Expert Advice with Simon Buckingham 01/07/2018
Over the last couple of articles we've been debunking the myth that you should only ever buy and hold property, but NEVER sell.
We've seen that a sophisticated property investor will sell an investment property when it makes financial sense, in order to move their investing forward (rather than holding onto the property and being stuck in a rut).
We've also identified that tax is a natural consequence of making money. If we're investing to make money then we shouldn't be afraid of selling and paying some tax along the way (rather than holding onto an under-performing investment just because a sale might trigger a tax consequence).
"But Can't I Just Borrow Against My Property To Buy The Next One?"
Many investors get hooked on the idea of buying a property, waiting for it to go up in value, and then borrowing against the increased equity to fund the deposit and closing costs (stamp duty, etc.) for the next investment property.
The story they've been sold is that they can simply keep leveraging from one property to the next as each one goes up in value. (Because all properties only ever go up in value... right??? )
By borrowing against the properties, rather than selling, they can avoid selling costs and put off having to pay capital gains tax.
Eventually, they believe, they'll get say 10 properties. And if they've all gone up (maybe even doubled!) in value, then they can then sell down half the portfolio to pay out the rest, and live off the rent from the remaining properties.
This is a wonderful fantasy ...except that it almost never works!
There are two fundamental problems with this approach:
PROBLEM #1... It falsely assumes that each property will only ever go up in value - and at a consistently high enough rate to rapidly build the equity to borrow against for the next deal.
However the property market doesn't actually work like that.
Historical fact tells us that rather than consistently going up all the time, property values typically rise in short bursts, and often go sideways or down for extended periods of time.
Even 10-years in the market is no guarantee of significant price growth.
For instance, median house price statistics reported by the Real Estate Institute reveal that between 1988 and 1998 the Sydney median house price barely kept pace with inflation - in fact it went backwards and sideways for several years. The same occurred between 2003 and 2013, another 10-year period where median prices hardly kept up with inflation.
And while many (but certainly not all) areas have seen growth over the last few years, there are plenty of suburbs around Australia where prices today are actually lower than they were 10 years ago.
Choose the wrong property in the wrong location, and price growth is anything but assured.
PROBLEM #2... Leveraging against a property to extract equity inevitably increases interest costs because it increases the size of the loan secured on that property.
If the property is already negatively geared, then this will only make the negative cash flows worse, and increase the loan servicing requirements.
The problem is exacerbated in the current financial environment, where banks assess your ability to repay a loan based on an assumed interest rate of 7% or higher, regardless of the actual interest rate you might be paying.
This means that most investors will simply run out of borrowing capacity attempting to leverage the equity from one property to fund the next, before they achieve a property portfolio large enough to retire on.
There are plenty of property investors who are asset rich but income poor... Who have substantial equity in their home or investment property, but can't get at that equity because they cannot demonstrate the capacity to repay the additional borrowing - especially under current tighter loan servicing tests.
Worse, if a property you want to borrow against is negatively geared and doesn't actually achieve rapid capital growth, then holding onto that property may only make it harder to raise the deposit for your next one.
(There are smarter, better ways to build a multi-property portfolio and create a passive income, than waiting years for growth and then trying to borrow from one property to fund the next. If you’d like to invest smarter and avoid common property investing mistakes, then check out this free report on “How NOT to Stuff Up Your Property Investing!”
Let's put all this in perspective by asking an important question that many investors overlook...
"When Does The REAL Transfer Of Wealth Occur?"
There's a concept bandied around by economists called "transfer of wealth".
This is the idea that at certain times or in certain market conditions, wealth "transfers" from the hands of some investors into the hands of others. Some say that there's a transfer of wealth whenever the market goes up or down (meaning some investors are now "richer" while others are "poorer" as a result).
But here's a simple truth...
A REAL transfer of wealth only occurs when an investor REALISES a profit by cashing out of an investment (or receives a positive cash flow from an investment).
In other words, the real transfer of wealth occurs when the money actually hits your bank account.
Until that moment, any wealth tied up in the property as 'equity' is just theoretical.
If you're on the fence about selling a non-performing property asset, then consider what the real transfer of wealth to you from a sale would do for your lifestyle, or for your ability to build your wealth further.
Ask yourself again - what are you investing for...
What is the goal that your investing is designed to achieve?
And will holding or selling the asset help you to achieve that goal faster?
Food for thought!
Simon Buckingham is Director of Results Mentoring and a highly experienced investor. Simon has been investing in property for over 15 years using a broad range of strategies including positive cash flow, renovations, property development and commercial properties, both within Australia and overseas.
Holding university degrees in Commerce and Law, and with over 10 years' experience as a business consultant, Simon turned his back on corporate life forever following the births of his two children and now spends his time investing, developing property, supporting multiple charities, and building businesses - while teaching others how they can do the same. He has personally coached hundreds of investors in techniques that can be used to profit from property in any market conditions, regularly facilitates public workshops and provides other free resources for property investors through ResultsMentoring.com, and has presented to thousands of people at property conferences and seminars around Australia and New Zealand.
Simon writes the highly regarded Sophisticated Property Investor e-newsletter and his opinions on the property market and real-world investing strategies have featured in Your Investment Property magazine, Smart Property Investment, Channel7 News at 6, Kevin Turner's Real Estate Talk, and Property Observer. He is co-author of the critically acclaimed property book The Real Deal: Property Invest Your Way to Financial Freedom, and a founding Mentor in Australia's award-winning personal mentoring service for property investors: the RESULTS Mentoring Program.
Disclaimer: while due care is taken, the viewpoints expressed by contributors do not necessarily reflect the opinions of Your Investment Property.