Making big profit through real estate is no longer just for the privileged few. Now, you too can rack up massive gains by learning the tricks from leading experts
Admit it – you want to make big profit on every property deal you undertake, but sometimes you get the opposite result. You’re not alone. Many investors get burned one way or the other.
Maybe the property buyer you enlisted was not really acting in your best interest and you ended up paying them for mediocre services that yielded nothing. Maybe you were persuaded to buy a property that didn’t fit your risk profile and are now left with an underperforming asset.
So how do you ensure you get the profit you want on every deal you make? We asked some of Australia’s most successful property investorsfor their top tips.
Nathan Birch, B-Invested:
Nathan's strategy: There are three things I look for in a deal before I will take it on. These three criteria must be present for me to take the deal further. I will not compromise even if just one of the criteria is missing. As far as I’m concerned, all three must be present or there’s no deal.
Property must be under market value.
Property must have strong cash flow.
Property must have potential to add value now and have reasons for growth in the future.
1. Buy under market value
This is a cornerstone of a profitable deal. For me, a property has to be under market value to be worth considering. By buying under market value, you get instant equity that you can then use to buy your next property. This also means guaranteed, instant profit.
Best of all, buying under market value lowers your risk. Say you lost your job or got sick and were unable to work. You would not lose money if you sold your asset, because you have already bought at a discount. The worst-case scenario would be for you to break even.
How I estimate/calculate market value
It comes with experience, and you will get better at it with practice. The way I do it quickly is to look at comparable sales over the past six months. I’ll also look at recent sales and what properties are on the market.
You need to make sure you’re comparing like with like to establish the amount the market is willing to pay for similar properties. You can then use this to estimate the value of a property. Of course, you also need to bring in a professional valuer to ensure your estimates are correct and you’re truly buying under market value.
How to spot an undervalued property
Cheap asking price. This can be tricky because a lot of agents engage in underquoting. But you can tell a genuine bargain when the agent is fairly negative about the property and is keen to take any offers to the vendor.
Property is undercapitalised and may have poor presentation. If the property is poorly maintained, you may have a higher chance of negotiating down on price.
Property is located in an area with a bad reputation. Some of the areas I have invested in had a bad reputation but are slowly gentrifying and shedding their bad images. In these areas, you can still pick up reasonably priced, even under-market-value properties as many investors often overlook these areas.
Distressed sales. The owner may be in financial trouble and needs to sell quickly.
I’ve spent many years building relationships with real estate agents and administration firms in order to be top of mind when properties come up so that they call me.
2. Buy properties with strong cash flow
In my experience, having a strong cash flow position reduces your risks and also enables you to build your portfolio more rapidly. This doesn’t mean you compromise on capital growth. You can have both, despite what many experts have you believe.
A strong cash f low position means the rental income is meeting the cost of holding the property, at the minimum. This is also called cash f low neutral. You’re not earning extra cash, but you’re not spending a cent on your property. Essentially, your investment property is costing you nothing.
From the serviceability point of view, you can buy as many properties as your risk profile allows you to, in principle. Since you’re not spending a cent on these properties, as far as the bank is concerned your serviceability remains intact.
Of course, you should try to get a cash f low positive property without compromising on the capital growth, where possible. This can be achieved by buying under market value and getting a strong rental income.
On the other hand, having poor cash f low, so that you’re using your hard-earned salary to support the lifestyle of your tenants, puts you at unnecessary risk and prevents you from expanding your property portfolio further.
In order for a property to be cash flow neutral, you need to get a yield of at least 7%. Personally, I would not accept a yield lower than 7%.
How to quickly calculate the yield
Weekly rent multiplied by 50 weeks(to account for two weeks’ vacancy), then divide it by the purchase price. Multiply the result by 100 to get the gross yield.
Another quick way to tell if your yield is high enough is to add 1.5% to the interest rate and factor in 1.5% expenses.
Using the example above, with the current interest rate at 6%, and you can see that you will barely break even: If you get a 7% yield before tax deduction, this may bring you to neutral position.
3. Potential for growth now and in the future
You need both cash flow and capital growth. Therefore, being able to add value to a property gives you the chance to manufacture growth for extra income or equity. Usually, the cheaper, tired-looking properties that have been poorly maintained can have plenty of upside.
The area also needs to have good infrastructure, such as schools, hospitals, shopping centres, freeways and public transport links if you’re buying in a regional centre. These things attract both renters and homebuyers and help ensure future growth in property prices in the area.
Putting it all together
Here is an example of a recent deal in which I bought well under market value, with strong cash flow and a potential upside in value.
I recently negotiated and bought a block of 29 units in Port Macquarie
, which was listed for $8.5m. I managed to secure it for $6.8m – well below market value.
Each of the two-bedroom units in this block now costs $235,000. Similar units in less than desirable locations in Port Macquarie were selling at around $300,000 and over. So by buying under market value each of our investors who bought one of these units has immediately made $50,000 on the purchase.
Rental income was also strong at $390–$420 per week, which is yielding at a minimum of 8.63%. This achieves a minimum of $79 positive cash flow each week after costs are taken into account and before depreciation allowances and other tax considerations are factored in.
With regard to the property’s potential upside for growth, Port Macquarie has a solid and diverse local economy that’s not solely dependent on tourism, although this sector contributes a significant proportion to the local coffers. Population and household income has continued to grow solidly, which suggests that demand for property will continue to be robust.
Rick Otton popularised the concept of buying properties using creative financing strategies that saw him accumulate 76 properties in just 12 months. He’s a well-known public speaker and author of the book How to buy a house for $1.
Rick's strategy: I make it easier for people to buy and sell properties. So I buy properties that sellers aren’t able to sell due to various factors, or just want to get rid of for financial reasons. I then sell these properties to people who are having difficulty saving for a deposit, have credit blemishes, or are unable to get a traditional loan.
I have many different systems I can tap, depending on the seller and buyer. I use instalment contracts, deposit finance, handyman special, rent-to-own and sandwich lease. In this article, I will focus on how to use rent-to-own to make a big profit.
In every property transaction, I want to ensure I get my target profit. This means I need to be specific about what I want to get. Many people get into real estate not knowing what they want; that’s why they never get it.
Once I’ve decided on the result I want, I then look at how fast I can get that result and what’s the least amount of resources I need to put in to get it.
Vendor finance:the real story
There are two parts to every property purchase. You may have heard them called other names, but I like to call them the ‘cash bit’ and the ‘debt bit’, because everyone can understand that.
In general, property problems fall into two categories: the need to sell a house quickly to either get access to the cash bit or remove the pain of the debt bit; or the need to either qualify for a bank loan or save up a deposit to be able to realise the dream of homeownership.
Historically, whenever bank loans have been difficult to get, buyers and sellers have talked directly to each other with no bank middleman. In fact, people have been using seller finance (also known as vendor finance) to support their property sales for hundreds of years.
When I first started talking to solicitors about this concept, the young ones didn’t know anything about it, but the older, grey-haired, almost-retired property solicitors all remembered it well, because they used to do it all the time before the mid-1960s.
Originally, banks only loaned money to buy houses, not land. Land was bought using vendor finance. Then, when you owned the land, the bank would give you a loan to build your house. When banks started lending money to buy land as well as houses, vendor finance wasn’t needed anymore, so it faded away into the background. But the old solicitors still remember the good old days when vendor finance was as common as sliced bread.
Nowadays, with the recent financial crisis, there has been a massive rise in mortgagee sales and a massive squeeze on bank loans. Bank loans are harder to get now than ever before. In other countries, where bank loans have always been difficult to get, vendor finance never went out of fashion. It’s only because bank loans were so easy to get for a few decades that an entire generation of Australians forgot about vendor finance. But it never disappeared completely.
Vendor finance is also known as ‘seller finance’, ‘terms contracts’, or ‘vendor terms’. It essentially means the vendor offers easy payment terms. This enables the buyer to pay off the property in a number of instalments over time, as opposed to paying the full amount up front. Vendor financing essentially makes the seller the bank.
Why it works
There is a very powerful reason why people will pay a higher-than-average rent on a rent-to-own: they see themselves as future homeowners, not tenants. Also, a percentage of the tenant’s rent can go towards buying the house.
The difference is that you can treat some of the extra rent as forced savings that can be counted towards a deposit under the contract to purchase the house at a later date. But the forced savings only apply as a deposit for this house.
If the tenant opts not to buy, then they don’t get their extra rental money back, but the trade-off is that the owner sets the purchase price during the lease period and, if the property increases in value, the seller doesn’t get any of the increased profit above the agreed-upon price.
Also, because the rent is higher, this strategy can single-handedly solve many negative gearing problems.
The rent-to-own strategy gives the renter the choice to buy a property on a fixed set of terms, but they are not obligated to buy, so they’re not locked in. Rent-to-own is ideal for investors who wish to control more properties without tying up cash, and increase their return on investment, as well as renovators who want to control a property for a short period of time in order to renovate it and then resell.
Setting the term of a rent-to-own
The longer the term of a lease option, the higher the percentage of people who will purchase the property; the shorter the term, the lower the percentage of people who will take ownership of the property. Instead, they’ll just keep renting, and keep paying the higher rate, or they’ll move out because they don’t want to be homeowners.
The power of ‘try before you buy’
Many first home owners have trouble getting over the psychological hurdle of making the transition from renting to buying. They get stuck thinking: “What if it’s the wrong house?” It’s not only a bigger commitment than what they’re accustomed to financially but also a bigger step emotionally.
Rent-to-own can serve as a stepping stone between renting and buying. First home owners can ‘try before they buy’, and lease the property for a year or two (or three) before committing to buying it.
I once bought a beautiful south-facing waterfront property. What I didn’t know when I bought it was that the house didn’t get any sun, and it was absolutely freezing all through the winter. With a lease option, a buyer can try the house out and find out all they need to know about it (like whether it’s freezing cold all winter or unbearably hot all summer), and then commit to buying the house when they’re ready.
Another way this strategy works for first home owners is to help them save up a deposit. Tenants/buyers can pay extra rent that can go towards their deposit. It works as a ‘forced’ savings plan. Then after the first year or two they can go to the bank and get a loan to finance the rest of the price and buy the house.
This is how it is possible to get higher-than-market rent with a lease option. Some transactions result in the seller receiving rental amounts that are higher than what tenants would pay in a conventional rental tenancy.
A lease option is also a great stepping stone from private finance to bank finance. If someone doesn’t qualify for traditional bank finance for some reason, this can be a great way for them to get into their own home straightaway. Then, a year or two down the track, after they have built up their deposit, they can go to a bank and start the traditional process of getting a loan.
You can buy and sell without the hefty costs
It’s normal for people to buy a house, live in it for five or six years, then move. They buy another house, live in that for five or six years, then move again. They do this over and over again. Every time they sell they get to profit from the increase in value of the house. But every time they buy and sell they incur all kinds of fees, rates, obligations and liabilities that come with homeownership.
With a lease option or rent-to-own, you can move into a property within a few days, so it’s a lot quicker than waiting for a sale to settle. Also, the sale price is set when you sign the paperwork for a lease option. So if the price goes up, you have already fixed the purchase price and you can sell the property for a profit.
With a lease option a buyer can get control of a piece of property and do things with it before incurring all of the normal ownership costs. Contractors do this a lot. They’ll use a lease option to get in, use their skills to renovate and increase the value of the property, and then sell it for a profit without taking on the ownership costs up front. It’s also possible to do a joint venture with the owner of a property. So you can fix the price, pay the owner rent, and take the full profit when you sell.
Here’s another way to profit from the property: you could move in rent free, renovate the owner’s property over time, and agree to split the profits that are created when you increase the value of the house. The possibilities are endless!
You can create positive cash flow on negatively geared properties.
Based on average rental rates and average loan rates, average investment properties will usually end up being negatively geared. But we want positive cash flow. If you have a negatively geared property, getting a tenant/buyer in on a lease option instead of a normal lease can turn your cash flow situation to positive overnight.
A lease option is faster to put in place than a traditional property sale. On a lease option, the tenant/buyer has bought into the idea of homeownership, so they generally pay much higher rent and may take care of any expenses themselves.
Saggers is a popular author and an active property investor himself, having accumulated more than $10m in assets from just $5,000 in capital. He’s also the CEO of Positive Real Estate Group.
Sam's Strategy: People spend too much of their valuable time complicating real estate or not knowing what they should do. Remember the principle is to keep it basic. When you analyse a deal, take it through the following two steps to ensure you have a basic understanding of the property itself and how it fits into its environment.
The steps include:
Return on investment
The downside risk
Return on deposit/investment
One of the secrets to effective property investing is safeguarding your investment. This means resetting the property value and getting your capital back out as fast as you can. This will permit you to transfer or recycle your money into a new investment.
Therefore, you need to be able to determine your cash-on-cash return. Let me explain.
When investing, you need to find a deposit – something you have to save for. For a property deal, you will need to put up anywhere from 5% to 30% of your own capital. The method used to gauge the likely performance of your deposit is known as cash-oncash return.
Your goal is to ensure your capital is in and out of the market within a set period of time. Use the following scale to assess a property’s return and the speed of being able to recycle your deposit:
If your goal is to get a $50,000 annual return, you need to consider how much money you want to put into the market to get this result. In Australia today, good markets seem to be performing at a 50% rate of cash-on-cash return. If you put $50,000 into the market, it may actually be two years before you see that money back, based on a good market’s average performance. This is still a better performance than keeping your money in the bank, earning paltry interest.
Managing the downside risk
Markets change, and factors beyond the buyer’s control often come into play. These factors can be economically based on a local, state or national level. Also, nature can play a hand in the form of floods, rain, fire, storms, drought and other environmental issues. Lenders can also change their assessments of areas. Investors need to remember that the outlook may not always be so rosy. When assessing a deal, you need to factor in and rate the risk. If a property market has grown heavily and seems expensive, it probably is. You are too late.
Always check the historical data, but don’t count on it to predict the suburb’s future performance.
Consider the following risks when studying a deal:
Location and neighbourhood
Are you buying into a desirable area? Does that street carry risk? An example of risk would be buying next door to a main road, or near a waste management centre or a high government housing area.
Are there no plans for the area, or is there a risk of overdevelopment? How will this impact your property?
Is there a risk of environmental impact? An example would be if the area is bush fire, flood, cyclone or earthquake prone.
Is the property overcapitalised? Is it in keeping with the area? In this case, it may be the best house on the worst street or in a downturn. Overcapitalised homes suffer massive losses.
Value or reduced value
Is the discount you’re buying at today the actual rock-bottom price, or will the market continue to fall? The risk is that the property you are buying today could be worth less tomorrow. You need to know the property and the market.
Market and buyer volatility
How likely is your property to sell in a downturn? You need to assess what your exit strategy is and who would buy the property in a falling market.
Local economic impact
Is the area going to be impacted adversely or could an external force devalue the market? An example would be a one-mining-company mining town. The town could suffer price loss on property if the employer left the area or retrenched staff.
In most types of feasibilities, you will be able to do one or more of the available strategies: discount, renovate, buy and use market confidence. Sometimes an excellent area is all you need to make a purchase, and on other occasions you will need to use a few strategies in one deal to realise the same profits. As you practise researching your offers and experience a variety of deals, your skill to spot a good deal compared to an excellent deal will increase substantially.
Can you make a good profit every time you buy?
While there’s no single approach that works for everyone, the following are tested and measured strategies that have helped our investors reach an extra $50,000 pa through property alone.
1. Buy positive cash flow property
If you buy a $250,000 property that rents for $500 per week, this immediately gives you a 10% return. Right now, the average interest rate on mortgages sits at 5%. After interest is deducted, you have a surplus yield of 5% – which becomes money in your pocket – leading to $5,000 in positive cash flow per annum.
If you’re looking at properties in a lower price range, you can use bump-up strategies (such as renovation) to add value and reap similar returns. You may have to purchase several positive cash flow properties to have an overall cash flow of $50,000 pa, or you could just combine this tactic with one of the two low-risk alternatives.
2. Buying at a discount
Discounts follow a simple formula. If you take an existing property, understand the true value of it and the motivations of a panic seller, you usually find a discount. To reach $50,000 every year, you must run a tight portfolio and constantly build on it.
The two strategies mentioned above are low risk and anyone can start with them. However, if you have greater appetite for risk, you may want to consider the following strategies.
Creative strategies for the more daring investor
While they’re meant for the brave, the following strategies are very rewarding ways to make your $50,000 target profit.
This entails buying a house with an extra-big block of land and dividing it to either build another house or create a new block of land that you can sell. You need to find out the minimum size required by council for a subdivision. If 400 square metres is required, look for 1000 square metres to subdivide. You may need the extra size for roads and infrastructure such as water, power, phone and gas. Corner blocks are great to subdivide as there will be two street frontages, which means the subdivision is a lot easier and the properties themselves will be more valuable.
Many places in Australia (mainly northern states and country areas) have timber houses built in the middle of big blocks of subdividable land. I’ve seen investors jack the house up, move it over 10 metres, and then subdivide down the middle. Other subdivisions have a driveway down one side to access the large block of land at the back, known as the battle-axe block. Subdivisions can be complicated, so be sure to educate yourself beforehand. I recommend a mentor with experience in subdivision and strata titling.
4. Buying and selling or trading
Trading properties, otherwise known as ‘flipping deals’, requires a minimum margin of 20% to be considered profitable.
For instance, if with the $250,000 property you chose to add value through time on the market or with renovation, you could potentially raise the value of the property by 20%.
This would leave you with a profit of $50,000 and an instant increase to your cash flow. The principles for trading properties are to buy when the market is low, hold as the market rises, and sell when the market reaches the top. The majority of investment property traders tend to be renovators and developers. You would need to learn the skill of renovating or developing for maximum returns.
5. Building for profit
The idea is to find a complying development land area that has the potential for better use of the land. Let’s assume we have a block of land worth $150,000 and it’s registered. If we haggle on the property and get a good deal for $120,000, we will achieve an instant $30,000 gain, thanks to the discount.
If the cost to build is $1,300 per square metre and the average home in the area is 200 square metres, we would be building for $260,000. Haggle with the builder. Let’s make them do the work for $1,200 per square metre. Instantly we are better than the market at $240,000.
Now combine that with the land deal we did, and that’s $360,000 for a home in a market that pays $410,000. Thus we build our way to $50,000 profit. Remember, investing is just a series of small wins over time. There will come a day when you will reminisce about your investments.
Don’t look back with any regrets because you didn’t have a go. There is a strategy for all of us, and $50,000 extra per year through property is achievable.
Can you afford to buy in this suburb? Find out how much you can borrow