Real Estate Questions Answered

Panel of experts in real estate investing answer questions from API Magazine readers in the March 2007 issue.

Using a trust structure

Question: My husband and I own an investment real estate property in Queensland and we rent a house in Sydney. We’re buying a second investment property using a company/trust structure. We’ve set up a hybrid trust for future real estate purchases. For our third property purchase, would it be legal for our company to purchase and we, as individuals, rent it at the current market rate? I’ve asked two accountants this question – one said there was nothing illegal about it but the other wouldn’t support such a move.

Answer: Most trust deeds allow the trust to rent a property to the beneficiaries of the trust. So, from a legal perspective, there’s certainly nothing to stop you from doing this. Further, there was an important legal precedent set in 1987 when the courts found in favour of the taxpayer in just such a case. For what it’s worth, this is known as the Janmor case. However, before you do this there are a couple of issues to consider:

- the home won’t be exempt from capital gains tax if you were to sell it in the future, whereas it would be if you owned the home in your own names;

- the home may attract land tax that it wouldn’t attract if the home was in your own names.

So, I would suggest that you consider whether this real estate property will be your home for a long, long time or just a short while before making your decisions. The real problem arrives if you wish to negatively gear your home using the hybrid trust features of having the loan in your own names while the trust owns the real estate home property. This is because the Tax Office has said that it will attack this. More information can be found about how the Tax Office would view y our negatively gearing your home through the trust in TR 2002/18. There are legal arguments that suggest that the Tax Office is wrong, but, of course no-one wants to be the one to test whether the Tax Office is wrong or right. As a general rule, you’re wise not to have your home in the trust and negatively gear this real estate investment.

Dale Gatherum-Goss.

Unit or House for Real Estate Investments?

Question: I’m unsure whether to purchase a unit or house. What are the positives and negatives of both? Apart from local property average prices what should I look for? And how long will the real estate buyers’ market last for?

Answer: When it comes to investment property real estate, the first thing you need to do is be clear about why you’re investing. Do you need enough rental income to replace your salary, or do you need to build equity through capital growth in real estate? Since I don’t know the particulars of your situation in investing, I’m going to assume for the purposes of this column that you’re like the majority of property investors, who need to focus on assets that will deliver strong capital growth. In this case, it doesn’t matter so much whether to buy a unit or a house. The most important thing is to identify properties that are in limited supply and have experienced consistently strong demand over a number of years, regardless of whether it is an apartment unit or home. More often than not, these are within short commuting distance of the CBDs of major capital cities, where a scarcity of available land drives up real estate property values. You should also focus on locations where there’s strong competition during negotiations, for example where there are several or more bidders vying for the same home real estate property during an auction. This is a good indication of strong demand and capital growth potential. If you’re looking at apartment units, stick to low rise developments with less than 20 properties. There are less likely to be multiple units in the same block on the real estate market at the same time, so the resale value will be higher.

In terms of research, look at recent sales results in ‘comparable’ properties, i.e. those in the area, with a similar land size, architectural style, and degree of renovation. This will help ensure you have a realistic purchase price in mind, and don’t overpay for the real estate property.

Generally speaking, the ‘right’ time to buy is when the right real estate opportunity presents itself – that is – when you find the real estate asset that’s most likely to help you achieve your objectives. However, there are indications that property investors will begin returning to the market in greater numbers during 2007. So if you find the right property, don’t procrastinate. You’ll face more competition from other real estate investors as the year goes on, which will drive up the asking price.

Mark Armstrong

Questioning a Property Valuation

Question: In September we completed building two residential properties with two different lenders. We asked for a revaluation on one and sold the other last December for $330,000. (We expected this sale price). For the other house the valuation came in at $285,000, well under the sale price of our other property next door! Both completed at the same time, similar size, same finishes etc. Our real estate agent organised sales comparisons for similar properties in the same estate, indicating $320,000 to $330,000 for two properties. Tell me what’s wrong with the facts? Can this low valuation be adjusted?

Answer: When a valuation is lower than your expectations the best approach is to supply some recent sales evidence which supports your case and simply ask the valuer to review the valuation in light of this evidence. Generally, a balanced and informed communication with the valuer will resolve any misunderstandings. If your real estate property next door hadn’t settled at the time of the valuation, there’s a chance the valuer may not have been aware of this evidence. In addition, some lenders insist that valuations be based on settled sales only – not on properties which are still under contract. Remember that valuers are totally independent and have no vested interest in your home property or the outcome of the valuation.

Phil Grahame

Your Real Estate Questions Answered

Our panel of real estate experts answers more questions from API Readers for the February 2007 edition.

Is it too late to invest in real estate?

Question: I’m 64 and have $320,000 equity in my house. I’m thinking of selling the house, renting and investing this amount in a real estate property. Unfortunately, I’ve moved too early from some previous properties and missed out on lots of money. I’m planning to work for another two years full-time and then work as a consultant. Is it too late for me to do anything in the real estate property market?

Answer: As you suspected, the key issue here is your age, which affects your investment real estate horizon, risk tolerance, and cash flow requirements. Investing in residential properties requires a long-term view; at least seven to ten years to give compound capital growth ample opportunity to do its work. Every time you buy real estate property, you incur entry costs including stamp duty and conveyancing. When you sell the real estate proerpty that’s generated rental income, you’ll pay capital gains tax as well as the usual agent’s commission and advertising fees. If you buy and then sell within a few years because you need cash to fund your retirement, entry and exit costs will chew up a substantial proportion of any capital growth the property has achieved. Additionally, because property real estate isn’t a liquid asset, it can take months to find a buyer and complete settlement. If you do need cash quickly, the ball is in the buyer’s court and you may be forced into selling for less than fair real estate market value. This may sound strange coming from a property adviser, but in your situation it may be better to consider investing in superannuation. I suggest you speak to a financial advisor about your options. – Mark Armstrong

After a big loan

Question: I’m a real estate investor in Perth. I want to take my investments to the next stage but the banks say my salary isn’t enough to give large equity loans. I want to borrow $1.5 million to $2 million to buy a house. I have equity on my present house as a deposit (20 per cent) and the remaining 80 per cent loan would be on the house I’m buying. My salary level is $100,000. How can I address this problem?

Answer: Despite your considerable equity, your problem is your income, which isn’t high enough to sustain the repayments required for such a large loan. The interest on a $1.5 million loan is more than $100,000 per year. This is more than you earn, so I can’t see how you would be able to meet you repayment commitments. And although you’ll receive rental income from the new real estate property, lenders generally only take around 75 per cent of the gross rent into account when determining ability to pay back the loan. I suggest you consider real estate investment properties in a more modest price range. If you buy several modestly priced properties over a period of time, you’ll build a portfolio that generates enough rent to boost your working income substantially and puts you in a much better position to pay back a $1.5 million to $2 million loan. Then you’ll find the banks will be more willing to come to the party – Mark Armstrong.

Making a joint real estate purchase

Question: My brother, his friend and I are looking to buy a real estate property in Cairns. We won’t be suing the first homebuyers grant as there are three of us, and we were wondering what we should do about the free stamp duty etc. for first homebuyers. As we’ll be getting the real estate property contract in all of our names we weren’t sure whether to take advantage of the first homebuyer perks or save them for when we buy our own properties separately. We were also wondering if a solicitor would be the best professional to write out the joint contract. We were also going to apply for a 100 per cent capital loan as we were looking at renting the real estate property out to start with. Is this wise?

Answer: You’re probably right to be cautious about using your first homebuyers concessions. If you receive the Federal Governments $7000 first Home Owner Grant for this particular puchase, none of you will be able to claim the grant for any real estate properties you may buy individually, further down the road. The same applies to the Queensland Government’s first homebuyer stamp duty rebate, which is available for real estate properties purchased fro less than $500,000. To get the stamp duty rebate, none of you must have owned property at any time previously, in Queensland or elsewhere. You must also be living in the real estate property as your principal residence, not renting it out. The rebate is calculated according to the value of the real estate property you purchase. The more your property is worth, the lower the rebate. For example, if you buy a property for $300,000 to $309.999, you’ll receive a stamp duty rebate of $2000. If you purchase for $410,000 to $419,999, you’ll receive $900.

If the three of you can afford to purchase without the first Home Owner Grant and the stamp duty rebate, it might be an idea to save these in case any of you decide to purchase a principal home of residence individually in the future.

Yes, it’s a wise idea to have a solicitor draw up a joint venture agreement so that all three of you understand your financial commitments. The joint venture agreement should also specify how long you will hold the property real estate, and spell out a contingency plan in the event that one of you decides to sell your share.

Regarding your questions about borrowing 100 per cent of the property’s value, I don’t know all the particulars of your situation, so I can’t advise on particular loan options. However, you should keep in mind that the more you borrow relative to the real estate property’s value, the greater your risk in the lender’s eyes, so they may charge a higher interest rate – Mark Armstrong.

For more Bricks & Mortar Q&As, go to www.apimagazine.com.au. If you have a question for our experts, you can send it to: editor@apimagazine.com.au.

This information is of a general nature only and does not constitute professional advice. You must seek professional advice in relation to your particular circumstances before acting.