This year I’ll be celebrating 20 years in real estate. During this time I’ve learned that some ideas are great in theory but don’t work on a practical level. To help you avoid these costly mistakes, I've put together the list of things I wouldn’t do in 2014.
1. Invest in NRAS (National Rental Affordability Scheme)
This is a federal program created to provide more affordable rental accommodation. Tenants who qualify for NRAS have their rent subsidised up to a maximum of 25%, and landlords who enrol in the program receive tax credits to compensate for the reduced rental amount.
Why I won’t invest in one
On paper, an NRAS scheme looks to stack up pretty well, but take a closer look and you’ll soon realise that you’ll probably find a better deal buying an investment property outside of the NRAS strategy.
- To qualify, all of the property purchased through an NRAS scheme must be brand new, and an NRAS manager, who consequently handles the tax credits on behalf of the investor, must manage it.
- You cannot have entered into any joint venture agreement – you can only hold the title in your name and cannot have an unrelated third party as beneficiary.
- You must use the reduced rental figures on your statement of financial position, rather than the true market rent. This negatively impacts on your serviceability and the amount you can borrow.
- Despite the fact that we’re using tax credits in an attempt to positively gear the property and improve our serviceability, we may end up doing the exact opposite to our portfolios as our costs can be higher than if we’d purchased a property outside of the scheme. For example, NRAS property managers can (and some do) charge management fees in excess of what other companies charge, yet the investor has no recourse to remedy the problem.
- Buying through the NRAS scheme prohibits buying vacant land; however, construction properties (eg house and land or off the plan) are possible.
- Often property prices are inflated in NRAS schemes with the consortiums. They’re large companies. The publicly listed consortiums answer to their shareholders, whereas the private consortiums operate according to their own agendas, leading to prices that are in excess of fair market value.
- Many have legitimate concerns about a decline in property values as a result of underrenting for a long period of time. This remains to be seen, as the scheme is still fairly new.
- Valuers are notorious for low-balling values on NRAS properties. Combine this problem with the fact that you can only use certain valuers, and your options of getting value with the second or even third valuation can be hard, sometimes requiring you to cover the shortfall out of pocket.
- The developer must be an NRAS-approved builder. Considering the fact that 50% of developers building at any one time are not NRAS builders, your choice of providers is very limited.
- Two out of the four big banks refuse to work with the NRAS scheme, which severely limits your funding choices, and that of any potential future buyers.
- Acceptable properties include both homes and units, yet some lenders (such as Adelaide Bank) won’t lend on an NRAS scheme if the property is a unit.
- You can get 90% LVR subject to LMI. Only one lenders mortgage insurer, Genworth, will do NRAS properties.
- Loan must be a standard residential loan – no low-doc loans are available for the NRAS.
- The Government Tax Offset, which is paid annually in arrears, is allowable at 80% of the government NRAS tax offset at the bank’s discretion.
- Land is not considered acceptable security for this scheme.
- As your tenant may be protected under affordable housing regulations, should you choose to sell, any future buyers (investors) will have to jump through the same hoops that you did.
- Should your asset increase in value, you cannot get hold of the equity by refinancing.
A property should be purchased on its ability to increase in value, not for a cash flow tax incentive.
Look for discounted property in a growing location with value-adding potential, or at least a property that doesn’t need a scheme to be its number one reason for purchase!
2. Lifestyle investment in coastal areas
Australians love the idea of buying in a lifestyle community that has access to waterways. Our culture’s desire is to live a sun-and-surf lifestyle.
The illusion that a beach area is a formidable purchasing concept is flawed. Many choose these areas because they are wonderful lifestyle locations, yet most of these areas lack the simple community infrastructure that inspires growth.
They have no real market drivers. Often they are actually retirement and small tourism communities. They have little prospect for long-term performance. The assumption that every waterway is the next Sydney Harbour is wrong.
Many new property investors or homebuyers run with this notion and are trapped in a non-performing asset for many years. That isn’t to say all waterfront areas are poor, but these areas always have an economic underbelly rather than the speculative cultural hope of change.
Why I won’t invest in one
Typically, lifestyle locations tend to have little or no growth in industry, which is needed to create jobs. They tend to have a lot of supply, which drives down rental yields and house values. Many coastal areas are dependent upon highly cyclical industries or industries that are heavily dependent upon economic factors such as tourism and retail outlets. There are finance issues: many banks issue restrictions or won’t lend on coastal area properties.
Many outer-ring suburbs of major metropolitan locations offer affordable price points yet deliver good yields and solid growth.
3. Mining towns that are ‘one trick pony’ areas
A 'one trick’ area simply means a location with only one major industry. The influence that the biggest mining companies have on world markets is profound, let alone what their activities can do for local Australian property markets. Over the next decade, trillions of dollars will be made from mining in Australia. Many assume the infrastructure and job security that the mines bring are growth drivers, yet the influences are completely external to the market. Many markets are solely dependent on the miners’ activities, making these markets very risky. If the mining company removes itself from the area, house prices could fall sharply.
Why I won’t invest in one.
One word – risk! We have seen that small, single-industry mining areas are not great investment opportunities for the long term.
Choose towns with a variety of industries whose growth drivers are moving in the right direction. Bigger service centres are much better areas to invest in.
If the town is not in the top 20 biggest Australian cities, you need to ask yourself, is it the best place to invest my hard-earned money? I once coined the phrase, “Mining markets are crack cocaine for property investors”, and I stand by this. They are an addiction. People chase yields with little thought for the downside risk.
If you’re set on investing in a mining town, here’s a checklist to help you assess a mining market’s potential.
4. Ineffective joint ventures
A joint venture allows a group of individuals to work together with the intention of obtaining a specific outcome. As unique as the individuals undertaking them, joint ventures can involve many different goals and required actions to achieve their stated purpose.In terms of property investing, it’s not uncommon to see family members pool their resources to obtain a property or number of properties that each person could not purchase individually.The following are just some of the reasons individuals choose to create a joint venture:
- Each member does not have enough money to go it alone or doesn’t have the ability to service the loan.
- The investor lacks either the knowledge or time to put an investment property deal together.
- A larger or more complex property purchase is desired, requiring help from other investors.
Joint ventures are a great way to buy investment properties; however, this is only if they are set up and managed correctly. Common problems include:
- Lack of a well-defined goal. A goal should include the purpose of the investment, such as short-term profit or long-term growth.
- No allocation and accountability process. Each joint venture should have clear goals, complete with expected actions from each member of the joint venture. For example, every member should know who is going to be responsible for contacting council and who will arrange to meet with the finance brokers, etc.
- Lack of legal documents. This holds true especially when the members of a joint venture are family members. Without legal documentation, establishing what is expected of each member is tenuous at best.
Have clear expectations of what you want the joint venture to do – who is expected to do what – and treat the process like a business decision, because that’s exactly what it is!
Cross-securitisation is, simply put, when a lender uses all of your properties as collateral for extending finance. In other words, all of your properties are under one or more blanket loan with one lender.
Most banks have clauses in their home loan documents that entitle them to review any one of your home loans with them at any time and ask for additional funds. This can happen if the bank believes that the value has decreased or your debt has climbed too high.
This clause also entitles them to force you to use any other of your properties as security in order to provide the bank with the additional funds necessary to resecure the loan in question. In other words, all properties are security for all loans. This can severely limit your investing future.
Why I wouldn’t do it
The following are just a few of the many reasons to avoid cross-securitising your loans:Your ability to borrow is tied down if all of your properties are financed with one lender. If, for example, you want to borrow more than 80%, the premium for the LMI is calculated on all of the money you have with that lender, not just the amount you’re currently seeking. This adds thousands to your borrowing costs.
If you want to sell one of your properties and keep the equity you’ve earned, the lender could require that you use all of the money you gained from the sale to repay your debt rather than allow you to only pay off the portion that was secured by the property you sold.
The ‘all monies’ clause (which most loans have) gives your lender the option to reassess the risk you present to their interests at any time. For example, let’s say you want to borrow to purchase a new property. The ‘all monies’ clause gives the lender the ability to revalue all of your properties, risking the possibility of properties with lower valuations offsetting those that are higher, resulting in a significant reduction in your available equity.
Spread your loans among a variety of lending institutions. This gives you much more flexibility in handling your finances. You’ll have the ability to choose which properties you want to strip equity from that can be put towards continuing to grow your portfolio.
6 High strata cost property
When you purchase a unit, you’ll likely be required to pay into the body corporate fees (also known as a strata scheme), which typically cover the following:
Why I wouldn’t invest in one
Very high strata costs can quickly erode any cash flow the unit may give you, seriously impeding your ability to buy more properties. Beware of bells and whistles that add to the cost. Gyms, pools, steam rooms, lifts and doormen all cost money. Beware of these added costs. The price will outweigh the benefit.
Should you choose to purchase a unit, it’s very important to include strata costs when calculating the feasibility of a property investment purchase. A good rule of thumb when estimating strata costs:
- Large properties with all of the bells and whistles will cost from about 0.7% to 1.2% of the purchase price
- Townhouses and properties with just the basics should have strata fees in the range of 0.4% to 0.7% of the purchase price
7 Buying at auction in a bull market
A bull market is a strong market, in which demand for accommodation exceeds the supply of available auproperties. Sellers in this kind of market are confident that they will receive the amount they are asking for, and this is why so many choose to sell their property at auction.
As many potential buyers bid against each other, the amount the vendor will receive potentially will meet or exceed the figure they’re asking for. If auction clearance rates are over 75%, you should wait to buy. There is too much pressure on pricing.
Why I wouldn’t do it
As a property investor, your focus is not on acquiring a property at all costs; rather, it is to buy a property in the right location, at the right time and preferably at a discount, use add-value strategies to increase its value, and then manage your cash flow and your portfolio to maximise your returns.
When you buy at auction during a bull market, you are buying at the top of the property cycle, which means you’re paying top dollar for a property. When the market begins to trough, as it typically does after a high, your property may lose value and eat into any gains you may have had. This will have a huge impact on your ability to continue growing your portfolio.
Search for emerging markets and buy at the bottom of the market. What you need to look for are great growth trends such as:
- Supply and demand
- Low supply of housing stock coupled with an increasing need for housing
- Diverse mix of industries, good transportation options, shopping, entertainment and schools
- Population growth
- Growing, not stagnant, and not affected by the supply of new land
- Infrastructure spending
- Increase in both public and private spending on infrastructure projects that is keeping up with the growing population
- Look for growth in wages, gentrification and rising house prices
- Yield variation – calculated by dividing the total rents for the year by the sales price. Look for the sweet spot of about 6%
8. High population growth and high land supply areas
These are areas with a growing population and lots of land available for release, controlled closely by governments and planners. Remember, governments want to see an affordable house price for the masses, and investors want to see rising house prices and low supply.
Why I’d be wary
The greater the supply of properties, the lower the rental yields. Markets with these features won’t deliver the returns you need to grow your wealth.Sometimes areas where there are high population forecasts are actually the worst areas to invest in. The state governments often identify this growth through town planning and will keep housing affordable by releasing land. The more land identified for release may mean the population increase is a zero sum effect. It’s a fine-line balance between land and population.
Look for locations where there is a limited supply of land available for development. When combined with strong economics, population growth, rental yield, demographic and infrastructure drivers, properties in these kinds of areas tend to deliver much greater returns than in areas with an adequate supply.
9. Land banking under option
Land banking is the practice of purchasing large tracts of land with the intent of developing at a future time rather than at the time of purchase. Land banking under option is a scheme auwhereby investors purchase an ‘option’ to buy property at a future date. While sophisticated investors and some option ideas can be great, many are set to fail.
Why I’d be wary
This particular strategy offers the potential for more harm than good. Property companies will offer investors options to purchase property, which has been banked – set aside for development at a future date. The idea is that the option holder will enjoy a capital gain and a windfall once development has taken place.
Yet many of these developments don’t even exist and the option is not registered anywhere. Worse still, the land is not even set aside for urban expansion within the timeframe of the option. Options are generally not refundable so the investors’ money is set to be lost.
According to a recent article in the Melbourne Age, the scheme is rife! “Mum and dad investors lured into the scheme pay up to $40,000 per ‘option’ on the premise of a future capital gain windfall when, and if, the land is developed in 10 years’ time,” states Simon Johanson.
Even subdivision numbers supplied on the ‘deeds’ do not match any issued by Land Victoria. Land banking is pointless, as who knows what will happen in 10 years’ time. Who can forecast price gaging, and what if the development doesn’t proceed? You have tied up a sizeable amount of money, and for what?
If you really want to own property and use time to your advantage, consider purchasing an off-the-plan property located in a high-growth area in a capital city, which is being constructed by a reputable builder. You will have a minimal outlay of cash, just as you would with land banking under option, but the risk of you ending up without a property are a lot lower.
10. Buying because you love it!
We tend to fall in love with our properties. That’s a normal human emotion. However, as property investors we must learn how to lay aside our emotions and let the numbers do the talking. If a property doesn’t stack up numbers-wise, it’s time to move on and look for something that does.
Why I wouldn’t do it
Our emotions don’t make good business sense! When we buy with our emotions we are putting our feelings ahead of what the market is doing. If, for example, we fall in love with a property that happens to be in a market that is at the top of the property clock – in other words, it’s at the peak of the market – we’ll be sorely disappointed with our returns as the market begins its natural decline into a trough.
It’s better to let the maths make the decisions for us, rather than our emotions! If we see a property that we simply must have, before doing anything get the advice of a third party – someone who is completely unbiased and who is knowledgeable about investing in property. Sometimes all it takes to help us ‘cool our jets’ is a cold dose of reality delivered by someone else.
Sam Saggers is a prolific property investor and the CEO of Positive Real Estate Group. For more information, visit www.positiverealestate.com.au
Disclaimer: All views expressed are solely the author’s. Make sure you do your own due diligence and speak to a qualified professional person before making any investment decision.