Take Control: How Home Equity puts you in the driver’s seat

Real Estate Capital Growth is the sure-fire route to financial freedom through real estate property writes Monique Wakelin, but it all comes down to choosing the right assets. Part 1 published in the API magazine December 2006 issue.

If a potential real estate investor were to ask what the single most important factor was when selecting residential real estate there could be only one answer – a home property’s potential for excellent long-term capital growth.

The consistent and compounding effect of real estate capital growth is the golden goose because compounding growth produces equity in your real estate assets. It’s the ability to control more and more equity that can produce an income – the key to financial independence. Not only does capital growth, over time, provide the leverage for further investments, whether it be real estate or other, it’s locked away tax-free for as long as you own the property. Understanding the whys and wherefores of home equity and real estate capital growth are crucial if a prospective investor is to achieve the ultimate aim – financial independence through real estate investments.

Many residential property investors take the view that this asset class should be income driven. However, a higher growth property will actually deliver the better income stream over time. It’s more a question of balancing the growth potential and achieving a steady rental income rather than looking for high rental returns at the expense of the growth of the real estate investment property. During the actual years of the investment strategy, the role of rental income is to meet holding costs such as loan repayments, maintenance, insurances, rates and other outgoings.

Choosing high growth property real estate allows the investor to build equity quickly, which means they don’t need to rely on saving for another deposit from after-tax income. Compounding capital growth produces an exponential increase in value over time. If, for example, you buy a $300,000 investment property real estate that increases by an average of 10 per cent a year, then the compounding factor doubles its value every seven years, and you’ll create $1.9 million in equity over 21 years.

There can’t be too much emphasis on the fact that residential real estate property investment is a slow path to financial security and not a “get rich quick” scheme. It must be based on correct asset selection to produce consistent capital growth. But time and again, we see real estate investors making the same basic mistake, hinging on the belief that all property is good real estate property and that it must at some point increase in value. Instead, real estate investors end up with a capital loss or price stagnation and no equity to show for the years of repaying loans and funding maintenance expenses.

Only correct and specific real estate asset selection will ride out any property cycle downturns and even out the returns. Provided you’re at least five to ten years away from retirement, focusing on capital growth of real estate will allow you to accumulate some serious net home equity and built on it relatively quickly.

If we take a specific example of a well-selected property investment bought in 1980 for about $50,000 and look at its current estimated value we start to get the picture. In today’s market real estate, its value would be around $500,000. Back in 1980 that amount of money would have bought a house in the top-drawer areas of most major capital cities.

We know that over the past 26 years a number of major economic, real estate investment and political cycles have transpired and real estate property values have increased strongly in spite of booms and recessions. Anyone can purchase a real estate property that looks like it might perform well but the real aim is to purchase the ones that perform no matter the prevailing market conditions.

At its simplest level, capital growth on a property increases your equity or net worth. In other words, it’s what you actually own rather than what you owe. Good capital growth will increase equity at a faster rate than an individual could achieve simply through loan repayments or by saving cash in after-tax dollars. Top-performing residential investment property doubles in value every seven to ten years and grows in capital value by an average of 5 to 8 per cent a year ahead of prevailing inflation.

The scenario of applying for a bank loan gives us a good snapshot of how home equity in real estate is viewed from a purely financial perspective. Lenders seek security on their home loans and number one on the list is property. The highest loan to value ratio (LVR) is given against real estate property. Lenders will offer up to 100 per cent (or even more) of the purchase price against real estate properties, whereas shares will attract a maximum LVR of 80 per cent if you’re lucky.

Therefore, the higher the rate of capital growth on the home property, the greater the owner’s ability to use the accumulating equity to purchase further income-producing real estate assets. A real estate property that returns low capital growth rates makes the owner much more reliant on having to actively reduce the debt in order to create more equity. This can only be done through extra repayments off the principal mortgage out of after-tax wages or by paying off lump sums when funds become available. Home equity in real estate build-up from properly selected property will outstrip the rate at which most people can find extra dollars regularly from their own pocket.

For more information, please visit the API Magazine website or Urban Living tips and checklists for condominium living here.

Some things never change when it comes to real estate investment opportunities, selling your home, mortgage financing and more.

No matter how much things change in the real estate world, there are at least four rules you can count on, writes Tim O’Dwyer for the Australian Property Investor magazine. Although we clearly live in a rapidly changing world, as a conveyancing solicitor I’ve long recognised and remarked on the “Immutable Laws of Real Estate”.

They’re not really laws but are certainly seemingly unchangeable rules of conduct. Or maybe they’re just ever-present facts of real estate life. There used to be three. Now there are probably four.

1. Real Estate agents move quickly
You can’t really blame them for this. Selling real estate successfully for seller clients is mostly all about timing. So real estate agents, by nature or training or experience, know they should move quickly in response to buyer’s enquiries. More significantly, agents usually move like greased lightning when it comes to sealing deals. In those parts of Australia where real estate agents are permitted by law to prepare sales contracts, sellers and buyers alike often find themselves under more than a little real estate agent pressure to sign up to binding contracts super-fast. Real estate agents seem to believe that if they hesitate in this regard, they’ll lose sales and miss out on commissions.

2. Solicitors move slowly
Or so it seems. Rather, we try to act cautiously. We’re primarily concerned for our clients’ interests and these are often best served by our not rushing in. Hence we usually take our time – to carefully read real estate contracts, check documents and consider the many troublesome issues that can often arise in even the most apparently simple conveyancing transaction. But we often do need to move quickly, especially when it comes to ensuring seller’s documentation is ready for settlement or critical searches are sent and received for real estate home buyers. Why? Because often we find our clients have already signed contracts, usually under speedy agent influence, with dangerously short time limits.

3. People change their minds
This is one of the prime reasons for the first two rules. Real estate agents invariably, and understandably, want consumers locked into legally enforceable contracts before they have time for second thoughts. Competent conveyancing solicitors know from experience how they must always be prepared for their own clients and the other parties getting cold feet and wanting out of apparently done deals. Sometimes when people do change their minds, solicitors have to become “contract killers” on behalf of their cold-footed clients.

4. Holidays happen
We all know that all sorts of things can happen to cause problems and put real estate sales at risk when you’re buying or selling but, for some strange reason, an awful lot of buyers and sellers seem to go on holidays after they’ve entered into serious contracts. They then return home only a week or so before settlement is due. Solicitors by and large have learned to cope with this but, gosh, it can often make things trickier, such as getting essential real estate legal documents prepared, signed and sent where they have to go on time.

The moral
Anyhow, the moral of this story is obviously not to sign anything without first getting sound, independent legal advice and possibly an independent valuation – no matter whether you’re buying or selling real estate. You simply must not let yourself by rushed. Try to be as certain as you can before you commit yourself and, if possible, try to keep your holiday arrangements flexible. After all, your solicitors should be just a quick protective phone call away – except when they’re on holidays. Then you’ll have to hope a legal locum is in place.

Tim O’Dwyer is a Queensland solicitor. Email: todwyer@westnet.com.au

Excuses, excuses when it comes to real estate investing …

When it comes to property real estate investment, it really is true that “anyone can do it”. Is it time to challenge some of your erroneous beliefs? Story by Michaela Ryan written for the December edition of the Australian real estate magazine called API.

I can’t afford to invest in a real estate property at the moment. Because I’m a single parent. A student. A low income earner. I’m single. I have four kids. Do any of these sound familiar? For just about every excusive you might think of, API has at one stage or another profiled a real estate investor to prove you wrong. Whether it’s your first property or your fifth, there are practical ways to overcome any obstacles you think are standing in your way. API regularly presents techniques for investing when you mightn’t have much home equity, cash flow or time. The scope of this article isn’t the practical things you can do, but the mental shift you need to make in order to succeed in property real estate investing.

Last month, we looked at some positive beliefs that tend to lead to success. Now it’s time to consider whether there are any negative beliefs standing in your way.

What is a belief?

Behavioural science expert Philippa Bond, CEO of Inform Training and Research, says beliefs aren’t substantial facts, although people mistakenly think they are.

“A belief is usually formed by anywhere between one or three experiences that occur, that the individual looks back on retrospectively and then formulates a belief based on (those incidences),” she explains. For example, Bond suggests a person might hear that everyone else is getting a much better return on their real estate property investment. Then they might have a bad experience with tenants. And they might go on to purchase another dud property or real estate investment. So any or all of these incidents might lead them to form a belief that they’re no good at property investing. Making a link between the events, they think that their belief is a fact.

The belief is not a fact, as it would be easy to do some learning and research and become quite good at property investments and real estate. But they never find this out, because their beliefs puts an end to their property investing. Alternatively, they keep investing, but all the time they’re telling themselves that they’re no good at it. “The pre-disposition of that belief being validated increases enormously,” Bond says.

How can you change a belief?

Bond says in order to change a belief, you need to think through its consequences. If the consequences are unsatisfactory enough, you might be prompted to change the belief.

So if you currently believe “I won’t ever be wealthy”, what are the consequences of that belief going to be? Perhaps you won’t ever develop a savings or investment plan. That might mean in 10 years’ time you’ll still be living in your current apartment or home. It might mean yuou’ll never get to take your family overseas. And in 30 years’ time you might be retiring to live on the pension – without a great quality of life.

If you’re spooked by any of the consequences, you’ll probably change your mindset. You might start to believe that you actually can be wealthy. There are plenty of practical things you can do to build your wealth. But until you alter that limiting belief, you’re never going to get off the ground. Now let’s look at some other examples of beliefs you might need to challenge when it comes to investing in property and real estate.

1. I can’t afford to invest“Some people say, ‘I can’t really afford it.” Says John McGrath. CEO of McGrath Estate Agents and author of You Inc. “The reality is you could have a lot more home equity than you think in your first property, and you might be able to borrow against it.” He adds, “Funnily enough, I think it’s as much about your belief and your strategy as it is about your financial capacity. I know people that are earning $50,000 or $60,000 a year that have bought two properties and real estate investments over the last six or seven years. And I know people that are earning $250,000 and they still have no assets or real estate investments.

“It’s not necessarily about how much you earn, it’s about how much you have the ability to save and how disciplined you are in your approach to your financial affairs.”

2. Property real estate is so unaffordable these days
If you listen to certain sections of the media on real estate and property, you’ll believe that property ownership is out of reach for most Australians and North Americans.

“it’s a very interesting psychological barrier – this ridiculous word called ‘affordability’,” says Bond. She suggests that affordability doesn’t actually mean anything; it’s only relative to your net worth, and your ability to access money. So the first thing you might need to do is define what affordable means to you. “Something that’s affordable has nothing to do with the price. Whether something is affordable or not has got everything to do with a cost benefit analysis,” Bond argues.

In other words, you don’t need to get a ‘bargain’ in order for a real estate property to be affordable. “If the return on the investment real estate property is going to be strong enough, and you have access to the funds for that property, then it’s affordable to you.”

3. Property homes can’t go up any more
McGrath regularly hears people say they don’t believe property real estate prices can go up any more. He recalls hearing the same thing 20 years ago when he was starting out in the real estate business. At an open inspection for a studio apartment in Centennial Park, he overheard someone say, “This is like a tiny room. How in the future will anyone pay more than $15,000 or $20,000 for a studio apartment?”

“Of course today that’s probably worth $220,000 or $240,000 for the same apartment. And someone walking in there today might be inclined to say the same thing,” he says. “I think you’ve just got to follow the trends, see that there are certain real estate assets – predominantly I think it’s real estate property and blue chip shares – that over a period of time have had a very consistent growth cycle that is dependable. There are some things that have faltered – I think you can buy risky shares. I think you can buy risky property. But if you stick with well located property and blue chip stocks, I thin you’re guaranteed the same cycle that generations before have enjoyed.”

4. Property’s too difficult to liquidate
Bond says many people believe that real estate property investments takes much more time and money to sell than other types of investments. She challenges this belief by saying, “(If) the contacts are in place, you can turn over a real estate property at a party! You get an exchange (of contracts) the next day. You then demand a 10 per cent release on the deposit … which gives you instant cash there and then.

“But if you have a managed fund, it can take anywhere between 14 days and 21 days to be able to get your money out.” “The shortest property settlement in real estate is going to be 30 days. But even it if goes up to 60 days, you’ve got it locked in by a legal contract real estate which is very difficult to get out of.”

This is only hypothetical, of course, and Bond isn’t arguing that real estate property is any better or worse than a managed fund. However, she makes the point that property investments can be liquidated (turned into money) a lot faster than many people would imagine. If a vendor is ambitious about getting a high price, then it might take a long time to sell a property or real estate investment home. But that’s a problem that’s easily avoided by keeping realistic price expectations from the start.

5. I don’t pick the best properties or real estate
Bond is impatient with people who believe that they aren’t good at choosing decent real estate. “If you don’t pick the best properties, it’s because you’re lazy,” she says. “There are so many magazines, so many reports. It’s so easy to pick the right properties and investments in real estate markets. You’ve just got to do your research. “(Someone might argue) ‘Yes but I don’t want to pay for the median price reports’. Well-pick the wrong properties then!”

Where to from here?

If you think through the consequences of any of these beliefs, they don’t auger well for your success in property investments in real estate. However, you can turn them around whenever you like. John McGrath suggests, “Use (your limiting beliefs) as a catalyst for developing specific solutions that help you move forward.”

“So if something concerns me or I don’t get a great feeling about it, it doesn’t always mean I won’t go forward on it. It often means, I’ll just ask myself the question, ‘what is it about this particular strategy or transaction that I’m uncomfortable with?’ And (I’ll” sit down on my own or with my advisors and say, ‘how can I get beyond this?’ “Sometimes there’s no solution and you’re better to not go ahead. But a lot of the time you’ll find there is (a solution),” McGrath says.

For example, if you believe you couldn’t cope with an interest rate rise in real estate, the solution would be to lock into a fixed rate home mortgage. Or if you believe you can’t afford another real estate property investment, you might resolve to see a lender to find out how much you can borrow. That way you can act based on the facts, not beliefs.

Home Financing Fundamentals

Written by Kelly Wharton for the Dec 08, 2006 – Jan 05, 2007 edition of the New Home Buyers Guide for Vancouver. The real estate market is hot and so is the competition for your home mortgage business. “The past six months have seen an incredible increase in the new products and options that lenders offer,” says Joanne Thomas, a mortgage broker with Centum Capital Group Inc.

There is so much information swirling around on home financing that the thrill of buying your new house – especially your first one – can quickly be replaced with a money headache. This article will help you focus on the fundamentals of financing your new home purchase and explore some of the newest products out there.

Don’t let the down payment get you down

Issue number one on your mind will probably be the down payment. A bank or other financial institution will lend you a significant portion of the purchase price of your real estate deal. The lender secures this loan by registering a mortgage against the title of your house. “The down payment amount is calculated on the purchase price of the house only, so the home mortgage does not usually cover closing costs like taxes and survey, appraisal and lawyer’s fees,” cautions Sheree Rankin, a Royal Bank mortgage specialist. So don’t forget these additional transaction costs in your savings plan, especially Goods and Services Tax if the house or real estate property is a new or substantially renovated, and the provincial property transfer tax or PTT calculated on the value of the house. First time home buyers may be exempt from the PTT if the value of the house is under $325,000.

In a normal or conventional home mortgage loan, you will need to save 25% of the purchase price. If you have less than the 25% down payment, you may qualify for a high ratio mortgage. These home mortgage loans require as little as 5% of the purchase price down since the lender is insured against the risk of default by mortgage insurers like the Canada Mortgage and Housing Corporation (CMHC). The premium for this home insurance – which is a percentage of the amount financed – is usually added to the home mortgage amount.

Whether you are getting a conventional or high ratio house mortgage, first time real estate home buyers can use up to $20,000 of their registered retirement savings plans (RRSPs) toward the down payment. This is a Canada Revenue Agency program called the Home Buyers’ Plan or HBP. It allows withdrawals from your RRSP to buy or build your home by October of the year following the year you withdraw the money. The withdrawn amount is not taxed and if you are buying with your spouse or partner, each of you can withdraw up to the $20,000. You can use RRSP contributions made up to 89 days before the withdrawal and still claim your current RRSP contribution as a deduction. You have to repay the withdrawn amount over a period of 15 years beginning two years after withdrawal. To find out if you qualify for the HBP, visit the website at www.cra.arc.gc.ca/tax/individuals.topics/rrsp/hbp.

In this new competitive world it is possible to finance 100% of your new house price with no down payment. First National offers this type of insured mortgage. Joanne Thomas reminds us that good things come at a cost, “The insurance rates associated with these types of home mortgages are higher than for other high ratio loans.”

Freedom 25…Or 35… Or 40

Once your real estate down payment is settled, you will know how much you need to borrow or the principal amount of your house mortgage. Your focus can turn to establishing a repayment schedule that is comfortable for you. The factors that determine the monthly payment amounts are the amortization period, interest rate and principal amount. The amortization period is the number of years it will take to actually repay the mortgage loan plus interest. The common length of time was 25 years but some lenders are now using 30, 35 and even 40 year amortization periods to calculate repayment amounts. The greater the amortization period, the smaller the monthly payments, but the longer you have the debt.

The total length of a home mortgage loan on your real estate property will be made up of several terms, the period of time the lenders will agree to lend you the principal with interest. Once the term is up, you can renegotiate your home mortgage for a renewal term or repay the loan.

Cracking the Nut

The annual cost of borrowing the principal or the interest rate will also affect your monthly payments. Each of the different real estate mortgage terms – usually between six months and five years – will carry with it an applicable interest rate and certain restrictions. Depending on your taste for risk, or your ability to read crystal balls, you can chose a mortgage loan that is variable (the interest rate changes with a lender’s prime rate) or fixed (the rate stays the same for the term), open (you can prepay the loan during the term without penalty) or closed (no prepayments or with a penalty).

Some new options may help you cope with the monthly mortgage nut for your real estate property. First National has an interest only mortgage which means you pay only the interest on the principal for a period of up to 10 years. The cost for this product is a higher insurance premium and you need a 10% down payment.

Lenders also advertise cash back mortgages which give you a percentage of the loan back in cash. A higher interest rate is the price tag for these types or mortgages. Planning the financing of your new home or real estate investment ahead of time by focusing on essential issues will mean exchanging headaches for homeowner bliss.

Bricks and Mortar Real Estate Investment Tips

Welcome to another instalment of Bricks & Mortar, where our panel of experts answers real estate property investment questions from API readers. Published in the December Australian Property Investor real estate magazine.

When to sell real estate?

Question: My husband and I are both working at the moment, however, I’m going to be starting 12 months’ maternity leave in January. We think we might need to sell one of our investment real estate properties (we have six) to help ease the financial load during this time. My question is, from a CGT perspective, would we be better off selling the property while we’re both earning an income or should we do it when I’m at home with the baby? The property is in both our names, 50/50.

Answer: Congratulations on your pregnancy. I hope everything goes smoothly for you. From a CGT perspective, it’s best to wait and sign the contracts in a financial year where you have a lower income so that any gains made on the sale of a property are added to a lower base income and not a higher base income. By the way, and for what it’s worth, another option instead of selling an investment real estate property is to use a line of credit (LOC) to help with the cash flow. This LOC will mean that your debt will increase over this time but twhere the funds are used to pay for property-related expenses and mortgage repayments, the interest should still be tax deductible.

This real estate investment strategy enables people to keep their properties at times like this instead of triggering the enormous costs of selling and seeing their portfolio decrease, and allos them to keep all future gains in real estate value on the properties in question.

Dale Gatherum-Goss

Can I claim the interest on a real estate investment property

Question: I have an investment property in real estate with about $68,000 left on the loan. Long story short, the interest I currently incur isn’t deductible against income against the property. If I were to “refinance” this real estate property loan as part of opening a new loan which I require for the explicit purposes of buying another investment property, will the interest earned on the sum total of the loan (i.e. the $68,000 plus the amount of the new property) now be deductible against income from the new and/or both properties?

Answer: No unfortunately the Tax Office follows the money in cases like this to see the purpose of the new home loan and how the funds were used. So, any new house loan would be apportioned between tax-deductible debt and non-tax-deductible debt I’m afraid.

Dale Gatherum-Goss

Is it too late to invest in real estate?

Question: I am a 53 year old nurse who works full-time and I’m concerned my superannuation won’t provide me with enough money to enjoy my retirement years. I currently earn $55,000 per annum and have almost paid off my home which is worth about $300,000. My question is, is it too late for me to invest in real estate or property to help secure my financial future? If it isn’t too late, what should my real estate strategy be going forward?

Answer: No, it’s not too late. Yours is a common scenario where an individual realises that relying on superannuation alone isn’t going to deliver the retirement lifestyle they were hoping for. Provided you are five to ten years away from retirement, you can still capitalise on your income and home equity in your existing real estate property to build wealth.

To maximise that wealth creation through real estate property investment at this point in your life will require a very unemotional and businesslike approach in order to maximise your capital gains. Your selection of the right real estate property asset is crucial and you should be concentrating on only one area – the high-growth inner urban areas 2 to 12 km from a major CBD – where scarcity value, high demand and low supply will underpin your real estate investment. By focusing your property strategy on capital growth you will build and control home equity. And it’s controlling equity that’s the key to attaining financial independence.

Don’t be daunted by the higher prices in these areas. One very well chosen, more modest real estate asset – such as an apartment – can outperform the wider marketplace and inflation, not to mention larger, lower growth properties in middle to outer suburbs. Seek independent financial advice on the best loan package for your circumstances.

Next, seek truly independent real estate property investment advice to ensure you do get the maximum capital gain and good, long-term rental income. These two advisory areas should be kept separate. Don’t waste any time before seeking the appropriate advice. Steer totally clear of any “get rich quick” property real estate investment schemes. Many people seeking to rapidly top up inadequate superannuation have been tempted by these to their financial detriment.

The safest way to invest in this real estate asset class ist o take an unemotional, longer-term very well advised view.

Monique Wakelin

Real Estate Valuation discrepancy

Question: Why is there such a big difference between a real estate agent’s appraisal and a valuer’s valuation of a property or home, particularly when it’s for the bank? I had an agent give me an assessment of the value of my home before getting my loan but the bank valuer said it was worth a lot less.

Answer: It probably comes down to a question of the instructions and motivations of the valuer and the real estate agent. The valuer is instructed by the lenders to provide a realistic assessment of the real estate market value of the property as they find it on the day of inspection. They can’t take into account future improvements or presentation issues you may attend to if you were to place it on the real estate market. The lenders simply want to know a “safe” amount they should use as security, so in the unlikely event they have to take over the property, they’re covered.

The real estate agent’s appraisal isn’t bound by these instructions. Often the reason for providing a free appraisal is as a marketing tool to try to gain your favour and ultimately a listing. Therefore, it’s in their best interests to be “bullish” about their opinion of the market value so that you’re more positive and inclined to list it with them. Remember that real estate valuers are totally independent and have no vested interest in your real estate property or home.

Phil Grahame