Puzzle Finance Blog


Property investment not for the faint hearted



You have to be tough, not to mention very careful, to make a fist of things in the property market.

There's a double-edged question of grit here: do you have the determination to hold on to your property through the tough times? And, equally, do you have the courage to make the decision not to proceed when it is imprudent?

The great oracle on interest rates is our Reserve Bank. The RBA quietly goes about its business, aiming to keep our financial markets out of trouble. Then, on the first Tuesday of the month, we suddenly remember the RBA and listen intently to what it says about rates.

It reminds me of the scene in Charles Portis's book, True Grit, where the talkative Texas Ranger LaBoeuf calls out to his travelling companion, the tough marshal Rooster Cogburn: ''You do not think much of me, do you, Cogburn?''

Which elicits the terse reply: ''I don't think about you at all when your mouth is closed.''

It's a good sign for property investors when we can be that relaxed about the work of the Reserve Bank. The same can't be said for general market predictions on property prices.

Recently I read that, according to a range of experts, house prices in Sydney were ''taking a breather'' and ''softening'' but it remained a ''sellers' market''. Forecasts for capital growth in the year ahead for that city were variously 0.2 per cent, ''low to middle single digit'', more than 5 per cent, or as high as 10 per cent.

I felt richer by the minute.

It all goes to show that property investing lies somewhere between art and science. It is an unpredictable ride and change is afoot.

'''Responsible lending' has come in and created a lot more paperwork,'' Kevin Breen, a director of mortgage broker Breen Financial, in the Newington area of Sydney's west, says. ''There are more requirements but these haven't really changed the way we, for example, do business.''

The ''responsible lending'' conduct obligations require that the mortgage broker takes reasonable steps to inquire about and verify customers' financial situations and does not steer them into a loan that would be unsuitable for them.

One of the trends is a renewed confidence from lenders following the passing of the worst of the global financial crisis.

''What I am seeing is that lenders who had reduced their LVR [loan to value ratio] from 100 per cent to 90 per cent maximum during the GFC have now returned to 95 per cent LVR,'' Breen says.

''This includes mainstream lenders.''

Rate movement

What does it mean when, as now, fixed interest rates come near variable rates? Is this a sign that variable rates have peaked or that financial institutions are competing hard for market share?

''A bit of both,'' the executive chairman and founder of Aussie, John Symond, says. ''Generally, it signals that variable rates are close to the top of their cycle. At the moment the combined perception is that interest rates will stay around where they are.''

This is good for property investors. The market is cooling and prices are coming off, good loans are available, good fixed rates are on offer, the banks are in real competition and there are fewer first-home buyers in competition with investors. There has been a lining up of the ducks for investors.

There is not a housing ''bubble'' because we have a housing affordability crisis. The acute shortage of housing, strong immigration and employment numbers underpin house prices.

The drastic shortage of available housing will also take some time to play out in the market. But, I wonder, if it is so influential, why does it sit at odds with other factors such as low auction clearance rates, falling prices and properties withdrawn from sale due to lack of interest?

''There has been a knock to consumer confidence brought about by seven interest rate rises [since October 2009], the bushfires, floods, cyclones and other natural disasters,'' Symond says. ''People are saving their money, too.

''There have also been large price gains, such as in Melbourne, where house prices are up by 30 per cent over the last two years. That is just not sustainable. My tip is that the market will continue to cool over the next five to six months.''

Smokin' gun

One of the economic factors to keep an eye on is inflation. The Reserve Bank, in setting the cash rate and thereby influencing the rates we pay on our loans, has made it clear it will act if inflation starts heading out of the 2 per cent to 3 per cent zone.

You can see from the consumer price inflation graph why the Reserve was concerned when inflation was trending out of the zone. But the corner was turned in time.

Rents have been increasing - another positive sign for investors - although the rate of change seems to be slowing, as the table from the Real Estate Institute of Australia shows.

Vacancy rates also tell a useful story. A vacancy rate of 3 per cent is generally considered to represent a fair balance in the marketplace, whereby supply is approximately matched to demand for rental accommodation.

Less than 3 per cent means supply is short and tenants will find it challenging to land a property, while above that level it starts to become a renters' market, whereby tenants have more choice and can often negotiate rent and terms.

For some time now, the balance has favoured landlords, with vacancy rates well below 2 per cent in many areas. Tenants are hurting.

Manage your risk

Even with many positive signs out there, it is wise to take action to minimise your risk exposure and secure your gains.

1. Are you insured?

You may be familiar with insuring your house but a rented property requires more. Insurers package a range of covers together under the banner ''landlords' insurance''.

Benefits include cover for:

The building (unless this is the responsibility of an owners corporation or body corporate).

Public liability.

The contents - including floor coverings, kitchen cupboards, appliances, paint, light fittings, blinds and so on.

Loss of rent - where, for example, a fire renders the property unliveable and rent ceases.

Malicious damage.

Rent default - when the tenant stops paying rent.

It is worth engaging an insurance broker to find you the best policy. A friendly broker will be a real asset when you need someone to push through a claim on your behalf. If you are not familiar with the cost, the table above has recent examples of cover for three properties from the same insurer. Premiums will vary with the insurer, rent and property.

2. Engage a managing agent

You can save money by managing the property and the tenants yourself but we all have to learn somewhere and learning has its price. Becoming a landlord can be a dogged pursuit. Deputise an agent to manage the tenancy; they will be the buffer between owner and tenant, taking emotional heat out of negotiations over rent, dwelling modifications, subletting and more.

You can expect your agent to charge between 5.5 per cent and 8.8 per cent of the rent as a commission, depending in part on local competition and who pays for advertising. In addition, it is common to take the first week's rent as remuneration for finding a tenant.

The agent is obliged to get your signature on a management agreement so pay attention to the fees for extras such as banking, advertising, post, financial report and tribunal attendances. These are generally tax-deductible. Start with a 12-month contract so you can move on if you are unhappy with the service.

3. Consider fixing

In budgeting for property investment, it is important to factor a period each year where there is no rent. You might be between tenancies or have a defaulting tenant.

It takes fortitude to tough out these periods. Having a fixed-rate loan is really another form of insurance. It gives you the security of knowing precisely how much you have to pay your lender each month. Of course, it can be expensive to end a fixed-rate deal early - paying ''break costs'' to the lender, which can add up to many thousands of dollars.

4. Ride the tax breaks

There are tax deductions for depreciation, capital allowance, running costs and let's not forget the 50 per cent concession on capital gains tax for personal investors who have owned the property for a minimum of 12 months. There is no shortage of places to go for information on these. But negative gearing is often assumed rather than relished. It's not all it used to be, when marginal rates were sky high, but it ain't bad, either.

At the end of True Grit, as straight-talking and financially savvy Mattie Ross reflects on her adventurous and prosperous life managing her property, she says: ''People love to talk. They love to slander you if you have any substance … It is true that I love my church and my bank. What is wrong with that? I will tell you a secret. Those same people talk mighty nice when they come in to get a crop loan or beg a mortgage extension!''

Hopefully, a bit of grit will get you through your property investment, too.

How it would work

Scott is looking at buying an apartment as an investment. The price is $450,000 and he will borrow $360,000 (80 per cent). He hopes to live on the rent income at some point. Immediately, however, he knows that if he negatively gears the investment it will reduce his overall tax.

Income: $70,000 (salary) + $20,800 (rent)

= $90,800

Scott's accountant estimates there will be annual depreciation of $5000. He anticipates the interest component of his loan repayment will be $25,884 over 12 months. Here is Scott's ''back of the envelope'' tally of deductions:

Depreciation $5000

Loan interest $25,884

Insurance $550

Rates and levies $6000

Agent's commission on rent $1602

Total deductions and allowances $39,036

Income - deductions: $90,800 - $39,036

= $51,764

Scott's taxable income is now lower than his salary. He will pay $9226 in tax rather than the $15,600 he would have paid on his salary alone.

A determined way to start

"I have a client who purchased her first investment property for $300,000 in the outer-western suburbs of Sydney with a deposit of $30,000 and a loan of $272,000 to cover the 90 per cent balance plus some costs," says Kevin Breen, the director of mortgage broker Breen Financial, based in the Newington area of Sydney's inner west.

'It's a three-bedroom house on land,'' he says. "She was able to achieve this despite her modest income - about $45,000 a year - because she is living at home and can save on expenses. Rent is an excellent $350 a week - her relatives acted as spotters to find her the right property with a high yield.''

Calculation

Purchase price $300,000

Expenses $2000

Total$302,000

Deposit $30,000

Mortgage $272,000

Total $302,000

Mortgage repayments $1943 a month

(at 7.12 per cent a year, 25-year term)

Met by rent $1516 a month

and balance from wages $427 a month

"She is highly motivated and aims to pay off the mortgage within 10 years,'' Breen says.

''She plans to use the rent to pay for travel.

"The most amazing part is that she is just 21 years of age.

''It shows what can be done."

What did this young person do right?

Rather than make mistakes - which could show up on her credit record - she found a mortgage broker to prepare her application and select an appropriate lender.

A real key to her story is that she enlisted family members to get out there and find the right property. The rental yield, at 6 per cent, is high for Sydney.

She is keeping her personal costs down by living with her parents.

She is motivated. ''Money for travel'' has traditionally been seen as a damaging investment direction.

But, in putting her investment strategy in place first¸ she is aiming to have her cake and eat it, too. She won't return suntanned and penniless from her travels.

Peter Cerexhe is the author of Smarter Property Investment and Smarter Property Improvement.

Posted by Peter Cerexhe - Domain on 27th March, 2011 | Comments | Trackbacks
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