99%
    $209,000.00 $52,250.00 $167,200.00 $9,196.00 $4,180.00 $11,700.00 -$1,676.00 -3.21%
    $235,000.00 $58,750.00 $188,000.00 $10,340.00 $4,700.00 $13,780.00 -$1,260.00 -2.14%
    $180,000.00 $45,000.00 $144,000.00 $7,920.00 $3,600.00 $10,140.00 -$1,380.00 -3.07%
    $199,000.00 $49,750.00 $159,200.00 $8,756.00 $3,980.00 $11,700.00 -$1,036.00 -2.08%
    $160,000.00 $40,000.00 $128,000.00 $7,040.00 $3,200.00 $9,360.00 -$880.00 -2.20%
    $165,000.00 $41,250.00 $132,000.00 $7,260.00 $3,300.00 $9,620.00 -$940.00 -2.28%
    $160,000.00 $40,000.00 $128,000.00 $7,040.00 $3,200.00 $9,100.00 -$1,140.00 -2.85%
    $249,500.00 $62,375.00 $199,600.00 $10,978.00 $4,990.00 $18,200.00 $2,232.00 3.58%
    $229,000.00 $57,250.00 $183,200.00 $10,076.00 $4,580.00 $15,600.00 $944.00 1.65%
    $169,500.00 $42,375.00 $135,600.00 $7,458.00 $3,390.00 $13,000.00 $2,152.00 5.08%
    $235,000.00 $58,750.00 $188,000.00 $10,340.00 $4,700.00 $13,780.00 -$1,260.00 -2.14%
    $240,000.00 $60,000.00 $192,000.00 $10,560.00 $4,800.00 $19,500.00 $4,140.00 6.90%
    $245,000.00 $61,250.00 $196,000.00 $10,780.00 $4,900.00 $15,600.00 -$80.00 -0.13%
    $189,000.00 $47,250.00 $151,200.00 $8,316.00 $3,780.00 $10,920.00 -$1,176.00 -2.49%
    $150,000.00 $37,500.00 $120,000.00 $6,600.00 $3,000.00 $9,100.00 -$500.00 -1.33%

    As you can see, when you do a bit analysis into the figures a lot of the properties start to give you poor returns, and are slightly negatively geared. Keep in mind that even the worst performing property above is only in negative about $1,700 per year, about $33 per week. But still, it is costing you money, not making you money! On the other end of the scale, there is a property that is earning you $4,140 per year, an extra $80 per week! It may not sound like a lot of money, but it is all passive income, money in your pocket for doing minimal work.

    As I said at the start, finding positively geared properties is very difficult, the list of properties above, although looking at the gross figures appeared to give you positive returns all of them, with a bit of analysis, it showed that most of them were indeed negative, albeit not too badly. But the point to remember is that the positively geared properties are still out there! I searched for about 30 minutes to find this list of properties above, and only searched in one city. The analysis took a further 30 minutes, so one hour of my time and I can find a good positively geared property to help increase my real estate portfolio.

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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.


  • 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.


  • How to Choose the Right Property Manager

    So, you’ve just purchased your property. You’re over the moon that you’ve finally made the leap into the property market and can now start reaping the rewards. Well, unfortunately the hard work is not over. The number one, most critical decision outside of when to buy and sell a property is choosing a suitable property manager.

    A property manager’s role is broad and can cover anything from choosing a tenant, collecting rent, carrying out repairs, and providing sensible advice on management decisions. A good property manager will do this and more, covering all of the little, but very important things as well. These should include, but are not limited to:

    • Find prospective tenants
    • Check a potential tenant’s criminal record
    • Prepare the lease documentation
    • Advertising
    • Maintenance
    • Take initiative with undertaking repairs under a nominated dollar value
    • Organise bond documentation
    • Pay authorised account and statutory charges
    • Undertake regular property inspections and provide good feedback back to the landlord
    • Check a potential tenant’s credit history
    • Give you up to date advice on rentals and the property market
    • Administer rent reviews
    • Pass on the rent payments to you promptly
    • Provide regular statements
    • Handle arrears

    So, how do you choose a good property manager? There are a number of ways that good property managers can be found. It’s rare that the best one for you will be the buyer’s agent. It’s much more common to find good property managers through word of mouth, looking through investment forums etc. Here are some tips for finding a good property manager:

    • Always contact the property manager’s current and previous clients to get a bit of perspective on his or her character
    • Have a clear contract set up with your property manager which outlines all the services that will be provided
    • Generally, try and steer clear of really cheap property managers as it’s likely the services will be of a much lower quality and will end up costing you more money in the long-run
    • Try and gauge the reputation of the company that the property manager works for by looking on the internet and contacting other professionals in the industry
    • Find a property manager that specialised in the types of properties that you are planning on buying

    Here are some other articles that you might be interested in:

    Advice on American Real Estate Agents

    American Real Estate Listing System

    If you have any questions or comments feel free to contact us.