More about real estate investing on a single income

Continued from a previous post:

Positive Cash Flow Property

Finding investing properties that earns enough rent to cover the costs of owning it canmake it a lot easier to get into investment property. Finding such property isn’t as easy as it used to be – but it’s still possible.

Tricia Green of Home Loans Now in Brisbane says positively geared property real estate will make a difference in getting a loan with a low income. “If it’s close to neutral, it’s pretty good as well,” she says. “But it depends on the individuals’ circumstances.”

Montgomery says: “If it’s positive cash flow it will increase their chances – totally.” But Lomas warns that the property needs to be positive by virtue of its rental income, not through tax deductions. “If it’s positive cash flow because of tax deductions, it won’t make much difference,” she says.

“If the return is 5 per cent and it’s on paper deductions like depreciation that makes it positive cash flow, the bank won’t be impressed. Borrowing criteria is worked out on disposable income – what you have left after you’ve paid tax and personal debts. “If you have positive cash flow because the income is greater than the expenses, then it will enhance your borrowing capacity. The bank will take whatever income the property is generating and add that to your income.”

Lomas suggests there’s a risk factor. These days, she says properties which are positively geared by virtue of a high-rent are mostly found in one-industry towns such as mining towns, where values are dependent on the longevity of the resource boom. Those willing to take the risk can find high-returning properties in town such as Moranbah and Blackwater in Queensland, Newman in Western Australia and Whyalla in South Australia.

Keep in mind, however, that the entry price is getting quite high in some mining towns, particularly in Moranbah and Newman where good houses cost $350,000 to $400,000 often more. It is possible to get 7 per cent to 8 per cent returns in major cities, but they tend to be found on smaller apartments – one bedroom and studio apartments – and that presents another set of problems. While such properties have a low entry price and good returns, many financiers are reluctant to lend on properties under 50sqm. Green says attitudes are changing and some lenders have reduced their minimum to 40 sqm, while some will lend on any size of property provided it’s not mortgage-insured.

Good locations to find units with the highest returns include Spring Hill in Brisbane, Tweed Heads West in northern NSW, Darlinghurst in Sydney and the Manoora/Manunda precinct in Cairns. Two likely capital-city locations for good returns on houses are the Beenleigh areas south of Brisbane and the Elizabeth precinct in Adelaide.

Making it easier to get finance

Wizard Home Loans says borrowers make a range of common mistakes that make it harder for them to get finance. In particular, it says borrowing hopefuls commonly believe a number of misconceptions. One prevalent myth is that banks are interested in how much you owe on your credit cards. They’re not; they want to know the total of the limits on al your cards.

“Every type of credit you have in your name, regardless of balance, is used to calculate your ability to service your loan,” says Wizard chairman Mark Bouris. “the less credit (credit cards and other loans) you have on your home loan application, the better.”

Green says: “if you have $30,000 in credit card limits, they’ll take 3 per cent of that limit as a monthly expense sometimes 2.5 per cent, it depends on the lender.” Another misconception is that you need a 20 per cent deposit to get started. “Not true!” says Bouris. “These days you can borrow up to100 per cent of the real estate property value. This is proving to be an attraction option for many cashed-up first homebuyers, who often wonder whether they’ll ever get their feet on to the property ladder.

“One hundred per cent finance provides a lifeline to many people who otherwise would be unable to buy a property.” “From a lending perspective, a lack of a deposit isn’t a major obstacle. What really matters is ensuring that borrowers can comfortably meet their mortgage repayments in the future – and if interest rates increase. “But a lower deposit may mean a higher interest rate and fees.”

Green says it’s possible to borrow 100 per cent of the purchase price of the real estate investment property, but borrowers need to have money set aside for costs such as stamp duty, legal fees and mortgage insurance.

“And when you’re borrowing 100 per cent, the lender is a lot tougher in their criteria. If you’ve just started a new job, for example, they won’t look at you.” The less deposit you’re able to pay when you apply for a loan, the higher the premium of the mortgage insurance.

Some borrowers think a bad credit history doesn’t matter if they eventually pay off the debt. The truth is that a patchy credit history can hurt a borrower’s chances, evne if the issue is very old or just a small, one-off amount. Lenders consult the major credit reporting agencies, which record debts (including any missed or defaulted payments on credit cards, interest-free contracts and mobile phone plans), while assessing a loan application.

Another myth is that assets count the same as income in the eyes of the lender. They don’t. Bouris says, “People often believe that a strong asset position can be a substitute for income when it comes to servicing a loan. But no matter the strength of your assets, what really makes the difference is your capacity to repay the loan through a regular income.”

Shared Equity Investing

Green says equity finance mortgages, or shared equity loans, are new to the real estate market and there’s lots of resistance from consumers. While buyers can achieve a property purchase for less than the full price, they have to forego a chunk of the capital growth when they sell. “The jury is still out on this kind of product,” she says. “There are lots of pros and cons – and many people are against them.”

The general concept is that the ban retains a 20 per cent share of the property investment but receives 40 per cent of the capital gain when the property is sold. The property is solely in the name of the borrowers: they’re granted two loans by the lender, one for 80 per cent of the value and the other for the remaining 20 per cent. The smaller loan is interest free.

When the property investment in real estate is sold, the lender gets there 20 per cent contribution back plus 40 per cent of the capital gain. The 80/20 split isn’t the only possible configuration – it could be 90/10 or 85/15. “A lot of people are against them once they realise they’ll lose 40 per cent of the future growth,” Green says.

Montgomery says this kind of loan product is specifically targeted at individuals who struggle to buy property in the normal way. “These types of loans are quite complicated in their structure at this point in time, but as these types of loans roll out and become a little simpler to understand, they may be an option for single people.”

Montgomery says the State Government in Western Australia recently introduced a shared equity product which allows first homebuyers to purchase part of a property, with the government buying the other part.

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.

Don’t make the same mistake in property investing in real estate!

Lawyer Rob Balanda pulls more property investment warning stories from his filing cabinet, so you can learn from the mistakes of others. This was published for the Australian Property Investor magazine in February 2007 (apimagazine.com.au)

Trading Properties

I received a call from a real estate investor who had been sitting on an old fibro cottage in an areas which he though would be a prime redevelopment real estate site. He had been watching real estate prices rise and rise but in the past year or two they’d slipped back.

He didn’t find this out until he put the real estate property on the market at what he thought would be a record price, only to find out that the real estate market hadn’t rung a bell when it hit the top, and he’d missed the upswing. Keen to see the real estate property investment, but with unrealistic expectations about its value in the market, he placed an ad in the exchanges and trades section in the real estate part of his local newspaper.

As luck would have it he found someone with a similar problem and he agreed to exchange his real estate property for another person’s expensive unit. The exchange got him out of a property investment that he no longer wanted but he didn’t have the cash fro the sale to, for example, pay his capital gains tax.

I also gave him a fright when I told him the amount of stamp duty he’d have to pay on the expensive unit that he was trading for. He then suggested to me that we should “write down” purchases prices of both real estate properties to save him and his co-investor a bit of stamp duty and a lot of tax. Wrong.

My advice to him was this was a definite no-no and I strongly urged him not to do it. The reasons I gave him were as follows:

1. Firstly, writing down the real estate purchase prices deprives the Australian Tax Office of revenue and this is considered fraud.

2. Secondly, the Office of State Revenue is entitled to stamp duty on the real estate purchase price of the traded property investment or its value, whichever is greater, and by writing down the purchase prices he will deprive them of revenue.

3. Thirdly, as he was transferring a loan from the fibro dwelling to the real estate unit this created all sorts of problems for him and his lender. Lenders base the amount they’re advancing on the value of the real estate property or the purchase price – whichever is lesser. If he wrote down the value, the lender wouldn’t be able to transfer the full amount of the loan that he had on the fibro cottage over to the new unit.

4. Finally, and worst of all, you artificially create a lower cost base for capital gains tax purposes which could come back to haunt you in the future. For example, if you wrote down the value of the real estate property which was valued at $600,000 to a $400,000 sale price and you later sold the property after it had gained $200,000 (making it now worth $800,000), tax would be payable on the amount of $400,000 ($800,000 less $400,000). This is a huge mistake and the real estate investor wanted to do it to save himself a miserable amount of stamp duty. Forget it!

Option or first right of refusal on real estate property investments

A real estate property investor advised me that he and the owner of the property had agreed that he would have first option to buy this property in the next six months and asked me if I could do something simple to document this agreement. I asked him:

What was the purchase price for the real estate property investment should the first option be exercised?

When would the settlement take place?

What was the amount of the deposit?

I also asked some other questions about details that are normally included in a formal contract of sale for real estate property.

It was clear to me that he hadn’t agreed to take an option to buy the property investment, but had simply been given a right of first refusal. There’s a fundamental difference between these two concepts.

An option to purchase real estate gives the buyer of the property the right, but not the obligation, to buy the real estate property within, say, a six-month period. It allows the investor of real estate to put the property on lay-by and during the next six months make up their mind about whether they wish to purchase the property or not.

It’s essential however that the exact terms of the contract that comes into existence if the option is exercised are finalised at the same time the option is granted for that real estate property specifically, for example the purchase price, settlement date, deposit, etc.

A right of first refusal has been described by the High Court of Australia as “worthless”. It means that if the real estate owner of the property at some time in the future decides to sell the property – and they don’t have to – they agree to first advise you that it’s now available for purchase.

That purchase will be on whatever terms and price they determine and once they’ve made you aware that it’s for sale, then you’ve discharged their obligations to you. It’s for this reason the High Court says it’s worthless.

For more practical point of view, and not the lofty heights of the highest court in the land, the right of first refusal does have some value. It’s worth something to be the first person to know that a real estate property is for sale, as you can then at least take the initiative and attempt to buy it.

Rob Balanda is a partner of MBA Lawyers at Surfers Paradise and the author of the “Made Simple” series of publications available from Business Mall. Please note that 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.