sorry Zennifa, but I really strongly disagree ....
I disagree with investing in ANYTHING if you dont know anything about it.
With property investment - you need to do the sums really carefully, and know the market well if you are going to risk all of your financial future.
Interest only loans are risky. You are basically relying on the capital gain of the property over a relatively short period of time in order to make a profit.
Over long periods of time, the property market is a strong, stable and great investment. Over short periods it can be very risky .... especially if you do not have the cashflow to see out difficult periods of low rental returns, vacancies, property damage or low capital growth.
If you have to sell for financial reasons ... because you cannot make the repayments, you lose a LOT.
Companies such as The Investors Club ... are for-profit businesses. Never forget - they make money when you invest. They get paid 6% from the vendor when you buy a property through them. That means they are NOT an independant advisor giving you the best advice for you. (I am not suggesting anything bad about them, they may be great .. but be aware of their own financial interest when you take advice from them) The same as finacial advisors attached to banks - make money from the trusts and managed funds they get you into.
At the end of the day, if you have some spare cash but not a lot - put it into your mortgage. Pay that off as quickly as you can, and then when you can afford it, sell your property and buy the next one up .....
*I am an accountant, who owns several investment properties and works in the property development industry.
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16-08-2010 21:34 #11
16-08-2010 22:05 #12
I get concerned with the amount of advice given out, both by people with good intentions and by financial advisors with a vested interest, so will explain a little about how money is made in property investment.
Please note - this is NOT financial advice to anyone. This is the ideas of someone who is NOT a licenced financial advisor ... but simply someone who has no vested interest.
If you are considering property investment, please do your sums, please speak to your accountant, please speak to your financial advisor ......
Many investors make money from the property market not by investing their own money, but by borrowing and investing thtat cash. This is called leveraging.
For example - Mary owns her own home, and because she has finished paying off her mortgage, has an extra $2,000 per month to invest. She has no real deposit or lump sum, but wants to invest her monthly savings.
Mary puts her $2000 per month in the bank, at an average interest rate of 6%.
After 5 years, her bank account will be $145,000
Mary borrows $500,000 from the bank, with no deposit (secured against her home) and buys a rental property. The property is rented out for $550 per week ... which after costs (rates, taxes, realestate fees etc) gives her $500pw.
After 5 years of putting the rental income, plus her $2,000 per month to the loan, she will owe $421,000. Using average property growth of *7% the property is worth $700,000 ... giving a profit of $279,000.
(*the average growth in the property market over the last 20 years is between 8 -10% depending on area)
Mary makes nearly double the amount by borrowing money and investing in property.
The reason for this is that the rental return (4.8%) is slightly less than the interest rate paid (6%) so costs her 1-2% per year, she gets 7% growth on the FULL amount of the loan. In the bank, Mary only earns interest of 6% on the actual money she has.
- to do this, you NEED to have cash flow. Unless you can service the debt and make repayments, it is risky. If you are in a position where you cannot make the repayments and have to sell the property, you are very likely to lose substantial amounts.
- Interest only loans tend to be for shorter periods, after which you either have to refinance to make capital repayments, or become due in full and you have to sell to repay. They also tend to be for higher interest rates.
- it is a LONG term strategy. You need to be patient and be able to sell at the right time. Selling at the bottom of the cycle will not make you money
- you need to research your market, and buy well. There are bargains in every market, in every area .... research and know your market.
- cash flow is everything. I would strongly advise anyone doing this to have extra cash available. In the scenario above, I would suggest 'Mary' borrow $600,000 .... and keep the extra $100k in an offset account. the offset account is 'offset' or netted against the loan account, and interest is only charged on the net balance so you arent out of pocket. But if an emergency arises (property vacancies, damage, lower rental return, lose your job so no cash to inject etc), you can use the money in the offset to make the minimum repayments or fix the property and buy some time to sell without it being a firesale.
- you need to make sure that you can afford the monthly amounts. Easily. Without sacrificing lifestyle. It is a long term investment, so not something you should be scrimping for as you will be doing it for a long time. Set your purchase price with this in mind.
Investing in the sharemarket is often best left to people who understand the market and the influences. If you have money to invest and want to invest in the share market ... either take the time to learn a whole lot about it, or get professional advice.
- Make sure your investment is appropriate to what you want out of it.
- Consider your time frame, risk profile and preferences ....
- Remember that risk and return are closely related. Higher return usually means higher risk .... so if it seems too good to be true, it usually is.
Last edited by BH-KatiesMum; 16-08-2010 at 22:12.
16-08-2010 22:12 #13
KatiesMum If you have a investment property, is the rent money from that classed as income for Centrelink ?
16-08-2010 22:13 #14
and if they have an assets test then the net amount of the asset (ie value of the house less the amount you owe the bank) will be included.
16-08-2010 22:19 #15
My inlaws keep telling us we should buy an investment property so DH can reduce his tax via negative gearing. Does anyone here benefit from that? I'm not great at finance but I think it's when your rental income is less than your mortgage repayments and that lowers your taxable income?
16-08-2010 22:33 #16
Negative gearing is basically when the costs of the property (all costs including management fees, repairs and maint, *depreciation and interst) are less than the income. Rental losses are then deductible against your personal income for tax purposes.
BUT - remember, to make a rental loss means your income is not covering the costs of interest. So you need to put cash to it to cover both the losses and the capital repayment of the loan.
So again it comes back to having the cash. If you dont have the cashflow, negative gearing is a disaster
*Note - depreciation is not a cash flow - and can be a really big factor. But I would never suggest anyone invest in property purely for tax reasons. You invest for the total overall value .... not just to minimize tax.
Last edited by BH-KatiesMum; 16-08-2010 at 23:00.
16-08-2010 22:37 #17Gone.....and no doubt already forgotten
- Join Date
- Apr 2005
Thank you so much for taking the time to outline that KatiesMum. It really put it into perspective for me and I understand it much better now.
16-08-2010 23:27 #18
WOW thanks Katie's Mum for taking the time to explain it in terms that I can understand! Buying an investment property is something we plan to do in the future and your explanation really helped clear things in my head... thanks again!
17-08-2010 12:18 #19
KatiesMum- your awesome! I am currently studying towards my degree in Accounting and while I got the general gist of leverage and negative gearing- I didn't ever completely understand it. You have put it so plainly and in an easy to understand scenario! Thanks, think I might print this out so I can refer back to it again later when I need it, as I'm sure I will.
17-08-2010 12:34 #20
Ok – next part …
There are many ‘wealth creation’ type firms who will assist buyers in purchasing, managing and investing in property. Some are great, others are not. ALL get paid by the investor purchasing a property. This means that some are less than upfront about the risks involved, and whether or not you can really afford this type of investments.
Typically, what happens is they will tell you ‘you don’t need a deposit, or any cash flow. You can use the euqity in your own home and build wealth’.
What this means is that you borrow more than the price of the property, on an interest only basis, and use the capital growth in the property to create your wealth. This is fine and works well in boom times when property growth is good, or when you have bought well and been lucky in having good tennants and no difficulties.
Using the example of my previous post …
Mary’s sister Jane is still paying off her home, but has built up substantial equity. She doesn’t have any spare cash, but wants to invest in property. FirmXYZ help her by arranging an interest only loan for $550,000. She uses $500,000 to buy a property, which is rented out for a net rental return of $500 per week. The other $50,000 is put into a bank account and is used to make the repayments.
The interest repayments of $3200 per month (7% interest) are made by using $2000 per month rental income, and $1200 per month from the $50k bank account. Under this arrangment, the $50k will last for 40 odd months … or a bit over 3 years. The idea is that after 3 years, the property will be worth substantially more than the loan value (eg at 7%pa growth the property would be worth $612,000 ….. making a profit of $62,000 for no investment up front and no cash invested)
It’s a great idea – and it works. Sometimes.
It is a risky strategy though – as if things don’t go to plan, you don’t have any cash to get out of trouble.
- if the property is vacant for any period of time, you still have to make the full interest repayments … and this will very quickly deplete your cash account.
- If the property is damaged, and you need to make repairs before being able to rent it out again, its even worse. You cant rent it as it is damaged, but without the rental income you have no cash to be able to afford to repair it as all the cash is going to the bank
- Interest only loans are usually made at a higher interest rate, for short periods, and can sometimes be on terms that are not fair and equitable.
- Growth rates are not 7% EVERY year. On average over a long period of time … there will be good growth. On average, property prices double every 10 years. But it’s a long term strategy. There are boom and bust cycles in this … and the above investment strategy is only a short term investment (banks etc will not do interest only loans over long periods). If you happen to buy in a rising market, and need to sell when things are flat …. You end up losing a LOT.
- You don’t really have much choice on when to sell. You have to either borrow more, or sell immediately when the cash runs out. If the market has risen significantly, all is good and you will sell anyway. But if the market hasn’t risen by the time your cash runs out, often you are unable to borrow more against the property, as you already borrowed more than it was worth and cant borrow more against it.
So in Janes example, assuming she had a great tennant that whole time and the money lasted 3 years, but the market has been pretty flat and property values are much the same as when she purchased the property (so her property is worth $500k). She cant borrow any more against the property as she has already got a $550,000 loan against a $500,000 property …. She cant afford to pay the interest as all the cash savings are gone … she decides to sell. She doesn’t have time to wait for the right price, so she gets a bit less than the property is worth, and ends up selling for $485,000. She now still owes the bank $65,000.
Worse is if after 2 years her good tennant moves out. (After 2 years, her bank account will be down to $20k) It takes 2 months to get a new tennant, who pays the first months rent, but then falls behind. After 4 months of no rent, she finally gets them evicted … but they do $10,000 damage to the property. She has now had 6 months (2 vacant and 4 from nonpaying tennants) of no rent, so has spent all the money in the bank account on the interest repayments … and doesn’t have the money to make the repairs. The property prices are not great, and she has to sell a damaged property in a hurry, so she only gets $450,000. She is now $100,000 in debt, and either has to refinance her own home (if she can) or sell.
Investing with no capital and no cash can be a risky proposition, and you ARE risking the security that you put up. The ONLY way to reduce this risk, is to have cash to put towards the investment. Even if it is only a small amount, being able to put some cash into the savings/offset account will reduce the risk of having to sell the property because you cannot pay the interest.
As I have said, risk and return are closely related. If you have no cash invested and are being promised a high return …. It usually involves substantial risk.
If you are happy with that level of risk – fantastic. Many people make money this way …. Many people use this to get a foot in, and then use the cash they make to invest in more risk averse strategies.
But many people invest in this type of arrangment without knowing the risks. My goal in these posts is simply to make people aware of the benefits and pitfalls of the type of investment they are considering.
The only major point I want to make is with the various investment advisors and Financial Planners. There are good and bad advisors (as with every occupation), but financial planning is relatively unregulated, and most financial planners do not get paid by the client. If YOU are not paying them … someone else is. Keep that in mind when regarding their advice. They are not giving you a free service, they are working for themselves or somebody else …. So the advice they are giving you is not independent. Its not in your best interest, they are paid to get you to invest in their product.
Property Investment seminars and various organisations such as the one referred to in this thread, all make money from you buying property. They get paid from the vendor (seller) when you purchase the property. So they WANT you to buy it, as they get a cut. Advisors provided by banks or super funds who generally recommend managed funds or trusts get paid a commission or percentage of your investment by the fund or trust. Its not a free service.
Good financial advisors will consider your preferences, your situation and your risk profile, and recommend an appropriate investment or product. Good advisors will tell you if their products are not really appropriate for you …. But not all advisors do this.
When considering advice such as this – whether it is in shares, in managed funds or trusts, or in property you need to carefully consider all the risks, including what the advisor is not telling you. They can be very financially rewarding and beneficial …. but they can also be much more risky at times than you were intending
Again – I am not a financial advisor. I am not advocating any type of investment at all. But I honestly believe that knowledge is power. Knowing how these things work and exactly what it is that you are investing in, will help you understand the risks involved and make an informed decision about your investment.
Last edited by BH-KatiesMum; 17-08-2010 at 19:06. Reason: fix font/spelling
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