The Power of Leverage : Something You Are Not Taught At School

May 2, 2017

Investment guidelines : The Power of Leverage.

I remember when I was quite young and was introduced to investing by my family – who as it turns out invested mostly in the share market. I was encouraged to buy my first parcel of shares. The business still exists today – Argo. After 12 months they had gone up and I remember proudly ringing my uncle and asking if I should sell, only to be told that “our family doesn’t sell” and that he would only help me if I was ringing to buy.

The message of course was simplistic but powerful all the same. To remember a conversation from so many years ago shows its impact. My early lesson was that investing is all about “time in the market” not about “timing the market”

There are many ways to approach investing – my comments are going to focus on guidelines for investing in property for the long term.

The first and perhaps most powerful message of all is “the power of leverage”

Let’s say you have $100,000 to invest and you can invest in an asset class that pays on average 7%pa. Let’s say you keep reinvesting the dividends or interest. In 10 years your money will have doubled to $200,000.

Now let’s take that $100,000 and use it as a 20% deposit for a property costing $500,000, meaning we borrow $400,000. With that same 7%pa return the property will be worth $1,000,000 in 10 years. With the $400,000 loan still in place your $100,000 has become $600,000

Give it another 10 years and the invested cash is worth $400,000, but the property is worth $2,000,000 and your investment worth a net $1,600,000

Invest for 30 years and the cash is worth $800,000 but the property is worth $4,000,000 and your investment a net $3,600,000

This is the power of leverage There are some cautions of course

  • You will need to monitor the condition of the property and of course this is not cost free.
  • There will be interest to pay on the loan – but you will receive rent to offset that.
  • The power of leverage works in reverse as well – in a falling market your losses are magnified. As long as you service the loan however no bank will ask you to sell for a loss.
  • This is not true of the share market where a lender can require you to sell at a loss even if you are servicing the loan. The share market is a legitimate market to invest in BUT if you are going to borrow it is a riskier proposition requiring a greater level of financial sophistication.

The blogs in this series will be about using the power of leverage by investing in property.

Want More? Download my app – Ask Alan – from the App Store and Google Play (click below) Talk to me, ask questions, read up to date information, watch video on topics of interest…

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Alan Heath… Mortgage Broker Brisbane CBD

Definition of an Asset plus Negative and Positive Gearing

May 2, 2017

 

Alan Heath, Home Loan Specialist for today’s you…

What is an Asset? There are differing definitions of what makes something an investment but they all focus on two main points

  • The ability to generate income
  • The ability to increase in value

In my opinion, the one to which the MOST attention should be paid is the ability to generate income because that is the most reliable indicator of something’s inherent financial value. From this perspective something that generates no income is NOT an asset. This rules out many things often “said” to be assets.

The most obvious here is a car. Let’s say the car is purchased with a loan. This car generates only expense for you, its value decreases year by year and the only income it produces is for the lender. The car is a liability to you. The car is an asset to the lender.

Let’s revisit purchasing an “investment” property.

Let’s say this property costs $100,000 and we borrow it all.

Let’s say it rents for $100pw so a 5.2%pa return

(if the property costs $200,000 and rents for $200pw, or costs $500,000 and rents for $500pw then the percentages are the same. Choose a value appropriate to your area – or just ignore the value and use my example)

Let’s say the interest rate is 5.2%pa This would be a neutral return (ignoring inflation)

Let’s say the interest rate is 6.2%pa. This would generate a negative return of 1%pa – this is what people call “negatively geared” – in this example that loss would be $1000

Let’s say the interest rate is 4.8%pa. This would generate a positive return of 0.4%pa – this is what people call “positively geared”

Negative gearing : How many times have you heard someone say that negative gearing is a good thing? Is it? What does it mean? Let’s put one thing to rest absolutely – losing money is a bad thing! Why would you invest to lose money.

There are two important points to understand Any real loss can be deducted from your taxable income reducing the tax you pay. In the example above let’s say you income is $15,000 – your income would reduce to $14,000. You didn’t pay tax before and you don’t pay tax now. The whole $1,000 loss is yours.

Let’s say your income is $60,000 – your income would reduce to $59,000 and given that your tax rate is 30c you get a tax refund of $300 so $700 of the loss is yours.

Let’s say your taxable income is $150,000 – your income would reduce to $149,000 and given your tax rate is 47c you get a tax refund of $470 so $530 of the loss is yours.

What is the financial “lesson”? All negative gearing generates a loss.Don’t take any notice of the refund – a loss is a loss.  NO investor tries to LOSE money.  A sub lesson is that using negative gearing as a strategy on a low income makes no sense.

So if ALL negative gearing means you have lost money – why do it? An investor is hoping that the other reason for investing – capital growth – outweighs the loss.

Let’s say that property rises by 8% in value this year. Your property is now worth $108,000. The loss can be justified with a very big BUT. The capital growth is a “paper gain”, the negative gearing loss comes out of your wallet each month – it’s real “in the moment”. One thing is clear – a negatively geared property that has no capital growth prospects is not a good investment 

Positive gearing : A positively geared property is what all investors should aim for. It generates income in the short term and capital growth in the long term. Sure the profit is added to your income and you pay tax on that profit. Making a profit and having to pay tax is a wonderful “problem” to have.

Now let’s go back to our examples

Let’s say our property that cost $100,000 (and we borrow it all) rents for $300pw which is a 15.6%pa return.

Let’s have an interest rate of 5.2%pa which gives us a profit of 10.4%pa or $10,400. Sure we have to pay tax BUT what a great problem. If you could find a property like that you’d want it!!

How do you find positively geared property – I sometimes have new investors come to me and say they only want to buy positively geared property.

There are two common sources but investors should tread very carefully. Often investment property in regional mining towns can be bought quite cheaply and rented out for very high rent. That would be a good thing, right? Not necessarily. Mining towns are often very narrow in employment scope and hence population. When mining is on the upswing, population swells, capital growth and rents escalate. As they say, all that glitters is not gold. If that mining town loses the mine then population leaves just as quickly and you investment property will drop in rent and have very little prospect of capital growth again. Investing in mining or other single industry towns is a high risk strategy. When a large company is considering closing that mine or industry down the average investor is rarely if ever given warning. The investor is left high and dry. You are probably gaining the impression that I would call investing in single industry towns “speculation” rather than “investment”

There is another way to find a positively geared property. EVERY property is positively geared if it is held for long enough. How? I have clients who purchased property for $100,000 and the loan was $100,000. It initially rented for $100pw but over time the capital value of the property rose – and is now $300,000 and the rent has risen with time too to $300pw. The key point is that the loan is still $100,000. There you have it! A $100,000 loan and $300pw in rent. What is the smartest way to get positively geared property.  Buy almost any property and hold it for a considerable time. The key now is simply to seek out a sound property that will be easily maintained over time.

There are other types of “specialty property” that can appear to have good rental returns. Let me give one example – Defence Housing. This is a property where you purchase a property and the Defence Force becomes your tenant. The tenancy period is usually quite long – say 10 years and the rent is often quite attractive. Let’s look at an important part of any investment – the exit strategy. This would commonly involve selling the property. You might need to sell the property because a particular situation has arisen. If you need to sell your property it is wise to be able to sell to the “whole” market, owner occupiers (including First Home Buyers) and investors. If you have chosen a property that can ONLY be sold to investors then you have eliminated the largest part of the buying market. It is wise to consider holding property that can eventually be sold without restriction to all segments of the market. (other types of property in this category – where you should look before you leap into buying – would be retirement style housing, and the govt sponsored NRAS (National Rental Affordability Scheme)

Although there is no right and wrong in this area, this factor in selling a home is often completely overlooked.

Want More? Download my app – Ask Alan – from the App Store and Google Play (click below) Talk to me, ask questions, read up to date information, watch video on topics of interest…

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Google Play: http://bit.ly/1MP04tP 

Alan Heath… Mortgage Broker Brisbane CBD

 

Is It time to buy real estate? Making Sense of the Market 2017

May 1, 2017

Is it time to buy Real Estate?

Hindsight is a wonderful thing, but it isn’t much help when trying to anticipate the best time to buy Real Estate. That said, by analyzing past data it is possible to expose telling trends and cycles. And right now, the trend is your friend.

Let’s take a closer look into three particularly interesting and current trends:

  • Trend 1: When interest rate goes down, house price goes up
  • Trend 2: Sydney Median House Price rises at 7% per annum
  • Trend 3: Brisbane Median House follows closely behind Sydney Median House Price 

Trend 1: When interest rate goes down house price goes up. 

Competing forces are at work with interest rates and there is evidence we are at a significant turning point.

 In early 2016, as inflation fell and the Australian economy slowed, the Reserve Bank cut official interest rates twice, catching (some) people by surprise. The truism that “when rates go down house price goes up” could not have been better demonstrated in Australia’s most expensive market – Sydney, where house price which had paused has kicked up strongly!

To see where house price is headed in 2017, we need to look at where interest rates are headed. The Australian p1 Jan 26 2017 stated that “low inflation has eliminated the chance of rate rises this year”. A proven reliable source, Bill Evans, Westpac’s Chief Economist, expects the Reserve Bank to stay firmly on the sidelines this year with no change predicted. He does however expect bank funding costs to rise by 0.3% this year. (Westpac Weekly Update Jan 23 2017). This is significant – Westpac are predicting rates will rise (by a small amount) this year.

 There are other players now in the rate equation – APRA and ASIC – both are government regulators with specific roles inside the financial system. (for a more info on their roles and effect, read my blog “What should I do about rate in 2017”)

 2017 could well prove to be the turning point in the (Sydney) property market.

 If rates to consumers trend up that means Sydney property price may well flatten and even turn down. Many people thought that in Sep 2015 and were proved wrong, but this time there is much more political sentiment encouraging a pause for Sydney house price.

 The message here: All signs suggest we are nearing, if not already at the turning point of the current cycle. If you were looking to ‘wait and see’ the bottom of the market, then wait no more!

 Trend 2: Sydney Median House Price rises at 7% per annum

Has Sydney house price gone too far? Opinions don’t matter – only numbers matter. And numbers show that by even the most conservative trend – Sydney Median House Price has been rising at 7% over the last 30 years.

 Look back to 1998 and 2002 when Sydney Median House Price “overshot” the trend. FOR EVERY YEAR THAT HOUSE PRICE OVERSHOOTS TREND, there is a year down the track that it must pause for.

 Fact – in Sep 2015 Sydney Median House Price overshot the trend. Fact – Sydney Median House Price has now overshot the trend by MORE in the current cycle.

 In my opinion, this means that Sydney Median House Price will now take a pause sometime soon. This upward trend cannot continue forever – it just doesn’t work like that.

 The message here: Buy in Sydney if you are going to hold long term until the next cycle – but don’t buy in Sydney to make a quick gain – as the saying goes – “that boat has already sailed”.

Trend 3: Brisbane Median House Price follows but lags Sydney Median House Price

Certainly, one of the most topical trends of the moment is the confident up-rise of Brisbane Median House Price. Interestingly this is equally true at the moment in … Gold Coast, Canberra, Hobart and Adelaide as well. (Domain Quarterly House Price Report Dec 2016)

 Our Sydney clients buying in Brisbane at the moment are doing so confidently, and either at or above asking price. They’ve seen this trend before…

Brisbane clients however, are experiencing frustration at not having their lower than asking price offers accepted and consequently are taking several attempts before being successful.  

 The market where you can offer low and wait to hear back from the agent to negotiate has GONE.

Look back at 2002 when this has happened before. Sydney house price swiftly rose, then stalled, and Brisbane (suddenly looking more affordable) eventually then caught up.

It is happening again right now – the numbers speak for themselves.

The message here: Buy now in Brisbane (Gold Coast, Canberra, Hobart and Adelaide) and capitalize on an upswing…  The trend is your friend.  

As always, you can call of email me anytime, it’s what I’m here for.. 0411 601 459

Investment 1: Start with the End in Mind

April 30, 2017

Start with the end in mind and focus on it often – especially when you feel like wavering!

Start with the end in mind and focus on it often – especially when you feel like wavering!

Both sides of politics in Australia are telling us that we will need to wait for an increasingly longer time before being able to access the aged pension. Although the rules around qualifying for the pension are complex and must be explained by a qualified professional in relation to your own needs, one thing is clear – you need to take responsibility for your own wealth creation if you wish to be able to have the retirement you wish for.

Set a personal goal is to create a capital base big enough to generate sufficient income to meet your daily and annual needs WITHOUT reducing the capital base.

Work out your income needs – let’s say $100,000pa. In retirement for the sake of this exercise let’s invest risk free – say govt bonds – and let’s assume an easy rate of 5%pa. A capital base of $2,000,000 at 5%pa generates $100,000pa. This is both simple and easy to understand.**

The rules around retirement in Australia are complex – you are being imprudent to ignore that complexity simply because it’s a long way off. You should treat your mortgage broker, accountant as your most important financial allies. You need to know each one personally and be able to talk to them whenever you need to.

Never invest in something you don’t understand. One day if your plans falter you need to be able to look at yourself in the mirror and see the person responsible  looking back at you. No-one will take an interest in your future better than you. Your key advisers should be integral passengers at the front of your financial bus trip but you need to be the driver. They should not be driving the bus with you not even being in the bus as a passenger.

Here is a financial folly – most Australians think that superannuation of $300,000 sounds like a lot. Let’s say you currently earn $50,000pa. How can savings equivalent to 6 years income last your potential retirement lifetime! This illustrates that financial folly.

We are sometimes told (by politicians) that $1,000,000 in superannuation makes you part of the super rich. By my definition – $1,000,000 invested at 5%pa equals $50,000. In my world that is not super rich. In my world $1,000,000 is not even close to enough to retire on. Those same politicians will retire on their parliamentary pensions for life. Don’t rely on politicians for your financial future.

Each and every one of us has the potential to aspire higher should we so choose. The principles that I will cover in this series of blogs will show you how. There are various asset classes to invest in with the two primary ones being property and shares.

My series of blogs will deal with investing directly in property

In the current housing boom post Covid, there is clearly considerable interest in property again.

Are all houses good investments? What makes a “good” investment?

I will cover that in next week’s blog

** When I began my own personal investment journey the govt bond rate was around 5%, it is currently under 2%. This does not alter the goal – it may simply alter the time taken to get there. Adjusting goals to reality is all part of the process.

Alan Heath

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

Investment 2: The Power of Leverage : Something You Are Not Taught At School

April 29, 2017

Investment guidelines : The Power of Leverage.

I remember when I was quite young and was introduced to investing by my family – who as it turns out invested mostly in the share market. I was encouraged to buy my first parcel of shares. The business still exists today – Argo. After 12 months they had gone up and I remember proudly ringing my uncle and asking if I should sell, only to be told that “our family doesn’t sell” and that he would only help me if I was ringing to buy.

The message of course was simplistic but powerful all the same. To remember a conversation from so many years ago shows its impact. My early lesson was that investing is all about “time in the market” not about “timing the market”

There are many ways to approach investing – my comments are going to focus on guidelines for investing in property for the long term.

The first and perhaps most powerful message of all is “the power of leverage”

Let’s say you have $100,000 to invest and you can invest in an asset class that pays on average 7%pa. Let’s say you keep reinvesting the dividends or interest. In 10 years your money will have doubled to $200,000.

Now let’s take that $100,000 and use it as a 20% deposit for a property costing $500,000, meaning we borrow $400,000. With that same 7%pa return the property will be worth $1,000,000 in 10 years. With the $400,000 loan still in place your $100,000 has become $600,000

Give it another 10 years and the invested cash is worth $400,000, but the property is worth $2,000,000 and your investment worth a net $1,600,000

Invest for 30 years and the cash is worth $800,000 but the property is worth $4,000,000 and your investment a net $3,600,000

This is the power of leverage There are some cautions of course

  • You will need to monitor the condition of the property and of course this is not cost free.
  • There will be interest to pay on the loan – but you will receive rent to offset that.
  • The power of leverage works in reverse as well – in a falling market your losses are magnified. As long as you service the loan however no bank will ask you to sell for a loss.
  • This is not true of the share market where a lender can require you to sell at a loss even if you are servicing the loan. The share market is a legitimate market to invest in BUT if you are going to borrow it is a riskier proposition requiring a greater level of financial sophistication.

Alan Heath

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

Construction 1: The building blocks: Valuations and Contracts.

April 28, 2017

Construction finance is a completely different ball game. As such it has all of its own pitfalls – it is without doubt the least understood area of mortgage financing.  An area where accurate information and an expert on your team are absolute essentials to making good decisions.

Nobody likes to pay a non-refundable deposit to a builder only to find you can’t get the finance.

My  very first “retail” presence in the mortgage industry was operating out of a display home that I owned and leased back to the builder. Every weekend for those two years were spent focusing on finance for construction.

So on that note, let me set the scene and open my CONSTRUCTION blog series with an important building block…

VALUATIONS

A bank lends against the value of the asset. The valuer (assigned by the bank as it is THEIR valuation – not yours) is asked to tell the bank a value that could be reasonably attained within a three month selling period. Its harsh – BUT – a bank is always looking at what it could sell your house for reasonably quickly if you default.

This value can take one of two forms

  • Current Market Value
  • On Completion Market Value (sometimes called a TOC valuation – Temporary On Completion)

There is another very important value for you – it’s called Contract Value.

They are not the same...

Lets say your house is worth $400k and you wish to spend $50k in renovations on it. Will its value be $450k?

The obvious answer is – it depends on what you spent the money on and whether you got “value for money” If that $50k was for a new family room and included the spend on TVs and furniture then the clear answer is obviously not. If some of that $50k included removal of an existing room then it all becomes a “matter of opinion”.

So the same principle is true with construction valuation – it’s a matter of opinion.  That opinion is based on what your house will be worth in the context of similar houses in the surrounding suburb.

This is such self-evident common sense. BUT, unfortunately, common sense often disappears when emotion and money mix.

Let’s say you agree (because that what a signed contract is) to pay a builder $250k plus $50k in “extras” to build a house on land you recently purchased also for $250k.

Is that house worth $550k? Is that $50k in “extras” actually all “added value”?

Here is a FACT – the valuer will give an opinion and the bank will lend against that opinion. You will pay the builder what you agreed.

If the Bank Valuer’s opinion is $550k – all parties are smiling – bank, builder and you.

But what if the Bank Valuer’s opinion is $525k? This is called a valuation shortfall.

This is THE SINGLE MOST IMPORTANT FACT in construction and leads to the most tears and heartache in EVERY form of construction.

YOU MUST PAY THAT SHORTFALL OUT OF YOUR OWN CASH RESERVES BEFORE CONSTRUCTION COMMENCES!!

If you don’t have those cash reserves – harsh but true – the project will NOT commence. Your deposits to the builder are potentially forfeited and you are stuck with a lovely set of plans, but no house. (This is unless it is “off plan” where this same issue arises, only later in the process – I will be covering that issue in an upcoming blog). 

Lesson – Don’t commence a building project unless you have a reasonable cash reserve.

A ‘reasonable’ cash reserve is individual to each situation however, with the aid of an expert it is possible to estimate what it is you will need to get your house off the plans and into reality! This is done with what is called a “Build Pack” – a set of documents that is given to me so that I can obtain a TOC valuation.

In order to obtain your Unconditional Finance Approval I will need;

  1. Land contract (for new) or Council rates notice (for existing)
  2. Fixed Price Build Contract (plus Variations*)
  3. Building Schedule (your selections and finishes)
  4. Building Specifications (shows it meets building standards)
  5. Contract Plans (signed and dated)
  6. Engineers Report (sometimes this is supplied , sometimes not)

In order to get the bank to release funds by way of Progress Payments to the builder I will also need;

  1. Council approval
  2. Builders Insurance specific to your site

Variations are an important pause point – you can make variations to the contract at any time – it’s your house – BUT – if you want the bank to lend for them I must have these with the build pack.

Any variations that come later (and there are almost always variations) MUST be paid for from your own cash reserves.

Once a house is under construction we cannot go back to the bank and ask for a new valuation – it just doesn’t happen. If you have ever driven past a site half finished – then this construction has gone horribly wrong. The bank is no longer lending and a new bank won’t pick it up. It can really only be sold for land value – after demolition!

Don’t EVER end up there!

All sounds difficult? It is to a certain extent – Construction should be entered into with your “eyes open” not your pockets. Following key advice from myself as your mortgage broker and making smart, informed desicions together however, can make your construction concepts a living reality.

Watching your HOME grow from paper plans to a physical property, and then moving in to  “live your dreams” is the very reason why I thoroughly enjoy construction finance and as your trusted expert we will walk that path together.

Alan Heath…Mortgage Broker Brisbane CBD…

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

…Mortgage Broker Brisbane CBD…

Construction 3: House and land packages

April 28, 2017

What can you borrow and what must you pay for?

It can be so much fun to build your own home – it literally is about building your very own dream. The first step and probably the most important, is to find your block of land.

People often start the other way – and looking at display homes is truly great fun!! If only the money barrel was bottomless!!

No matter where you start, the house salesperson will pull you back to the block of land because the house you like must fit the block of land you have.

There are TWO separate purchases – and each must be financed;

  1. The land is a single payment – with its own settlement
  2. The house is a series of progress payments to the builder – the first payment (when the foundations and slab are poured) is usually defined as its “settlement”

What makes a house and land package a “package”?

It is ONLY a package if the builder who is selling you the house, also owns the land. To be specific, that means – the VENDOR on the land contract and the VENDOR on the build contract are the same. This is as rare as the proverbial hens’ teeth.

Most “packages” are sold in display homes using that language to make you think that you MUST use that builder for that land. The builder probably has a few blocks on hold with the land developer – it’s not a package at all.

We should continue now by removing “package” as a meaningful term in lending – we simply have land and a house – two transactions;

  • The builder will build your house on your land
  • I will “build” your house finance on top of your land finance.
  • The land will settle and you pay that loan (usually P&I) until the builder starts
  • The land loan is then “consumed” by the construction loan and switches to I/O as Progress Draws occur until handover (you get the keys).
  • At which point it switches back to P&I and hey presto! – You have your final home loan…living the Dream!! As they say.

Now for an important factor which must be considered. You need to live somewhere while you build. This could well be renting, meaning you have rent and a construction loan in your lives, so it’s always good to build with a bit of a cash buffer behind you. For first home buyers, it could be understanding parents who let you shift back in for a while.

Let’s turn back to the fun now – designing and building your home. What can you borrow? What must you pay for?

In most cases you will pick a design from a builder and add your own modifications and selections. You will in all likelihood add items outside of the contract – typically;

  • Driveway
  • Perimeter paving
  • Fences
  • Floor coverings
  • Light fittings
  • Air conditioning

If you wish to borrow for these then I need fixed price quotes from your supplier of choice.

At some stage during the design process you will make your selections for;

  • Kitchen appliances
  • Tiles
  • Tap fittings
  • Bath
  • Electrical – no. of power points and their type
  • The “facade” of your choice
  • Roof material

Once the contract and the final plans (contract plans) are dated and signed you can still make changes – these are called variations to the contract.

A good builder will wait until all of these processes have been completed at which stage I am given the “build pack” for bank valuation.

If there is a shortfall between the contract price and the bank valuation you need to fund that from your own cash.

Variations and Shortfalls are a very important pause point, both of which I have covered in a previous construction series blog. 

Even if the bank valuation matches the contract price there will still be a gap between the loan amount and the contract price. That is completely normal. Before the bank picks up payments by way of progress payments you will need to put in your contribution first – also completely normal.

Progress payments are laid out in the contract. The builder gives you an invoice at pre-planned stages. You sign them to say you are happy with the work, fill in a form that the bank will have given you previously and email both to me. I will look after it for you from there – that part couldn’t be simpler.

All sounds difficult? It is to a certain extent. Construction should only be entered into with “your eyes open”.

However – it is such fun to see your very own dreams come true and then move in “to live your dreams”.

I thoroughly enjoy construction finance for this very reason and as your trusted expert in construction finance we will walk the path together.

Alan Heath… Mortgage Broker Brisbane CBD…

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

Investment 3: Assets, Negative and Positive Gearing

April 28, 2017

What is an Asset? There are differing definitions of what makes something an investment but they all focus on two main points

  • The ability to generate income
  • The ability to increase in value

In my opinion, the one to which the MOST attention should be paid is the ability to generate income because that is the most reliable indicator of something’s inherent financial value. From this perspective something that generates no income is NOT an asset. This rules out many things often “said” to be assets.

The most obvious here is a car. Let’s say the car is purchased with a loan. This car generates only expense for you, its value decreases year by year and the only income it produces is for the lender. The car is a liability to you. The car is an asset to the lender.

Let’s revisit purchasing an “investment” property.

Let’s say this property costs $100,000 and we borrow it all.

Let’s say it rents for $100pw so a 5.2%pa return

(if the property costs $200,000 and rents for $200pw, or costs $500,000 and rents for $500pw then the percentages are the same. Choose a value appropriate to your area – or just ignore the value and use my example)

If the interest rate is 5.2%pa This would be a neutral return (ignoring inflation)

If the interest rate is 6.2%pa. This would generate a negative return of 1%pa – this is what people call “negatively geared” – in this example that loss would be $1000

If the  interest rate is 4.8%pa. This would generate a positive return of 0.4%pa – this is what people call “positively geared”

Negative gearing : How many times have you heard someone say that negative gearing is a good thing? Is it? What does it mean? Let’s put one thing to rest absolutely – losing money is a bad thing! Why would you invest to lose money.

There are two important points to understand Any real loss can be deducted from your taxable income reducing the tax you pay. In the example above let’s say you income is $15,000 – your income would reduce to $14,000. You didn’t pay tax before and you don’t pay tax now. The whole $1,000 loss is yours.

Let’s say your income is $60,000 – your income would reduce to $59,000 and given that your tax rate is 30c you get a tax refund of $300 so $700 of the loss is yours.

Let’s say your taxable income is $150,000 – your income would reduce to $149,000 and given your tax rate is 47c you get a tax refund of $470 so $530 of the loss is yours.

What is the financial “lesson”? All negative gearing generates a loss.Don’t take any notice of the refund – a loss is a loss.  NO investor tries to LOSE money.  A sub lesson is that using negative gearing as a strategy on a low income makes no sense.

So if ALL negative gearing means you have lost money – why do it? An investor is hoping that the other reason for investing – capital growth – outweighs the loss.

Let’s say that property rises by 8% in value this year. Your property is now worth $108,000. The loss can be justified with a very big BUT. The capital growth is a “paper gain”, the negative gearing loss comes out of your wallet each month – it’s real “in the moment”. One thing is clear – a negatively geared property that has no capital growth prospects is not a good investment 

Positive gearing : A positively geared property is what all investors should aim for. It generates income in the short term and capital growth in the long term. Sure the profit is added to your income and you pay tax on that profit. Making a profit and having to pay tax is a wonderful “problem” to have.

Now let’s go back to our examples

Let’s say our property that cost $100,000 (and we borrow it all) rents for $300pw which is a 15.6%pa return.

Let’s have an interest rate of 5.2%pa which gives us a profit of 10.4%pa or $10,400. Sure we have to pay tax BUT what a great problem. If you could find a property like that you’d want it!!

How do you find positively geared property – I sometimes have new investors come to me and say they only want to buy positively geared property.

There are two common sources but investors should tread very carefully. Often investment property in regional mining towns can be bought quite cheaply and rented out for very high rent. That would be a good thing, right? Not necessarily. Mining towns are often very narrow in employment scope and hence population. When mining is on the upswing, population swells, capital growth and rents escalate. As they say, all that glitters is not gold. If that mining town loses the mine then population leaves just as quickly and you investment property will drop in rent and have very little prospect of capital growth again. Investing in mining or other single industry towns is a high risk strategy. When a large company is considering closing that mine or industry down the average investor is rarely if ever given warning. The investor is left high and dry. You are probably gaining the impression that I would call investing in single industry towns “speculation” rather than “investment”

There is another way to find a positively geared property. EVERY property is positively geared if it is held for long enough. How? I have clients who purchased property for $100,000 and the loan was $100,000. It initially rented for $100pw but over time the capital value of the property rose – and is now $300,000 and the rent has risen with time too to $300pw. The key point is that the loan is still $100,000. There you have it! A $100,000 loan and $300pw in rent. So what is the smartest way to get positively geared property?  Buy almost any property and hold it for a considerable time. The key now is simply to seek out a sound property that will be easily maintained over time.

Alan Heath

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

Construction 4: Off the Plan Construction

April 27, 2017

Lets take a detailed look at “Off the Plan Construction”… 

Off the plan construction can occur both in the large developments of units and also individual house and land projects however, it predominates in multiple storey unit developments.

The builder keeps control of the product from start to finish and you have very little choice, if any, of finishes.

You sign a contract (usually well before construction commences) and pay a deposit (usually 10%).

Once the developer has a certain number of “pre-sales” their bank will approve finance to them to commence construction.

In this case the developer has the construction loan and once the construction is nearing completion you are notified that you need to have your finance in order so that you can settle (usually with 14-30 days of this notification).

You “settle” on the finished product.

In some respects it is similar to buying a “second hand” property but in some very significant aspects it is very different. The most common “off plan” option is a multi storey unit development.

Pre-sales and initial contracts could easily occur up to two years before you will take eventual possession.  Finance approvals once issued last 90 days.

No matter what you might think, and no matter what words are used, you will sign a contract, which will be unconditional and binding on you to settle, but you cannot obtain unconditional finance approval at this stage.

You might (in fact should) seek out opinion as to whether you can obtain finance on your current circumstances. You might obtain an indicative approval but no matter what you might think or even be led to believe it will remain subject to:

  • Valuation of the finished product
  • Reconfirmation of your financial circumstances within 90 days of settlement

This is a VERY important point, as there is an element of risk. At the very least before you make ANY other financial commitments in the time between signing your off plan contract and its completion you MUST stay in very close contact with your mortgage broker.

Financial commitments that could impact on your ability to gain the unconditional approval necessary to settle include:

  • Buying a car under finance
  • Shifting house
  • Buying an investment property
  • Taking maternity leave or having a child
  • Changing careers or employment

There are risks and benefits of buying off plan.

Perceived Benefits:

  • The property may be sold out or unavailable if you wait – buying now secures what you want
  • The value of the market may rise between signing and taking occupancy
  • Depreciation benefits of new property

Perceived Risks:

  • The value of the property may fall between signing and taking occupancy
  • Your circumstances may change and you may not qualify for a loan.

Let’s consider these risks in more detail and look at ways to manage them

Falling value: 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 let’s say the bank values it an only $450k. You will have to put in the $50k shortfall in addition to your original deposit. 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.

Changing Circumstances: A lender will only lend within 90 days of settlement. (As I mentioned earlier this is 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”.

As a general rule, people buy off plan because they perceive a benefit. To cover the risks it is advisable to:

  • Sit very still financially until the property settles
  • Have a strong cash buffer behind you so that you can cover any surprises

If you know me at all you’d understand that even crossing the street carries considerable risk.

The old saying – “Look to the right, then look to the left” before you cross a busy street applies very well to buying “off plan”

  • Consider the risks carefully before “stepping off the kerb” (signing the contract)
  • Think carefully as you cross for any surprises (stay in touch with me)

Following these steps and maintaining contact with me and you will arrive safely at the other side – with a new property and a loan that settles.

Alan Heath… Mortgage Broker Brisbane CBD…

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

Construction 5: Mezzanine Financing, The Whole Story from Top to Bottom

April 27, 2017

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 :

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…