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2 WARNING Disclaimer This e-booklet contains general information only This information has been prepared as a general guideline. This e-booklet is not intended to be an exhaustive or a complete analysis of the topics in question or issues raised. There are many particular legal, taxation and accounting matters that have not been dealt with in this e-booklet and readers are urged to discuss any aspect of the operation of any of these matters discussed herein with their professional advisers. In particular asset protection, estate planning and property investment are potentially very litigious areas and you will need specific advice before you take any actions if you want your wishes complied with. Before taking action or implementing any strategy, you should seek professional advice from your lawyer, accountant and/or financial planner who will take into account your specific circumstances and objectives. Whilst reasonable care has been taken in preparation of this information, subsequent changes in circumstances (including legislative changes) may occur at any time and may impact on the accuracy of this information. Chan & Naylor Australia Pty Ltd including its directors, officers or associated and related entities, including the author, take no responsibility for any omissions or inaccuracies in this information and will not be held liable for any losses or damages that may result in the use of this information. 1

3 S uccessful property investing starts with purchasing the right property for an expected outcome. Many property investors purchase with their heart. They buy in suburbs that they think they know with little regard for what tenants actually want. Anyone spending $500,000 on a café would look at their expertise, best finance, structure, competition and cash flows as well as their exit strategy i.e. a thorough due diligence. More than that, you must have a business person s mindset. A good capital growth property will pay for itself much quicker than a poorly performing property. There is always a debate between positive cash flow properties and negative cash flow properties. In the end you must have high capital growth that will keep your rents rising and gives you equity to further leverage.. No one should be chasing negative geared properties for the tax benefit as who wants to give away a dollar to receive 50 cents. Negative gearing should only be used to get you into a good capital growth property that can move to positive cash flows relatively quickly. Successful property investors know only too well that shortcuts or lack of research are sure to cause financial distress. ATO Data shows that 73% of property owners just have one investment property (18% own two) leaving only 9% of property investors with three or more. If property was such a good investment why stop at one or two? People buy the wrong property and either sell quickly and never buy again or stubbornly hold onto it hoping things will change. Investors who do it right normally succeed and succeed extremely well. Therefore to be a successful property investor, requires a different approach to conventional wisdom. Property investing must be looked at and operated as a business. Property investment must be looked at and operated as a business They also know that given the level of expertise and knowledge required to make the right decision it is essential that they have the best professionals on their team. Like baking a soufflé, successful property investing requires these important elements: a well-proven recipe, good ingredients and technique. I ve followed a well-proven recipe for years, which I refer to as the 10 Commandments. These are 10 investment principles that can be applied to any asset class, but I ll focus on how each of them is specifically relevant for property and property investors. 2

4 1) Money that you invest must carry minimum risk so do your homework. Risk can be mitigated in many ways. The principle tool of the investor should be education and knowledge. Property investors must know the markets in which they are investing in better than the local real estate agents. The rule of 72 can also be used to calculate time i.e. if you want a property to double in 7 years its capital growth must be on average 10.2% pa (i.e. 72 divided by 7) over the cycle. This is achieved by research and given the current tools in the market such as price comparisons, demographics, clearance rates and rents this job is significantly simplified. Remember the rule of 72. This allows the investor to understand who lives in an area, the split between investors and owner occupiers, their annual income etc. All this helps in understanding specific capital growth, rental yields, vacancy rates and price points. Your research should go down to the specific suburb and type of property and then finish up with the actual property. Knowing what a specific property has been sold at over its life and time in the market for a sale gives the buyer a significant advantage when negotiating. Remember the rule of 72. This will help you work out growth rates and time required to achieve these. If a property is growing at 7% pa over the cycle then it will double in 10.2 years (i.e. 72 divided by 7) compared to a property growing at 5% pa which will double in 14.4 years. 72 / interest rate % = # of years for your money to double. Even in times of high vacancy rates the rent can always be marginally reduced to secure a tenant. Property like any asset class has its cycles. There will be periods of decline but hopefully they can be minimized with the right property and even in a declining market there are strategies available to increase value. 3

5 2) You must achieve the highest possible returns on the money you invest as opposed to the return on the total asset value Maximise your returns by investing the minimal amount. Even on an 80% lend a property that doubles in 10 years will see your cash investment (i.e. the 20% deposit and costs) yielding you over 50% return pa. Over emotional owner occupiers help grow your equity so purchasing in areas with higher levels of owner occupiers should be targeted. You can sometimes borrow up to 100% of the property value. While banks will charge you lenders mortgage insurance (LMI) on loans over 80% this should be seen as a good investment. If a bank charges $15,000 but lends you and additional $100,000 you are still $85,000 ahead. This cost is even tax deductible over 5 years or the term of the loan whichever is shortest. In many cases using other assets as security will eliminate LMI. This tip is particularly useful for first home buyers where parents can assist. As there is no clear market price for property their can sometimes be a lot of emotion especially with owner occupiers. As an investor you do not need to purchase a specific property, you can always buy next door. Maximise your returns by investing the minimal amount 4

6 3) You must invest your money in incoming producing assets that outperform inflation and return no less than 7% over the 10 year period Property price growth is often stated to be on average 7% over a cycle but who wants to invest in an average asset? Average means a mixture of bad returns, mediocre returns and high returns, so target the high capital growth areas and property types. Compound interest is the eighth wonder of the world those that understand it, earn it those that don t, pay it. For those who like numbers, a $500,000 investment after 10 years will potentially grow in value to $814,447 (5% growth), $983,576 (7% growth) and $1,296,871 (10% growth). The more equity you have, the more potential there is to refinance and reinvest. A poorer-performing capital growth of 5% will require twice the time to double than a superior 10% growth property. This would allow your next investment to occur much sooner. The name of the game is to maximize your assets not necessarily minimize your debt; Size does matter when looking at your assets. It is the market value that grows over time not your debt. In many cases inflation will help reduce the value of your debt. Investors should be looking at maximising growth which is then compounded year to year and as Albert Einstein is reported to have said Residential property is the only asset absolutely required by the majority of people and so with the current and dare I say endemic supply shortages there should always be a tenant or buyer. Given the banks love of residential property lending property investors do not need to sell to access their equity but rather refinance which in many cases yields a high cash amount than a sale and subsequent repurchase given the taxes and costs associated with selling and buying. 5

7 4) You must invest using the right structure: own nothing, but control everything A particular area of risk or trap that many property investors fall into, is failing to identify the correct name to purchase the property in before they sign the contract.. Property can be purchased in individual names, a company or a trust. If buying your home individual names would normally be used. Issues such as land tax, income tax, capital gains tax, asset protection and estate planning need to be considered before finalizing which structure to buy in. The home would normally be purchased in individual names but the main residence tax exemption can be available if a correctly structured trust is used. If an Investment property is in a structure that does not give adequate asset protection or ability to significantly improve returns, then you could risk losing everything you own as a result of a frivolous lawsuit against you, or risk diminishing the profit potential by paying too much tax. Buying investment properties in your personal name (or in your spouses ) does not offer any asset protection, so If you are personally sued by say an injured tenant and the investment property is in an individual name, you could potentially lose that asset. Remember that even if buying in personal names, then ou can have different percentage ownership between the parties if you purchase as tenants in common. On the other hand, the problem with a Company is the individual usually is the shareholder so they could lose the shares in a successful lawsuit and therefore the assets. The other problems with a company are it does not receive the 50% general Capital Gains Tax discount so there is the potential to pay double the tax on a sale in a company compared to individual or trust ownership when the proceeds are taken-out. A company is inflexible on who can receive distributions (current shareholders) plus if the asset was negatively geared the taxpayer could not normally take advantage of the tax credits of the negative gearing. On the plus side a company does get a land tax threshold similar to an individual so for people in businesses operated out a trust there could be an advantage notwithstanding the CGT impact-on-sale. Traditionally, people have used trusts to protect their assets they control the assets in the trust but don t own them...therefore if the individual is sued they have no assets to lose 6

8 Traditionally people have used trusts to protect their assets. A trust is useful in this regard as the individual does not own the asset; it is owned by the trust. Therefore, if the individual is sued they have no assets to lose. The individual controls the trust but has no ownership. But not all Trusts are created equal. For negative geared properties a Property Investor Trust can be used that will still allow the taxpayer to claim negative gearing against their wages. Depending on the state there could be a higher land tax liability but this could be negated by the other benefits. For positively geared properties a Business Enterprise Trust can be used thereby allowing distributions to various family members. In both cases the 50% CGT discount is available For investors with assets including investment properties and a home asset protection can be achieved with the use of an Equity Bank Trust without triggering CGT or transfer duties normally applicable if assets are transferred to a trust. 5) You must invest where tax benefits are plentiful. Negative gearing benefits on a high loan to valuation ratio or when a higher growth property is initially purchased with lower rental yields. Deductible borrowing costs and the ability to leverage through superannuation via an Enduring Family Superannuation Fund may improve your wealth creation. A scrapping schedule will identify the value of any outstanding depreciation on what is being thrown out and allows an immediate tax deduction. This deduction would not normally be available unless the property had been previously tenanted. If purchasing a property in more than one individuals name ask your quantity surveyor to prepare a split depreciation schedule as this will normally greatly increase your annual depreciation allowance and hence increase your potential cash flows. Remember to claim depreciation and if renovating a property, obtain a scrapping schedule 7

9 6) You must invest in assets that can be insured and protected. This type of insurance also is of assistance if tenants stop paying rent and in some instances can also cover involuntary work terminations. You need to discuss what options are available with a policy with your insurance broker. The ability to use fixed interest rates creates some certainty over this major cost. These can also be prepaid particularly if you have changing taxation liabilities over different years. The ability to fix part of a loan i.e. not all is also available and many banks allow the use of offset accounts that can reduce interest costs if you have surplus cash for time to time. Caution is required if you have a redraw facility as withdraws of previously deposited sums may reduce tax deductibility of the loan as each redraw needs to be for investment purposes to retain tax deductibility. This is not the case for offset accounts. Land lord insurance should be taken out and in the event of a tenant destroying the property a refurbishment is available without costs to the owner. Income protection and mortgage insurance can also be taken out individually and especially in the early years where they maybe little equity adequate life cover can assist with leaving your family an income as opposed to a debt. You should be periodically assessing market values and rental yields and while this is what your real estate agent is supposed to do, keep them on track by prompting them. Periodic contact with your mortgage broker should also be maintained to always have your line of credits or equity balance maximized to allow you to quickly take advantage of any opportunities. Constant market research on price can also assist to ensure the property is adequately insured as under insurance can cost you dearly. 8

10 7) You must have an investment system that is specific and all encompassing. Stick to what you know best and invest in the property types that can maximise your returns. That means in some areas apartments are favoured while in others maybe town houses are, and if you enjoy the thrill of cosmetic renovations and or improvements, then target properties that fall into these categories. Pay attention to all the cash flow streams i.e. purchase price, rental and capital growth. To begin with, look at rental yields as a quick guide to cash flows. This can be calculated by dividing the annual rent by the purchase price ie $20,000 annual rent is a 5% rental yield on a $400,000 property purchase. You can then compare this to say your interest rate. Care is needed to differentiate between gross yield and net yield which is after deducting property expenses excluding interest. As a purchase guide, also look at purchase price based on square metres. While this is only a guide it is a useful tool when comparing properties. Use the upcycles to maximise borrowings to then draw down in down cycles or when opportunities arise. As banks do not tend to call in loans or request additional funds to be paid into loan accounts if repayments up to date this helps in times of property value declines. 8) You must invest in assets which require minimal input. Residential property can provide you with this type of investment. While property should not be a set and forget asset we are normally busy or purchasing interstate and so minimal involvement is valued. A good property manager can save you more than they cost and are a good intermediary when negotiating rental increases and up to date information in the rental market. They can also be particularly helpful in the event of needing to terminate a lease agreement. The ability to renovate or improve allows a refreshing of the value thereby increasing equity and rental yields. For single occupancy dwellings such as a home the ability to maximize land usage by extending or adding a granny flat can significantly improve vale and cash flows Adding value to a property can greatly improve your returns and cash flows and be a defensive strategy in times of downturns. 9

11 9) You need to invest in assets which require little to no money while maximising your capital growth. Residential property allows for massive leverage due to the power of borrowing. Residential property can be secured with minimal down payments Residential property allows for extended settlements thereby increasing your returns prior to purchase and with early access approval can allow for renovations prior to taking the property over Off the plan means buy now pay latter. Growth with no mortgage. Care is required with off the plan to ensure you are not paying the developers profits in the future today and that you are able to complete settlement in that the banks final approval will not be known until completion. If values fall or banks change lending policies you could be caught short and unable to complete with the associated penalties. Residential property can be purchased with options or delayed settlements again reducing the impost on your cash 10) You need to be able to input your control over assets. Your input should increase the asset value. Residential property is the only asset class that allows this in the form of renovations and refurbishments. Even minor changes (repainting) can greatly increase value. Residential property is not subject to unscrupulous management which can destroy all value and can give passive income without the need to continuously replace your asset. Under certain conditions you can borrow the equity to either top up living requirements or to fully supplement your income. While the interest on these borrowings is nondeductible the cost is normally much lower than marginal tax rates so maybe view this interest charge as your tax and in today s market a 4% interest is much lower than tax. Care is needed not to overly borrow and certainly to only extract sums which are well below growth rates. With multiple properties this is more easily managed. 10

12 Conclusion As I mentioned before successful property investing is like baking a soufflé as it requires these important elements: a well-proven recipe, good ingredients and technique. The Ten Commandments I have outlined in this e-book may help guide you to better success. But to sweeten the result, you need to surround yourself with Master Chefs or experienced professionals who know your situation and can assist you in refining the recipe, sourcing quality ingredients and coaching you towards mastering technique. Knowledge may be power but wise counsel heeded is essentially more powerful. Key Takeaways: Educate yourself with knowledge - know your recipe Equip yourself with tools get the right ingredients Associate yourself with people more successful than you and be mentored by seasoned professionals in various fields (property accounting, taxation, finance, financial planning etc.) master your technique In other words, don t do it alone and don t be afraid to get help. That way, you will ensure the result is not half-baked. To your success! Ken Raiss Director, Chan & Naylor Australia Chan & Naylor is a National Property, Business Tax Accounting & Wealth Advisory Group Helping clients to grow and protect their wealth and caring for their family and business from generation to generation. Chan & Naylor has offices nationally conveniently located in: Sydney, Melbourne, Perth, Adelaide, Perth, Regional Victoria and South Australia. Our team consists of reliable accounting, finance and financial advisers who get property and are proactive about helping clients to grow and protect their wealth. Not sure which Strategy is right for you? Request your free phone consultation (10-15 minutes) to speak with a Partner or Client Manager visit or click on the green button. Please share this with your family, colleagues and friends using these links below 11 Share on Facebook Share on Twitter Share on LinkedIn

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