Should you sell or rent? The ongoing debate of selling property for capital gains versus keeping them for positive cashflow

Part 2 of this article published in the Australia Property Investor Magazine.

You don’t need to sell to access your gains in real estate

Lomas says people think they have to sell real estate to release the capital gains they’ve made. “But your unrealised gains are worth just as much- probably more, because you don’t have to pay CGT (capital gains tax),” she says. “The gains are there for you to leverage against. You don’t have to realise the gains to leverage into more real estate property or another kind of investment. If people are thinking of selling because they want to cash for seomthing, they would be better to get that cash by borrowing against their equity – although it depends on many variables.”

A comparison of two hypothetical scenarios shows how home equity is more powerful in creating wealth if good property is retained rather than traded. Take two real estate investors who buy similar investment properties for $300,000, one who plans to use the equity build-up to buy more properties, the other seeking to trade the property. For the purposes of the exercise, let’s assume values rise 10 per cent a year andignore buying costs (identical for both real estate investors).

After two years both investors in real estate buy again. Investor A ha $63,000 equity and uses that as leverage to buy a second property for $400,000. Investor B realises his $63,000 equity build-up by selling (and paying around $25,000 in fees and taxes) before buying a better property for $400,000.

After another two years, both real estate investors buy again using their respective strategies. Compare their situations after another two years (i.e. six years after each made the initial purchase):

Investor A owns three investment properties worth around $1.72 million, with total equity of $521,000. Investor A is well-positioned to buy more property.

Investor B has one property worth $605,000 with equity of $105,000. Along the way, Investor B paid out $60,000 in fees and taxes by selling and is about to lose more, because the strategy in real estate property investments calls for Investor B to sell and buy again.

Plan and be patient with real estate

Perth real estate agent Bernie Kroczek says building wealth through property investment requires a long-term goal, developing a real estate strategy and being disciplined enough to follow the plan without over-extending.

“Assuming that you’ve done your homework and purchased wisely within your financial capabilities, holding a real estate property over the long-term (minimum of 10 years) virtually guarantees success – without taking unnecessary risks or trying to pick the real estate market,” Kroczek says. “It’s really quite simple and doesn’t require tricks, elaborate schemes or superior knowledge – which many people pay thousands of dollars for, attending one seminar after another looking for the magic bullet.”

Bright tells all his real estate investor clients they should look at a five-year buy-and-hold as a minimum – but preferably they should never sell. “They should be happy to own the property real estate if the market shut tomorrow and never reopened,” he says. Balanda says he helps many wealthy people with lots of property assets prepare their wills; invariably they’re people who’ve bought and held shares and property. “Very few people create wealth through trading, but I see a lot who create wealth through buying and holding good assets,” he says.

Wakelin advises investors in property to hang on to their tax-free profits and use them to leverage into other assets. “Hold on to good quality assets in real estate and use the equity build-up ad your notional deposit to buy the next property. It’s incredibly simple. The real take home advantage message is that there’s no need to line anybody else’s pocket. Hang on to your profits.”

Wakelin says real estate investors should base property-buying decisions on the potential to double in value every seven to ten years. “You only need to build up $50,000 to $60,000 in equity. You can unlock a good proportion of that and use it to springboard into the next asset.”

Hegney buys with a long-term view and never sells (these days) because he want to avoid the capital gains tax. “I’ve bought and sold 10 or 12 properties and the wealth I’ve created out of that hasn’t been as high as buying and holding five good properties – because a lot of my growth has gone in fees and taxes. “By the time you sell, pay fees an dpay capital gains tax, the next real estate investment you buy has to work that much harder to make up for that.”

Lomas owns more than 30 properties and has only once sold a property. “You might get good growth in the first year or it might be the ninth or tenth year, but you need to hold for ten years to make it work for you. If you’re buying to trade, you probably won’t give it that much time.”

Of course, there are real estate expectations…

Mortgage broker Tricia Green of Home Loans Now is an experienced real estate investor who sometimes sells assets in property. She says it depends on her initial objective in buying a particular property. “Sometimes I buy with the intention of making improvements to achieve capital gains and then on-selling,” she says. “But if it’s negatively geared for tax benefits I wouldn’t want to sell. It depends on what you’re buying it for.”

Green bought a block of apartment units with friends who planned to renovate and sell the improved product. “Our objective is to hold the property investment for a year to reduce the capital gains tax impact – and as the units become vacant we’ll renovate them and sell.”

Green says people who retain properties and build their equity so they can borrow against it to buy more need to be aware of the commitments they are taking on. “That’s fine providing it’s not going to create hardship in meeting repayments,” she says. “You have to service the loans and if the repayments are much higher than the income, it might work against you.

“But I agree, why sell if you’re comfortable with the commitment, because the real estate capital gains will still be there for you to use. If you’re investing for your retirement, just keep them and build up a property portfolio.”

Wakelin says there’s a danger in the buy-and-hold strategy in real estate property investing for people who over-commit and become too gung-ho. “There have been lots of so-called gurus urging people to be highly speculative,” she says. “It’s better to buy a good tenantable property, be patient and let it do its work to allow the home equity to build.”

Hegney says many home buyers in the recent boom market in Perth have made the mistake of buying with short term vision. “People have bought assets in real estate that have been fantastic performers over one or three years, but they’re not long-term performers,” he says. “if the property real estate market goes into reverse, they’re the assets you’d want to get rid of. “I would say to people – all those properties you bought in the cheaper areas that aren’t long-term high growth areas, I would sell them now. They’ve had their run.”

Lomas says trying to trade away your way to wealth is a mistake but it’s also a mistake to hang on to property real estate that doesn’t perform.

“In those circumstances, you have to cut your losses and get out when you can,” she says. “I always say you should never sell but sometimes you need to. I discourage people from hanging onto something that’s a bad real estate investment which is soaking up money and preventing them form buying more property real estate. You might need to get rid of it to allow you to do something else.”

A client of McGeever’s provides a striking example. The real estate investor paid $120,000 for a small suburban unit in 1992 and found it was only worth $95,000 10 years later. He had to decide whether to persevere or cut his losses. He decided to sell and used the proceeds to buy a small retail property investment for $365,000, yielding 9.5 per cent.

McGeever says with rental increases and firming yields, that real estate property is now worth $645,000.

Terry Ryder is the creator of hotspotting.com.au and author of four real estate books.

House Not For Sale – Should You Sell your Real Estate Property? - Part 1

API Magazine of Australia examines why some real estate investors try to trade their way to real estate riches… but is buying and selling property really the best investment strategy? This is what Terry Ryder explains in this article. Part 1 of 2.

Ever driven past a house you owned 15 years ago, knowing you sold for $150,000 and it’s now worth $500,000? If you have, you’ve experienced one of the reasons why most property analysts agree that if you own good real estate, you should never sell. There are other strong reasons to reject the trading method of wealth creation. The high cost of selling and buying real estate is one of them. So too is the power of equity in creating a real estate portfolio.

Sydney property buyers agent Patrick Bright applies the philosophy of American share market legend Warren Buffet to real estate investing. “Buffet’s approach is to buy something he would be happy to won forever. His fundamental question is, ‘if you could never sell it, would you be happy forever?’ “That’s become my focus with real estate. If you follow that approach, you’ll make sure you do proper research and look at areas with future prospects.”

Many real estate property analysts agree. Monique Wakelin of Wakelin Property Advisory in Melbourne says: “Trading is absolutely not the way to go.” And Perth analyst Gavin Hegney of Hegney Property Group says: “If you’ve done your research and bought the right property, you should never sell.”

Impatience and Imprudent Decisions in Real Estate Investing

Gold Coast solicitor Rob Balanda of MBA Lawyers sees many real estate investors make mistakes with their assets because they get bored with them. They sell property assets they should keep because they lack long-term vision. “Patience isn’t a virtue many investors have,” he says. “But it’s a virtue real estate investors need to have to be successful and create wealth.”

Balanda says some residential property investors get too caught up in problems with tenants. They make the mistake of trying to manage the property themselves. Hegney says too many investors in property apply a ‘get rich quick’ mentality and lack a long-term outlook.

He says, “People buy a property, it goes up in value by $50,000 or $100,000 and they think: that’s my vision. I’ll sell and take my profit. And typically they spend it on a car or an overseas trip. “People don’t see real estate investments as businesses. They see them with a terminal life: making a certain amount and then spending it. A good investment is like a business. If it’s a good business and continues to create wealth, why would you sell it?”

Hegney says some sell real estate and properties too soon because they don’t understand the impact of compound interest. “If you have a million dollar asset and it grows 10 per cent, its value is $1.1 million after one year. When it rises another 10 per cent, that’s 10 per cent on $1.1 million, not on the original rela estate property price. By the time you get to year 10, it’s $2.6 million. It’s that compounding effect of property investing that creates the wealth.

“The same thing happens with rental return. With the current rental rates and growth, within five to ten years your rents are well and truly servicing your repayments for a high-growth asset. “In 90 per cent of cases, the most an investment property will cost you is in the first couple of years. After that, your costs should decrease as your rents increase.”

Hegney says in an ideal real estate investment world the only asset people should trade is their principal place of residence. As they create wealth, they can buy a bigger and better home and not be liable for capital gains tax. “But all other real estate property assets you hold forever – unless some drastic change comes to your life.”

Brisbane buyers agent Scott McGeever agrees that the only time you should trade in real estate is to upgrade the family home. “You do that to give yourself a better standard of living and it’s a tax-free ride,” he says.

Real estate investment advisor and author Margaret Lomas says a lot of people trade property assets because they believe it’s the way to get ahead. “But I haven’t seen anyone make a lot of money doing that,” she adds. “And if you do it too often, the Taxation Office will conclude that your business is property trading, which has many implications.

“I knew people who used to do that. After doing it for 15 years, they weren’t very far ahead. All they had was a pretty good house in a good suburb but they hadn’t built up a great amount of equity. They would admit, I think, that it didn’t work for them.”

Real Estate Property Value Growth Does the Work For You.

Imagine if you’d bought the average Melbourne house in 1990 – and did nothing since. You would have paid around $150,000 for the property and by 2005 it would have been worth around $365,000 – providing enough equity to finance you into several investment properties (depending on your ability to service the loans). On the other hand, imagine if you’d sold it in 1992 for the then-average price of $144,000 because the real estate market was taking a caning and property values had fallen in the wake of the bust which followed the boom of the late 1980s. You’d cry every time you drove past it wouldn’t you?

Why hand your gains to the government?

Selling an investment property before buying another means you’re handing a big chunk of your capital gains to government, the legal profession and lenders. Taxes and fees eat a big share of the profits. Bright says buying costs are about 5 per cent of the price – and selling costs include 3 per cent to the marketing agents, 1 per cent in marketing costs, solicitor’s fees and mortgage discharge costs, as well as stamp duty and capital gains tax.

“if you sell and buy again, you’ll blow around 9 or 10 per cent on costs.” Bright says, “You’re just wasting money. It doesn’t make sense when you can save that money and borrow against the property you have to buy a second property. Rather than trading up you’re better off having multiple properties.”

Lomas says a property investor who’s made $300,000 in value growth is looking at $80,000 in capital gains tax if they sell. And Wakelin says: “the bottom line is that property real estate isn’t an inexpensive asset class to get into and out of. So it requires a long term strategy. It’s important to buy the best quality real estate property assets you can and hold them long term.” “When you buy and sell, you’re up for very hefty costs, not the least of which are stamp duty and capital gains tax. Why line someone’s pockets? Line your own.”

For more tips, please read through more articles on Condo Blogger or visit the API Magazine website.

Unlocking your Home Equity

Are you a member of the Equity Rich, Cash Poor Club? Discover how you can use your real estate property to free up money. By Senlitonga for the March edition of the API Magazine Australia where you will find useful information about real estate investing and tips to success.

What are our options for unlocking home equity?

Question: We own our home and are looking to unlock the equity in the cheapest way, in terms of interest rates, application and ongoing fees. The home is worth $350,000 and we would need about $100,000 in the short term. What would you recommend?

Answer: You have a few options to release the equity in your real estate property. First up, although you’ve paid off the property, check that the title has been released by your previous lender. This will decrease the fee you pay when you register the title with another bank lender. One option worth considering is a revolving line of credit. If you’re familiar with this loan type, it can be basically described as an overdraft account which is secured against your home property.

The word “revolving” means there’s no contribution required to your principal, as there’s no set term. You do, however, need to cover interest expenses. Some bank lenders allow interest to be capitalised into the bank loan. This means no repayments are required if you’re still under the borrowing limit. Another option in your case is choosing a “normal” mortgage, whether basic variable, standard variable or fixed interest. This avenue is likely to cost more since most of these loans enforce an “early repayment penalty” for the first three years.

Offset Explained in Real Estate Investing

Question: What’s the difference between a transaction account which reduces interest and an offset account?

Answer: In a nutshell, most offset accounts are transaction accounts but not all transaction accounts are offset accounts. Clear as mud? To get it into perspective, you need to understand the way an offset account works. It’s a way of shrinking your home loan by linking with your transaction account, the idea that every dollar in your transaction account is offset against your home loan. There are two types of offset accounts: 100 per cent offset and partial offset.

A 100 per cent offset account will reduce the full interest charged on the home loan by the amount you have in your transaction account. For example, if you have a $250,000 loan and you have $10,000 in your transaction account, you’ll only pay interest on $240,000.

Partial offset, on the other hand, means you receive a fixed amount of interest abased on your balance in this account. For Example, you might receive 5 per cent interest on a $10,000 you have in the account. That interest then goes straight into your home loan debt without incurring the income tax owed on the interest which would happen if the money was in the normal savings account.

Obviously an ordinary transaction account that isn’t linked to your home real estate loan is of no benefit in reducing that loan but the costs versus the benefits of a standard home loan, 100 per cent offset loan and partial offset loan have to be weighed up before making a decision.

A pitfall CANNEX has identified is the ineffective use many people make of offset accounts. To generate net benefits with a loan of $250,000, borrowers need to maintain a savings account balance of $12,000. This is to compensate for the 0.6 per cent extra an offset loan will cost compared to a loan without offset facility. Of 6000 offset accounts CANNEX surveyed, 63 per cent had a balance of $5,000 or less. These borrowers for real estate aren’t making the expected inroads into their loans and may have been better off in the long run with a standard mortgage.