Thursday, December 12, 2013

Get Your Golden Rule Straight

I opened up the Hobart Mercury Property Guide recently and sat down to enjoy a luxuriating read only to be struck down moments later with a sense of irate anger.

I usually enjoy reading the “property expert” pieces in various news publications. As a real estate business owner ( and avid property investor I figure you can never be exposed to too much information about your passion or your career.

Only the article I read about the “golden rule of investing in property” printed on the inside of the cover was shameful.  This article (pictured) was written by Andrew Winter @andrewtwinter “FOXTEL TV's Selling Houses Australia - Presenter and Property Expert. NewsLtd Property Writer”. It’s my opinion that articles like this are part of the reason that people buy investment properties without doing enough research and that is what limits a lot of people to just one investment property. Anecdotal figures told to me say more than 80% of investors stop at one property. If I look at my history in real estate (almost 20 years) the stats on the investors I’ve dealt with over the years would back that up.

Now shameful is a pretty strong word – so let’s drill down on what I found so abhorrent. Firstly – Winter states that your golden rule in real estate should be don’t buy the home unless the rent equates to at least 1 per cent of the purchase price – an example he gives is $400 per week rent on a $400,000 purchase. Now simple maths aside (1% of $400,000 is $4,000 not $400) I don’t disagree with this as a general guiding principal to START with.

But then Winter goes on to say that “at $425 - $450 per week you should be very excited and buy the property immediately. Even higher? Well, book the holiday to Europe.” Utter nonsense. He does state that it’s a “rough guide”, but to advocate going out and buying a property “immediately” when it’s showing a return of less than 6% without even mentioning other factors such as buying costs, vacancy rates in the area, maintenance, property management costs and the borrower’s repayment abilities is what gets people in over their heads and leads to them making uniformed decisions.

The crux of the lunacy in this article for me was when Winter described himself as “old-fashioned” and wanting investments with a “positive cash flow”.  You know what– me too! Only I want it to be an actual positive cash flow.  Let’s take a property that Winter would is recommending we, the reader, buy immediately - one returning $425 per week on a $400,000 purchase.

Let’s look at an absolute best-case scenario:
·      -  Annual rent would be $22,100 (not taking into consideration any time for vacancy – which of course isn’t that realistic).
·      - Let’s say you manage it yourself (I wouldn’t recommend it – but hey, I’m a real estate agent) so you’ve got no management fees – but you’re going to have council rates, water, land tax - $3,500 at a bare minimum (probably more.)
·      - Let’s say you have the only investment property in the world that requires no maintenance (again, completely unlikely – but we’re looking at a best case scenario) – but you’re likely going to have smoke alarm compliance costs and other unavoidable expenses – let’s do a very conservative $500 estimate.
·      - Say you got a 4.5% loan, you’re on interest repayments only and you had 20% cash deposit as well as being able to fund all your initial costs such as stamp duty, conveyancing, building inspections etc. You’re going to be outlaying $18,000 on interest (not to mention other associated banking costs).

And this super property that you should buy immediately – how positively geared is it given all the above near impossible “best case” scenarios? It’s earning you the princely sum of $100 per year. Now sure – you’ll likely have some depreciation benefits to consider in there based on what type of property you purchase – but more likely than not, you’ll also have costs to engage a professional property manager (who will likely more than earn their fee), you’ll have maintenance issues that pop up (yes, even in a brand new property), you’ll borrow more than 80% and shock horror – that property might sit vacant a few days every now and then. That $100 isn’t going to go too far. You could look towards capital growth – something all investors desire, but it’s not cash flow.

Now – I don’t want to sound like a negative nancy. I love property investment. It is one of my true passions in life. But it isn’t a board game of monopoly. It takes actual understanding of the concepts at play. Mess it up and you won’t lose a tiny red plastic hotel – you could lose anything from a lot of sleep to a lot of your financial freedom or more.

Want to start investing in property? Here are my tips:

Whether the property you buy is negatively or positively geared – look for all the areas in which it’s potentially going to cost you money. Work out a worst case scenario (including one where your personal circumstances change – unexpected baby, loss of job, illness) and consider all the potential expenses.

Speak to a successful, real world investor. If my experience in real estate has taught me anything it’s that you probably already know one. It could be your builder, the school teacher down the road or your uncle. Do not only talk to people who have had one crack at investing, had a bad run and given it up.

And finally - don’t rely on “golden rules” presented by “experts”. Do your own research, work out your financial goals and what works for you. And if you really, really want an expert – I’d recommend Jan Somers (check out any of her books in your library or at any good bookstore). 

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