Australian Real Estate Investment Seminar!

Like anything that we do in life,
property investment does have its share of pitfalls.

Let’s now have a look at some of these & how we can avoid them.

By far the biggest of these is financial over-commitment

Property investment can be very profitable however when starting out, it may pay to be a little conservative. Many "first timers" have soured their experience by buying too much too quickly & hence, placing themselves under pressure.

One of the positive points about property investing is that it forces us to commit a part of our income into an appreciating asset. It's important though, to be sure that you can handle the commitment no matter what else happens in your life.

What about interest rates?

Well, if they’re down they can go up and if they’re up they can go up!

The recommended financing method is to use fixed interest loans whereby you pay only the interest. This allows you to concentrate on paying the mortgage on your own home, optimises your tax relief and gives you the security of knowing your interest rate cannot rise.

Of course you may choose to take advantage of a low variable loan now and take the option to fix should interest rates look like rising in the future.

The fear of vacancies

The worst vacancy factor in Australia in the past 20 years has been 9%.
In other words 9% of properties were vacant but importantly, 91% were occupied.

The fact is that, those properties that present well and where a reasonable rent is being sought will always be tenanted regardless of the state of the market.

Buying in the wrong location

Is a trap that catches many purchasers, investors & owner-occupiers alike. Usually, the only attraction for badly located properties is the lower price being sought. The first problem is that tenants do not want to live in undesirable locations & when it comes time for you to on-sell your investment, you too will have to accept a lower price.

Speculation.

Many new investors are attracted by the thought of speculating in property but it is important to remember that speculation is short term and high risk, while investment is long term and almost risk free if simple rules are applied.

The successful speculator usually works full time in property, buying improving and then reselling. These people will usually have a large bankroll and do not have to rely on rental income.

Property speculation is a specialised field and in essence, provides a full time job for those involved. On the other hand, property investment does not require a huge ongoing commitment in money or time.

Suffice to say, any of these traps can be avoided ...
with adequate preparation, planning & thought.

CAPITAL GAINS TAX
Is probably one of this countries most misunderstood taxes.

In September 1999 a new capital gains system was introduced.

With this new system only 50% of the realised capital gain is taxable but, unlike the old system, there is no allowance for indexation. In other words, you will pay tax at your marginal rate, on half of the capital gain.

For example:

If your total capital gain was $50,000 & your marginal tax rate was 35%, you would pay $8,750.

Remember, the secret is to never sell while you are earning a high income & never sell all of your property assets in the same tax year. The lower your marginal tax rate the less capital gains tax you will pay.

WHAT CAN YOU CLAIM

Interest paid on the mortgage is usually your biggest tax claim, however there are many other items that can be offset against your income tax liability.

These items can be broken down into:

Cash items, in other words, things that you pay cash for during the year to support or maintain your property.

Some examples of cash items are;

Land and water rates

Property managers fees

Strata levies (if you purchase a property in a strata complex, each owner usually pays a levy towards the maintenance of common areas, security lighting, insurance, etc)

Postage and stationary used in relation to your investments

Insurance - general, contents and landlord protection.

Advertising

Bank charges

Inspection reports

And, most other items for which you pay cash (or its equivalent) in relation to your investment properties.

The second category of claim is - Non cash items.

These are the deductible items you do not actually pay cash for during the year,
these include things like:

Depreciation on chattels. (This is a big one, and it’s one that many investors do not optimise). It is a good idea to have your agent list all chattels on a separate sheet, along with their values, to be signed by the vendor when you purchase the property.
Floor coverings, cupboards, exhaust fans, hot water units, window treatments, light fittings are some examples of depreciable items but there are many more.
Depreciation on the construction. All residential investment properties built after the 1987 budget was introduced, include a 2.5% depreciation allowance on construction costs. This is a substantial & legitimate claim, & you should ensure your accountant includes it when compiling your tax return.

Although you may be doing your own tax return at the moment, once you begin to build your investment portfolio it's advisable to use the services of a specialist property investment accountant. His/her charges are also a tax claim.

BUYING WITHOUT CASH INPUT

Using the equity you have in your current home, you may be in position to invest in one or more rental properties, with no initial financial input. Using current equity instead of a cash deposit is probably the most popular method used to begin & then expand into property investment.

In this example you can see that Mr & Mrs Smith have a mortgage of 120,000 on their own home which is worth $200,000.

In other words they have $80,000 equity.

If they were to purchase an investment property worth $150,000 they could borrow the $150,000 plus any other costs involved (say $157,000 total) without paying a deposit.

The bank simply uses the equity held in the current property as security for the investment loan. Most financial institutions will lend up to 95% of the total value of all property.

This is good news for people who are on good incomes, but who do not have access to disposable cash. If this option interests you, you should discuss it with your mortgage originator or lender.

BORROWING FOR PROPERTY INVESTMENT

Even without the tax advantages of negative gearing, The fundamental basis for property investment still applies. That is: the less money you invest in a property, the greater the return!

As you can see in this comparison:

Investor (1) Adam Jones buys a property in a unit development and pays $200,000 cash. Over the next twelve months the property increases in value by 6%. Effectively, the investor has made a simple return of $12,000 or 6%.

Investor (2) Evelyn Brown buys an identical unit in the same complex but instead pays a $20,000 deposit and borrows $180,000.

Effectively, she has invested $20,000 instead of $200,000 so she would make a $12,000 return on her $20,000 & would have achieved a 60% return on her investment.

Of course, your level of borrowing will depend on the rental return & your own income and financial circumstances. It’s worth keeping in mind however, that all of the interest paid by Evelyn can be claimed against her tax liability - whereas Adam would be in the opposite situation where he would be liable to pay tax on his rental income.

YOUR LOAN OPTIONS

To purchase your own property, you most likely used a principal & interest loan. A P&I loan allows you to pay extra amounts off the principal, however is usually susceptible to interest rate movements. Although, you may be willing to put up with rate movements to retain the flexibility to pay off your own home quicker, this is not necessarily the best way to go with investment loans.

A better option may be the Interest Only Loan.

This type of loan only requires you to pay the interest component & allows you the security of fixing the interest rate for up to five years. This would be the most popular type of loan for investors, however there are a proliferation of competitive loan options available & it's good advice to deal through a good mortgage origination company to get the full story.

You also have the option of Splitting your borrowings, fixing some of your loan & having the remainder on a principal and interest basis.

Mortgage Originators have access to the loan products available from of the banks and other lending institutions. Unlike individual banks, they are able to demonstrate the full spectrum of loan options and then assist you to find the one that suits your particular needs. The lender usually pays mortgage originators so there is no charge to you for this fantastic, in home service.

PAYG WITH HOLDING VARIATION

Under the Taxation Act, investors who earn & pay tax under the PAYE system may be able to reduce their weekly/fortnightly or monthly tax deductions rather than waiting until the end of the financial year for a refund cheque.

This is a popular method of increasing affordability & freeing cash for property investment. For more information you should speak to your tax accountant.

WHAT YOU SHOULD PLAN FOR

A well planned & smooth running property investment portfolio
should provide a situation where:

You have an appreciating asset
You have regular rent income which is paid on time
You have long term stable tenants
You are comfortable in the knowledge that your properties are being cared for by specialist investment property managers.

* Our Real Estate Investment Department specialises in providing a dedicated service to people who are looking to purchase investment property.

If you live in or wish to invest in another state or locality we suggest that, rather than just using any agent, you do your best to locate a company that specialises in serving the needs of property investors.

THE SERVICE TO EXPECT

To help you construct your successful wealth creation plan, your chosen agent should be able to offer you or give you access to the following services;

INDIVIDUAL ANALYSIS

They should provide you with an individual spreadsheet guide allowing you to plan your portfolio to suit your individual circumstances.
They should keep your plans personal & ... confidential.
And more importantly, they should not charge you for their service,
until your property is being managed – agents are usually paid by the seller.

ARRANGE COMPETITIVE FINANCE

They should have access to a reputable mortgage originator who can arrange a competitive loan package for you.
In Australia, a growing percentage of home loans are now being coordinated by mortgage originators.
The better origination companies provide a free, in home service whereby you can assess the loan packages being offered by all of the major lenders. This alleviates the necessity to shop around all of the banks & it ensures that your application is presented in its best light.
You can also be provided with a letter or certificate verifying that your finance has been pre approved. This pre approval can give you the power of a cash buyer which can be very handy tool, when your negotiating your offer to purchase.

SOURCING SUITABLE PROPERTIES

An experienced investment agent will source & arrange inspections of properties that fit the recommended investment criteria. They will also avoid showing you unsuitable properties.

ANALYSING THE CHOSEN PROPERTY

Once you have found a property that you are interested in purchasing, your agent should assist you to project what maintenance items you may be confronted with over the next 3 to 5 years.
The cost of these should be taken into account when you are negotiating the price.
Also, prior to making you offer, your agent should assist you with a final computer analyses of the property. This will enable you to assess what is a fair price to pay, & how much you will be investing on a weekly basis before and after tax.

NEGOTIATING - CO ORDINATING & FOLLOW UP

Your agent should be able to demonstrate comparative values so that you can assess what is a realistic offer.
They should be able to prove average prices in your area of choice.
They should ensure that the offer is written correctly
Skilfully negotiate the price and terms on your behalf.
And, continue the excellent service by following up until settlement & beyond.

EXPERT PROPERTY MANAGEMENT

All tenant applications should be systematically screened.
You should be provided the option of having a photographic record of your properties condition prior to it being tenanted.
All inspections should be completed on time & recorded against a detailed initial property condition report.
Your Property Manger should communicate with you on a regular basis keeping you totally informed about all important aspects of your portfolio.
And, you should be provided with comprehensive monthly statements in regards to your rental income and expenses.

HOLD FOR THE LONG TERM

"Now it’s time for us to study the long term plan."

The secret to long-term wealth using property is to start with the end in mind.

In other words plan out your long-term financial goals taking into account just how much income you’ll need to retire comfortably.

Let’s say you are currently earning $60,000 per annum & would like to maintain that level of income when you retire.

We’ll assume that you are now 40 years of age and would like to retire at age 55. We will also take inflation into account & assume rents, & wages will increase at a conservative 4.0% per annum and property at 6.5%.

Keep in mind that, over time, property values have always stayed well abreast of inflation.

Although we have completed our projections on only 6.5% appreciation, average Australian capital gain over the past 40 years has been in excess of 8%.

Let’s say you are living in your own home & it's currently worth $200,000 with an out standing mortgage of $120,000. In other words the equity you have in your own home is $80,000.

Today, you locate & purchase your first investment property for $150,000 borrowing 100% of the purchase price - plus ingoing costs of say, $7,000. Your total loan is $157,000.

The bank would allow you to use your current equity to secure the investment loan, but your loan to value ratio would remain at below 80 percent. Although you can borrow up to 95% of the total value of your property holdings, keeping it to 80% will help minimise your up front costs and avoid the added cost of mortgage insurance.

Assuming the rent on your investment property is $200 per week, the shortfall after a tax refund at 35% & taking into account depreciation claims, would be [approx] $46 per week.

At this level, you may be in a position to buy two properties to start your portfolio, but we will assume that you have purchased just the one in addition to your own home.

Over the first 3 years, appreciating at just 6.5% per annum, your total property value would increase to $422,000 and taking into account that you would have reduced your own home mortgage by $10,000, your equity would have increased from $80,000 to $155,000.

Within 3 years it would be recommended that you purchase two more properties. Naturally, to aquire similar properties to your first investment, you will now be paying approximately $181,000 or $362,000 for two, plus about $16,000 in ingoing costs.

Sounds like a lot of debt but remember, rather than a new car or a credit card, you are borrowing against a rock solid, appreciating asset.

After settlement your total property holdings would now be $784,000 with borrowings of $645,000. Taking into account rent increases at 4% per annum, your personal, after tax, commitment for your investment portfolio would now be approximately $147 per week but your wages would have increased by $134 per week.

At this point, we’ll assume you hold off for another three years before buying more property but then purchase three more houses similar to your current holdings. You pay $218,000 each for them.

The mortgage on your own home would have decreased by at least another $15,000 to $95,000. That property, plus your existing investment properties would have increased by 6.5% per year to $947,000.

This added to the value of the 3 newly purchased properties would give you a total holdings of $1,601,000 with borrowings of $1,278,000 & a weekly commitment towards your investment properties, of only $346.

So you are now holding six investment properties plus your own home.

After another 3 years you again purchase an additional three properties for approximately $263,000 each or $789,000 in total.

Despite your increased holdings, your weekly, after tax outlay is now down to $307. This is largely due to increased tax benefits & rent increases. Your salary has increased by 4% per annum, up by another $192 per week. That’s a total wage increase of $480 per week over the past nine years.

You now hold $2,719,000 worth of property with a total loan of $2,118,000 and equity of $601,000.

Your next step is to stop buying, let your properties continue to increase in value while concentrating on paying off your own home. To do this would mean committing an additional $190 per week.

Now, remember your original goal was to be able to retire on the same income as you are earning today. So your current $60,000 would be $108,000 increasing at our projected rate of 4% per annum.

Importantly, this would equate to an after tax income of approximately $80,000.

Let’s analyse whether or not you have achieved your objective.

You now own your own home and it's worth $514,000
Based on 4% inflation and 6.5% capital appreciation:
Your investment portfolio (9 properties) is now worth $3,453,000
Your compulsory, employer paid superannuation would amount to at least $300,000 (plus any contributions made by yourself).
You have equity in your investment portfolio of $1,410,000
Your rental income would now amount to $168,500 per annum.
Your investment loan would be $2,043,000 requiring you to pay $96.00 per week - after tax refund and rental income.

You have several choices at this point;

You may decide to progressively sell up all of your properties, & to invest the equity into a tax effective income producing investment or to add it to your superannuation.
You may decide to keep working & allow your properties to continue to appreciate or,
You may do a little bit of both.

Regardless of what you decide, you will have an extra 1.4 million dollars to support you through your retirement years. This is in addition to your normal superannuation!

You can also proudly state that you are among only 6% of our population who have actually set themselves financially up for a very comfortable and prosperous future.

Most people consider their own home to be the single best investment they have ever made – and they are usually right!

There is no arguing that our own home is a great investment but we have to pay the interest, maintain the property, we have no allowance for depreciation, no rental income and ... no tax relief.

Before we close, it’s worth considering who pays the majority of the holding costs when you move into property investment.

Thank you for joining me to for this Wealth Builder Presentation.

The best way to kick off your property portfolio
is by taking the first step today!

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