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When is buying property not buying property – or “shared” construction schemes.

This is a blog about things to avoid!

In my mind, buying property (real estate) puts your name on the title. If your name isn’t on the title you didn’t buy it.

I cannot give advice but, I can give guidance in relation to the question “WHY you would want to invest in property?”

In that respect – do you ever remember looking up the answer page in a maths text book and then working backwards to the start?

The answer is clearly found in two of my earlier blogs :

• Investment guidelines : start with the end in mind
• The power of leverage : something you are not taught at school

The WHOLE POINT of investing in property is that you want the power of leverage – you WANT the borrowing.

Why? – read the abovementioned blogs for a detailed answer, but as a quick summary …

• $100,000 invested in cash or shares – when it doubles is worth $200,000
• $100,000 used as a 20% deposit in a $500,000 property – when it doubles is worth $600,000 – how?
• $500,000 doubles to $1,000,000, then sell and pay back the $400,000 loan

Now back to the blog : when is buying property not buying property?

In my mind, buying property (real estate) puts your name on the title. If your name isn’t on the title you didn’t buy it.

At times of high interest in real estate (such as we are in now) all the “schemes” of the past come back to haunt the market.

They present as low risk because you are “sharing” with others. They are sold as an easy entry to property without the risk of borrowing. Nothing could be further from the truth.

Mezzanine financing (in real estate) is when a developer uses a “property advisor” to raise money from private investors.

To use a fictitious example –  DEV Property Group raises $1,200,000 from private investors. You might only have to put in $10,000. You are promised a return on your money at very attractive rates – say 20%. You are given an official document called a Convertible Note. It promises that if the developer can’t pay you the interest you can convert to shares in the company.

DEV Property Group puts $200,000 of the capital aside to “pay the interest” – that in itself is a warning bell. Dev Property Group now takes the remaining $1,000,000 and uses it as “deposit” on a loan with a Bank. They might be able to borrow up to $9,000,000 to develop a piece of real estate. DEV Property Group has the loan and is on the title, the Bank holds the mortgage.

If and when it turns to tears – and eventually some of these do turn to tears – DEV Property Group goes into receivership. The bank sells the property for a loss (it isn’t completed). You are left holding a convertible note in a company that is bankrupt. Your $10,000 “loan” ranks behind the bank and other secured creditors. It is usually small investors who thought it was a low risk way into property who discover they get NOTHING back. It is the highest risk of all.

Similar to mezzanine financing is when a “financial advisor” encourages you to buy into either “listed” or “unlisted” property trusts. Once again pooled funds are handed over with “pieces of paper” given in return. In some cases these “pieces of paper” have restrictions on when you can sell and who you can sell to. You will probably be given a glossy brochure showing some of the “property” the trust may or may not invest in. The property trust may or may not borrow – giving some similarities to the previous example.

What is your investment worth?

It is here that words from my stockbroker uncle are emblazoned into my brain. He said “Unlisted property trusts are valued by the trust itself and can only be bought and sold through “advisors” – DO NOT – invest in it”.

The owner of a house is an unreliable source of its value – it’s called a vested interest. A listed property trust can be bought and sold every day on the stock market – at least its value is determined by “the market”. This then is no different to buying shares. There is absolutely nothing wrong with that – BUT – you are simply buying shares – you don’t have the title – so you are not buying property.

To go back to start – if you wish to buy property – the whole point is to borrow. The whole point is to take advantage of the power of leverage.

If borrowing isn’t for you that’s ok BUT, that simply means that property isn’t for you.

The only way that you should buy property, is to borrow and put your name on the title.

Alan Heath…Mortgage Broker Brisbane CBD…

No question is too small for my time…Call or email me anytime…

There are many people with many varied opinions in sourcing property and in this respect my opinions are only that – opinions. All the same, let me offer my opinions based on experience.

If you are looking to source quality “second hand” property one excellent source is a buyers’ agent.

A buyers’ agent can discuss and advise on suburbs, will have statistics at their disposal on value (which is different to price) and also expected rental amount and vacancy rates. Eventually, in consultation with the buyers’ agent you will define the property characteristics you want, and he or she will then obtain a shortlist of properties that meet the criteria. You can inspect them and only buy the one you want.  You pay the buyers’ agent for this service.  A buyers’ agent will look at up to 100 properties to buy just 1, you might typically look at 5-10 before fatigue takes over. It can save time and money (they will probably negotiate better than you, as they know its value).

If you are looking to source quality “brand new” property which is usually “off the plan*” an excellent source is often referred to as a “research house”.  This is a very mixed area for its trustworthiness because such a business is paid by the developer. There is nothing wrong with that. When you sell your own house you engage a selling agent and pay them. This person is called a real estate agent and works exclusively (or is supposed to) for the vendor.  A research house is effectively a real estate agent, as they are paid by the vendor. The BIG difference though, is that they represent themselves as working for you. This is a clear conflict. There is nothing wrong with a “conflict of interest” as long as it is declared, understood, and does not influence the recommendations. One way is to ask for a referral from someone you know and trust – someone who has used this particular business before,  then trust comes from the referral. You might ask for contact details of satisfied customers. Ideally obtain this information from someone other than the research house.  It is very much a case of “buyer beware” BUT if the business is one that can be trusted it is an invaluable source.

*”off the plan” is usually bought before the developer has even gone to site. Completion and hence settlement might be 12-24 months away. Some things to keep in mind:

• A lender will lend against the value at time of completion. In a falling market this presents a risk. Let’s use an example. The purchase price is $500k and you have a 20% deposit of $100k, and hence a loan of $400k. At time of settlement let’s say the bank values it at only $400k and at 80% the maximum lend is now $320k. You will have to either put in $180k or should you elect to borrow 95%, that loan would be $380k. Even still you would have to find $120k and pay a mortgage insurance premium. In a rising market everyone has happy faces at settlement time as you have made a capital gain with no holding costs, but for every benefit the coin can be turned over. When buying off the plan you must be sure you are aware of the risk.
• A lender will only lend within 90 days of settlement. (A little known fact – loan approvals and loan documents “expire” after 90 days and must be reapplied for.) This might be as simple as reassuring the lender that nothing has changed in your financial circumstances. The consequence of this in buying off the plan is that you will sign an unconditional contract for the purchase BUT you cannot apply for the loan until 90 days from settlement. It is prudent to check with your mortgage broker that you qualify for the loan now BUT then you need to realise that you need to carry that risk all the way to settlement.

Let me give an example of things NOT to do.

• Don’t give up your salaried employment and become self-employed during this time.
• Don’t take ANY other credit facilities (eg. upgrade your home and increase your home loan)  unless you have checked with your mortgage broker. 

Off plan purchases are becoming popular again because the market is rising. It is a concern that people will ignore the past and take imprudent risks. We have only just come out of a period of falling values in the off plan market that have created a large number of very sad stories. If a developer forces you to settle (which they can do as you have agreed unconditionally 2 years prior) then, unless you can raise the additional capital you may have to sell the asset. This can be a very sad story as you are going to be selling that asset in a market that has fallen. Once again, with off plan buying as with all property purchases,  it is a case of buyer beware.  

My advice would be to always seek expert advice. If you wish to purchase a new “off plan” property, ask me. 

Alan Heath

No question is too small for my time…Call or email me anytime…

Important Guides to help make your Investment Home Loan work better for you; Interest Only versus Principle & Interest Loans (often referred to as I/O and P&I) 

I cannot emphasise strongly enough how important it is to thoroughly check strategy involving Interest Only loans with your accountant. Common sense unfortunately doesn’t always agree with Taxation Office rulings.

Let’s start by going right back to basics. One of the main reasons we invest is to give us the future we wish for and, if they have been nice to us, we might leave some to our children – even in a blog I can have some humour.

Food and Shelter are two of our most basic physical needs. We should aim to retire with either a home that is debt free, or with enough capital to produce sufficient income to cover accommodation needs for the balance of life. There are products now called Reverse Mortgages but they are a last chance fall back – not a primary plan.

So what is the lesson? As a general rule it is sensible to have the home loan for your primary place of residence as Principle and Interest so that it is slowly retired over time. There are many good reasons to modify this rule BUT only if there is a strategy in place that still aims to have a debt free residence in retirement. Your mortgage broker, financial planner and accountant can work together with you on this.

This is where an Interest Only loan can become a part of an overall strategy.

You only have so much after tax income. Any interest expense on an income producing asset is tax deductible. Payment of principle must come from after tax income.

As a general rule you should aim to pay down principle on your owner occupied residence and reduce that debt before paying down principle on an investment loan, hence ..

• Your owner occupied home loan might be Principle and Interest.
• Your investment home loans might be Interest Only.

Ok – that’s the general principle. Now for some finer points;

If there is a possibility that your current owner occupied residence might one day become a rental property, a Principle and Interest loan with minimum repayments and an offset account might be useful. You should discuss this with your accountant and mortgage broker.

I/O always has a term – let’s say 5 years. After 5 years your property might be positively geared – therefore you might consider letting it roll to P&I then and let your tenants pay off Principle as well as Interest.This is really using other people’s money to create your wealth.

An interesting point, not widely known is that although an Interest Only loan has lower repayments and hence is “easier” to pay, they are “harder” to get. This is because the overall loan still has a term of 30 years. When a bank assesses servicability of a loan with a 5 yr I/O period, they assess it over the remaining 25 years. If you want a second 5 Yr I/O term , it is assessed over the remaining 20 years. Eventually the bank wants its money repaid!

Be very wary of any scheme that involves what is called “capitalising the interest” on Interest Only investment loans – effectively letting the loan increase. The taxation office has given specific warnings about such schemes – best not to be too smart and create a problem you don’t need.

Either way, there are a number of combinations of options suitable for creating your investment wealth.

Call or email me today to discuss your personal situation and how we can make your money work harder for you.

Alan Heath

No question is too small for my time…Call or email me anytime…

 

What’s happening with APRA and interest rates?

 For most people the question would be who is APRA? The Australian Prudential Regulatory Authority or APRA was established by an act of parliament in 1998 following the collapse of several regional banks and is charged with the financial stability of the financial system – which includes oversight of the banks.

When a bank lends $100 – they must hold some “unlent” or lazy capital. For the biggest banks this is as low as $2, for smaller banks it might be as high as $10.

This money can’t be “lent” so earns no money.

It is this capital that buffers a bank in the event of a large default on its loans

 APRA is directing Australia’s largest banks (ANZ, NAB, CBA, Westpac, Macquarie) to raise more of this “lazy” capital (and in the event leveling the playing field with smaller banks.

 This, of course, comes at a cost – and someone has to pay. These banks have decided that the borrowers must pay

 In the midst of a construction uplift being encouraged by low interest rates, and with these dwellings being taken up in larger than historically usual numbers by investors, APRA has also directed lending institutions that they MUST restrict GROWTH in investment lending to no more than 10% per annum

 Their logic is that in a downturn, investors would be more likely to offload property than someone in their own home and this might “destabilize” the financial system.

 The stick that APRA are applying is forcing a bank to have to raise additional capital if they go over that target.

 So in a nutshell

• All banks MUST restrict growth in investment lending to 10% or endure the cost penalty of having to raise additional capital
• The 5 majors have been directed to raise additional capital AND restrict growth in investor lending to 10%

 The majors have decided to raise the cost to ALL existing and new investment loans (all Interest Only loans in the case of NAB)

 The others have decided to raise the cost to all NEW investment loans

 The additional cost varies a little but is generally around 0.27%pa. To keep this in perspective this means that investors have lost out on the most recent Reserve Bank rate cut

 The upside at the moment, if there is one, is that owner occupied loans are in high demand. First home buyers and owner occupiers are highly sought after at the moment and this will reflect in price.

 “Serious” investors , if I can use that term, will take this in their stride by simply factoring in the cost. A decision to invest should not be so marginal that 0.27%pa would change the decision.

 The consumer is entitled to feel a little confused though

• The Reserve Bank has its foot on the accelerator
• APRA has its’ foot on the brake

 To understand – the Reserve Bank and APRA in conjunction with each other are trying to have their cake and eat it. Lower interest rates to decrease the Australian Dollar , without over heating housing (especially over heating the investor segment)

 Have you ever driven your car with your right foot firmly on the accelerator and your left foot firmly on the brake? It isn’t a good strategy.

 There are some who question the wisdom of the Reserve and APRA – but that is not my role. My role is to help you understand what is happening, guide you with accurate facts and help you make considered decisions.

What should you do?

• If you notice the rate on any of your loans go up in the next few weeks and you think it shouldn’t have then you must contact me and we will deal with that together – it’s what I’m here for
• If you believe you currently have 20% or more equity in your own home and if your rate is not currently under 4.5%pa then you should contact me – together we will decide if we can help you make use of the current competition for your highly desirable business as an owner occupier.

References:http://www.afr.com/markets/equity-markets/secret-to-big-bank-profits-20130419-ilt9b, http://www.apra.gov.au/adi/prudentialframework/documents/agn-112-1-1.pdf

Call or Email me anytime… It’s what I’m here for… 0411 601 459

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Alan Heath… Mortgage Broker Brisbane CBD

 

A very predictable path … 

The effects of regulators (APRA and ASIC) in mid 2015 have ensured that price rises seen in Sydney over the last three years have paused. The cycle that has lasted from 2003 to 2015 is now complete.

Other capital cities have had their own cycles, with a degree of loose connection to Sydney. They also have their own contributing local factors. 

Sydney investors and owner-occupiers are now turning to the Brisbane market and based on trends visible in the last cycle, Brisbane house price will likely continue to rise for the next few years. This is why Sydney and Brisbane are so closely linked.

 

Read the Domain.com.au House Price Report, Dec Quarter 2015, in full; click here

If the Brisbane market peaks at 75-80% of Sydney Median House Price as it did in the last cycle, then that would suggest that Brisbane price will move up from its current $511k to around $750k.

Affordability is now a significant handbrake in the Sydney market.  Affordability is not yet a factor in the Brisbane (Gold Coast/Sunshine Coast) market where house prices are still on the way up, with low interest rates and (even if temporary) low petrol prices combining to give the markets significant buoyancy.

Funnily enough – it is a reasonable time to invest back in Sydney too – as long as you are buying for the next cycle.

Adelaide is also tracking the Brisbane path. The local factor in Adelaide being around what will create demand – with perceived optimism or pessimism (depending on your view) for which industry will replace car manufacturing.

Historically, when real estate cycles conclude, there is no evidence of substantial price falls – price simply pauses until the next cycle. What this means for you is that “wait and see” in SE Qld or Adelaide will simply mean you will pay more. 

As always you can call, text or email me anytime… It’s what I’m here for… 0411 601 459

Alan Heath, Mortgage Choice Brisbane CBD

Brisbane’s trusted mortgage broker of choice…