Becoming a landlord means taking on a whole suite of new responsibilities to do with managing money, time and relationships.
But one of the biggest responsibilities you take on as a property investor is the fact that your life and your actions are now bigger than you. You suddenly have people counting on you – not just financially in terms of banks and property managers, but also on a very personal level. Your tenant is relying on you to provide a safe, comfortable space to come home to, and you can’t get much more personal than that!
It’s therefore very important that you protect your investment to the best of your ability. The last place you want to be as a landlord is in a precarious or stressful financial position, without safeguards and insurances in place to protect your investment.
Unfortunately, many investors fail to have even a basic (let alone adequate) asset protection strategy in place to cover their property holdings.
“Unless you hear about it at a seminar, read about it in a magazine or learn about it from your accountant, there’s a good chance that you’ll embark on your property investment journey with no idea about asset protection,” explains property author and educator Helen Collier-Kogtevs, managing director of Real Wealth Australia.
“But the truth of the matter is that structuring your assets correctly could be the difference between becoming rich and staying rich, or being rich and being sued into poverty.”
Asset protection is about much more than just buying your property in the correct name or structure, however. Broadly speaking, when reviewing your asset protection strategies, you need to consider the following four categories:
• Protecting your asset
• Protecting your income
• Protecting your wealth
• Protecting your legacy
Making the wrong decisions when managing your property asset can be costly, so it’s worth spending a little extra time and money to get it right upfront.
“If you buy a property in the wrong name, to change it over can trigger stamp duty again, which can cost thousands or tens of thousands of dollars,” explains property sales and management expert Andrew Fawell, director of Beller Property Group.
“You need to seek proper advice from day one, and don’t just take the advice of people like us! I probably have more experience due to my exposure to different facets of property, but you need specialist advice. It is an extra cost to consult with people, but in the long run it could be the best investment you make.”
The definition of marriage and de facto partnerships in relation to assets can be one of the biggest issues when it comes to asset protection, because people don’t really understand the rules around de facto partnerships.
Michael Fetter, principal at Tisher Liner FC Law, explains that, by default, the general rule of thumb is that if you’re living with someone for two years in a permanent relationship under the same roof, then each party is legally able to claim part of the other party’s wealth.
Your 4-pronged strategy for success
1 PROTECT YOUR ASSET
Before you sign a contract to purchase a property, you should give some thought to the ideal structure for the purchase.
Most investors default to investing in their own names, but that’s not always the most efficient and effective method, warns Collier-Kogtevs.
“My philosophy has always been to learn from the rich, and they generally place their assets in companies
and/or trust structures where they have control of the assets, but not ownership. If all of your assets are in your own name, it means that if you are sued for any reason, then all of their assets will be up for grabs,” she says.
“Having a will myself, I discovered that trusts and the assets within them do not form part of my estate at death. Therefore the beneficiaries of the trust are the only ones entitled to the assets. What I really like about this is that I dictate who my assets go to, not the judicial system.”
Even with a trust ownership structure and solid asset protection policies in place, remember there are three people you cannot protect yourself from:
1. The bank – if they have a mortgage over the property
2. Your spouse
3. The taxman
“You can generally protect yourself against everyone else by using appropriate structures,” says Collier-Kogtevs.
“When considering asset protection, speak to qualified asset protection experts, but make sure they are also personally experienced in property investing. Ask them lots of questions or buy a book explaining what asset protection is all about.”
One such expert is property lawyer and town planner Darryl Richards, director of Certus Legal Group, who says you need to be mindful of state-specific rules and considerations when using trusts.
“My philosophy has alwwways been to learrn from the rich, and theyy generallyy place ttheir assets in companies anndd/or trustt structuures” -LARDG
In Queensland, for instance, each trust has a $350,000 land
tax threshold – so if you buy two properties in a trust and the land value of them combined exceeds this amount, you’ll start paying land tax.
“To get around this, you’d need to set up different individual trusts to purchase each property. In New South Wales, you may need a specific fixed unit trust to have a land tax threshold, so there are some state-specific considerations to keep in mind.”
2 PROTECT YOUR INCOME
As a landlord, if you lose your job you have the benefit of relying on your rental income to pay your investment loans. But if the rent doesn’t cover the full cost of mortgage repayments, council rates and other repayment costs, how are you going to pay the shortfall when you don’t have an income?
Paul Davies, director of Jarickson Insurance Brokers, says losing a job is a scenario that many people fail to plan for – and it’s one of many that can substantially impact on their finances.
“The majority of the people I work with are investors who have anything from three to 20 properties. Most of them have three to five properties. They’re generally not costing them that much to hold, but one of the things that is often overlooked is income protection,” he explains.
“For many, it’s simply a matter of not knowing where to start. But you need to consider: what are you going to do if something happens and you’re no longer working?”
Income insurance can provide an income equal to 75% of your regular salary. Let’s say you earn $80,000 annually. With an income insurance policy in place, if you become injured or can’t perform your job you will receive the equivalent of $60,000 annually ($5,000 per month before tax) to help pay your bills while you’re incapacitated.
Generally, policies offer coverage up to around $10,000 per month, and you may even be covered for a few months’ worth of income if you are involuntarily unemployed – that is, made redundant.
If you’re self-employed, you can also claim your income protection premiums as a tax deduction.
3 PROTECT YOUR WEALTH
While investors may be familiar with the concept of using a trust
to purchase your assets in, Darryl Richards, is an advocate for a simple yet multilayered structure for asset protection that protects your wealth for the long term.
“When I started investing in 1995, I just bought in my own name, then as I bought more properties I needed to learn how to do it the right way,” Richards says.
“You just don’t know what’s going to happen later in life. People usually invest small then get bigger, then diversify into business or development. If all of your assets are all tied together, then if one thing goes bad – such as an investment loses money or your marriage breaks down – it could sink the lot.”
The idea of a multilayered ownership system, Richards says, is to “ring-fence and separate everything”. It can be structured in such a way that you could personally go bankrupt but still have all of your other assets producing income as well as be able to regain control after the designated bankruptcy period.
“Basically, people set up their own personal bank, which is a discretionary trust. That trust then ‘lends’ money back to the person at a commercial rate and becomes a creditor to anything you do,” Richards explains.
For instance, you might want to purchase a $500,000 property with a $100,000 deposit, using equity from your personal place of residence.
You might borrow $100,000 against your own home to use as a deposit. Under Richards’ structure, he would then document and assign that $100,000 loan to the trust.
“If you’ve then got a $400,000 mortgage with the bank, and a $100,000 loan back to your discretionary trust, then there’s nothing left for a creditor to get their hands on in the event that you get sued,” he explains.
If you’re already an established investor with a number of properties in your portfolio, it’s not too late to set up this kind of trust structure to protect your wealth.
“It is a bit harder to do retrospectively, but it can be done. If you’ve borrowed against your PPOR to pay the deposit on your first investment property, we could document an agreement to assign that loan back to a discretionary trust, and you can have a second registered mortgage over the property reflecting that money if required,” Richards says.
“The second mortgage doesn’t even need to be registered; it could be executed and sitting in a solicitor’s safe custody, but if you think someone’s preparing to sue you, you could then register the second mortgage.”
“Often investors are strapped for cash financially, as they’re often trying to get into more properties so all of their funds go towards that. Fortunately, you may be able to use your retail superannuation fund to pay for your life insurance premiums. This way you’re paying it pre-tax and it doesn't aff ect your cash
flow.” – Paul Davies, director, Jarickson Insurance Brokers
“I once worked with a woman some years ago whose husband owned a number of assets, including their home, in his personal name.
“When he died, all the assets became part of his estate.
“Although he had a will spelling out the disbursement of his assets, his adult children from a previous marriage contested it, claiming they were entitled to more than they were allocated.
“This woman had to battle it out through the court system and ended up losing her home in order to pay out to his children. The devastation she experienced could have been avoided, had they considered the various forms of asset protection available.”
– Helen Collier-Kogtevs, managing director, Real Wealth Australia
4 PROTECT YOUR LEGACY
You work hard to build a diverse property portfolio in the hope that it will allow you to retire with no financial stress.
But if you succeed in that goal, what happens next? For instance, if you pass away or become disabled and you own a hefty portfolio of properties, what will happen to your wealth?
Without life insurance, your family risks losing it all – and worse, having your debts foisted upon them. That's not a legacy most of us would be happy to leave behind.
“This is the big one to work out, in terms of finding a balance of how much coverage you need. It will really depend on your situation,” says Davies.
“If you’ve got children and your partner is working, then it may not be necessary to have a huge life insurance payout. But if your partner isn’t working and therefore doesn’t have an income, how much will you need to cover your bills and your investments if they’re gone? You want to avoid a ‘ﬁre sale’ scenario, if you can.”
He suggests that investors consider the ‘DIME theory’:
• Debt – what are your personal
• Income – how much do you need to hold your portfolio and cover your expenses?
• Mortgage – what is the value of all your mortgages combined?
• Education – how much will it cost to educate your kids?
“I’ve had a couple of clients recently with very different situations.
“One is a couple of people who are 25 years old with three properties, but they’re both in high-paying jobs. If one of them were no longer around, the other would continue working and could easily service their property bills.
“The other is a family with seven properties, but the mum is a stay-at-home parent to three kids. In this instance, his life insurance needs to cover quite a lot more if he dies.”
It may be worth speaking to an insurance professional about your situation to ensure you get the insurance you require, and your family is left with a positive legacy.