Is successful property investing an art or a science?
Albert Einstein once said, “COMPOUND INTEREST IS THE EIGHTH wonder of the world.
He who understands it, earns it… he who doesn’t… pays it.”
If we accept the above, then the longer we hold a property investment the more likely we are to make a gain.
As a professional investor, we should be looking for a property that outperforms the average, as even a small gain above the average can create significantly different results.
Buying right also adds to risk minimisation.
For example, the following table shows how the value of a $500,000 property may differ depending on growth over time and highlights the significant difference that even a two per cent per annum growth rate can make over 20 years.
|Year/growth per annum||2%||5%||7%||10%||12%|
Conversely the wrong property will severely restrict any investor’s dream of financial security, or worse, after taking into account purchase costs, holding and exit costs.
How many times have we heard that someone sold a property because it was underperforming only to see the next buyer make a success of it?
The question is why?
And given that property can be such a great investment mechanism why do many of us stop at only one or two properties.?
RECIPE FOR SUCCESS
I’d argue the answer to both is that most investors are simply purchasing the wrong property.
So, what’s the basic recipe for successfully purchasing the right property?
Consider the following:
- Have a plan and work with a team that can assist you. Remember you can’t be the smartest person in your team.
- Do your research as not all properties are created equal and you need to be able to identify the differences. So, access to suburb reports, demographics, historical property values, square metre values, potential to improve and local council rules will help focus your efforts.
- Buy in proven higher capital growth areas. As equity increases so does your ability to use the equity to purchase more.
- Buy at below intrinsic value. While it’s difficult to buy cheap this comment infers buying below replacement cost but remember a small premium will become significant over 20 years, so buy on present value for future potential.
- Buy property with a twist – not the dry martini kind but something that’s different. This can be location, floor layout, nearby amenities, transport, high proportion of owner-occupiers, views, off-street parking, storage or a brand name developer to name a few.
- Don’t just rely on market forces to move values as anything can happen. Take charge and maybe you can add value with a cosmetic renovation or structural improvement.
- Set up the correct loan. Look at both fixed and variable, offset or redraw and loan-to-value ratio (LVR). Investors should also have access to a safety net fund in case of an emergency. A ‘buffer’, such as access savings, equity or other cash resources is vital if things go wrong. Even in the worst-case scenario a buffer will buy time and allow us to sell the property in a more orderly manner.
- Buy in the structure that will meet your requirements. This could include buying in individual names, together (joint or tenants in common), trusts or companies. All have significant pros or cons so remember to seek advice.
Some more success factors
Having put in place your strategic plan you need to ensure a number of other basics are taken care of at around the time of purchase.
- From the outset, you should be working with a specialist property strategist – one who is independent, has no properties for sale and who’s advice is not limited to one state, city or property type. And of course one who has NO properties to sell.
- Get an accurate depreciation schedule from a quantity surveyor, as your accountant wouldn’t normally be approved by the tax department to prepare these. If you’ve purchased with someone else then arrange for a split depreciation schedule as this can significantly increase the overall annual expense.
- If you’re contemplating a renovation between tenancies then you should get a ‘scrapping schedule’, which both identifies and puts a value on what you throw away. This is then written off in the year of the renovation plus you can also depreciate the new work thereafter.
- Remember to add up all costs related to borrowing such as bank fees, valuation and lenders mortgage insurance as you can also write this off over the life of the loan or five years, whichever is lowest.
- To minimise your accounting fees, get your real estate agent to pay for everything other than interest, as they will give you a monthly and annual statement. You then only need to keep bank statements. Remember if you have dual-purpose borrowings, i.e. investment and personal, then get a split loan so that you get separate bank statements.
- Land tax is a fairly muddy area. Each state has different land tax rules. The current landowner is responsible for land tax so remember to get a land tax clearance certificate as part of your requirements.
- Try and save yourself time and stress by having all relevant documents ready for your property specialist accountant at tax time, including a copy of your contract of sale, loan documents, settlement sheet and all documents showing interest and other costs paid. If you’re really organised then you may try and put this into a spreadsheet for your accountant, which is why using an managing agent to pay for everything other than interest helps as they will give you a monthly and the yearly summary of all income and expenses they have managed.
- For added peace of mind get landlord insurance to cover things such as damage and even rent non-payment by your tenant. Work with real estate agent who will regularly inspect the property and provide you with a written report.
- As part of your agreement with the real estate agent to manage your property, get up-to-date rent valuations and if you’re slipping behind then increase your rent subject to the terms of your tenant’s agreement. While it’s always reasonable to have a small discount for good tenants all too often we see large discrepancies to market.
- If you did repairs immediately or shortly after the purchase then you may need to discuss this with your accountants as these could be capitalised, i.e. added to cost of the property, and not expensed.
- Remember that you can only claim expenses, including interest, if the property was available for rent. A property that’s not occupied by tenants for any period could be problematic.
- If the property loan is in a different name than yours on the contract of sale then you’ll need to fix this for tax purposes to ensure interest deductions are applicable. This can be compounded if funds from equity in another property is used, however all of this can be fixed via a loan agreement but you need to discuss this with your Wealth Advisor – this is what we specialise in at Metropole Wealth Advisory
- Finally, if a trust was used to buy the property make sure all documentation is correctly drawn up to conform with Australian Tax Office (ATO) rules and requirements to allow you to claim interest deductions. Not all trusts are the same and not all allow tax deductions on expenses including interest expenses. Again this is an area that we specialise in at Metropole Wealth Advisory
BORROWING IN SUPER
Finally, it’s worth mentioning leverage within superannuation.
Current legislation currently allows you to use superannuation to borrow to purchase a property and effectively use your wages to claim negative gearing.
To do this you must use a self-managed super fund (SMSF), as you have to control the strategy and decisions.
A retail or industry fund won’t allow you to use this strategy, however funds from either can be rolled over into an SMSF.
Care is needed to ensure inadvertent problems don’t arise that could’ve been avoided
Investing in property using your super requires a five-step process:
- Seek advice that the type of property being contemplated is allowable. You can purchase off the plan, do cosmetic renovations and buy existing property. You can also purchase commercial property (not residential property) off a member or related party
- Get finance approval, which could include loans from yourself as well as the bank.
- Set up the property structure, including your SMSF and others, to hold the property. Note you also need to ensure proper loan documentation.
- Ensure proper structure, including your SMSF and others, to hold the property. Note you also need to ensure proper loan documentation.
- Ensure proper rollover from any other superannuation funds into your SMSF, bearing in mind insurances and any capital gains implications.
- Go shopping!
There’s a lot to take in but I return now to the original question: is successful property investment an art or science?
Broadly the mix must be heavily orientated toward science (do the numbers) with a pinch of faith (faith that property valuations over time move up).
Therefore, for any purchase an investor must do proper due diligence, set up appropriate loans and structures and maintain proper records.
The investment must be periodically reviewed and any increase in capital values should be reinvested.
Success is a combination of buying the right property in the right location and being able to fund it long enough for it to grow in value for reinvesting.
My number one recommendation is to get a good team around you and if there’s any question of doubt in your mind then you should seek professional advice before acting.
How can this apply to you?
If you’d like to know more about how an Equity Transfer Trust could protect your assets, why not have a strategic discussion with me about your individual needs and let Ken Raiss formulate a Strategic Wealth Plan for you, your family or your business.
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This article is general information only and is intended as educational material. Metropole Wealth Advisory nor its associated or related entitles, directors, officers or employees intend this material to be advice either actual or implied. You should not act on any of the above without first seeking specific advice taking into account your circumstances and objectives.
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