Download From 0 to 130 Properties in 3.5 Years

Table of Contents
Cover
WHAT’S NEW IN THIS EDITION
Readers’ comments
Title page
Copyright page
Acknowledgements
Epigraph
Preface
G’DAY!
MY ORIGINAL MASTER PLAN FOR FINANCIAL FREEDOM
Part I: The Steve McKnight story
1 Humble beginnings
DANGEROUS ASSUMPTIONS
MY WAKE-UP CALL
THE ‘ALL-HYPE, NO-SUBSTANCE’ SEMINAR
A NEW DIRECTION
2 Making a start
FINDING THE NEEDLE IN A HAYSTACK
IT’S ALL ABOUT APPLICATION
3 Ramping it up
A CHANCE MEETING WITH A FRIENDLY CANADIAN
TURNING AN IDEA INTO AN INVESTING SYSTEM
AN URGENT SHIFT IN FOCUS
NEW ZEALAND — HERE WE COME
MULTIPLICATION BY DIVISION
THE CURRENT ENVIRONMENT
HOW TO CREATE A MULTI-PROPERTY PORTFOLIO TODAY
4 Achieving financial freedom
WILL YOU BE HAPPIER?
A DAY IN THE LIFE OF STEVE
DAVE AND STEVE PART WAYS
WHAT’S NEXT FOR STEVE?
Part II: Property investing home truths
5 The truth about creating wealth
THE SECRET TO BECOMING RICH
LIVING BEYOND HER MEANS
SOLVING YOUR MONEY PROBLEM
I’VE NEVER BEEN MORE ADAMANT!
6 The truth about property investing
WHY INVEST IN PROPERTY?
DECISION TIME
PASSIVE INCOME AND PROPERTY INVESTING
WHICH IS BETTER, CAPITAL GAINS OR POSITIVE CASHFLOW RETURNS?
MEET CRACKERS
7 The truth about negative gearing
WHY IS NEGATIVE GEARING SO POPULAR?
PROPERTY AND TAXATION
CAN YOU RELY ON CAPITAL GAINS?
DO PROPERTY PRICES REALLY DOUBLE EVERY SEVEN YEARS?
FALLING TAX RATES
INFLATION
CAPITAL GAINS TAX
THE BOTTOM LINE ON NEGATIVE GEARING
8 The truth about financing
WHAT IS LEVERAGE?
GETTING A LOAN
LEARN THE INDUSTRY
OBTAIN PRE-APPROVAL
SUSTAINABLE INVESTING
LOAN APPLICATION CHECKLIST
9 The truth about structuring
LIFESTYLE AND FINANCIAL ASSETS
WHAT IS STRUCTURING?
WHAT ENTITY SHOULD YOU BUY IN?
WHY YOU SHOULDN’T BUY PROPERTY IN YOUR OWN NAME
THE STRUCTURE STEVE USES
WANT MORE INFORMATION?
10 The truth about depreciation
WHAT IS DEPRECIATION?
DOES REAL ESTATE DEPRECIATE?
TAX AND DEPRECIATION
TURNING NEGATIVE CASHFLOW INTO POSITIVE CASHFLOW
TAX DEFERRAL, NOT TAX SAVING
FINAL THOUGHTS ON DEPRECIATION
11 The truth about selling
PROPERTY LIFECYCLE
FAST-TRACKING USING COMPOUNDING RETURNS
REASONS WHY YOU WOULDN’T SELL
REASONS WHY YOU WOULD SELL
CAN’T BORROW ANY MORE MONEY?
Part III: Strategies for making money in property
12 Buy and hold (rentals)
TYPES OF BUY AND HOLD PROPERTIES
HOW YOU CAN MAKE A PROFIT
CREATING POSITIVE CASHFLOW PROPERTIES
IDENTIFYING THE REAL ASSET
PARTNERS IN WEALTH (THE STEVE MCKNIGHT APPROACH TO
LANDLORDING)
SOLUTIONS
13 Vendor’s finance sales
WHAT IS A VENDOR’S FINANCE SALE?
THE FOUR PHASES OF A VENDOR’S FINANCE TRANSACTION
THE HUMAN NATURE OF A VENDOR’S FINANCE SALE
VENDOR FINANCING IN TODAY’S PROPERTY MARKET
THE CRITICAL SUCCESS FACTORS IN A VENDOR’S FINANCE SALE
THE ARGUMENTS FOR VENDOR’S FINANCE
THE ARGUMENTS AGAINST VENDOR’S FINANCE
THE FINAL WORD ON VENDOR’S FINANCE SALES
14 Lease options
MY ‘HOMESTARTER’ APPROACH
THE MORE FORMAL LEASE OPTION MODEL
A CONTRIBUTION BY LEASE OPTION EXPERT TONY BARTON
THE DIFFERENCE BETWEEN A VENDOR’S FINANCE SALE AND A LEASE
OPTION
CRITICAL SUCCESS FACTORS IN A LEASE OPTION
KNOW THE LAWS!
WHO WOULD BE INTERESTED IN A LEASE OPTION?
LEASE OPTIONING IN TODAY’S PROPERTY MARKET
SANDWICH LEASE OPTIONS
THE FINAL WORD ON LEASE OPTIONS
15 Simultaneous settlements
WHAT IS A SIMULTANEOUS SETTLEMENT?
CRITICAL SUCCESS FACTORS IN A SIMULTANEOUS SETTLEMENT
TRANSACTION
THE FINAL WORD ON SIMULTANEOUS SETTLEMENTS
16 Subdivisions
A SUBDIVISION DEAL
THE ART OF SUBDIVIDING
17 Renovations
MY FIRST RENO DEAL
THE RENO FORMULA FOR SUCCESS
ARE YOU AN INVESTOR OR A RENOVATOR?
18 Developing
NAIVE THINKING
THE 6 Ps OF PROPERTY DEVELOPING
CRUNCHING THE NUMBERS
SMALL DEAL: $77 000 PROFIT IN 12 MONTHS
NINE TIPS FOR FIRST-TIME DEVELOPERS
Part IV: Your next purchase
19 Planning for success
THE PATH OF LEAST RESISTANCE
YOUR PERSONAL WEALTH-CREATION PLAN AND PATH OF LEAST
RESISTANCE
MAKING THE NECESSARY SACRIFICE
HOW LONG WILL IT TAKE?
THE PLATEAU EFFECT
THE NEXT STEP
20 The Asset Zoo
THE CHICKEN OR THE NEST EGG?
THE ASSET ZOO
MIXING UP THE ANIMALS
THE FINAL WORD ON THE ASSET ZOO
21 Finding the money to begin investing
YOUR SAVINGS
YOUR EQUITY
THE MONEY RAISED FROM A PUBLIC OR PRIVATE FINANCIER
HOW MUCH MONEY DO I NEED TO GET STARTED?
HOW TO BUY PROPERTY WITH LITTLE OR NO MONEY DOWN
22 Where, what and how to buy
LOCATION . . . BAH HUMBUG!
BECOME AN AREA EXPERT
MY SIX-STEP PROCESS
A WORD ABOUT DEPOSITS
Part V: Real deals, real people
23 Peter and Jackie from Tassie
PETE AND JACKIE’S DEAL
24 Sue from South Australia
A BIG, SCARY DECISION
SUE’S DEAL
THE FUTURE
25 Matt from Queensland
MATT’S DEAL
THE FUTURE
26 Scotty from Sydney
CARAVAN LIVING
BECOMING AN INVESTOR
A MAJOR MISTAKE
SCOTTY’S DEAL: GARNHAM DVE
27 Jenny from Western Australia
JENNY’S DEAL
THE FUTURE
28 Dean and Elise from Victoria
DEAN AND ELISE’S DEAL
THE FUTURE
29 What’s your next move?
CRISIS
COMFORTABLE
CHAMPION
SELECT YOUR SETTING
YOUR CHOICE
THE WORST-CASE SCENARIO
THE ANSWER
YOUR JOURNEY
What to do next . . .
Index
WHAT’S NEW IN THIS EDITION
Already Australia’s #1 best-selling real estate book with over 160 000 copies sold, From 0 to 130
Properties in 3.5 Years just became even better!
Completely rewritten, revised and updated to take into account the latest trends and investing
techniques, this book includes everything you need to know to achieve financial freedom using
positive cashflow real estate, as well as 16 brand new chapters that explore many new topics,
including:
How to get the most finance possible for your property projects.
Steve’s fantastic new 1 Per Cent Rule for finding positive cashflow property.
How to gain maximum asset protection while also paying the least income tax legally possible on
your profits.
When is the best time to buy, hold and sell.
Specific guidance about what and where to buy for your next highly profitable investment
property.
The Asset Zoo — a new way to review your portfolio that will explain whether or not you have
the right mix of assets to achieve your wealth-creation dreams.
A detailed explanation of how you can make quick and attractive lump-sum cash gains from
subdividing and property developing.
New case studies to provide additional insights and ideas.
Feature contributions that reveal how those who have read and applied this book have
profited — and how you can too.
And much more!
If you bought the first edition then you’ll enjoy this edition even more as you’ll find the expanded
content informative, practical and profitable.
Alternatively, if you are buying this book for the first time you have a proven and powerful resource
that will show you exactly how to use real estate to achieve your financial dreams.
Readers’ comments
‘I’d rate this book a 10 out of 10, with the most practical, do-able and sensible advice I’ve read on
property investment. And I would like to thank you because for the first time I have HOPE that not
only is this possible, it is possible for us, and possible even in this difficult housing market.’
Karen S (ACT)
‘From 0 to 130 Properties in 3.5 Years is simply the best property investing book I have read so far.
Thanks!’
Shane M (NSW)
‘Having finished this book I’d have to say I love it. It’s written very simply yet practically. There
are a number of tips that I will be implementing in my endeavours to purchase property.’
Diana E (Vic.)
‘I’m halfway through this book and WOW! I can understand it! Thanks for keeping it simple and
plain. I’m excited about possessing it and your principles. An extra bonus was to find your website
and newsletters.’
Christine McL (Qld)
‘This book is truly amazing! I have been carrying it with me to work and even quoting from it to
family and friends! Will we act on the information? We already have! We have now developed a
strategy for positive cashflow properties thanks to this book.’
Con V (NSW)
‘This is a wonderful book. It’s the first book I’ve ever started to read and finish. I’m one of those
kids that hates reading but I couldn’t help but to finish your book because I know knowledge is power.
I have told countless friends about your book and the strategy of positive gearing and they all seem to
say I’m nuts, but I don’t care what anyone else thinks.’
Peter K (SA)
First published 2010 by Wrightbooks
an imprint of John Wiley & Sons Australia, Ltd
42 McDougall Street, Milton Qld 4064
Office also in Melbourne
© Steve McKnight 2010
The moral rights of the author have been asserted
Reprinted January 2010
National Library of Australia Cataloguing-in-Publication data:
Author: McKnight, Steve.
Title: From 0 to 130 properties in 3.5 years / Steve McKnight.
Edition: 2nd ed.
ISBN: 9781742169675 (pbk.)
Notes: Includes index.
Subjects: Real estate investment. Real estate business.
Dewey Number: 332.6324
All rights reserved. Except as permitted under the Australian Copyright Act 1968 (for example, a fair
dealing for the purposes of study, research, criticism or review), no part of this book may be
reproduced, stored in a retrieval system, communicated or transmitted in any form or by any means
without prior written permission. All inquiries should be made to the publisher at the address above.
Original cover design by Alister Cameron
Illustrated by Paul Lennon
Cover image © iStockphoto/deanna
Disclaimer
The material in this publication is of the nature of general comment only, and does not represent
professional advice. It is not intended to provide specific guidance for particular circumstances and it
should not be relied on as the basis for any decision to take action or not take action on any matter
which it covers. Readers should obtain professional advice where appropriate, before making any such
decision. To the maximum extent permitted by law, the author and publisher disclaim all
responsibility and liability to any person, arising directly or indirectly from any person taking or not
taking action based upon the information in this publication.
Acknowledgements
While I offer sincere thanks to everyone who has had a hand in making this book possible, I’d like to
make several specific acknowledgements.
First and foremost, I’d like to recognise my belief and faith in Jesus Christ, my personal Lord and
Saviour who said, ‘All things are possible for the one who believes’ — Mark 9:23.
To my family, and in particular my wife and daughters — thank you for your love, support and
understanding.
To the office team: Jeremy, Emy, Norm, Renee, Tony and David — I greatly appreciate your
encouragement and assistance. To Lesley Williams and Michael Hanrahan — thanks for your help
with the editing and proofing.
Thank you also to those who contributed, including: Katrina Maes, Martin Ayles, Tony Barton, Peter
and Jackie, Sue, Matt, Scotty, Jenny and Dean and Elise.
Thank you to the Real Estate Institute of Australia for providing data and other information, to Dave
Bradley for partnering me in the early years of my property investing and Robert G Allen for his
valuable advice about real estate investing.
And finally to you the reader — I’m delighted that you chose to invest in this book. It’s now time
for you to take advantage of the information I’ve provided by using it to transform your life.
Proverbs 3, verses 13 and 14
‘Blessed is the one who finds wisdom, and the one who obtains understanding. For her benefit is more
profitable than silver, and her gain is better than gold.’
Preface
Right now, as you read this book, someone in the suburb or city where you live is closing a property
deal that will make more profit in one lump sum than you’ll earn from your job over the next 12
months.
And if you’re worried about the effects (or after-effects) of the global financial crisis, let me
reassure you that more money is made as economies recover from downturns than at any other time in
the economic cycle. This is because during the gloom assets are oversold to the point that values
become artificially low. Once the economic climate improves, values bounce back, and those who
took action at the right time become substantially richer.
We are in a time of unprecedented opportunity. Yesterday I signed the contract to sell a subdivision
deal that will make a very handy pre-tax profit of $130 643. Property transactions such as this are
happening every day of every week, and unquestionably prove that you can still make a lot of money
from real estate.
It begs the question then: why are you working so hard for so little pay, when you could be investing
in property and taking life a lot easier? If you think it’s because you’re not smart enough, or that you
need to be a brilliant investor to find and profit from the best deals, you’re wrong.
As I’ve outlined in chapter 16, the subdivision deal that released this impressive lump-sum profit
wasn’t particularly tricky or complicated. In fact, after reading this book you’ll be able to do deals just
like it with your eyes closed.
The answer as to why you are not making a financial killing from property investing right now is
because an experienced investor, who knows what he or she is doing, hasn’t shown you how. But don’t
worry. That’s all about to change, because in this book I’ve documented the proven knowledge and
experience that has seen me purchase well over 130 properties and achieve financial freedom.
Today, my family and I live the lifestyle we’d always dreamed of. My goal in writing this book is to
provide you with the knowledge, confidence and motivation so you can too.
G’DAY!
My name is Steve McKnight and I’m a 30-something ex-accountant. My wife, Julie (whom I met
while on holiday at Ayres Rock — how about that?), and I live in the eastern suburbs of Melbourne
and have two gorgeous little princesses.
You’d pass me on the street and not look twice. Why? Because I’m just a normal-looking guy who
got average grades at school, is average at sport (except maybe table tennis, where I routinely thrash
my older brother), and, like many approaching-middle-age men, I am gradually becoming more and
more ‘folically challenged’.
In fact, life for me would have been decidedly normal, except for one fateful day in May 1999 when,
pushed to the brink of an early mid-life crisis and desperate to try something new, I bought my first
investment property. Far from being the Taj Mahal, it was a three-bedroom house in West Wendouree,
which is a suburb of Ballarat, a regional Victorian town about an hour’s drive west of Melbourne.
It’s hard to imagine given what has happened to property prices since, but all I paid to buy that
property was $44 000. You have to understand, though, that West Wendouree is no Toorak, Vaucluse,
Balmoral or Mossman Park.
My first investment property
As you can see in the photo, it’s a normal-looking home. However, looks can be deceiving. I later
found out that these types of houses were trucked in as two halves, assembled, patched up and then
rented out as cheap government housing to people who needed subsidised rent.
If you look closely you’ll see that the chimney is painted. If you’re wondering why, it’s because
letterboxes were a non-essential luxury at the time these types of houses were built, and a cheap
solution was to spray-paint the house numbers on the chimney.
Over time these houses became privately owned, and modesty prevailed. Letterboxes were installed,
chimneys were painted to hide the crude street numbering, paling fences were erected and gardens
planted.
Although it looks fairly basic, this property was still one of the better homes in the neighbourhood.
Properties across the road had front yards full of weeds, cars (many in different stages of disassembly
or decay) and shopping trolleys.
Given this property is not the sort of investment you’d show off to your family and friends as an
example of your investing brilliance, you might be wondering why on earth I bought it.
I know it’s early on in the book, but this property demonstrates one of my essential real estate
investing rules.
Steve’s investing tip
When investing, only ever buy houses for other people to live in.
Without wanting to sound like a snob, there’s no way I wanted to live in that property, but that
didn’t matter. My only concern was whether or not I could earn my desired financial return.
This is an important point, because the minimum standard of some property investors is whether or
not they could live in the house. This attitude is a mistake, because once you become emotionally
involved with your investments, you’ll make decisions based on how you feel rather than the financial
facts. The fact is that often, after deducting all expenses from the rent, there is a surplus left over. That
is, the property is cashflow positive.
Let’s do a little exercise to test your financial IQ. I’ll help you by giving you the first answer.
Bricklayers work with …
bricks
Stone masons work with …
Woodcutters work with …
Property investors work with …
I’m assuming you said stone masons work with stone, and woodcutters work with wood, but did you
say that property investors work with property? If so, you’re mistaken. Property investors work with
money, not property.
When you strip away all the emotion, the only decision worth considering is how much money your
investment will make, compared to how long it will take to earn it and how much risk there is that you
will lose some of your capital. Anything else is an afterthought. Who really cares whether the
dwelling is made of brick or weatherboard, or whether the curtains are pulled together or pulled down?
If all this sounds a little strange, let me ask you a question. Is your current home better, or worse,
than the house you previously lived in?
Irrespective of whether you rent or own, as we get older and have more money, it’s usual for us to
improve the quality of the houses we live in. However, what I’ve found is that increases in rent don’t
keep pace with appreciation in value. Talking investor-speak for a moment, as value increases, return
diminishes. That’s why income-focused investors are better off buying more basic houses as opposed
to fewer elaborate homes. That is, you’ll get a better income return by owning two $250 000
properties than one $500 000 property.
In summary, as we age we gain a bias away from the sorts of properties that are the best
investments. This means that relying on emotion, rather than financial skill, will cost you money.
Don’t worry if you’re confused by what I just said. We’ve got the whole book ahead of us and by the
end you’ll be much more advanced than you are now. The key point is not to get emotional about the
property you purchase.
MY ORIGINAL MASTER PLAN FOR FINANCIAL FREEDOM
Owning one or two West Wendouree–type investment properties wasn’t ever going to put me on the
BRW Rich List, but that was never my aim. My master plan was to own enough houses that I could
substitute the salary I was making as an accountant with the rental income earned from the property. If
I could do this then I’d have an income for life and never have to work again.
It took five years of hard work and sacrifice, but with the help of my wife and my business partner at
the time (Dave Bradley), on 9 May 2004 I achieved the goal of having $200 000 in annual passive
income and a million dollars in the business bank account. I was financially free.
‘That’s great Steve’, I hear you say. ‘But $44 000 properties don’t exist anymore, so can you still
apply your strategies today?’
I concede the game has changed. Property prices are a lot higher and the effectiveness of individual
strategies ebbs and flows. But one thing is certain: as long as people need to live in houses, you’ll be
able to make a profit from real estate investing, provided you buy problems and sell solutions.
Steve’s investing tip
As long as people live in houses you’ll be able to make a profit from property.
And that’s what this book is all about — how you can identify the right investing solution to
transform everyday property problems into enough profit to become financially free forever.
Along the way we’ll debunk many of the myths that are kneecapping your potential, and by the end
of chapter 29 you’ll be well on the way to a brighter financial future.
But enough of the chitchat, it’s time to make a start. Let’s jump in our time machines and travel
back to 1998 when I was contemplating life beyond working 9 to 5. I have a feeling that it’s probably
a lot like what you’re going through at the moment.
Thanks for buying this book. I encourage you to treat it badly, which means highlighting your
favourite passages, writing in the margins and dog-earing the pages. It’s great to see a well-loved
book!
I hope we get the chance to meet up. Until then, remember that success comes from doing things
differently!
PS It’s reasonable to expect that the economic climate will change over time. To ensure you remain
fully up to date, readers of this book can register their copy and receive periodic updates, which I’ll
write and email to you free of charge. Visit <www.PropertyInvesting.com> for more information.
Part I
The Steve McKnight story
1
Humble beginnings
A few months ago I received an invitation to attend my 20-year high school reunion. On one hand I
was interested in going along and seeing what my old high school friends were up to, and on the other
hand perhaps it is better to leave the past in the past.
I wonder, what would you do?
My high school years weren’t particularly happy. I was overweight and an academic underachiever;
my year 10 maths teacher summed up my potential when he wrote on my end-of-year report: ‘Always
pleasant and amiable, Stephen has much difficulty with even the most basic of maths problems’.
It’s lucky that high school isn’t always the best indicator of future success.
Today, at age 37, I’m involved in more than $13.5 million worth of property projects that span all
types of real estate (residential homes, units, commercial property, land and so on), have multimillion-dollar business interests, and am the author of Australia’s most successful real estate book
ever (which you happen to be reading right now).
On reflection, I’d have to say that the kid who struggled with algebra managed to at least gain a
good appreciation of the maths involved in making money!
Steve’s investing tip
While your past doesn’t determine your future, if you want something other than what you’ve got at the moment, you’re
going to need to make some changes!
Please don’t think this is a rags-to-riches story, or that I have some supernatural ability that only the
truly blessed receive. Neither is the case. My upbringing was decidedly middle-class, neither flush
with money nor crying poor.
Working hard in the one job selling trucks for 40 years, my father abandoned a lot of his own
ambition so that his wife and children would never go without food, shelter and the occasional luxury.
For this I love and respect him deeply. Mum never worked in a paid, full-time position, instead she
showered her children with delicious home cooking and cuddles. As a gifted musician, Mum would
teach piano after school for extra housekeeping money when time allowed.
DANGEROUS ASSUMPTIONS
My life was decidedly normal and uneventful until the end of high school. Previously a strictly pass
and occasional credit student, I discovered a rote learning strategy that allowed me to achieve a
respectable year 12 score — I even got a C for English; a miracle for sure!
Looking back it’s clear that I was never shown how to study effectively. Instead, it was just assumed
that everyone could do it — like reading and counting to 10. A similar problem exists today in that
property investors are never taught how to invest profitably. It’s just assumed that all of us will be
able to invest successfully once we have the finances to start, but no-one ever explains how we should
go about it.
Having languished at the bottom of the social and academic pecking order for most of high school, I
feel compelled today to do what I can to right the wrongs caused by dangerous assumptions. In terms
of property investing I will show you how to make a profit from day one. But more on that later.
My choice of career was made with little forethought. I always wanted to be a physiotherapist, but I
was deemed too mathematically challenged and my high school forbade me to do maths in year
12 — a prerequisite for the course of my dreams.
So, what does someone who is hopeless at maths do? I became an accountant, of course! Now,
please don’t make the mistake of thinking that accountants need to be savvy with maths — that’s what
they invented calculators for. All that’s needed is a solid grasp of how to push buttons, a callused
index finger and a good understanding of your times tables.
I managed to graduate from my RMIT accounting degree without dropping a subject and somehow
talked my way into a job in the midst of the early 1990s recession. Turning up for work in a suit that
looked uncomfortably like plush-pile carpet, with a pink shirt and tie that I’d be embarrassed to give
away today, I began my accounting apprenticeship completing simple tax returns and running errands.
Still, much to my Dad’s surprise, I never had to make the coffee.
Before long my career took a turn for the better and I secured a job with one of the big six (now big
four) international accounting firms. The only cause for concern was that I worked in audit.
Unfortunately, audit is not the most exciting of fields, especially at the junior level. But I had a bout
of late-onset work ethic (inherited from my father) and worked exceptionally hard. I was regularly
promoted and, having already completed the prerequisites, I began to study to become a chartered
accountant. This was not an easy thing to do as the postgraduate exams are notoriously difficult to
pass. I’d work long hours during the day and then come home to many long nights of study. You could
accurately say that I had absolutely no social life. Such was my lot until I succeeded in gaining the
status of a chartered accountant — at which point I immediately suffered a massive meltdown.
Disillusioned with my chosen career, I tried in vain to study physiotherapy at Sydney University. It
was the only course that would even consider me, and I did exceptionally well to get number 17 on the
second-round offers, but the cold, hard fact was that I was not offered a place.
Shattered, I realised I needed a change, and I made a career blunder by accepting a job in industry
(as opposed to public accounting), more because I felt wanted than because it was a match to my skill
set. In between roles I took a holiday and met a woman, Julie, who captured my attention, and my
heart. The only problem was I lived in Melbourne and she lived in Mackay — 2500 kilometres away.
Lasting only two months in the new job, I used the excuse of moving to Mackay to be closer to Julie to
save face when resigning. Luckily, accounting skills are portable and I had no trouble finding yet
another position as an audit manager, with yet another firm of chartered accountants.
By this point in my life I was certain that I’d shaken off the shackles of my high school limitations.
I’d gone to Weight Watchers and lost 16 kilos, I’d worked hard and achieved membership to what
many regard as the peak accounting body in Australia, and I’d found a woman whom I loved. Yet this
new-found self-confidence was to come crumbling down when I was sacked after nine months, and
told I was someone who overpromises and underdelivers. This left my confidence savagely beaten and
those nasty self-doubts that I thought I’d buried began to resurface.
Luckily, Julie was a rock of stability. We became engaged and then moved back to Melbourne. Once
again, I found work in a small accounting firm, again as an audit manager, and soon I was working
harder than ever in an effort to resurrect my career.
I remember my office well. It was long and oddly shaped. A glass partition separated me from the
only other manager, Dave Bradley, with black venetian blinds providing limited privacy. What I
remember best were the thick iron bars on the windows, which I’d regularly joke were there to keep
the employees in rather than the burglars out.
By late 1998 Julie and I were married and I was still working, working, working. I’d regained my
confidence and was beginning to branch out into teaching, too. I’d taken on a lecturing role at my old
stomping ground, RMIT, and was also, ironically, mentoring other aspiring chartered accountants to
manage the art of studying effectively.
I wouldn’t say that I ever felt truly settled though. I’d dread Sunday nights and having to iron five
work shirts for the week ahead. I was certainly someone working five days to fund two days off. I was
a rat taking my place in the race.
MY WAKE-UP CALL
You might be able to ignore the warning signs, but when you’re not happy your body will eventually
give you a wake-up call you can’t ignore. Some people are unlucky and suffer crippling or fatal
events, such as heart attacks or strokes. For me it was ulcers on … well, ‘unusual’ body parts.
I raced off to see the doctor, who happened to have a surgery next door, and I was lucky to get an
immediate appointment. The doctor was perplexed at my condition and suggested I needed some time
off work. Later that afternoon after returning from a walk, I found a piece of paper in the letterbox. It
was a photocopy from a medical journal explaining my condition. The doctor had written in large
print ‘Take a holiday!’ and also highlighted some text outlining that the ulcers were caused by stress.
It was my wake-up call telling me to change my lifestyle or suffer the consequences. The lack of
career planning and job satisfaction had chipped away over the course of several years and had finally
caused my health to suffer.
I talked over my situation with friends and was surprised to learn that other people felt the same
way. The obvious common theme was that while we all wanted to be wealthy, what we wanted more
was to be free from the obligation to have to work — a concept that someone called ‘financial
independence’.
I spent some quiet time reflecting and decided one thing was for certain: when I looked up the
corporate ladder all I could see was the backside of the guy in front of me, and I didn’t like the view.
So, when I received a flyer in the letterbox outlining how I could discover the secrets to retiring a
multi-millionaire in five years, you could say that it looked like the opportunity I’d been searching
for — the chance to exit the rat race forever. The flyer was an A4 photocopy on white paper and it
promised (in large print) to show me the way to a lifetime of riches through the power of the tenant
and the taxman. It concluded with a 1800 number for me to call and book my strictly limited seat at an
upcoming no-cost, no-obligation ‘wealth-creation extravaganza’. Since the event was free, and since I
might have actually discovered some amazing secret that only the rich knew, I booked two
tickets — one for me and the other for Julie.
THE ‘ALL-HYPE, NO-SUBSTANCE’ SEMINAR
The seminar was held the following week at a local motel conference centre. The room was quite
professionally arranged with 100 seats neatly set out in rows of 10 by 10. There was a data projector
and a large screen to cater for a computer slideshow presentation. We arrived early and were among
the first in the room. By the time the presenter — a 40-something balding executive wearing a power
suit and matching tie — was ready to begin, the room was three-quarters full with a good crosssection of the community. Most were young or middle-aged workers, tired after a long day at the
office. Others were tradespeople — as evident from their overalls. The remainder appeared to be
retirees, or soon-to-be retirees. They seemed the best prepared as they brought pens and pads to write
down ideas.
A hush came over the audience as the presenter indicated he was ready to begin. ‘Raise your right
hand if you think you pay too much tax’, he said. There was a shuffle as the entire room raised their
right hands.
‘Good. Later I’ll show you how you can eliminate your tax bill. Now raise your left hand if you want
to be rich.’ There was more noise as pads and pens were placed on the floor, followed by more hand
raising.
‘Excellent’, the presenter said with a beaming smile. ‘You folks are in the right place at the right
time because I’m going to reveal how the tenant will make you rich, and the taxman will fund your
financial independence.’
Over the next hour or so we were shown slides of graphs and tables outlining how property only
increases in value, and why now was an excellent time to buy. The presentation was a carefully
scripted and much practised sales pitch leading to a critical question.
‘Now, who’d like to discover where the great growth properties are located and how to purchase
them at a bargain price?’ A large number of hands went into the air.
‘Wonderful!’ the presenter exclaimed. ‘In that case, let’s take a short break, and when we come back
I’ll outline an exciting opportunity to buy property below cost.’
My wife and I, sensing that this was a sham marketing scheme selling overpriced out-of-town
property to unwitting investors, decided to leave, and I couldn’t help but wonder whose best interests
the presenter had in mind. Being an auditor, I was highly suspicious of the presenter’s lack of
independence as it turned out he was being paid a commission for each property sold to a person
attending the seminar.
Steve’s investing tip
A good rule of thumb is to always be on guard when your adviser — whether a sales agent, a financial planner or
otherwise — is paid a commission for his or her recommendation.
I only lasted a few more months in my job before failing health and continuing frustration forced yet
another career move. This time I thought I’d try a different take on the old accounting theme. Instead
of being an employee for someone else, I joined forces with the other manager I worked with — Dave
Bradley. We were both disillusioned with our managerial roles and decided that we could work less
and earn the same amount of money by going into business for ourselves.
In January 1999, the chartered accounting firm of Bradley McKnight opened its doors for business.
In an attempt to keep overheads as low as possible, we worked from our respective homes and met a
couple of times a week to talk through issues and to ensure we remained focused.
Still not settled, by April I’d finally decided a more substantial change was needed. While enjoying
the flexibility of not having to travel far to my desk, I came to the conclusion that I hated working in
accounting. With some reflection I realised that all I’d managed to do was to trade in those bars on the
windows of my old office for invisible handcuffs to my new clients.
A NEW DIRECTION
At our next meeting I dropped a bombshell by telling Dave that I didn’t want to be an accountant any
more. ‘That’s great,’ he said, ‘but what do you plan to do in our accounting partnership then?’
‘I don’t know,’ I replied, ‘but something other than accounting … give me some time to think about
it’.
A week or so later I attended an introductory event that contained a good mix of information about
alternative wealth-creation ideas. I was impressed with the speaker (Robert Kiyosaki) and was eager
to hear more about his upcoming two-day intensive training seminar. Even the price tag — $2000 per
seat — didn’t seem completely unreasonable. The intro event finished at 10 pm and, as there was only
a strictly limited number of seats left and the real possibility of the upcoming seminar being sold out
quickly, I immediately phoned Dave to convince him that we both had to attend. I was understandably
hyped up after coming straight from the introductory seminar, while Dave was preparing for bed.
After I gave him my best pitch, Dave replied with a sleepy, ‘Mate, that’s great, but at $2000 a pop, the
presenter gets rich off people like you’.
‘No, no’, I said. ‘We really have to go!’
Wanting to go to sleep, Dave said, ‘Look, go home, cool down and we’ll talk about it in the
morning. Bye’. As I began to frame a counter-argument, I heard the phone hang up. Not to be put off, I
called him straight back.
‘Look,’ I said, ‘we don’t want to miss out on this opportunity’.
‘Steve. We’ve only been in business three months’, Dave said. ‘We can’t afford to go. First you say
you don’t want to be an accountant and now you want to spend money we don’t have going to a
seminar in Sydney. Mate, get a grip and we’ll talk tomorrow. Good night.’ Click — down went the
phone again.
Still undaunted, I rang back, only to find that Dave had taken his phone off the hook. Ah ha! A
challenge. I called him on his mobile. Expecting him to be irritated, I tried to head him off at the pass
by saying, ‘Do you trust me?’
‘Of course I trust you’, Dave replied.
‘Well then, trust me on this. We won’t be disappointed.’
That night I booked and paid for two seats to the impending Sydney wealth-creation seminar. It was
a decision that Dave and I have never regretted, not so much because of the mind-blowing content but
because we gleaned one revelation. We found that some of the attendees were investing in property in
such a way as to earn immediate passive income. This could then be used as a replacement for salary,
allowing the recipient to work less without taking a lifestyle cut. This discovery was to change our
lives, and our career prospects, forever.
Oh, and by the way, I did end up going to my high school reunion. I’m glad I went because many of
the ‘cool boys’ had high-earning yet time-intensive and extremely stressful jobs. It reinforced what a
great decision I’d made to leave my career, and how success really does come from doing things
differently!
CHAPTER 1 INSIGHTS
Insight #1
We all have our own story of where we’ve come from. The truth is your history isn’t as important as your future, and
your future is what you make of it.
Insight #2
Don’t fall into the trap of thinking that because I have an accounting background I’m better qualified than you to invest.
You can pay a good accountant to be on your team and access the same skill set that I have.
Insight #3
You need to expect to pay for your education, either directly by attending seminars or indirectly through making
mistakes and paying to fix them. I recommend attending seminars provided you’re committed to implementing what you
discover — otherwise they’re a waste of valuable time and money.
Insight #4
Financial independence is not just a dream that only a select few can achieve. It’s a matter of making a series of choices
that are consistent with moving you closer to your goal.
Insight #5
When it comes to high school reunions, there’s nothing to be afraid of!
2
Making a start
I understand if you think that owning a multi-property portfolio and becoming financially independent
seems almost impossible. That’s how I felt coming home from the Robert Kiyosaki seminar. Desire is
something, but how on earth do you make a start when you have precious little money in the bank and
know next to nothing about how to invest in real estate?
Steve’s investing tip
The first step to becoming a more successful investor is gaining clarity on what you are looking for from your investments.
Instead of focusing on what you don’t know or what you don’t have, which can be daunting and
overwhelming, a better place to start is to gain clarity on what you do know, or, at the very least, what
you don’t want (for example, you don’t want to work five days a week, or you don’t want to keep
driving around in a hunk of junk).
A trap many inexperienced investors fall into is simply saying they want to find a property that will
make money. At any one point in time, there are about 950 000 properties for sale in Australia, and if
you ask the agents who listed them, I’m sure every single one of them would tell you that their
property could potentially turn a profit.
Steve’s investing tip
You only have a limited amount of time and money, so casting the net far and wide will waste precious hours and leave you
confused about which deal is best.
Remembering that property investors work with money (and use property to get it), your first
important decision is what kind of profit you would like from your investment. You only have two
choices: cashflow or capital appreciation.
In my case capital appreciation was great, but a higher priority was finding a source of regular and
reliable cashflow that I could substitute for my salary. It was decided then: all I had to do was find
positive cashflow properties and I was well on my way to becoming financially free.
FINDING THE NEEDLE IN A HAYSTACK
It seemed to me that the logical place to start looking for positive cashflow properties was in the
suburbs in and around where I lived. At the time, my wife and I were leasing a two-bedroom unit in
Box Hill, Victoria, and were paying $200 per week in rent. The property was worth about $200 000.
On the back of an envelope I worked out that the annual rent ($10 400) would be less than the interest
on the loan ($16 000 assuming a loan of 80 per cent of the purchase price at an interest rate of 8 per
cent per annum). If passive income properties did exist, then it wasn’t anywhere close to where I
lived!
A little less enthusiastic but still determined to keep looking, I started searching among houses that
were for sale on the internet using a simple formula that took the likely weekly rent and worked
backwards to calculate a maximum purchase price (see page 215 for more information on this
formula). Provided the property was within these price guidelines I could reasonably expect it to
produce passive income.
What about country areas?
I must have analysed hundreds of properties within the Melbourne metropolitan area, and I couldn’t
find a single one that would provide a positive cashflow outcome.
Rather than giving up though, I somehow recalled a conversation I’d had with a colleague, Alina, a
few years earlier about how her family members were looking into buying an investment property in
Ballarat for the seemingly cheap price of $60 000.
‘Ballarat?’ I remember saying incredulously. ‘Why would you want to invest there? You’ll never get
capital growth in the country. Forget it.’
I encounter a lot of people who say they have serious reservations about investing in rural areas.
However, when pressed on the issue, these same people generally own no property and work very hard
in a job that’s making someone else rich. Their ignorance about the opportunities on offer is literally
keeping them poor. Consider this: what difference does it make if your property achieves little or no
capital growth if it, nevertheless, delivers enough reliable cashflow for you to never have to work
again?
So it was then that Ballarat, the place where Alina had mentioned that cheap real estate existed a few
years earlier, became the centre of my focus on the quest to find positive cashflow property.
Early in the morning a few days later, Dave picked me up and we ventured up the Western Highway.
Feeling that it was important to look the part, we wore our finest business suits and packed clipboards
and business cards to show the world that we were professional investors from Melbourne.
It was still early when we arrived at the city limits, so we decided to stop for a hot chocolate and to
formalise our plan of attack. As we cruised up Sturt Street, Ballarat’s major thoroughfare, it was still
dark and quite cold outside. Not many shops were open, and few looked even close to opening, which
provided a sleepy atmosphere. I had to check with Dave to make sure that it was, in fact, a weekday
and not a Sunday morning.
Eventually, though, we came across a cafe which seemed to be open judging by the fact the lights
were on inside. Dave didn’t have any trouble finding a park as there wasn’t another car parked within
100 metres anywhere on the street. I held the cafe door open as we entered and escaped the biting chill
of the wind. The only person in the cafe was a waiter — a young guy who was genuinely surprised to
see customers so early.
‘Ah … I’ve only just opened’, he said. ‘The grill’s not warmed up yet so all I can do is toast.’
‘No problem’, I replied. ‘We’ll have some toast and two hot chocolates then.’
Sitting down at a table near the service counter, I unfolded a map and tried to gain a feeling for the
layout of Ballarat, including the major streets and landmarks. Dave picked up the local paper and
began to flick through the property section. A few minutes later the waiter brought over our hot
chocolates. Offering thanks, I thought I’d try to start up a conversation to glean some local knowledge
of the area.
‘We’re new in town’, I said, at which the waiter looked us up and down and shot a glance that said
no kidding!
‘Where’s a good place to live?’ I enquired.
Leaning over the map the waiter said, ‘Here’, pointing to a spot on the map I now know as
Alfredton. ‘Oh, and anything central too’, he added, waving his finger in a wide circle around the Sturt
Street area. ‘And if you’re rich then you live by the lake.’
Dave and I exchanged shrugs and smiles. ‘Okay, and where wouldn’t you want to live?’ I asked.
The waiter considered his response and then pointed to the map and said emphatically, ‘Here’, as he
pointed out the area of West Wendouree.
‘Why not?’ I asked.
‘Oh, it’s a rough area with lots of commission houses’, the waiter replied before hurrying off to
investigate a noise coming from the kitchen. He returned a few minutes later with a plate of hot toast.
‘So, who are you guys?’ he asked.
Dave replied, ‘We’re professional investors from Melbourne’.
With one eyebrow raised the waiter walked off muttering something under his breath about strange
city people.
It was 8:30 am by the time we left the cafe. I wouldn’t say that the streets were crowded, but there
was certainly more activity with people going about their early morning tasks. Dave and I were keen
to begin looking for houses as soon as possible. We decided that talking with several local real estate
agents would be a good place to start. While this seemed like a good idea, none were open as yet, so
instead we just drove around for about half an hour to see what the houses in Ballarat looked like.
I’m not sure what I expected, but I was certainly pleasantly surprised with the majority of
houses — mostly old weatherboard period homes. Occasionally there would be a more modern
dwelling or maybe a home made of brick but, all in all, the houses seemed relatively normal and what
you would expect in some suburbs of Melbourne.
One thing we did notice though was the large number of properties that had ‘For Sale’ signs out the
front. It seemed the property boom that had hit the Melbourne market hadn’t quite made it all the way
to Ballarat.
Steve’s investing tip
Often the best way to discover information about an area is to ask a local.
My first encounter with a real estate agent
Having no idea what the houses were worth, Dave and I began to write down the addresses and pencil
in what we thought their asking prices might be. Later, once we had a better understanding of the
market, we discovered that we weren’t too far wrong with our initial guesses. After driving around for
nearly half an hour, we headed back to Sturt Street and finally found a real estate agent that was open.
As I opened the door, a bell rang announcing our arrival. The interior was modern and well kept,
giving a professional ambience to the office. There was only one person on duty and he was a young
guy who, by the look of him, should have been in a year 10 science class rather than acting as the front
person for a real estate agency. The name tag on his shirt read ‘Hi, I’m Tom’.
‘Can I help you?’ he asked.
‘Yes’, I replied. ‘We’re from Melbourne and are interested in buying some investment property.’
Now, Tom’s boss had no doubt promised that a day like this would eventually occur, when a couple
of chumps, as green as green could be, would walk in off the street and want to buy something without
any idea of what they were really doing.
‘Oh’, Tom said thoughtfully. ‘Investors from Melbourne. Hmmm, right’, he said with a hint of a
smile. ‘Well then, what exactly are you looking for?’
My initial thought was, ‘Come on! Money trees, show me the money trees! How hard can it be?’ But
to be honest, I hadn’t thought this far ahead. I didn’t think to work out a budget, or to use our available
deposit to work backwards to a possible purchase price. I didn’t even think to start with properties that
were for sale and came with tenants.
A little lost for words, but not wanting to sound cheap or look like a fool, I asked if he had any
blocks of units for sale. After all, that’s the sort of thing a professional investor from Melbourne
would say, right? Tom switched the phones over to answering machine mode and ushered us into one
of the several client meeting rooms, following us in and closing the door behind him. He pulled out a
large, bound, blue book that contained all the properties they had listed for sale and flicked to a tab
that said ‘Units’. Scanning through his list he asked, ‘How much do you want to spend?’
Dave answered, ‘We have an open budget, provided we like the property’.
Tom scribbled down a few details on a pad, closed the book, looked up, clasped his hands and then
told us that he only had one property that he thought might be suitable. It was a block of eight units in
a brick complex just a few blocks from the middle of town. He invited us to immediately inspect the
property, since he could show us through a few of the units that were currently vacant, as well as one
that was occupied as he was on good terms with one of the tenants who was home nearly all the time.
Since we didn’t know the way, Tom suggested that he drive us. Dave and I happily accepted and we
headed out of the office backdoor to a carpark. The only car in the lot was Tom’s — an early model
Ford Falcon that had quite a few dents and scratches.
Accepting a ride from Tom was one of the bigger mistakes I’ve made in my investing career. He
drove fast — 90 kilometres per hour through the back streets. He overtook a truck turning right on the
inside lane of a roundabout, and all the while loud doof-doof music belted out from two huge rear subwoofer speakers.
Our first property inspection
The only saving grace of the car ride was that it lasted just five minutes. We parked out the front of
the property and walked down the side driveway. The complex was built with four units on the ground
level and four units on the first level. It was a brick structure and you didn’t have to be a builder to see
that the exterior needed some urgent cosmetic repair. Tom warned us that the interior wasn’t exactly
Buckingham Palace either. But no amount of preparation could have helped me to mentally prepare
for what was about to happen.
The first unit Tom showed us through was the one rented to his friendly tenant who didn’t mind
showing us through at a moment’s notice. It was still quite early, about 9:30 am, so when Tom
knocked on the door it took a few minutes before it was opened by a sleepy looking middle-aged
woman. Tom enquired as to whether it was okay to come through. The tenant agreed and opened the
door allowing us to walk inside. Well, I was totally speechless.
The entire unit was covered in wall-to-wall crochet. Truly, it was like someone had placed a thick
rug, like the one your grandma might have knitted, on just about everything — the walls, ceiling,
floor, over the furniture, over the light stand, over the toilet seat … everywhere. The only other object
of any note was a suspicious-looking incense burner on the coffee table with two strange cylindrical
openings … but that’s another story.
Apart from inspecting a few properties as a tenant when Julie and I were looking for a place to live,
I’d had precious little education about what to look for when walking through a potential investment.
Undaunted by my lack of experience, I left the crocheted lounge room — stepping over the crocheted
rug — and ventured into the hallway to inspect the remainder of the apartment. The few visible
fixtures that weren’t covered by crochet were quite basic, and the interior was of very late 1970s
design — right down to the brown kitchen tiles and orange kitchen bench.
In what would become known as our ‘good cop, bad cop routine’, Dave took Tom aside to ask
questions about the sale terms, while I returned to the lounge room and spoke to the tenant, Connie,
who was already smoking her second ‘herbal’ cigarette since we’d arrived.
‘Connie’, I asked. ‘Do you like living here?’
I’ll never forget her response, because it taught me a critical investing lesson. Connie was
thoughtful for a few seconds and then replied, ‘Yeah. I love being here. I love hearing the sound of the
traffic all night long, it helps me to go to sleep’.
Personally I doubted if Connie needed anything to help her sleep since she seemed quite calm as it
was. I don’t know about you, but I’ve lived on a main road before and I vowed never to do it again.
The sound of the cars and trucks didn’t put me to sleep — it kept me wide awake all night! But Connie
didn’t just tolerate the noise, she enjoyed it. This reinforces the lesson I mentioned in the preface that
you buy investment properties for other people — not yourself — to live in.
I didn’t know what else to ask Connie, partly because I was totally speechless. However, after
composing myself I did manage to ascertain that she had lived in the property for a number of years,
and there wasn’t a major problem with crime or hard drugs in the area, although a few of the tenants
had been evicted for disruptive behaviour. When Tom and Dave reappeared, they indicated that it was
time to move on to the next unit. I thanked Connie for allowing us to look through her home and bid
her a good day.
The next unit we inspected was one that Tom hadn’t been through before since this was the unit that
the rowdy tenants had been evicted from a week or so earlier. He warned us that tenants sometimes
leave surprises, but what was in store for us was something completely out of the ordinary. Taking a
key from his trouser pocket, Tom inserted it into the lock and pushed firmly on the door. With a little
pressure it gave way to reveal a very sparse unit. No sign of crochet here — quite the opposite; there
was no carpet, no curtains, no stove, no light globes and no smell. We walked through a small hallway
into a combined lounge and kitchen area. The floorboards were bare timber, revealing that the carpet
had been recently ripped up.
And there it was, in the middle of the lounge room — a homicide-style outline of a life-sized body
that had been spray-painted on the floor. This was the previous tenant’s idea of a parting joke and, I
must confess, Dave and I thought it was pretty funny. Even Tom had a chuckle.
We had a brief look through the rest of the unit, and aside from the spray-painted homicide body
there wasn’t much else to see or note so we moved on to inspecting the exterior of the property. The
carport area where the tenants parked their cars needed repairs, and the grounds were generally
overgrown with long grass and weeds.
Was this a good deal? Was it a diamond in the rough that we could polish up and turn into positive
cashflow? Even though Dave and I didn’t have enough money to pay a deposit, we nevertheless
submitted an offer for about $100 000 less than the asking price. We justified this by saying that we’d
have to spend about this amount of money bringing the property back to its former glory. This offer
was submitted to the vendor but it was rejected because the seller needed full price to settle other
debts.
A few weeks later we learned that the property did sell, to another investor (from Melbourne) who
paid full price sight-unseen on the basis that it provided an excellent negatively geared return.
Not making the same mistake
Tom dropped us back at his office and, sensing that we were serious (perhaps because we submitted an
offer on the spot), he made a more determined effort to sell us something else. He reopened his blue
book of property listings and wrote down several more addresses — this time mainly single family
homes.
He explained that he could only show us through one of the properties as the others were tenanted
and would require 24 hours notice to arrange inspections. Tom offered to drive us out to look at the
property we could inspect, but we didn’t want to risk our lives a second time, so we politely declined.
I suggested that we follow him instead.
It was one of the funniest experiences of my life sitting in the passenger seat as Dave tried to follow
Tom to the property. Instead of driving sedately and making it easy for us to stay on his tail, Tom
seemed to go out of his way to lose us. He’d accelerate through orange lights, make hard right turns
without indicating, and he drove at excessive speeds. Dave did his best and tried to keep up, but to no
avail. It was a good thing that I’d kept the piece of paper Tom had written down the address on, as
well as my trusty map, otherwise there’s no way we could have found the place. When we finally
arrived at the property Tom gave the impression that he’d been waiting around for hours.
We didn’t end up buying any properties through Tom. In fact, a few weeks later we called into his
office only to discover that he’d moved on to another job in a different field of expertise. Perhaps it
was for the best.
The lesson we learned
Dave and I spent the rest of the day with various other real estate agents looking through 14 other
properties located all over Ballarat. While it was time consuming and we didn’t really know what we
were doing, talking face to face with agents and inspecting properties pushed us well beyond our
comfort zones and provided the practical context for us to learn and grow as investors. This
experience was more valuable than any seminar or any book, as there’s simply no substitute for taking
action.
We decided to call it a day at about 4 pm and drove back to Melbourne. Although Dave and I
returned from our first trip without signing any contracts, we had discovered a valuable property
investing lesson: that there was one price for locals and another higher price for investors from out of
town.
By dressing in suits and trying to give a professional image we were, in fact, providing the real
estate agents with a sign that said, ‘These guys are from out of town’. This meant that the asking price
was often inflated since we seemed to have money and didn’t know the market or the value of what we
were buying.
Steve’s investing tip
When you look like you’re from out of town, you will get treated like you’re from out of town, too.
This point was best demonstrated a few months later when Dave and I were sitting in a real estate
agent’s office negotiating to buy three houses from the one vendor. The first question the seller asked
the agent was, ‘Are they wearing suits? People in suits will pay more’. We learned the lesson and
switched our attire to mainly tracksuit pants. Occasionally, if it was going to be really cold, I’d also
wear a beanie.
By the time we arrived home, Dave and I were exhausted. Yet we were also encouraged by our
experience and we agreed to return to Ballarat the following week to keep looking.
Determined to be better prepared the second time around, I spent several hours over the next week
searching for potential deals in the local Ballarat paper and on the internet. I even created a profile of
my ‘ideal’ investment, since a lot of agents needed a specific description of the sort of property I
wanted — apparently our initial answer of ‘anything that’s positive cashflow’ was too vague. The
profile we created was of a three (or more) bedroom home, in a neat and tidy condition, priced at up to
$60 000 that could be expected to rent for about $120 per week.
Steve’s investing tip
The more specific you can be with what you’re looking for, the more chance you have of finding it.
On the morning of our second trip to Ballarat, Dave again dropped by to collect me at a reasonably
early hour so as to avoid the Melbourne peak-hour traffic. This time I met him in more informal
attire — old jeans and a casual t-shirt. Dave wore what became his ‘house-buying pants’ — tracksuit
pants that were well worn after many years of use.
By the time of our first appointment, Dave and I were starting to feel like we knew the Ballarat area
reasonably well — and certainly much, much better than we had on our first visit just one week
earlier. The lesson in all of this is that if you plan to invest in an area that you don’t live in you’ll find
it next to impossible to pick up a feel for properties unless you spend time ‘on the ground’ there
yourself.
Steve’s investing tip
If you don’t know an area like a local, don’t invest there.
The importance of due diligence
After looking through so many properties on our first visit, I knew that unless I implemented a
standard way of inspecting properties there was a huge risk that I’d forget something important. When
you look through multiple properties in an afternoon, unless you have a photographic memory they all
start to blur into one.
To jolt my memory I created a series of templates that ensured every property I inspected was given
the same thorough once-over. It wasn’t a substitute for a proper builder’s report, but it was an
excellent first glance over a property that forced me to pay closer attention to details that I might
otherwise have glossed over or missed entirely. Later I’d come to know that real estate agents are
experts at showing you the things they want you to see, while subtly deflecting your attention away
from potential problem areas. To ensure I was as thorough as possible, I created a two-page ‘tick the
box’ style template (see figures 2.1 and 2.2 on pages 29 and 30), and this allowed me to focus on
issues that might cost thousands to fix if there was a problem.
Figure 2.1: inspection template (page 1)
Figure 2.2: inspection template (page 2)
For example, one property I inspected featured a central heating system that was turned off on the day
of my inspection. When I asked for it to be switched on it sounded like an aeroplane taking off down a
runway. When I looked over the unit it was clearly old and would probably have been difficult to find
parts for. This meant that it was more of a potential problem than a benefit.
Other issues I watch out for include:
old-style wiring (easy to tell by whether or not the fuse box has been rewired)
the condition of the floorboards under the carpet (pull up a corner of the carpet)
illegal sheds out the back (if they don’t have downpipes then they’re probably illegal)
the age of the hot water service (have a look at the compliance plate on the unit).
Whereas the tools of an accountant are a pen and a calculator, the tools a property investor needs are
a spirit level and due diligence templates. While using the template allowed me to identify potential
issues, of equal value was the agent’s perception that I was a serious investor because I used a form
and looked organised with my clipboard and pencil. Apparently, next to no-one else bothered, so I
looked like a veteran when in truth I was just a beginner.
This inflated perception was very valuable at negotiation time. On more than one occasion I
overheard the agent tell the vendor (on the phone) that there was no point trying to eke out a few
thousand dollars extra since the interested buyer was a professional investor.
Meet Micky G
The last agent we were scheduled to meet was Michael Golding, or Micky G as we later affectionately
called him. Micky G is a great guy — a real character and a true country lad.
Michael is a smart agent. I’m not sure whether he’d ever admit it, but I’m certain he used a trick
right out of the agent’s ‘How to Sell Property’ manual the first time he met us. The trick is simple;
show the purchaser through a few houses which you know are not suitable and then, like magic,
present the most appealing house as the final property on the inspection list.
It was late afternoon when Mick drove us into West Wendouree — the area the waiter in the cafe on
our first trip had warned us to stay away from. ‘It’s a rough area’, he’d said, and judging by the look
of some of the houses and a few of the people walking the streets, that was no exaggeration!
Steve’s investing tip
If you want to find out more about the due diligence templates I use (which can potentially save you thousands of dollars)
then please visit <www.PropertyInvesting.com/HomeInspectionSpy>.
There were several upcoming auctions of Ministry of Housing properties to be held by Michael’s
agency and he had the keys to show us through many of the houses. We began by looking through
some properties in Violet Grove, a particularly rough part of West Wendouree that was apparently
dubbed ‘Violent Grove’ — perhaps a fair title judging by the disaster of a place we inspected first.
Micky G simply opened the door and said, ‘I’ll let you boys wander through this one by
yourself — just watch out for holes in the floorboards’.
Most ex-commission properties have a similar layout. Built after the end of World War II, they were
constructed offsite and trucked in as two rectangular halves and then joined together. There’s not a lot
of architectural finesse, but they’re solid homes that are built to last.
Anyway, the first ex-commission house that we looked through made the unit with the spray-painted
homicide body on the floor look like a palace. There was thick black graffiti on the walls, the entire
kitchen was burnt out, and where the stove once stood there were blackened walls and small clumps of
charcoal — evidence of a small fire close to where the gas pipe came up to service the stove. As Dave
and I walked around the house we noted that many floorboards were missing and any chattels of worth
had been either vandalised or ripped out. Most of the walls had several holes where someone had
punched into them and there was a constant smell of stale urine emanating from the half-intact carpet.
In all respects this house was a disgrace, but Micky G was optimistically cheerful, winking at me
while he told Dave that the property was ‘a renovator’s delight if ever he’d seen one’.
Our first deal
Things were looking grim as the sun started to set on another day in Ballarat. We had been through
three more houses and there was only one more property that Michael had us down to
inspect — another ex-commission house in The West. Our prospects weren’t looking good if the
hovels we’d inspected so far were any indication of what was to come.
As we drove to our final inspection Mick said, ‘This one’s different to the others we’ve just been
through. It’s been privately owned for several years and is in good condition’.
In fading light, Micky G, Dave and I walked up and knocked on the front door. Despite the generally
positive external appearance of the place, I left my clipboard and evaluation form in the car, having
long since abandoned the idea of buying a property in this area.
If the exterior of the property was well kept, then the interior was immaculate with a real homely
feel about it. While I raced back to the car to get my clipboard, Dave started to quiz Mick about the
house.
It turned out the owners, who were watching television as we completed our inspection, were a
retired couple who needed to sell due to poor health. Interestingly, the property had been almost sold
twice before (for $54 000 and $52 000), however both times the sale had fallen over because the
purchasers couldn’t secure finance. With the owners now becoming more determined to sell, they had
dropped the asking price to ‘offers above $50 000’.
As I completed my due diligence form it was clear that the property didn’t need any money spent on
it to make it appealing to a future tenant. Dave asked Michael to estimate how much it would rent for,
and he replied ‘at least $110 per week’.
Doing some quick calculations in our heads, Dave and I knew that, finally, we’d found the sort of
property we were looking for. We thanked the owners for allowing us to tramp through their home
before walking out the door and through the front gate with Micky G in step behind us.
‘Well boys,’ Mick said, ‘what do you think? Is this the sort of thing you’re after?’
As the last rays of afternoon sun touched the nature strip, Dave and I requested a few minutes to talk
it over in private. We both quickly agreed that this house was exactly the sort of property we wanted,
but how much should we offer? Without any science or method, we just pulled a number out of the air.
Returning to Mick, who had walked a dozen or so paces further down the nature strip, I said, ‘We’d
like to submit an offer of $40 000’.
Michael smiled as he replied that he’d submit the offer immediately, although he wasn’t sure
whether or not it would be accepted since it was a little on the low side. My heart was thump-thumpthumping as Dave and I waited by the car while Micky G disappeared inside to put our offer to the
owners.
Dave and I used the time while Mick was inside to chat about what we’d do if our offer was rejected.
We concluded that we were happy to go a few thousand higher, but we agreed to wait and see what the
agent came back with before upping our offer.
Micky G returned a few minutes later. ‘They won’t go below $48k guys’, he countered with a
concerned look on his face. We were now at the final stages of negotiating. Dave and I again moved
away for a few moments to confirm our next step. When we rejoined Mick on the nature strip, this
time Dave (bad cop) spoke. ‘All right. Last offer. We’ll meet you half way at $44 000.’
Although this was less than the figure that Mick had said was the minimum the vendors would
accept, he went back inside with a hopeful look upon his face. After what seemed an eternity but was
in fact about five minutes, Mick came back outside and said, ‘It’s a deal’. We’d bought our first
property!
The following tables give the figures for the deal. Even if you struggle with numbers, it would be
wise to spend a minute or two becoming familiar with tables 2.1 and 2.2. I’ve included extra detail so
you can see the sorts of additional costs you’ll pay, as well as how I crunch the numbers to calculate
the return.
Table 2.1: purchaser’s settlement statement
To: Purchase price
$44000.00
To: Purchaser’s solicitor costs & disbursements (current bill)
$375.55
To: Purchaser’s solicitor costs & disbursements (prior bill)
$200.00
To: Bank cheque fees
$18.00
To: Rate adjustment
$14.46
To: Stamp duty fee - transfer
$856.00
To: Titles office fee - transfer
$204.00
To: Misc. transaction charges
$36.77
By: Deposit paid
$4400.00
By: Balance required to settle:
$41304.78
Total:
$45704.78 $45704.78
Table 2.2: return calculation
Purchase price
$44 000
Initial cash spent to acquire the deal
Deposit (20%)
$8 800
Closing costs
$1 705
Loan establishment
$714
Initial cash needed
$11 219
Our loan
Principal
$35 200
Type
Principal & interest
Term
25 years
Initial interest rate
8.05%
Weekly repayment
$62.82
Annual cashflow received
Rent per week
$120
Annual cashflow received $6 240
Annual cashflow out
Loan repayment
$3 267
Management costs
$840
Rates
$690
Insurance
$200
Repairs budget
$200
Total cashflow out
$5 197
Annual net cashflow
$1 043
Cash-on-cash return
Annual net cashflow
$1 043
÷ Initial cash needed
$11 219
Cash-on-cash return
9.30%
We also had to contribute a further $713.80 in mortgage application, legal and registration costs,
together with another $4400 as a deposit since we were only borrowing 80 per cent of the purchase
price. Our cash-on-cash return is shown in table 2.2.
The car ride home
Eureka! In partnership with Dave Bradley, I’d finally bought my first investment property. Had you
met us that afternoon you might have mistaken us for investors who had just negotiated a $44 million
deal, rather than a $44 000 property in the backblocks of Ballarat. There was no shortage of high fives
and talk about how easy it was to find good opportunities. Sure, we’d spent two full days looking for
the property, but now we’d found one, others were sure to follow.
IT’S ALL ABOUT APPLICATION
Property investing is a lot like a rollercoaster in a fun park — there are lots of highs and lows. You
also meet all sorts of characters spruiking for your business.
My hope in sharing the story of my first property purchase is that it demonstrates just how hard it is
to make a start. You’re kidding yourself if you think you’re just going to call an agent and find the
deal of a lifetime. However, as one opportunity comes to a dead end, another opens. For example, it’s
common that the property you are most interested in doesn’t quite stack up, but in the course of
driving around or chatting with agents a better deal appears.
Steve’s investing tip
Failing to try means you’re trying to fail.
I’m willing to bet that the main reason you can’t find great property deals is because you’re too busy
not looking for them. Your financial future is worth a hundred times more than the inconvenience of
looking like a fool or trying something new.
CHAPTER 2 INSIGHTS
Insight #1
You’ll only ever do your first deal once. From then, as your experience broadens, you’ll become more and more
confident in dealing with agents, inspecting property and making offers. It’s nowhere near as scary the second time
around.
Insight #2
A good place to start is to create a profile of your ideal property. I’ll show you how in chapter 22.
Insight #3
Time is your most valuable asset, so look for ways to leverage it wherever possible. There are just so many properties for
sale that you need to establish ground rules to enable you to distinguish a good deal from a bad deal.
Insight #4
Find an area where you’d like to invest and then take the time to visit. There is no substitute for getting to know an area
personally. And remember, if you want to be treated like a local, look like a local.
Insight #5
If you’re planning to get serious about your property investing then using templates will save you time and help ensure
you don’t make an expensive oversight. The templates I recommend can be purchased at
<www.PropertyInvesting.com/HomeInspectionSpy>.
Insight #6
The world of property investing is full of surprises. Enjoy the experience.
Insight #7
Never get into a car with someone called Tom who was working as a real estate agent in Ballarat in May 1999. There are
bad drivers, really bad drivers, and then there’s Tom.
Book bonus
Upon registering your copy of this book at <www.PropertyInvesting.com>, you’ll be able to download the property
inspection template for free.
3
Ramping it up
I have some good news — you don’t need to own hundreds of properties to be financially free. As I’ll
reveal later in the book, all you need to do is own a couple of the right types of properties debt free
and you’ll never have to work again.
However, before I outline the best way to build a multi-property portfolio in today’s real estate
market, let me answer a question that you might be thinking: ‘How on earth did you manage to buy
130 properties in just 3.5 years?’
A CHANCE MEETING WITH A FRIENDLY CANADIAN
Shortly after Dave and I bought our first investment property, my wife and I headed overseas to
Vancouver, Canada on a delayed honeymoon.
While the main attraction was a two-week camping and hiking trek in The Rockies, I’d somehow
convinced Julie that we should also attend a three-day ‘Direct Marketing Mastermind Conference’.
During one of the breaks at the conference, I met and chatted with another attendee, an older
gentleman named Chuck. I’ll never know why Chuck took me into his confidence, but once he found
out that I’d just bought my first investment property his manner relaxed and he enthusiastically told
me about a unique way he was using real estate to make a lot of money.
Steve’s investing tip
Networking with other real estate investors is one of the best, and cheapest, ways to learn.
What Chuck did was buy properties (let’s say he bought one for $100 000) and then resold the
dwellings to people who wanted a home but couldn’t qualify for traditional finance. When selling the
property, Chuck would increase the sales price a little (let’s say he’d add on an extra $20 000), and at
the same time he would lend the purchaser the sales price, less any deposit paid, at a slightly higher
interest rate than what he paid on his mortgage (let’s say an extra 2 per cent). In summary, Chuck was
selling properties and receiving a series of periodic repayments rather than a lump-sum cash
settlement.
I distinctly remember calling Dave that night to tell him about Chuck’s novel approach to investing,
yet before I could get a word in Dave excitedly told me how he’d received a call from Micky G saying
he had a buyer willing to pay $54 000 to purchase our West Wendouree property. If we accepted, we’d
make a quick $5000 net profit — not bad for a couple of weeks work.
‘That’s great Dave’, I replied. ‘But I’ve just learned of a strategy that might make us even more
money, and I think we should give it a go’.
After explaining Chuck’s strategy, we agreed this new approach was worth a shot. In the meantime,
our West Wendouree investment property had been rented back to the vendors on a short-term lease
because they needed extra time to move out.
A few days after arriving home I sat down with my solicitor and animatedly outlined the concept
Chuck had told me about in Canada. ‘Could the same thing be done here?’ I asked.
Smiling, my trusty legal adviser said not only could it be done but it had actually been done for well
over 100 years. In Australia it was called a ‘vendor’s terms’ sale.
‘Is it hard to do?’ I asked.
‘No. It’s quite straightforward’, my solicitor replied. ‘Just some extra disclosure, such as
incorporating the terms of your vendor’s finance in the special conditions.’
Thinking creatively
Secure with the knowledge that it could be done, both theoretically and legally, the challenge before
me was to work out the practical steps needed to put a deal together.
Thinking through the variables of a vendor’s terms sale, the prerequisites were:
1 A vendor willing to accept a sale on terms.
2 A house to sell.
3 A buyer who wanted to purchase using vendor’s terms.
I had items 1 and 2, all I needed was a buyer who wanted to purchase via vendor’s terms.
Having no-one in mind, I decided to put the skills I’d learned at the direct marketing conference to
good use and draft up a classified ad to be placed in the ‘For Sale’ section of the local paper (The
Ballarat Courier). At a cost of about $70, the ad I submitted is shown on the following page.
I’d like to tell you that I received hundreds of phone calls that day but I didn’t, I only received one
from a guy called John, who wanted to know how I could help with the finance. We arranged to meet
up later that day, and after I’d shown John through the property, he liked what he saw.
---------Finally, A Family Home That’s Warm, Affordable and Convenient
Relax with the family in this WARM and well-maintained 3Br family home. Enjoy the quiet yet convenient location by
walking to shops, schools, bus and parks. Sunny lounge area with gas heater, tidy kitchen, spacious bathroom (sep. bath and
shower) and enormous backyard. Owner can help with finance.
Call Steve today on [mobile].
----------
I only wanted to do this deal if it would result in a win–win outcome in the form of a profit for us
and a house for John at around the same dollar repayments as what he’d otherwise pay to rent the
property. John’s main issue was that he had a good income but he lacked a deposit. To get around this
issue we agreed to make his repayments slightly higher in the first year, and then reduce them in the
years thereafter.
By selling on vendor’s terms I was able to increase our weekly cashflow from $20 per week (on the
basis that it was rented) to $234.92 per week in the first year and then $125.19 in the second year and
thereafter (on the basis the property was sold on vendor’s finance). Clearly, the vendor’s finance
option provided a much better cashflow return. A summary of the numbers is provided in table 3.1.
Table 3.1: our vendor’s terms sale
TURNING AN IDEA INTO AN INVESTING SYSTEM
Once the legals were finalised, John paid his $1000 deposit and moved in. Encouraged by how well the
transaction had gone, we decided to further refine our strategy in two important ways:
Require higher downpayments so more of our initial deposit would be recovered.
Advertise for clients in advance and empower them to find a house they’d like to call home,
which we would then buy on their behalf and resell to them on vendor’s terms.
The first step certainly helped maximise our buying potential, but the effect of empowering others
to find houses was extraordinary. Instead of us spending hours and hours trying to find suitable
properties, we prequalified potential clients to find houses that they could afford and wanted to live in
as a home. Soon we had a long list of potential clients scouring the countryside, and, once they had
found a property, we would negotiate to buy it and then on-sell it to them.
We prioritised our purchases based on those who could leave the biggest deposits. In many cases we
were able to buy properties for a net cash outlay of $2000 — and sometimes even less.
Dave and I came to an agreement with our wives that we would live meagre lifestyles so that every
available cent we made would be ploughed back into buying property. This included all our business
profits, plus equity Dave refinanced from his home and an inheritance I’d received.
Within six months we had created and refined a good investing system where we would sign a
contract to buy a property leaving the lowest deposit possible (often just $1000), arrange all the legal
paperwork for our vendor’s finance sale during the settlement period, and then in the week following
our purchase, sell and receive the deposit back from the vendor’s finance purchaser.
By cleverly staggering the purchase and sale dates, we were able to buy a lot of property with only a
relatively small amount of capital. Every sale represented another trickle of cashflow, and before long
the trickles became a stream.
An unexpected boost
With a reliable source of cashflow secured, I was able to achieve my goal of giving up work as an
accountant and becoming a full-time investor. Dave was happy to continue servicing his clients,
though, which was important because we needed to demonstrate a healthy source of non-investment
income in order to be able to keep borrowing to buy more real estate.
Then, in early 2000, something happened that was to have a dramatic and profound impact on our
investing futures. In conjunction with the introduction of the GST, the Howard government announced
a new $7000 incentive called the First Home Owner Grant, but it did not come into existence until 1
July. In response, a large number of would-be buyers made the decision to hold off purchasing until
after the grant came in. However, people still needed to sell their homes and, given there were fewer
buyers, had to accept lower prices.
Sensing a once-in-a-lifetime-opportunity, Dave and I bought as much property as we could, with the
lowest possible deposits (now as little as $200), and with settlement dates after the grant came into
effect. It was a risk, but we (correctly, it turned out) thought that once the grant was introduced the
number of people interested in buying property would increase dramatically, as would property values
because now there would be more buyers than sellers. Our aggressive buying practice made us
$500 000 in only a few months, and much more down the track.
Once the grant came into effect, first home buyers using vendor finance now had an extra $7000 on
top of their savings to leave as a deposit, and, you guessed it, this meant that we could recoup most, if
not all, of the money we had committed as part of our aggressive expansion strategy. Our cashflow
stream turned into a raging torrent.
Irrespective of whether you think we were clever, opportunistic or just plain lucky with our timing,
one thing is for sure — we made a lot of money by coming up with win–win solutions for people who
wanted to escape the rental trap and own their own home but weren’t able to qualify for traditional
finance.
Steve’s investing tip
The best way to make money in real estate is to buy problems and sell solutions.
AN URGENT SHIFT IN FOCUS
Although the introduction of the First Home Owner Grant was a huge help, before long it also caused
some unexpected hassles that forced us to rethink this investment strategy. Given prices had risen so
quickly, we were finding it harder to purchase properties because:
To avoid mortgage insurance, we only borrowed a maximum of 80 per cent of the purchase price,
and higher prices meant we needed more investing capital.
The property market was hotting up and it was getting harder to negotiate discounts on the asking
price, as well as convincing agents it was okay to leave small deposits.
Higher prices meant that we were finding it harder to keep the vendor’s finance repayments as
near as possible to what would otherwise be paid to rent the property.
Lenders were becoming more flexible with their loan products, and whereas once some of our
vendor’s finance purchasers weren’t able to qualify for finance, now they could and they were
refinancing us out. This resulted in a nice cash payout, but it also eliminated part of our ongoing
cashflow.
As the year 2000 drew to a close, it was becoming increasingly obvious that our golden era of
vendor’s finance was coming to an end, and that we needed to find other avenues to profit. That’s
when we shifted focus to buying blocks of units — first of all in regional Victorian towns, and then
later in Tasmania. What we found was that although finding positive cashflow rental houses was
proving as hard as ever, multi-unit complexes (also known as ‘plexes’) were a previously unexplored
investment frontier.
It was apparent that the rents on houses did not increase at the same rate as their value appreciated.
For example, a house that was worth $60 000 and rented for $150 per week (a 13 per cent return)
before the First Home Owner Grant was worth $85 000 and rented for $160 per week (a 9.8 per cent
return) in early 2001.
On the other hand, because first home owners were not interested in buying blocks of units and the
higher prices of homes had not yet filtered through the wider property market, you could still
occasionally find multi-unit complexes that offered positive cashflow returns.
We started buying four-, six- and eight-unit complexes for between $200 000 and $400 000, and the
rents were around $100 per week per unit. Although we needed more money to pay for the bigger
deposits, in addition to our accounting fees enough vendor finance deals refinanced to provide the
extra capital required.
It did get hairy on occasion though. Sometimes we’d have a property settlement looming and not
enough money in the bank to complete the transaction. We’d scrimp and save though and somehow
get through.
It was more luck than design, but before long the boom in homes filtered through to all forms of real
estate, and the blocks of units that we’d bought appreciated significantly in value — in some cases an
incredible 50 per cent within 12 months.
As opportunities presented, we started buying high-yielding positive cashflow commercial property
too. A particularly good deal we bought was a large shed/workshop in Launceston.
With time on my hands one afternoon, I went shopping for property by looking at the
advertisements in real estate agents’ windows. You might find it surprising, but not all properties have
‘For Sale’ boards out the front, or are advertised in the paper. In some cases the vendor wants a quiet
sale, and in other situations the seller has exhausted his or her marketing budget without attracting a
buyer and only low-budget options (like leaving an ad in a window) remain. This was such a deal.
The ad that caught my attention read as follows:
---------Industrial property comprising 8,594 sq. metre land area with newer 600 sq. metre warehouse/workshop building all
fully leased to a secure tenant
Six-year lease plus a further five-year option Current rent $20,800, rising to $22,100 after the next rent adjustment due in two
months Council Rates and Land Tax paid by the tenant
For Sale at $160,000 13.8% Return Warehouse Investment
----------
Bingo! This was just the sort of property I was looking for because I could tell the return was high
enough, and the price low enough, to guarantee I’d make money from day one. I made an offer of
$155 000, which was accepted, and I became the new owner of a warehouse. Table 3.2 (overleaf)
shows a summary of the preliminary numbers.
Table 3.2: warehouse investment preliminary figures
Item
Amount
Purchase price
$155 000
Notes
Closing costs (stamp duty, etc.) $7 750
Allow 5% for closing costs
Deposit
$46 500
Most commercial loans are a maximum lend of 70% of the purchase price
Cash needed
$54 250
Deposit of $46 500 plus closing costs of $7 750
Rent
$22 100
Annual loan payments
($7 595) Loan of $108 500, 10-year interest-only term, weekly repayments, 7% interest
Repairs budget
($1 105) Assume 5% of rent
Positive cashflow
$13 400
Income (cash-on-cash returns) 24.7%
And that’s before any capital gains!
NEW ZEALAND — HERE WE COME
New Zealand came up on our radar as a land of positive cashflow properties, and so Dave and I
decided to take a trip across the pond and scout out new opportunities.
If there is a land of milk and money for property investors, New Zealand is it. There is no stamp
duty or capital gains tax, and generally speaking the yields are far better than in Australia. But that’s
not to say there are positive cashflow properties on every street corner.
Using the internet, we focused our attention on two areas on the North Island, Huntley and Tokoroa,
because the houses were cheap and rents were high. In many ways it was like winding the clock back
to May 1999 and returning to West Wendouree, only this time with more money. We had been
systematically cashing up our unit complexes on the basis of receiving what we thought were
ridiculously high offers.
To say we went crazy is an understatement. In one afternoon we put offers in on about 80 houses,
and ended up buying 60 of them. The agents couldn’t believe their luck, our stupidity, or both. I’ll
never forget it — one particular agent from Tokoroa asked, ‘Do you guys know something we don’t?’
We shrugged our shoulders and winked, not wanting to give anything away.
If you’re wondering how cheap the properties were, the lowest price we paid was $28 000 for a twobedroom property in Lanark Street that received rent of $120 per week.
Rather than vendor finance the properties, we simply rented them out. And guess what; just like in
West Wendouree, before long those so-called cheap and nasty houses started to appreciate in value.
Within a year we had doubled our money.
MULTIPLICATION BY DIVISION
So, how did we buy so many properties in such quick time? Well, through a combination of
determination, strategy and old-fashioned good timing. We bought the right properties, at the right
time, and held them until we could do something better with the money, at which time we sold and
reinvested elsewhere.
I call the strategy ‘multiplication by division’. Crudely speaking, we bought a property for $50 000,
and when its value had appreciated to $100 000, we sold and bought two more $50 000 houses in
another location. When those properties appreciated to $100 000 each, we sold them and bought four
houses in another location. And so it went, first buying houses in Ballarat and the La Trobe Valley,
then blocks of units in Victoria, Tasmania and Queensland, and then finally houses in New Zealand.
There’s no doubt about it, we were lucky to time our purchases during an unprecedented boom in
property values. But then again, I wasn’t feeling all that lucky renting when my friends owned their
homes, or all that lucky when I was told I was a fool for walking away from a high-paying career.
Steve’s investing tip
Luck is something that happens when the right opportunity and the right time collide.
The truth is we were in the right place at the right time, and used the right strategy to solve housing
problems in a cost-effective way. I wouldn’t say we were smart but rather opportunistic. All in all, it
was hard, but it sure beat working in a job, and the pay was a lot better too!
THE CURRENT ENVIRONMENT
You couldn’t do what we did again today because you’d be hard pressed to buy a decent threebedroom property anywhere in Australia for under $80 000. The opportunity to buy cheap positive
cashflow properties has gone, probably forever.
However, before you curse this book and go and watch some mind-numbing TV show, the economy
is always shifting, and new opportunities are emerging monthly, if not weekly. The global financial
crisis is an excellent case in point. Talk about putting the cat among the financial pigeons!
Many people were waiting for a buyer’s market, when prices were soft and you could easily
negotiate a great deal. Then, when it arrived, investors locked away their chequebooks and sulked in a
corner wishing that the good times would return.
While real estate values didn’t collapse like share prices, the dramatic drop in interest rates without
a similar fall in rents meant that positive cashflow properties were back again.
Furthermore, those who had heeded my recommendations about cashing up were perfectly
positioned to negotiate huge discounts on property from vendors who had to sell to cover losses in
other parts of their asset portfolios.
Steve’s investing tip
Opportunity always exists for those seeking it, but the nature of it changes with the mood of the market.
A home purchased by a friend of mine is a perfect example. In July 2008 the house was put up for
auction, only to be passed in. It was still on the market in September as the vendors were hoping for a
rather optimistic $1.8 million. My friend’s initial offer of $1.41 million was rejected. Two months
later the agent called him to see if he was still interested. He was, but his offer fell to a cheeky $1.39
million. The vendors, who had bought property interstate and now needed to sell, finally agreed. As
the economy started to recover, buyers returned, and within six months my friend’s house had
increased in value and was worth at least $1.8 million. Was he lucky? Perhaps, but I’d say he was
cashed up at the right time, and was in the right place to snag a bargain.
HOW TO CREATE A MULTI-PROPERTY PORTFOLIO TODAY
The secret to creating a multi-property portfolio is to use a model that’s profitable, scalable and
sustainable.
Profitable
You might find this shocking, but not everyone who invests in real estate wants an immediate profit.
As explained in chapter 6, some investors are convinced that it’s a good idea to make a loss in order to
reduce the amount of income tax they pay.
Steve’s investing tip
Your goal should be to make money, not save tax.
While I don’t want to pay more than my fair share, I regard paying tax as a by-product of successful
investing. If you’re bragging about how much tax you’ve saved because your properties have lost
money, it’s time to seriously re-evaluate your investing goals.
How many properties could you afford that lose money? For most people it’s one, perhaps two, and
in the best case scenario, three. The point is that there are only a finite number of hungry cashflowmunching negative cashflow properties you can own before you start starving yourself of the money
needed to live a decent lifestyle.
Are the properties you own making money? If you don’t know how to tell then you’ll find my
template on page 56 very helpful. I created it as part of the RESULTS mentoring program, and it is
useful because it helps you to evaluate the profitability per property, and across your portfolio as a
whole.
Book bonus
Upon registering your copy of this book at <www.PropertyInvesting.com>, you’ll be able to download your own free copy of
this template, get instructions on how to use it, and watch a video where I explain how to interpret the results.
Scalable
Unless you have access to a lot of cash, it’s unlikely that you’ll be able to purchase enough debt-free
property to quit work and retire into a life of luxury. As outlined in table 3.3, it’s more realistic that
you will need to transition through three phases.
Table 3.3: three phases to financial freedom
Maintain regular employment and build your savings by spending less than you earn.
Use savings and debt to purchase real estate using quick-cash strategies to make lump-sum gains. As
your skill and funds allow, undertake multiple transactions to multiply your investing kitty as fast as
possible.
Use your savings and investing kitty to purchase debt-free commercial property, the income from which
you use to replace your salary and finance your financial freedom.
Sustainable
Sooner or later, most investors are unable to buy more property because they run out of cash to use as
deposits and/or can’t borrow any more money. However, this can be solved by:
Maintaining a reliable source of non-investment income. Just as an army will quickly perish if its
supply lines are cut off, a property investor will be in dire straits if his or her main source of
regular income is severed.
Even if keeping your job is not part of your long-term plans, you will still need your paycheque
while you buy property to demonstrate to lenders that you have the ability to repay the loan.
Having access to ongoing funding. It’s important to have a plan for how you are going to use your
savings, equity and debt to buy as much property as possible, and to have strategies for how you
will keep investing once your own funds run out. Chapter 8 provides you with guidance on how to
maximise your borrowing ability.
Buying property in an appropriate accounting structure. It’s a bad idea to purchase investment
property in your own name because your assets are at unnecessary risk, you’ll potentially pay
income tax at the highest possible rate and you’ll experience restrictions on your ability to
consistently borrow more money.
In chapter 9 I outline and explain the accounting structure I use. I suggest you discuss with your
accountant whether it would be suitable for you too.
The secret to me being able to acquire so many properties so quickly was to use an investing system
that evolved as the property market changed, but kept at its core the need to be profitable, scalable and
sustainable.
If you hope to buy multiple properties you’ll find it difficult, but not impossible. For instance, one
study estimated that as few as 3.6 per cent of all investors owned five or more properties.1 This just
goes to show that success comes from doing things differently.
CHAPTER 3 INSIGHTS
Insight #1
To own a multi-property portfolio you will need to use an investing system that is profitable, scalable and sustainable.
Insight #2
If your old investing strategies aren’t as effective or profitable as they were, then you haven’t evolved as the property
market changed. Don’t risk becoming an investing dinosaur; rethink your approach now or else your ongoing profits
risk extinction.
Insight #3
If you are planning on using real estate to become financially free you’ll need to transition through three phases: The
Saver, Quick Cash and Cashflow.
Insight #4
I highly recommend networking with other investors. A free and easy way you can do this is via the forum boards at
<www.PropertyInvesting.com>. I’m on there regularly and am happy to answer questions when time permits.
Note
1 Rental for Investment: A Study of Landlords in NSW, Department of Housing, Research and Policy
Paper No. 3, 1990.
4
Achieving financial freedom
How will your life change once you become financially free? Will you quit work? Sleep in every day
for a month? Buy that luxury thingamabob you’ve always wanted? You’ll certainly be able to do that,
and much, much more.
However, after you’ve played golf until your arms hurt, or had so many pedicures that your toenails
sparkle, what next? What will you do with your newfound freedom that’s purposeful, meaningful and
leaves others touched, moved and inspired?
WILL YOU BE HAPPIER?
I was running a seminar in Sydney when, during one of the breaks, I was approached by a middle-aged
guy who sought my advice about an unusual predicament.
He’d read the first edition of this book, and then applied it by buying enough positive cashflow
properties in Mount Isa to build an income that allowed him to quit his job and never have to work
again.
Congratulating him on his success, I’ll never forget his reply. Offering a smile devoid of any joy, he
asked, ‘Now what do I do?’
It turned out this super-successful investor was extremely lonely during the day because he had noone else to play with; he lived in a regional community and all his friends worked. He had the freedom
to do whatever he wanted, but no-one to share it with.
Our culture places a lot of emphasis on the need to have money to live a happy life. This is an
illusion. Rich people have just as many problems as poor people, they just get to be miserable wearing
better clothes and upset while driving nicer cars.
Being financially free won’t in itself make you happier, however it will empower you with the time
and money to be able to pursue the activities and causes you are most passionate about.
Steve’s investing tip
Money assumes the character of the person using it.
If all you’re concerned about is your own wellbeing, then you’ll never taste the true joy of what
being financially free really means, and how you can use it to enrich your life by touching the lives of
others.
A DAY IN THE LIFE OF STEVE
From time to time I receive interesting emails from people who ask to spend a day following me
around to watch and learn first-hand from what I do. They must think I live an exciting James Bond
kind of life. They are mistaken.
I spend my time following three passions: my faith (I’m a born again Christian), my family and my
fortune.
My faith
I grew up in a Christian home where mum made us go to church, and although I would have called
myself a Christian, the truth is that I had knowledge of, but no relationship with, God.
When I was about 14 mum said I was old enough to make up my own mind about whether or not I
went to church, which to me was like a red rag to a bull to never attend another Sunday service again.
Things started to change though as I made more and more money from real estate. Instead of feeling
satisfied, I felt increasingly disillusioned because if all there was to life was making money, I’d
figured out how to win at quite an early age. Surely there had to be something else. Around that time I
found an old Bible on my bookshelf and thought I’d read it to see if the answer I was looking for was
inside.
Thinking the Bible was like a novel and the best way to read it was from cover to cover, I started at
page one. Before long I started to struggle, became sidetracked and lost interest.
However, around the same time I happened to engage Allan, a graphic designer, to do some artwork
for a product I was working on, and before long I learned that Allan was an ex-pastor. Confiding in
him about how hard I was finding it to read the Bible, Allan gave me the same look a headmaster
gives a student who ought to know better, and said, ‘Steve, the Bible is a collection of books written
by different people over thousands of years, not the latest John Grisham thriller. You need to study the
Bible rather than read it, as there are all sorts of contexts and connotations you can easily miss’.
Hello! Why didn’t anyone ever tell me this secret?
Taking me under his wing, Allan invited my wife and me to his house, and each Thursday night for a
year we’d read a passage from the Bible and talk about its relevance then and now. I had heaps of
questions, so we didn’t get very far — just the book of Matthew — but it didn’t matter. For the first
time in my life I understood what it meant to have faith, and although I didn’t have much, it was
enough for me to acknowledge that I wasn’t pond scum with legs, rather a person created for a
purpose. Better yet, the thing that created me wanted to have a one-on-one relationship.
Since that date my faith has multiplied. I’m far from perfect, but as a guide I try to apply the
teachings of Jesus in the way I live my life. One way I do this is to see my wealth as a responsibility
rather than a right.
Besides being active in my church community, I’m committed to applying a biblical model in my
life and this means I take an eternal viewpoint rather than living for the here and now.
My family
My family are a very high priority.
Most mornings I wake up around 7 am and go for a 50-minute walk, come home, eat some breakfast
and then walk my girls to school. After spending time reading my Bible and praying, I’ll hop into my
Nissan Maxima and drive the short distance to the PropertyInvesting.com office.
Between about 10 am and 3 pm, I split my time between managing my investments, looking for new
deals and helping investors via the products and services offered through the PropertyInvesting.com
website. I leave work just after 3 pm to get home in time to walk up to school to pick up the kids.
Once we get home we’ll have a play (oh how I loathe dressing up as a fairy, but the things you
do … ), practise reading and maths, then it’s time for bath, dinner, book and bed. My wife chooses to
split her time between being a full-time mum and being available to do volunteer work. As you can
see, it’s not exactly lifestyles of the rich and famous, but it’s the lifestyle I dreamed of living.
Financial freedom for me was never about toys or trinkets, but rather flexibility and family fun.
My fortune
It’s been a journey to reconcile being wealthy with being a Christian, but I’ve come to understand that
it’s the love of money, rather than money itself, that God hates.
Jesus said, ‘To whom much is given, much is required’, and I try to apply this message by being
ethical with how I make the money and wise with the way it’s spent, remembering that I’m ultimately
accountable and there are eternal consequences for whatever decisions I make.
Aside from the intellectual stimulation of investing, I continue to buy real estate as a way of making
money in order to fund my family’s needs, as well as the causes and charities I support.
You might be surprised to learn this, but I don’t hoard money or squirrel it away. I believe that
living by faith means trusting that God will provide, and so rather than having millions tucked away in
offshore bank accounts, I keep sufficient reserves to make ends meet and look to be generous with the
rest.
For example, 100 per cent of the royalties from this book are given to the Bradley McKnight
Foundation — a prescribed private fund Dave Bradley and I set up in 2004. Today there are enough
assets in the Foundation to give away around $100 000 each year to charities supporting children from
disadvantaged backgrounds.
How we came to set up the Foundation is an interesting story. In the early days when Dave and I
were buying cheap houses in Ballarat and the La Trobe Valley, we would sometimes do our initial
house inspection on a potential purchase while the tenant was home.
More often than we care to remember, houses would have a vile stench — a mixture of alcohol,
vomit, cigarettes and poo. As we did our inspection, mum would be on the couch smoking, dad
drinking and the baby in the cot crying. To some extent the parents had a choice, but the child didn’t.
We never forgot that sorry situation but at the time didn’t know what to do about it.
That changed though after the first edition of this book was released. Although my goal in writing
was never to earn a profit, the sales were extraordinary and before long the amount on the royalty
cheques started to get bigger and bigger.
Rather than pocketing an unexpected profit, Dave and I agreed to channel the funds back to worthy
causes. As we talked and prayed about where to donate the money, we discovered prescribed private
funds (PPFs). Using a PPF, we could donate the royalty money, control how the money was invested
and then give away the income to bona fide charities we supported. Thinking about the charities we
wanted to support, we remembered the kids in the cots and realised that we could now do something
for those who fell through the cracks in the system.
To me it’s the ultimate win–win–win situation. You win because you read this book and find out
more about investing. I win because I’m helping and contributing. And then many disadvantaged
people win who would probably never even contemplate investing in real estate, because the royalty I
receive is invested on their behalf and they receive an income from it.
To date, causes the Bradley McKnight Foundation has supported include:
paying for presents for children in housing commission flats who would otherwise go without
gifts at Christmas
providing mentoring and housing assistance for kids who want to get off the street and start again
funding self-esteem-building endeavours such as music and dance lessons, sporting festivals and
community gatherings
paying for shipping so that second-hand library books, sporting equipment and other items can be
gathered and redistributed to needy children in schools without any equipment at all
helping families of deaf children meet the cost of moving to Melbourne so their kids can receive
specialist education
providing expert care and schooling for children with mental disabilities
providing financial support so that kids can get the clothing, books and supplies necessary to start
and remain in school
financing the upgrading of equipment so that charities can reach more people and be more
effective.
And much, much more …
You should feel just as proud as I do about this, because it’s a team effort. Without your support
there wouldn’t be a royalty, and without the royalty I wouldn’t be able to help fund such important
needs in the community. As I said, it’s a great win–win–win outcome.
DAVE AND STEVE PART WAYS
Dave and I have been through a lot together, both personally and professionally. Aside from being
business partners, we’d been at each other’s weddings, supported each other as our children were born
and were roommates on many overseas trips to buy property or attend seminars.
While we were successful and enjoyed each other’s company, we were very different personalities.
One of our strengths was the way we talked through problems, and you always knew a difficult chat
was coming when one of us invited the other to step inside the imaginary ‘teflon-coated
room’ — where you could speak your mind and nothing ‘stuck’.
It’s certainly true that a business partner relationship is a lot like a marriage. You need to learn to
give more than you get, and compromise rather than kick up a stink. In our case, the bond that kept
Dave and me together when things became tough was our incredibly strong common desire to be
financially free, and knowing that we wouldn’t be as good apart as we were together.
On 9 May 2004, five and a half years after first starting in business together, Dave and I met up at
my house, shook hands and congratulated each other on achieving our financial goals. Bit by bit
though our differences became more obvious, and now that we were financially free, our willingness
to compromise lessened. Tensions that once upon a time would have been quickly forgotten gradually
started to linger.
Steve’s investing tip
The best business partner relationships are where the parties have strong common interests, are accountable to each other and
enjoy open communication.
Unlike many business partner relationships that end in bitterness and animosity, Dave and I were
mature enough to acknowledge that it was time to pull up stumps, amicably divide up the Bradley
McKnight empire and walk our own paths.
As part of our agreement, Dave bought out my interest in our property portfolio, I bought out his
interest in PropertyInvesting.com, and we agreed that I’d take over responsibility for the Foundation
given that was where my greatest passion was. To this day we’re still friends and enjoy catching up to
have a laugh about old times, a whinge about the frustrations of dealing with lenders or hear the latest
family news.
Readjusting to life without Dave was difficult, but it was a necessary part of my growth as an
investor. The major struggle was coming to terms with going from over 130 properties to nil in 3.5
seconds. Here was Steve McKnight, property expert, with no investment property!
Although I had a large amount of cash, I had foregone my cashflow. As you might expect, I turned
to real estate to provide what I was looking for. Within a few months I’d acquired two unusual
deals — a billboard for positive cashflow and some vacant land that used to be the carpark for a
bowling club that I hoped to develop as a quick-turn opportunity.
Today I’ve been able to rebuild my property portfolio with a mixture of private and joint venture
projects. With more capital behind me, I no longer invest in single family homes and instead do larger
investments where the dollars and profit are significantly higher. At the time of writing I have an
interest in property deals worth an estimated $13.5 million, split across rentals, subdivisions and
developments.
I remain the CEO of PropertyInvesting.com, and have been extremely fortunate to partner with
Jeremy Thomas. Jeremy is a godly guy, an awesome team leader and has been the driving force behind
the business becoming more professional and successful. My only wish is that, for the sake of my ego,
he’d let me beat him a little more often at table tennis.
WHAT’S NEXT FOR STEVE?
Remembering that my focus is faith, family and fortune, my plans for each are:
Faith: I’ll keep pressing in to God and remain open to what he wants me to do with my time and
money. It’s all his anyway, I’m just the caretaker.
Family: For as long as my daughters think it’s cool to hang with their daggy dad, I’m right where
I want to be. I must confess though, girls were a mystery to me in my youth, and I’m not sure I’ll
be that much wiser second time around as a parent. I’m looking forward to doing more travel as a
family, and continuing to enjoy life as a husband and dad.
Fortune: Some people can sing, others can juggle. My gift is making money, which is great
because the more I make, the more I can give away.
The future is an exciting adventure, and whatever happens, I’ll be constantly telling myself that
success comes from doing things differently.
CHAPTER 4 INSIGHTS
Insight #1
Being financially free won’t in itself make you happier, however it will empower you with the time and money to be
able to pursue the activities and causes you are most passionate about.
Insight #2
Don’t be afraid of money. You’re asked to be a good steward of your resources, and to multiply what you’ve been
given. Just be careful not to become a money lover or forget that money is a tool, not an idol.
Insight #3
Having a good team around you will be essential to your success. You will be able to do more with a business partner
than you can do on your own. Just make sure you team up with someone who has a common goal, and that you have
open and honest communication channels.
Insight #4
Most relationships and situations you are in at the moment are for a season, not forever. It’s important to maximise
opportunities by fully grasping each chance that comes your way.
Insight #5
If you think there’s more to life than meets the eye, you’re right. Jesus said, ‘Ask and it will be given to you; seek and
you will find; knock and the door will be opened to you’. God, who made you and knows you intimately, is calling you
into a relationship. How will you respond? I urge you to ask, seek and knock by finding a Christian friend and asking
them to explain their faith.
Part II
Property investing home truths
Introduction to part II
Part I of this book provided a glimpse into my background prior to investing and also several of my
experiences along the way to becoming financially independent. While I’m sure you’ve enjoyed the
tales, I’m conscious that I also want to provide you with a substantial amount of information to equip
you with a detailed understanding of both the nature of property and how you can use it to invest
profitably.
Some of the information in part II may be a little dry — especially if you’re not a numbers person.
Please persevere, as many of the concepts discussed later in the book build on issues discussed in
chapters 5 to 11.
If you feel your mind drifting then take a moment and regain your focus as knowledge is the
difference between success and failure. Let’s start our discussion of real estate by looking at the ways
and means by which you can profit from property.
5
The truth about creating wealth
Could you live on $335.95 a week? That’s what the Commonwealth Government currently provides
single aged pensioners1, and from it housing, living and other expenses must be paid. Distressing as it
is, it’s not surprising that some pensioners say they can only afford to eat bread and tomato sauce for
supper.
The ASFA Retirement Standard 2 for the March 2009 quarter estimated that the cost of living a
modest lifestyle3 was $374.60 per week. If you want a comfortable lifestyle4 then you’ll need $725.36
a week — more than double the current aged pension payment.
Not planning on needing the aged pension in retirement? You’ll be one of the fortunate few.
According to Australian Bureau of Statistics (ABS) data, 76.3 per cent of persons living alone aged 65
and over noted that their primary source of income was the government pension or another
allowance.5
Seeking to empower retirees to be more independent and less reliant on the pension was one of the
key reasons that compulsory superannuation was introduced, and why there have been several
incentives offered over the years to top up your super in tax-effective ways.
However, even if the global financial crisis didn’t crack your retirement nest egg and force you to
work longer, the politicians in Canberra want to keep you in your job. In May 2009 the federal
government announced that it was gradually increasing the entitlement age for the aged pension from
65 to 67.
Steve’s investing tip
It’s your responsibility, not the government’s, to secure a comfortable lifestyle for yourself in retirement.
You don’t need to be a genius to understand that the way the majority of people handle money is
flawed and destined to fail. A lot of effort goes into teaching our kids to read, write and count, so why
don’t we also start teaching them how to use money and invest? Until we make some fundamental
changes, generation after generation will keep mismanaging their money and end up with little to
show for a lifetime of employment.
THE SECRET TO BECOMING RICH
It doesn’t matter how much money you make, the more important question is how much of what you
earn are you able to keep? At the risk of scaring you, take a moment to reflect on how much money
you’ve earned over your life to date, and then compare your total lifetime earnings with how much
money you have in the bank. What conclusions can you draw about how you are handling your
money?
If you end up poor in retirement it’s unlikely to be because you didn’t earn enough money.
Assuming you began work at age 25 with an annual salary of $40 000 per annum with a 2 per cent pay
increase each year, by age 65 you will have earned in excess of $2.5 million. That’s more than most
lotto jackpots!
Steve’s investing tip
It doesn’t matter how much you earn, just how much you keep.
The reason why the majority of people work a lifetime and end up with little to show for it is
because we have a love affair with spending money. The government knows it, which is why they ask
employers to take tax and superannuation from your pay before providing you with what’s left.
We live in a time of unsurpassed consumerism. It’s never been easier to spend money we don’t have
buying things we don’t need; 48 months interest free might help retailers, but it’s keeping generations
to come broke and unhappy, because long after the trinket has lost its shine, the responsibility to repay
remains.
What is debt?
When someone lends you money, what are they lending against? It’s not the asset (such as the plasma
TV or investment property), it’s the salary that you have not yet earned.
By borrowing money you are reaching into the future, grabbing hold of cash you have not yet
earned, bringing it forward to today, and spending it. The more dollars you spend that you haven’t yet
earned, the longer you must work to repay the debt.
Could you stop work today, or do you need to keep your job to pay off the debt that you’ve
accumulated on items that have long since lost their value?
The secret to creating sustainable lifetime wealth
It’s not sexy or fancy, and it doesn’t require a university degree to comprehend it. The secret to
sustained wealth creation is to simply spend less than you earn, and invest what’s left over.
Steve’s investing tip
If all you did was spend less than you earn, you’d have no choice but to accumulate wealth.
This important principle can be applied to all aspects of your financial life, including:
Your job: If you spend less than you earn from your employment you will have surplus funds to
invest.
Your business: If you spend less than you earn from your business you will have higher profits to
reinvest back into your business or else you’ll be able to pay bigger dividends back to yourself or
shareholders.
Your shares: If the companies you own shares in spend less than they earn, they will appreciate in
value.
Your property: If your investment properties have more income than expenses you will have
surplus cashflow or lump-sum profits to reinvest.
Answer the following question: is the reason why you are not further advanced with your wealth
creation in one or more areas of your life because you are spending more than you earn?
If so then you may believe you have an earning problem and that if you could only get more money
then all your problems would disappear. Not so. In all likelihood, if your pay increased then your
spending would increase by even more and you’d be in an even worse financial position.
Compare the salary you earn now with the salary you started on when you began work. It’s higher,
right? But do you have more or fewer money hassles? I’m not trying to make you feel bad, just
responsible for the past and empowered to change in order to have a brighter future.
As a child, because no-one lent you money, you could only spend your allowance and had to save up
for the fancy-pants item you really wanted. This was slow and boring. Then, once you became an adult
you were introduced to a new world, where the kind folks in the credit department would let you buy
whatever you wanted without needing the money upfront. Getting the reward before earning it is every
child’s dream, and a world where this can happen is like a fairytale.
However, the fairytale soon becomes a nightmare once you realise that you’ve traded your freedom
for trinkets and now have to work. It seems the only way out is to marry a millionaire, win lotto, or for
a rich family member to pass away and leave you a substantial inheritance. If all these sound like long
shots (and they are), a more useful guideline for getting out of debt is to:
allocate 10 per cent of your pre-tax salary to charity
allocate 10 per cent of your pre-tax salary to investing
allocate 10 per cent of your pre-tax salary to additional debt reduction6
spend the remaining 70 per cent of your pre-tax salary guilt free.7
If you think you’re going to invest your way out of debt then think again. Until you master the habit
of spending less than you earn you will continue to be the weak link in your investing. Any profit you
make might cover your debts for a while, but before long you will be back to spending more than you
earn and facing an even bigger debt burden.
LIVING BEYOND HER MEANS
Are you or is someone you know like Jacquie? Jacquie was my back neighbour who had an addiction
to spending money.
In early 2000, while I was working from home, there was a loud knock at the back door. As I went to
see who was there I heard the muffled sounds of sobbing. Opening the door I found Jacquie in tears.
Putting my arm around her and trying to comfort her, I said, ‘Jacquie, what’s wrong?’
‘Steve, I can’t do it any more — it’s just too hard.’
‘What?’ I replied in a confused tone.
‘My financial situation is crippling me.’
A short time later I was over at Jacquie’s house sorting through a great wad of pay slips, bills and
letters demanding payment. Trying to make sense of the chaos, it was quickly evident that I was
working with a financial time-bomb of unpaid bills and mounting debts — and the bomb was about to
explode.
Now, you or someone you know might be in some financial trouble, but Jacquie was the closest I’ve
ever seen to someone on the brink of financial collapse. It wasn’t that she didn’t earn enough money;
she was a well-paid sales executive on a salary package of $60 000 per annum. What was crippling her
was her lavish lifestyle, which was funded by debt. She had a mortgage, a car loan for her BMW, a
maxed out Amex, a Visa card which she used to pay her monthly Amex bill, a personal loan and a few
store-issued credit cards with nasty interest rates in excess of 24 per cent per annum. The interest and
loan repayments on this debt meant that my unfortunate neighbour had many more expenses in the
month than her money could ever cover. How could this have occurred?
Managing your money effectively is simple enough — the secret is to only spend what you earn, or
preferably less than you earn. But there are two tricks that catch many people out. You must:
remember that you take home less than your gross salary, because what you receive is eroded by
tax and superannuation
learn to equate the joy of spending with the effort of earning.
Let’s expand on these two points.
The erosion of your pay packet
If you don’t know how much money you have available to spend then it’s easy to live beyond your
means. Working out how much you have to spend is not necessarily easy because you’ll need to
deduct tax and superannuation, and these can be difficult to accurately quantify. Let’s use my
neighbour as an example and apply 2009 tax and superannuation contribution deductions to her salary.
Jacquie made the fundamental error of believing that a salary package of $60 000 per annum meant
that she had $60 000 (or thereabouts) to spend. Sure, she may have been a little financially naive, but
she would certainly not be alone. From her salary are deducted superannuation contributions ($5400),
PAYG income tax instalments ($12 000) and the Medicare levy ($900). The result was that all Jacquie
actually had available to spend was $41 700. The breakdown of her salary is illustrated in figure 5.1
(overleaf).
Figure 5.1: breakdown of Jacquie’s $60 000 salary
Where my neighbour really came unstuck was that she enjoyed a $60 000-plus lifestyle but only had
$41 700 available to pay for it. Can you guess how the shortfall between what Jacquie earned and what
she spent was funded? Yes, by debt — principally personal loans and credit cards.
As I explained to Jacquie exactly how and why she didn’t actually have $60 000 to spend, I saw the
flicker of understanding in her eyes as she remarked, ‘Why doesn’t anyone tell you this?’
‘Well’, I replied, ‘usually it’s just assumed that you know these things but, in reality, it’s a littleknown fact that’s keeping many people poor’.
Keeping control of what you spend
I couldn’t find a quick fix for my neighbour. I tried to roll all of her credit card and personal loan debt
into her home mortgage to reduce the interest bill, but the bank refused, as it considered her a poor
credit risk. The only answer I could come up with was to lock away her credit cards and provide a cash
budget to spend each week that would leave extra to begin repaying her debts, starting with the debts
that attracted the highest interest rates.
My efforts to turn my neighbour’s finances around also hinged on getting her to face up to her
obligations.
The road to recovery
While it was difficult, we were able to rein in my neighbour’s poor spending habits and gradually
turned her finances around. Before long we’d managed to wipe out most of those nasty store credit
cards, which charged massive rates of interest. Next on the hit list was her Visa card, which had a
balance that had steadily risen over three years. Ultimately Jacquie and I achieved success, at which
point she turned to me, smiled and said, ‘Right, now I’m back in control, tell me what I can do to start
investing’.
Are you in control?
Do you know the difference between your gross salary and what you receive as cash in your pocket? A
simple test to determine whether or not you’re on the right side of the lifestyle line is to calculate how
much money you’re saving (or using to repay old debts) and then dividing it by your base salary. A
great rule of thumb is to put away 10 per cent of your pre-tax pay to draw upon when you’re ready to
begin investing.
Are you in control, or are you sitting on a money-trouble time-bomb that is about to explode?
Equating the joy of spending with the effort of earning
The first component of effective money management is to take control over your spending. The
second component is translating the cost of something you buy back into the hours of work it took to
earn the money in the first place.
People underestimate the true cost of an item because they have to pay for it in after-tax dollars. For
example, $100 worth of groceries to someone earning over $35 000 per annum is $142.86 in pre-tax
terms, which equates to more than a day’s pay.
Translating money into equivalent days or hours at work is often an excellent way to see the
financial impact of your spending. For example, $80 per month for a gym membership is $960 per
annum, which in pre-tax terms for someone paid $45 000 per annum is $1371. This equates to eight
working days, so you’d work nearly two weeks each year just to pay for your gym membership, which
is more time spent working for someone else and less time and money available to start investing.
Steve’s investing tip
It takes less effort to spend than it does to earn.
The rat race is a trap for people who spend first and then have to work to pay for yesterday’s
extravagances with tomorrow’s earnings. A car payment here, a gym membership there and the
occasional thingamajig on interest-free terms will keep you needing to work. If you want freedom,
you must become a good steward of your money. It’s not easy, but effective money habits demand that
you master your finances by allocating a portion of your pre-tax earnings to investing, and then only
spend what’s left in your pocket.
Delaying gratification
If your money goal is financial independence, a key skill you’ll need to acquire is the ability to delay
gratification — to forego today to set up a better opportunity tomorrow. If you don’t want to delay
gratification then you’ll be left in the land of the get-rich-quick schemes that promise maximum
return for minimum effort, and we all know, in our heart of hearts, that sustainable wealth creation
doesn’t happen that way.
SOLVING YOUR MONEY PROBLEM
There are three strategies you can implement to beat money problems:
Option 1: Rein in your lifestyle expenses to match your take-home income. This can be difficult,
since no-one likes to take a cut in his or her standard of living.
Option 2: Work harder, earn more money and don’t increase your lifestyle expenses. This is a
challenge because the more you earn, the more you pay in tax and superannuation.
Option 3: Invest in something that makes money to fund the shortfall between your income and
lifestyle expenses.
Of these choices, only option 1 provides a solution to the core problem. Options 2 and 3 are band-aid
solutions that will not work to permanently stop a severe financial haemorrhage.
Steve’s investing tip
In every case of financial hardship that I’ve ever seen, the problem has not been earning too little, but spending too much.
Earning more might provide temporary relief, but pain will persist and it’s just a matter of time
before you will find yourself short of money again. A favourite saying of mine is, ‘For things to
change, first things must change’. You must be willing to give something up to create room for a new
opportunity. I’m not suggesting that you need to give up work entirely, but if you think you can create
a personal fortune doing what you’re doing now, then you’re probably kidding yourself.
One of the most amazing ironies I discovered was that to earn more later, I had to earn less now.
Sure, fewer hours behind the calculator meant a significant drop in money coming through the door,
both at home and at work, but such was the sacrifice I had to make to free up the time needed to begin
looking for investment deals.
Steve’s investing tip
You will always be a slave to money until you discover how to become its master.
I’VE NEVER BEEN MORE ADAMANT!
Adopting the information in the remaining chapters of this book will ensure you have excellent
success in your property investing activities. However, whether or not you achieve financial
independence depends on your ability to master money, delay gratification (by reinvesting rather than
spending your profits) and by having faith that you’re on the right road, albeit the road less travelled,
during the many inevitable setbacks.
I’m passionate about empowering you to have a brighter financial future — and this means having
more money as well as the ability to access it well before you hit the twilight of your life. To make
this happen, you’ll need to manage your money carefully and to remember that success comes from
doing things differently.
CHAPTER 5 INSIGHTS
Insight #1
If you don’t want to end up relying on the government aged pension you need to spend less than you earn and sensibly
invest the difference. The sooner you get started the bigger your nest egg will be.
Insight #2
If you don’t teach your kids to be good money managers, who will?
Insight #3
It doesn’t matter how much you earn, only how much you keep.
Insight #4
The secret to sustained wealth creation is to always spend less than you earn.
Insight #5
If you think you’re going to invest your way out of debt then think again. Any profit you make might cover your debts
for a while, but before long you will be back to spending more than you earn and facing an even bigger debt burden.
Insight #6
A dollar saved is a dollar earned.
Notes
1 Source: <www.centrelink.gov.au/internet/internet.nsf/payments/age_rates.htm>.
2 The Association of Superannuation Funds of Australia Limited, media release 24 July 2009, Fun
In Retirement.
3 Defined as: ‘Better than the Age Pension, but still only able to afford fairly basic activities’.
4 Defined as: ‘Enabling an older, healthy retiree to be involved in a broad range of leisure and
recreational activities and to have a good standard of living through the purchase of such things as;
household goods, private health insurance, a reasonable car, good clothes, a range of electronic
equipment, and domestic and occasionally international holiday travel’.
5 Cat. no. 6523.0, Household Income and Income Distribution, Australia, 2007–08.
6 Once you are out of debt you increase your investing portion to 20 per cent.
7 Your normal debt payments need to be covered from this portion too.
6
The truth about property investing
How many people do you know who own three or more investment properties? Probably not many,
because judging by the surprising findings of an ABS survey, the majority of those who invest in real
estate only own one or two dwellings.
Reported results from an ABS survey of property investors:1
76 per cent of investors owned one rental property
16 per cent of investors owned two rental properties
8 per cent of investors owned three or more rental properties.
A question that must be asked is: if owning real estate builds wealth, why do so many investors own
so few properties? Once you understand the answer, which I’ve included in this chapter, your new
thinking and approach will help you to be among the top 8 per cent of all real estate investors.
WHY INVEST IN PROPERTY?
While there are many reasons why someone might choose to invest in property, they all ultimately
boil down to a choice of three alternatives.
Reason #1: To save (income) tax
One of the most popular methods of minimising tax is a property investing strategy called ‘negative
gearing’. Negative gearing allows investors to access an immediate tax deduction while also
potentially building wealth via long-term capital appreciation.
Australian tax law allows investors to claim a deduction for expenses associated with owning an
investment property. If these expenses are more than your property’s income, the result is a loss that
can be used to offset other taxable income that you might have, such as your salary or wage, to reduce
the amount of income tax paid.
Reason #2: To make money
Unlike fads that come and go, people always need a place to live which means there will always be
demand for houses. By supplying housing — either in the form of rental properties, or else renovating
or building dwellings — investors are able to make money. The three types of real estate profit are:
Capital gains made as property values rise over time.
Lump-sum cash profits from quick-turn real estate, created by adding more in perceived value
than actual cost.
Recurring positive cashflow returns — where you receive more money in cash receipts from the
property than you pay in cash towards the investment.
Reason #3: Out of a love of landlording
I’m yet to meet anybody who seriously falls into this category in its own right. Instead, most landlords
feel they’re doing tenants a favour by letting them stay in their property.
Treating a tenant like a potential menace rather than a valued client impedes the development of a
good tenant–landlord relationship. I’ve managed to avoid many of the ‘tenant from hell’ stories you
hear and read about by implementing simple reward strategies, rather than ranting and raving with
threats about nasty consequences unless my needs are promptly fulfilled.
Being a landlord can be a rewarding experience provided you create win–win outcomes where the
needs of the tenant become intermeshed with your own. I outline strategies that reveal how you can do
this in chapter 12.
DECISION TIME
Okay, assuming you can either make money or save tax (but not both), place a
acknowledge which is a higher priority for you.
I want to invest in real estate to save tax.
I want to invest in real estate to make money.
in the box below to
Saving tax: the negative gearing model
Negative gearing is the weapon of choice for property investors seeking to save tax. Here’s how it
works.
Step 1 in the negative gearing model: equity and lifestyle
The negative gearing model begins with you working in your job, from which you earn money that can
be invested, less your living expenses, income tax instalments and superannuation payments.
Any surplus is collected in your savings account. Alternatively, you might already have equity in
your home or other assets that you can use to fund the acquisition of investment properties.
Step 2 in the negative gearing model: choosing to invest
Once you’ve accumulated equity or savings, you can use your cash and/or equity to pay for the deposit
and closing costs on properties you purchase.
The arrow pointing towards your property represents the redistribution of wealth from your equity
or savings into your real estate portfolio.
Step 3 in the negative gearing model: cash outflow
When you acquire a negatively geared property, not only is there a once-off payment (for the deposit
and closing costs), there’s an ongoing cash outflow too, which arises because your property’s cash
outflows are higher than your property’s cash inflows. This cash shortfall is illustrated by the arrow
from equity/savings, through the cashflow square and into the property square.
If you buy a negatively geared property you do so knowing that your dwelling is certain to create a
cashflow shortfall that must be funded by:
your after-tax salary — which ties you to your job; and/or
equity in other assets you own — which will increase your level of debt.
Step 4 in the negative gearing model: capital gains
The only two ways you can profit from a property that you purchase as a negatively geared investment
are:
when your property rises in value at a rate in excess of the after-tax loss plus
inflation — otherwise you’re simply recycling your money at a zero or negative return; and/or
if your cashflow increases and/or the expenses decrease so that your property becomes positively
geared.
Capital gains are shown in the diagram overleaf via the dotted line. I’ve used a dotted line for two
reasons: first, capital gains are not certain, and second, capital gains usually come in fits and starts
rather than steady and reliable long-term increases.
Step 5 in the negative gearing model: reinvestment
Our final diagram reveals the last stage of the negative gearing model. Once you’ve earned capital
gains you can access these profits and use the proceeds to either fund your lifestyle or to acquire more
assets.
An important point to note is that in the absence of further savings, the only way you can continue to
afford additional properties is by accessing the equity you earn from capital gains.
Since capital gains generally take a number of years to accrue, expanding your property portfolio
can take a long time, which is more evidence to account for the fact that 92 per cent of investors only
own one or two properties.
In summary, negative gearing is a term used to describe purchasing loss-making investments
(‘negative’) using borrowed money (‘gearing’). Does anyone else see a problem here? Owning real
estate is supposed to increase wealth and unlock a better lifestyle, yet many investors have to wait
while values appreciate, and in the meantime continue to work hard to fund the negative cashflow
being generated from their investments.
Figure 6.1 reveals the impact acquiring more negatively geared property has on your available cash
reserves. That is, each negatively geared property you buy means you have less cash in your pocket to
pay for lifestyle expenses. Wealth creation is about expanding your empire, not watching it diminish
in ever-decreasing circles.
Figure 6.1: the negative gearing spiral
Making money: the positive gearing model
If the only way to invest in property was via negatively geared real estate then I’d understand why so
many intelligent investors become convinced that losing money today for the sake of potentially
making money tomorrow is a good idea. However, there is an alternative to purchasing negative
cashflow properties. It’s called positive gearing, and here’s how it works.
Step 1 in the positive gearing model: equity and lifestyle
Step 1 in the positive gearing model is exactly the same as the first step in the negative gearing model.
You work in your job to earn income from which expenses, tax and superannuation must be deducted.
Any surplus accumulates as savings, which can be used to pay the deposit and closing costs on
investment property. Alternatively, if you can access equity then you may be able to borrow against it
to buy property irrespective of how much money you’ve saved.
Step 2 in the positive gearing model: choosing to invest
The second step in the positive gearing model is the same as the negative gearing model in that you
use your equity and/or savings to fund the deposit and closing costs on your property investment.
The redistribution of wealth from savings into property is shown in the diagram by the solid arrow
out of the equity/savings square and into the property square.
Step 3 in the positive gearing model: positive cashflow
Okay. Here’s where it starts to get interesting. Do you remember that in the negative gearing model
the cashflow square was under the savings square, representing a net cashflow loss? Well, in the
positive cashflow model the icon changes to say ‘Cash & Cashflow’:
Cash properties: Cash properties are those acquired for lump-sum gains under quick-turn
investment strategies. Examples include subdivision (chapter 16), renovation (chapter 17),
development (chapter 18), as well as flipping houses (chapter 15).
Cashflow properties: Properties provide a positive cashflow outcome when there is a surplus of
cash received over cash paid. Examples include positively geared rental properties (chapter 12),
vendor financing (chapter 13) and lease options (chapter 14).
The essential difference between these properties and those bought under a negatively geared model
is that under the positively geared model capital appreciation is not the principal objective, rather the
aim is to earn a lump-sum or ongoing positive cashflow return.
Step 4 in the positive gearing model: reinvest your returns
Once you’ve earned your cash and/or cashflow return, you must then decide what you want to do with
it. You can save it, or else either spend it on acquiring more investments or on funding your lifestyle.
If you spend your money on lifestyle then it cannot multiply or compound further for your benefit.
Instead it goes to work for someone else. You might choose to save your positive cashflow return, but
at the low interest rates that deposits earn you’d be lucky just to keep pace with inflation. Finally, you
could choose to reinvest your cashflow surplus and buy other assets. So long as you invest and make
money, your personal wealth empire will continue to grow.
I conceptually break my total cashflow into thirds and allocate the money as described below (and
shown in the diagram).
The first third of my cashflow surplus is immediately reinvested back into the property that created
the cash in the first place. I do this by:
Repaying debt. A great way to increase your cashflow is to reduce your debt, since less debt
means lower interest payments, and lower interest payments means more cash in your pocket.
Paying off just a few extra dollars a week will dramatically reduce your interest bill and shave
years off your mortgage.
Reducing the amount of money you owe also mitigates your credit risk, which is the impact on
your investing activities should there be a sudden increase in interest rates. My grandfather,
considered by many to be quite astute with his money, had a favourite saying: ‘No-one went
broke because they owed too little’.
Providing incentives for my tenants. Were you or anyone you know ever put on detention in high
school? Did it really ever stop the bad behaviour? The same is true when it comes to tenants in
that it makes no sense to penalise them. In fact, given that most state tenancy laws allow renters
to be up to 14 days late before a landlord can instigate eviction proceedings, only conscientious
tenants will make their rent payments on time, and it’s almost unheard of for a tenant to pay the
rent early.
Ranting and raving may make you feel better, but it won’t do much to get the tenant to pay the
rent that’s due or put you higher up the pecking order when dealing with overworked rental
managers. On the contrary, if you want to get what you want then you need to start rewarding
tenants for doing the right thing, rather than penalising them when they don’t. The attitude I
adopt is that my tenants fund my financial independence, so I need to respect them and look for
ways to keep them pleasantly surprised.
One of the incentives I’ve used in the past has been to provide a nursery voucher when new tenants
move in. I believe that having a tenant plant something in the garden makes them feel like the
property is more of a home.
Tenants who pay the rent on time and look after the property receive free movie tickets and minor
property improvements of their choice to increase the quality of their tenancy, and the value of the
house.
A good friend of mine, Peter, has done a deal with the local video store where he supplies his tenants
with a free movie voucher (it costs Pete $2.50 per voucher) provided his tenants pay the rent on time.
This is a win–win–win outcome as the tenants get a bonus for doing what they are obliged to do under
the lease, Peter gets his rent paid on time and the video store has the chance to upsell to the tenants
once they have entered the store.
Steve’s investing tip
The best way to get the outcome you desire is to provide an incentive.
Making minor property improvements. A great way to increase rents as well as build equity is via
low-cost capital improvements. Heat lamps in the bathroom are a great example. Unless
substantial rewiring is necessary, most electricians can install a base model for a total cost of
about $350. I would go to the tenant and say, ‘Mr Tenant. You’re doing a great job and thanks for
paying the rent on time. I know that the bathroom can be a little cold from time to time, so how
about I pay for a heat lamp to be installed? All I’d have to do is increase the rent by $1 per day.
How do you feel about that?’
The rental increase will not only see you cover the cost in year one, but you’ll increase the value
of your property too.
The second third of my positive cashflow return is redirected back to my equity/savings account,
and is used to do one of the following:
Replace my salary. Contrary to what many of the ‘get-rich-quick’ seminar presenters want you to
believe, financial independence is not achieved overnight. It’s a gradual process that can take
years while you grow your passive income to the extent needed to phase out your need to work.
Still, every dollar of passive income you acquire will weaken the bonds that tie you to your job.
A great idea is to break up your financial independence into the amount of weekly passive
income you need to take a day off work. This is shown in table 6.1.
For example, if you earned $50 000 per annum (excluding superannuation) and you wanted to
work one less day per week without suffering a lifestyle cut, then you’d need passive income of
$192 per week. Complete financial independence would occur when you had passive income of
$962 per week.
Achieving financial independence is no fluke. It starts by determining the amount of passive
income you need and then acquiring assets that will bring you closer to your goal.
Reinvest to grow my empire. You can also take the third of your net positive cashflow allocated to
your savings/equity and use it to acquire other cash and cashflow property, which is also known
as ‘pyramiding your profits’. When you do this you create a new positive cashflow model and
begin compounding your returns.
Table 6.1: passive income matrix
The final third of my positive cashflow is allocated to purchasing assets that are specifically
designed to earn capital gains (rather than cash or cashflow) returns. The two most popular classes of
assets for capital growth are:
Shares: One of the most attractive features of shares is that it’s possible to make money in a
stock market that is trending up (going long) or trending down (going short). The stock market is
my preferred method for earning capital gains.
Property: Property can also be used to earn capital growth, provided the prevailing market
conditions are right. In fact, if you were absolutely convinced that negative gearing was a
strategy you wanted to pursue, then you could use this third of your positive cashflow to fund the
cashflow shortfall rather than having to rely on your salary.
Let’s have a look at an example. The positive gearing model will allow you to earn an immediate
cashflow return as your cash inflows will exceed your cash outflows. Once you earn a profit, you can
upscale your wealth building by taking advantage of a three-way compounding return.
First, you compound the return of your existing property by channelling one-third of your cashflow
surplus into repaying debt or making improvements to increase the value. Second, take a third of your
cashflow surplus and use it to buy more cash-and/or cashflow-positive property. Finally, use the
remainder of your cashflow to buy assets that have a low income but high capital gain return.
Adopting this approach means that irrespective of what happens to the value of your (positive)
cashflow property, you’ll still be primed to earn capital gains.
Assuming that you can earn a weekly net passive income of $50 per property, table 6.2 reveals the
future value after 25 years of investing one-third of your positive cashflow at various capital growth
percentages. Remember, these figures are based on just one-third of your positive cashflow being
invested for the long term. The other two-thirds of your cashflow can be reinvested back into your
property, allocated to your savings account or simply spent.
Table 6.2: the power of compounding returns
Note: To be fair, these compounding return figures will be eroded by tax and inflation.
Table 6.2 reveals the power of multiple property income streams, compounding at various rates and
invested for the long term. Not only does this look good on paper, I can tell you from personal
experience that it works even better in reality!
Step 5 in the positive gearing model: capital gains
In addition to the capital gains generated by investing the final third of your positive cashflow in
growth-focused assets, you’ll also benefit from any capital appreciation in the value of your
underlying property. This increase is illustrated in the step 5 diagram by the dotted line between the
property and capital gains squares.
Step 6 in the positive gearing model: reinvestment of capital gains
The final step in the positive gearing model is when you access your capital gains by doing one of the
following:
Selling the property and turning the gain into cash. (However, before you sell it’s important to
weigh up the tax consequences.)
Borrowing against the asset, which will allow you to turn a portion of your gain into cash. Be
careful to properly weigh up the risk versus reward of doing this, remembering that you will pay
more interest and have higher levels of debt.
You can then use the cash to invest in more positive cashflow property.
Do you remember the direction of the negative gearing spiral? It pointed inwards and revealed that
the more properties owned the less cashflow there was. The positive gearing spiral is the exact
opposite (shown in figure 6.2), and is the preferred model because each property acquired is
increasing your wealth.
Figure 6.2: the positive gearing spiral
Which direction is your wealth-creation spiral heading?
PASSIVE INCOME AND PROPERTY INVESTING
The three ways to make money in real estate are:
Your property can appreciate in value; and/or
You can make lump-sum cash gains by adding more in perceived value than actual cost; and/or
You can earn recurring positive cashflow returns, provided your annual cashflow received is
higher than your cashflow paid out.
All are valuable and can occur independently of each other. That is, you can have:
general market-driven capital gains and negative or no cashflow returns (a negative cashflow
position); or
a positive cash or cashflow return and no or negative capital appreciation (a positive cashflow
position); or
no capital appreciation and no positive cashflow (a cashflow neutral position).
Table 6.3 (on the following page) compares capital gains and cash/cashflow returns.
Table 6.3: capital gains and cash/cashflow returns
WHICH IS BETTER, CAPITAL GAINS OR POSITIVE
CASHFLOW RETURNS?
Only you can determine which property investing strategy is right for you, but if you want to achieve
financial freedom without waiting a lifetime then you know which model I recommend: positive
gearing.
Table 6.4 (overleaf) is included to help you appreciate the key differences between the model most
property investors use and the one I advocate and used to achieve financial freedom within five years.
Table 6.4: investment models compared
Model followed by the majority of investors
Steve McKnight model
Job
A long-term necessity to pay for lifestyle expenses and fund the
negative cashflow derived by the property portfolio
Short-term necessity to raise seed capital and
to demonstrate borrowing ability
Property
acquired
Negatively geared. Bought to lose money now to save tax, but
hopefully appreciate in value over the long term
Positively geared. Bought to make money
immediately — either by adding value or else
holding for the long term for a positive
cashflow outcome
Seed capital Waiting — potentially for years — for enough savings or for capital
for more
appreciation to occur so it can be redrawn
property
acquisitions
Actively doing quick-turn property deals to
build investing capital
Attitude to
tax
Look for ways to lose money in order to reduce the amount of
income tax paid on employment income
Look to pay more tax, but the least legally
allowed, as a by-product of successful
investing
Retirement
income
Borrow against capital gains. Once spent, gone forever and
eventually assets must be sold to keep debt levels manageable. This
then triggers a capital gain, which requires more equity to be
accessed and properties sold
Live off the positive cashflow generated by
your property portfolio. No need to sell or
refinance any equity. Capital gains still occur
and are a bonus
Ability to
Restricted to the amount of employment income that can be soaked
own multiple up by the loss-making properties
properties
Degree of
difficulty
Easy — which is why most people adopt this approach
Unrestricted — use your initial capital to get
going and then use quick-turn strategies to
source never-ending investment capital
Hard, but can be done and sure beats working
If you’re looking to retire from your job without necessarily taking a lifestyle or pay cut, it’s critical
to source regular and reliable passive income to replace the wages you’ll forego when you cut back at
work. One way you can achieve this outcome is by drawing down any capital appreciation in your
property portfolio. However, once you spend your capital gains on lifestyle expenses the money is
gone forever. Your financial freedom becomes dependent on further capital appreciation, which is by
no means certain. While property prices generally trend up over the long term, they also experience
periods of flat and even negative growth. You don’t want to be caught short of cash and need to go
back to the workforce.
On the other hand, positive cashflow returns regenerate, which means they continue indefinitely.
Each week, fortnight or month you will receive a cash injection into your bank account that you can
use to fund your lifestyle. When you run dry, you just have to wait another month! Sure, tenants will
come and go and there may be times when your property will be vacant, but this risk can be mitigated
with sensible landlording.
Positive cashflow returns occur independently of what is happening to property prices and, as such,
are a more secure and reliable source of passive income. You can’t use a capital appreciation EFTPOS
card to fund your weekly grocery bill, but you can pay for it out of a property’s positive cashflow
surplus. As such, if your investing purpose in buying real estate is financial independence, it makes
sense to focus on positive cashflow returns first and capital appreciation second.
The missing piece in the jigsaw puzzle, which explains how you can build up enough capital to own
enough properties to become financially free, is to supplement your wages (or other earned income)
by using quick-turn real estate investing strategies to make lump-sum gains.
It’s fair to say that different types and classes of property offer the potential for varying financial
returns. Some properties are better suited to capital appreciation, others are ideal to be made-over for
quick cash gains, and you can still find high-yielding positive cashflow investments too.
The right property for you is one that will help you achieve your financial goals within your
predetermined time frame. It’s time for you to make another decision. Grab a pen and circle the
multiple-choice answer from the selection in the table below that best summarises your investing
purpose (only one answer is allowed).
Your investing purpose
Multiple-choice time (circle your answer)
Today’s date:
Question: My end purpose for investing in real estate is …
a) Financial freedom within the next 10 years or sooner.
b) I plan to keep working for the next few decades and wait and hope for capital appreciation.
c) I don’t know … I just want to read the next chapter!
Which is a higher priority for you: making money and building wealth, or losing money to save tax
and having to work harder? It seems a ridiculous question, but somehow the majority of investors are
convinced, usually by agents who get paid for selling real estate, that it’s a good idea to buy lossmaking property.
Steve’s investing tip
Anyone who suggests it’s a good idea to lose money is a fool.
MEET CRACKERS
It’s time to tell you about Crackers — another real estate agent from Ballarat. While he’s gone on to
achieve some impressive things, when I first met him he was the kid fresh out of high school,
employed to drive around putting up and taking down ‘For Sale’ signs, as well as running general
errands.
One day I wanted to complete a property inspection and the only person available to show me
through the house was Crackers. Normally he wouldn’t be given such responsibility, but his supervisor
knew we’d met before and that I wasn’t looking to be dazzled by an impressive sales display.
After about five minutes of walking through the house, it was clear it wasn’t what I was looking for
as it was in a shabby condition and a touch overpriced. On the way back to the car Crackers and I
struck up a conversation about investment property and the difference between making and losing
money.
Crackers was intrigued that I seemed to be buying a lot of properties whereas other investors
stopped after about one or two acquisitions. I began explaining the difference between positive and
negative gearing, and, sensing an eager young mind, I went into quite a bit of depth. Perhaps I went
into a little too much detail, because when I’d finished, Crackers simply replied, ‘Steve, where I come
from a positive is always better than a negative!’
Feeling like I’d been shown an easy way to solve a complicated problem, I was temporarily
speechless before being totally impressed by the ability of this young kid to grasp a concept that many
adults can’t.
Let me finish this chapter with the same question I asked you at the beginning. Place a tick in the
box that describes your objective for investing in property from this day forward:
I want to invest in real estate to save tax.
I want to invest in real estate to make money.
It’s clear that if you want to be in the 8 per cent who own a multiple-property portfolio you’ll need
to adopt a different model to how the other 92 per cent invest. This proves once again that success
comes from doing things differently.
CHAPTER 6 INSIGHTS
Insight #1
If owning real estate builds wealth then it makes sense that you would want to own as much of it as possible. Why is it,
then, that 92 per cent of investors only manage to acquire one or two rental properties?
The reason why so many investors own so few properties is simply that they cannot afford to own more. Instead of
building wealth, their approach to property investment keeps them needing to work, so if your goal is to regain control
over your time, a different approach is needed.
Insight #2
If you want the same result as 92 per cent of property investors then follow their lead and invest in the ‘normal’ way,
which is negative gearing. If not, then you’re going to have to do something different in order to achieve a different
outcome.
Insight #3
How many properties can you afford that lose money? How many properties can you afford that make money?
Insight #4
When you allocate a portion of your profits to a different class of assets, such as shares, you create diversification, which
is a hedge against having all your financial eggs in the one investment basket.
Insight #5
When someone tells you it’s a good idea to buy real estate that loses money, don’t listen.
Note
1 Household Investors in Rental Dwellings, Australia, 1997 (cat. no. 8711.0).
7
The truth about negative gearing
This chapter is written for those who want to know more nitty-gritty information about why negative
gearing is a flawed investment strategy for those seeking financial independence. It’s heavy going
in parts, but I recommend persevering because there are many useful insights that will help you to
become a more skilled and successful investor.
WHY IS NEGATIVE GEARING SO POPULAR?
Negative gearing, often spruiked as a way that you can use the tenant and the taxman to make you
rich, is a popular investment strategy because it speaks to the heart of every investor who wants to
make money and save tax, and that’s just about everyone.
Aside from tugging at our greed glands, considering the prices asked compared to the rents earned,
more than 90 per cent of properties for sale at any given time will be negatively geared.
Another consideration is the huge amount of hype and spin generated by those who benefit
financially from investors purchasing negatively geared property. This includes developers, real estate
agents, accountants, lawyers and financiers, as well as the plethora of free seminars, books and other
information published by so-called wealth-creation experts.
Steve’s investing tip
Many of the free seminars and courses are simply shams for selling overpriced property to unsuspecting buyers.
The final and perhaps most compelling reason why negative gearing is so popular is because history
suggests that negative gearing works very well. After all, as shown in table 7.1 (median house prices
at 10-year intervals from March 1980), who can argue that property values haven’t increased over
time?
Table 7.1: increases in property values 1980 to 2009
Source: Real Estate Institute of Australia <www.reia.com.au>.
* Latest available data at time of writing.
With the benefit of hindsight, how many properties do you wish you bought back in 1980, 1990 or
even 2000? Before you beat yourself up too much, there is a compelling reason why you didn’t buy
more property in years past, and that’s because you couldn’t afford to.
When you separate the facts from the hype, a simple truth that negative gearing can’t hide from is
that it is a strategy created to make a certain loss today and maybe a profit tomorrow (via future
capital appreciation). And when you compare negative gearing against the other option of cash and
cashflow investing (where you make a profit now and tomorrow), it simply doesn’t stack up.
PROPERTY AND TAXATION
Please note that the information here is a general overview. Taxation is a complicated matter and
you should seek specific advice from a qualified and experienced professional.
Under Australian income tax law, property investors must include on their annual tax returns any
income earned from their property investments, including rental receipts and realised capital gains.
The timing of when the real estate income must be declared varies. For rental receipts it is usually
when the amount is received, but capital gains are not taxed until the property has been sold or
otherwise disposed of. Refinancing is not disposing of an asset, and as long as ownership does not
change, properties with capital gains can be refinanced without any capital gains tax (CGT) impact.
Real estate investors are also allowed to claim a tax deduction for expenses incurred in earning their
real estate incomes. Common deductions include interest, rental management costs, insurance, council
rates, utilities, minor repairs and depreciation. Importantly, your property investments do not need to
be profitable to qualify for a tax deduction. The test is simply that you expect your real estate
investments to be profitable in the future, and that one day you will pay income tax on that profit.
It is normal for an investment property — especially if it has been bought for capital appreciation
(which will not be taxed until the investment is sold, potentially many years in the future) — to have
more expenses than income. The resultant loss can offset any other income (including employment
income) the taxpayer may have to reduce the amount of tax paid.
Table 7.2 contains some examples of the various tax positions a property investor may face.
Table 7.2: example tax outcomes
Let’s have a look at each of these.
Scenario A
This is the usual position in a negatively geared transaction. While rental income ($10 000) must be
included in the taxpayer’s income tax return, the unrealised capital gains ($55 000) are not, because
the property has not yet been sold. As the property deductions ($15 000) are higher than the rental
income ($10 000), a loss results ($5000), which can be used to reduce the tax payable on other income.
Scenario B
This is the same as scenario A, except the property has been sold and so the capital gains must now be
included in the investor’s income tax return.
Under current tax laws, the capital gain could be discounted by up to 50 per cent in certain
circumstances, and if this were the case the amount of the taxable gain would be as shown in table 7.3.
Table 7.3: scenario B with and without 50 per cent CGT discount
Without 50% CGT discount With 50% CGT discount
Rental income
$10 000
$10 000
Capital gains
+$55 000
+$27 500
Property deductions –$15 000
–$15 000
Taxable gain *
=$22 500
=$50 000
* Income tax is then levied at the appropriate marginal rate.
Scenario C
This is the usual position in a positively geared transaction. While rental income ($10 000) must be
included in the taxpayer’s income tax return, the unrealised capital gains ($55 000) are not because the
property has not yet been sold. As the property deductions ($7500) are lower than the rental income
($10 000), a profit results ($2500), which must be included in the taxpayer’s income tax return.
Scenario D
This is the same as scenario C except the property has been sold and so the capital gains must now be
included in the investor’s income tax return. Table 7.4 (overleaf) shows the effect of the CGT
discount.
Table 7.4: scenario D with and without 50 per cent CGT discount
Without 50% CGT discount With 50% CGT discount
Rental income
$10 000
$10 000
Capital gains
+$55 000
+$27 500
Property deductions –$7 500
–$7 500
Taxable gain *
=$30 000
=$57 500
* Income tax is then levied at the appropriate marginal rate.
How a property loss saves tax
Here’s a case study revealing how the property loss can be used to offset a taxpayer’s other income.
Sally is a lawyer on a salary of $70 000 per annum, plus superannuation. Two years ago she bought a
property at 55 Green Street which has since appreciated in value by $55 000. Her property attracts
rental income of $10 000 and she has total property-related expenses of $15 000. Her overall tax
position is as shown in table 7.5.
Table 7.5: Sally’s tax position
Sally with no property Sally with one property
Salary
$70 000
$70 000
Property losses
–
($5 000)
Taxable income
$70 000
$65 000
Income tax + Medicare ($16 050)
Total
$53 950
($14 475)
$50 525
Although Sally has succeeded in reducing her tax bill by $1575 ($16 050 − $14 475), she is $3425
worse off overall ($50 525 − $53 950). This is because only 31.5 per cent of the $5000 property loss
was recovered by the tax she saved. The other 68.5 per cent had to be paid from her own pocket, and
this reduced her after-tax spending power.
Provided Sally’s property keeps increasing in value, she will be ahead. However, you may be
surprised to learn that over the past 30 years, property values have historically only increased about
one-third of the time. For the other 20 years they trended sideways or declined.
CAN YOU RELY ON CAPITAL GAINS?
Capital gains are a form of investing profit that occurs when your property appreciates in value, or, to
put it more simply, when an asset is worth more than the cost of acquiring and holding it. Capital
appreciation is by far the most popular reason why investors buy real estate.
Property appreciates in value because there are more people than there are houses, and when demand
exceeds supply, prices increase. However, before you rush off and buy a new growth-focused
investment property, you need to know that real estate values do not necessarily increase in a steady or
predictable manner.
With thanks to the Real Estate Institute of Australia, figure 7.1 (overleaf) shows a graph of Sydney
median house prices from 1980 until 2009. The graph clearly identifies the three phases of a property
market: growth, stability and decline. Commonsense explains why this occurs. First of all, prices
increase as buyers bid up values, in fear that they will miss out on their desired home at a price they
can afford.
Figure 7.1: Sydney median house prices 1980 to 2009
Source: Real Estate Institute of Australia <www.reia.com.au>.
The boom times can’t last forever because a borrower’s ability to service his or her loan (that is,
demonstrating how the loan will be repaid) is one of the main factors financiers consider in deciding
how much to lend. When home values increase faster than incomes, fewer and fewer people can afford
the loan repayments and cannot enter the property market. Once there are more sellers than buyers,
values begin to decline (as the market corrects from the artificial highs reached during the frenzied
peak), and then stabilise.
In most cases the majority of the purchase price of a home is borrowed, and so the trigger for the
next growth phase is for credit to become easier to access and/or more affordable. This can happen if:
Incomes increase so borrowers can service higher debt repayments.
Interest rates fall, meaning borrowers can borrow more debt for the same dollar repayment.
New loan products are released so that people who wouldn’t otherwise qualify for a loan are now
able to source finance.
The government offers incentives to purchase real estate, or makes the laws pertaining to
investing more investor-friendly.
Real life examples of the sparks that have led to the property market igniting include:
Interest rates falling from around 18 per cent in 1990 to a cyclical low of 6 per cent in 2001.
New or increased government incentives for property purchasers and investors, including the
federal government’s First Home Owner Grant and the National Rental Affordability Scheme, as
well as state government stamp duty savings for first home buyers.
The creation of low-documentation (low-doc) loans, making it easier for those who couldn’t
prove their income to nevertheless qualify for a loan.
The increase of loan-to-valuation ratios from a traditional maximum of 80 per cent (that is, a
maximum borrowing of 80 per cent of a property’s value) to as much as 100 per cent and even
more.
What causes prices to increase rapidly?
Looking back at figure 7.1 for a moment, what do you think causes a sudden and rapid price increase,
like what happened between 1998 and 2004?
The answer is price speculation. Like a snowball increasing in size and speed as it rolls downhill, a
booming property market feeds on itself as buyers start to behave irrationally. Values are bid up
quickly as home buyers fear being priced out of the market, while speculators look for quick profits.
In time the property market will peak and then soften, which usually happens in conjunction with:
The economic climate deteriorating and speculators becoming less willing to risk their capital
and more interested in preserving their wealth.
Home buyers becoming less motivated to buy, since values are falling or drifting, so there isn’t
much urgency to make a commitment.
Finance becoming harder to source, particularly for investors, as lenders become choosier about
who they lend to and for what purpose.
The truth is that although property values trend up over time, they are not increasing all the time.
During periods when prices are flat or declining, capital-growth-focused investors will not be making
any money. Looking at what happened to median house prices in Sydney over the past 29 years, it
appears property prices:
increased for 31 per cent of the time (nine years: 1988 to 1989, 1997 to 2003)
decreased for 17 per cent of the time (five years: 1990 to 1991, 2004 to 2005, 2007)
were stable or flat for 52 per cent of the time (fifteen years: 1980 to 1987, 1992 to 1996, 2006,
2008 to 2009).
There have been two substantial booms, followed immediately by two price corrections, and the rest
of the time prices were flat. Would you be happy with an investment strategy that was only effective
31 per cent of the time? I wouldn’t be.
The number of years of median house price increases, decline and no movement are shown in table
7.6 for Australia’s capital cities. You can find graphs of median house price movements for all capital
cities at <www.PropertyInvesting.com>.
Steve’s investing tip
Investing for growth is about timing the market, not time in the market.
Table 7.6: movement in median house prices 1980 to 2009
Source: Approximate, based on data from the Real Estate Institute of Australia.
* Data from 1991 to 2009.
# Data from 1987 to 2009.
Note: Only obvious downward movements were treated as a decline; minor declines were treated as the market trending sideways.
The conclusion here is that the broad investing strategy of buying and holding real estate for the
long term will be profitable, but for somewhere between 60 per cent and 70 per cent of the time you
will not be maximising your money because prices will be flat or declining.
A much better approach would be:
1 to be heavily invested in real estate for growth as the market booms
2 to sell once prices have peaked and start to correct
3 to buy positive cashflow and quick-turn properties while the market is trending sideways.
I’m not sure what the future holds, but firmly believe that the best strategy is to tailor your investing
to the prevailing market conditions rather than adopting a one-size-fits-all approach.
DO PROPERTY PRICES REALLY DOUBLE EVERY SEVEN
YEARS?
Although property spruikers regularly claim that property prices double every seven or so years,
statistical evidence indicates this is a furphy, designed to dupe unsophisticated investors into buying
second-class real estate.
Taking actual median house prices from 1995 and assuming values doubled every seven years (to
2002 and 2009), table 7.7 reveals what property should be worth today (forecast) compared to current
prices (actual).
Table 7.7: 2009 property price forecast vs actual
Source: Real Estate Institute of Australia <www.reia.com.au>.
As the data above reveals, despite there being the biggest boom in property prices in 100 years, there
was not one major city in all of Australia that experienced a doubling of house prices within
consecutive seven-year periods from 1995 to 2002 and 2002 to 2009.
FALLING TAX RATES
When you think about how much people were taxed in the past, you can understand the historical
attractiveness of negative gearing as a legal tax-minimisation strategy. For example, as shown in table
7.8, the top marginal tax rate for individual taxpayers in 1985–86 was 60 cents in every dollar (above
$35 000). Ouch!
Table 7.8: individual tax rates 1985–86
Source: ATO website, copyright Commonwealth of Australia, reproduced by permission.
Taxable income
Tax on this income
$0 − $4 594
Nil
$4 595 − $12 499
25¢ for each $1 over $4 595
$12 500 − $19 499 $1 976.26 + 30¢ for each
$1 over $12 500
$19 500 − $27 999 $4 076.25 + 46¢ for each
$1 over $19 500
$28 000 − $34 999 $7 986.25 + 48¢ for each
$1 over $28 000
$35 000 and over $11 346.25 + 60¢ for each
$1 over $35 000
Yet gradually since, the amount of income tax we pay has been falling in two ways:
The income thresholds have been increased.
The marginal tax rates have decreased.
Table 7.9 (overleaf) shows the income tax rates for individual taxpayers for the 2009–10 income
year.
Table 7.9: individual tax rates 2009–10
Source: ATO website, copyright Commonwealth of Australia, reproduced by permission.
Taxable income
Tax on this income
$1 − $6 000
Nil
$6 001 − $35 000
15¢ for each $1 over $6 000
$35 001 − $80 000
$4 350 plus 30¢ for each
$1 over $35 000
$80 001 − $180 000 $17 850 plus 38¢ for each
$1 over $80 000
$180 001 and over $55 850 plus 45¢ for each
$1 over $180 000
However, while it’s great to pay less tax, there is a substantial downside for negatively geared
investors as the amount of their tax saving reduces as the marginal tax rates fall. Taking scenario A
from earlier in this chapter as an example, the so-called tax benefit has dropped substantially, even for
those on the top marginal rate, as shown in table 7.10 (overleaf).
Table 7.10: diminishing tax benefit
1985–86 tax year 2009–10 tax year
Loss created by the negatively geared property $5000
$5000
×60%
×45%
Top marginal rate
Tax benefit at top marginal rate
= $3000
= $2250
The diminished benefit is even worse for middle-income-earning taxpayers.
You can also conclude that as the tax rates drop, the amount of money needed to fund your negative
cashflow property increases. Using the figures in table 7.10, an extra $750 ($3000 − $2250) must be
found to maintain the property portfolio, and this takes away from your ability to fund your lifestyle.
INFLATION
Looking back at table 7.1, the median price for a house in Brisbane in March 2000 was $150 000. By
March 2009 the median house price had increased to $428 000.
Assuming you had bought a property that achieved this price growth, how much of a gain would you
have made? At first glance you might say $278 000 ($428 000 − $150 000), however the real profit
would be much less because you would need to adjust for:
purchase costs, including stamp duty
the annual amount of your negative cashflow
sale costs
inflation
taxation (if you sell).
Inflation represents the erosion of the buying power of money as a result of increasing prices. The
most common measure of inflation in Australia is the Consumer Price Index (CPI).
A good example of inflation is hot chips. It shows my age, but when I was a boy I can remember that
a ‘minimum chips’ at my local fish and chip shop cost 30¢. Nowadays, minimum chips is about $3.00!
You get the same amount of chips, but the cost has gone up 1000 per cent since around 1980.
Steve’s investing tip
The impact of inflation is that a dollar today buys less than a dollar yesterday.
Returning to the example of the Brisbane house, to make the comparison fair we need to inflate the
purchase price (which was paid for in year 2000 dollars) up to 2009 dollars, because a dollar in the
year 2000 bought more than a dollar today. Once you’ve adjusted the purchase price for movements in
the CPI between March 2000 and March 2009, $49 121 of your gain (17.7 per cent) is gobbled up by
inflation, leaving an inflation-adjusted profit of $228 879. This then needs to be adjusted for purchase
costs, holding costs, sales costs and taxation.
The point here is that the profit you make from any capital appreciation may not be quite as good as
you think because if you hold your investments for a long time then a significant amount of your gain
will be eroded by inflation.
CAPITAL GAINS TAX
The way capital gains are taxed changed in September 1999. Up until that date, the cost of the asset
was indexed, meaning that you only paid capital gains tax on the after-inflation gain. For example,
taking the Brisbane property again, you would only have to include $228 879 on your income tax
return rather than $278 000.
However, from September 1999 adjusting for inflation was scrapped, and instead individual
taxpayers who held an asset for longer than 12 months were eligible to receive a 50 per cent capital
gains tax discount. Using the Brisbane example again, only $139 000 of the $278 0001 capital gain
would need to be included in the taxpayer’s income tax return. In this example the 50 per cent
discount provides a better outcome than indexing — but this isn’t always the case.
Where the property market drifts upwards slowly, as happens for the majority of the time, a greater
portion of the gain made will be eaten up by inflation. For example, let’s say you bought a Melbourne
investment property for $347 0002 in March 2003, and held it until March 2008 when you sold it for
$432 500.3 You rented the property out at $400 per week, and paid rental management of 6 per cent,
annual interest on your loan of $19 000 and other costs of $4 000 per annum.
At first glance you have made a good profit of $85 500. The reality, as shown in the following steps,
is otherwise.
Step 1: annual cashflow
Rent
$20 800
Rental management − $1 248
Loan interest
− $19 000
Other costs
− $4 000
Annual cashflow loss = $3 448
Step 2: property’s cost
Purchase price
$347 000
Purchase costs (say, 5%)
+ $17 350
Annual cashflow loss (5 years) + $17 240
= $381 590
Total cost
Step 3: sales proceeds
Sales price
$432 500
Sales costs (say, 4%) − $17 300
Sales proceeds
= $415 200
Step 4: profit/loss
Sales proceeds $415 200
Total cost
− $381 590
Total profit
= $33 610
Step 5: tax on capital gain
Total profit
$33 610
Annual cashflow loss *
+ $17 240
Taxable capital gain
= $50 850
Tax on capital gain (50% discount, tax on balance at, say, 30%)
$7 628
Tax benefit of the annual negative cashflow($17 240 at, say, 30%) − $5 205
= $2 423
Net tax on property
* This is not relevant to the capital gains tax calculation and is added back.
Step 6: inflation adjustment on your investment capital
Deposit paid (20%)
$69 400
Closing costs
+ $17 350
Annual cashflow loss
+ $17 240
Total investment capital = $103 990
Inflation adjustment *
= $15 381 #
* CPI for March 2003 was 141.3. CPI for March 2008 was 162.2. Inflation adjustment on the capital contributed is:
((162.2 − 141.3) ÷ 141.3) × $103 990 = $15 381.
#
This means that after you have sold and your initial investment capital is returned, it buys $15 381 less than it did when you bought
in 2003.
We calculated that the tax payable on the capital gain was $7628. However, if we adjusted the
capital gain for the impact of inflation, the amount of tax payable would be $5320.4 This means that
we are paying tax of $23085 on a capital gain that has given us no benefit because it has been eroded
by inflation.
Step 7: real gain
Total profit
$33 610
Inflation adjustment − $15 381
After-inflation profit = $18 229
I know it’s been a lengthy example, but I have gone into a lot of detail to show you that the tax
system now says you must pay capital gains tax on a portion of your profit that you actually haven’t
made because it has been eaten away by inflation. That is, the capital gains tax was levied assuming
you made a pre-tax gain of $50 850 when in fact your pre-tax inflation-adjusted profit was $18 229.
You might argue that the 50 per cent discount is high enough to cater for the erosion of inflation,
however there is an anomaly. You only have to hold the property for a year to get the 50 per cent
discount. There is no increase in the discount if you hold the property longer, yet the more time that
passes the more inflation erodes your gains.
Steve’s investing tip
The way the capital gains discount works means those who hold their properties for the long term are disadvantaged
compared to those who hold for shorter time frames.
It’s been a complicated discussion, but this is a very important point, particularly as one of the
common beliefs held by a lot of property investors is that you hold for the long term. In fact, the 50
per cent capital gains discount works better for those who hold for just over a year (or a few years)
because inflation has less of an impact. Those who hold property for decades suffer a significant
inflation erosion of their profits without being further compensated by the tax system.
THE BOTTOM LINE ON NEGATIVE GEARING
My aim has not been to pour freezing cold water on the idea of negative gearing. Rather my objective
has been to present an independent perspective outlining that all is not as rosy as the free seminar
presenters would have you believe.
When you allow for holding costs, tax and inflation, negative gearing does not seem like a great
long-term wealth-creation strategy. Indeed, when prices are flat or going backwards, which is most of
the time, negative gearing builds no wealth at all.
Negative gearing is a strategy designed to lose money, and in order to fund that loss you will need to
continue working. This makes the strategy at odds with the broader target of financial independence.
If your goal is to stop working as soon as possible or to free up more time to do the things you love,
then negative gearing is not a wealth-building strategy you should implement. An alternate approach
is needed because, as you know, success comes from doing things differently.
CHAPTER 7 INSIGHTS
Insight #1
When comparing the purchase price and the rental return, most properties sold in Australia are negatively geared. This
means that you won’t be interested in buying most properties that are available for sale, and certainly not dwellings
offered off the plan or at free seminars.
Insight #2
Even though you are able to use the loss made from negative gearing to reduce the amount of tax you would otherwise
pay on your employment income, you will only receive back a maximum of 46.5¢ in every dollar lost. The remaining
53.5¢ must be paid from your own pocket, and this means less money to live.
Insight #3
The trigger for a growth phase in property prices is when incomes improve and/or access to credit becomes easier.
Insight #4
Property prices certainly trend up over time, but that does not mean they are increasing all the time. Over the past 30 or
so years, prices have only increased for around a third of the time, and this is split over several intervals. The truth is that
for the majority of the time, property prices trend sideways.
Insight #5
Despite what some wealth-creation spruikers may promise, property prices do not double every seven years. Even
considering the biggest boom in property prices for 100 years, the median house price did not double in any capital city
in the two consecutive seven-year periods from 1995 to 2002 and 2002 to 2009.
Insight #6
Inflation erodes the buying power of your money. The longer you hold your property portfolio, the higher the
proportion of any gain made that is gobbled up by inflation.
Insight #7
The way capital gains are taxed means that, even though inflation erodes more of your gain over time, there is no
compensation for this, as property investors who hold for a year are treated the same as investors who hold for 20 years.
Practically, you will end up paying capital gains tax on a portion of your gain that has no benefit to you because it has
been eroded by inflation.
Notes
1
2
3
4
5
In reality the gain would need to be adjusted further for relevant purchase and sale costs.
Median house price at the time as reported by the Real Estate Institute of Australia.
Median house price at the time as reported by the Real Estate Institute of Australia.
(($50 850 – $15 381) ÷ 2) × 30%
($15 381 × 50%) × 30%
8
The truth about financing
It was one of the most bizarre meetings I’ve ever attended. Early on in our investing life, Dave
Bradley and I met up with two senior managers from one of the major banks to discuss securing a
$500 000 loan to buy more investment properties.
The bankers were enthusiastic because they had recently introduced a new loan tailored for small
business owners who didn’t have five or more years of financial statements (usually a bank
requirement to prove earning capacity). We were pleased because $500 000 would allow us to buy
another 20 or so houses.
Everything seemed to be going well, until our banking friends mentioned that in order to get the
$500 000 loan, we’d have to provide first mortgages on the property we bought plus leave $500 000 on
deposit with them as extra security.
Dave and I exchanged bemused glances, before I asked, ‘What percentage interest rate will you give
us on our deposit?’
‘Three per cent’, they replied.
‘And what percentage interest will you charge us on the loan?’ Dave enquired.
‘Seven per cent.’
‘Hang on a minute’, I said. ‘Aren’t you just lending us our own money back at a higher margin?
Also, if we had the $500 000 to start with, why would we need a loan from you?’
Dave added, ‘How many of these loans have you written so far?’
Unsurprisingly they replied, ‘Not many’. No guesses why!
I joke that I used to have a full head of hair before dealing with financiers, but the truth is that if
you’re planning on buying real estate then sooner or later you’re going to need to borrow
money — and that means dealing with lenders.
WHAT IS LEVERAGE?
Leverage is a fancy way of saying ‘being able to do more with less’. Applied to real estate, you can
use leverage in the form of other people’s money to buy more real estate than you could if you solely
relied on your own funds.
Steve’s investing tip
Leverage means being able to do more with less.
How many properties could you afford to own if you had to pay 100 per cent of the purchase price
and all other costs from your savings? Probably not many. On the other hand, how many properties
that made money from day one could you afford to own if you didn’t have to contribute one cent
towards the purchase costs? The sky is the limit.
Steve’s investing tip
LVR means loan-to-valuation ratio, and it is used to express the amount of money you can borrow relative to the property’s
independent valuation (which is almost always the purchase price).
Provided you can prove your creditworthiness, you should be able to borrow up to 80 per cent of a
property’s purchase price without too many troubles (so you would have an LVR of 80 per cent).
Before the global financial crisis you could borrow 100 per cent or more, but those rather heady days
have gone for the time being.
Just because a financier is willing to lend you a flattering amount of money does not automatically
mean it’s in your best interests to borrow as much as possible. This is a very important point. The
person writing the loan is probably being paid a commission, and the bigger the loan, the more money
he or she will get paid.
Steve’s investing tip
Just because a financier will lend you a flattering amount of money doesn’t mean you should accept it.
The name of the sustainable property investing game is to borrow in such a way that you’ll be able
to continually go back and ask for more money without the lender perceiving you as an increased
credit risk. One of the ways I’ve been able to do this is to never borrow more than 80 per cent of the
purchase price.
GETTING A LOAN
Financiers are in the business of lending money, which means that they’ll potentially lend to anyone
who satisfies their loan requirements. Now, given that you need to meet the lender’s systems (rather
than the other way around), the secret to getting financiers to say ‘yes’ to your application is to take
away all the reasons for them to say ‘no’.
Steve’s investing tip
The secret to getting financiers to say ‘yes’ to your application is to take away all the reasons for them to say ‘no’.
To do this, you must stand in the shoes of your financier and understand what risk you pose as a
potential client.
In discussing how to improve your chances of having your loan application approved, we’ll look at
the following issues:
The Australian lending industry. Lending in Australia is heavily influenced by the federal
government’s monetary policy, together with consumer credit laws. Recently, global
events — including the ‘sub-prime’ lending collapse, failures of several large offshore financial
institutions, and the resulting global financial crisis — have led to tougher credit lending
policies. What lenders can and can’t do is shaped by these factors.
The process of applying for a loan. All lenders have an application process that must be adhered
to. While each lender has a slightly different process, the way the information is reviewed is
largely consistent across the entire lending industry.
Getting the lender to say ‘yes’. We’ll have a look at some tips and techniques you can employ
when completing your loan application to dramatically increase your loan approval chances.
I’ve included a loan application checklist at the end of the chapter.
The Australian lending industry
Before deregulation, which began in the early 1980s, banks operated in a market where there was little
competition. At that time, most of the savings and loan interest rates were determined by the
government monetary policy of the day.
This lack of competition led to the emergence of a monopoly by the major Australian banks, and
few, if any, creative loan products were available. Basically, if you had a mortgage it lasted for 25
years and you paid monthly principal and interest loan repayments. The housing loans on offer were
very basic in structure, and features that are taken for granted today (such as redraw and offset
accounts) were not offered.
Other financiers existed, such as solicitor trust funds, but they were small and lacked the power and
resources to take on the major lenders.
In a bid to break the stranglehold, the Australian government deregulated the finance market and
invited foreign banks to not only open up in Australia but also potentially acquire previously
Australian-owned lenders.
Steve’s investing tip
The need to drive profits higher will be the driver for the re-emergence of more aggressive borrowing practices that were
scaled back when the global financial crisis first hit.
Banks are no longer operated for the benefit of deposit holders. Now private and/or public
shareholders own the equity and force management to engage in profitable activities to generate high
returns. This has increased competition and led to the release of new lending products with creative
features that have made the traditional ‘no-frills’ principal and interest loan all but obsolete.
With competition now influencing the lending market, lenders have looked for ways to streamline
operations and reduce costs. Efficiency savings have made it easier for lenders to provide employees
with notebook computers rather than employing additional support staff at a branch level.
The next logical step was not having employees at all, rather to have consultants who were paid a
commission for each loan written. In restructuring their operations, major lenders aggressively cut
costs by re-training some employees, and retrenched a lot more.
Some of the retrenched employees used their knowledge about the finance industry to set up
databases of lenders and their products. They used these databases and their knowledge about how to
get loans approved to carve a niche as intermediaries between lenders and clients. Within the industry,
such people are known as mortgage originators or mortgage brokers. Mortgage brokers make a living
from the commission paid by the lending institution when a loan is approved to a client introduced by
them. The service is free for the client.
Most recently, with the impact of the global financial crisis and the failure of several large overseas
financial institutions, there has been some tightening in available credit. This has made it difficult for
many smaller lenders to stay in business, and as a result some of the competitive pressure on the
major banks has eased.
What does it mean for you, the borrower?
Firstly, while the number of lenders has reduced in recent times, the market is still competitive and
there’s likely to be a lender interested in having you as a client, no matter what your credit history or
circumstances. All you need to do is meet their lending criteria.
Secondly, unless you have an existing relationship with a lender, it makes more sense to begin by
talking to a mortgage broker rather than directly with a financier, as a broker will be more interested
in getting your application approved because he or she receives a commission, whereas an employee is
likely to be paid the same salary no matter how many deals are approved.
Steve’s investing tip
No matter what your circumstances, there is sure to be a lender who can service your needs.
Applying for a loan
There are two components to your loan application: your personal information, and details of the
property you wish to purchase. Let’s have a look at these.
Personal information
Applying for a loan is like applying for a driver’s licence — the more effort and practice you
undertake, the better your chance of success; turn up on the day unprepared and you’ll probably fail.
Ideally, the best frame of mind to be in when asking for money can be achieved by trying to stand in
the shoes of the lender and asking: if a complete stranger came to me and asked to borrow money,
what are issues I’d be thinking about?
Lenders are primarily concerned with two things:
What is your ability to repay the debt?
What security are you offering as protection should you default on the repayments?
To answer these questions, lenders will seek personal information about your earning ability. Most
lenders will have standard application forms. Photocopy the application form and complete a few trial
runs to make sure you are familiar with what is required, and also that you can fill in the form neatly
and, more importantly, completely. Be sure to attach documents that support the information on your
application form, and don’t forget to sign it.
Many lenders now have online ‘pre-approval’ application forms where you can obtain instant
(conditional) approval. This is a good way to shop around, but you should seek to establish a network
with a broker rather than rely on a computer to process your application.
Proof of income
Unless you go for a low-doc loan, any potential financier will require proof of your income, which is
needed to help gauge your ability to make repayments. Proof of your income will include copies of
payslips, bank statements and tax returns.
If your tax returns are not up to date, then do yourself a favour by getting them in order now. Get in
touch with your accountant, get your records together and get your tax returns done, so that you can
provide these in support of any investment loan application.
When processing your application, a lender will seek to establish the maximum amount of debt you
can afford to take on given your current income by applying a formula called a debt-to-income ratio
(also known as a serviceability check). Each finance provider sets a different ratio, so it makes sense
to find out what the benchmark is before you submit your application. Don’t waste your time applying
to lenders when you know your debt-to-income ratio is outside their lending policy, unless you have
mitigating circumstances such as a higher deposit or additional security.
In order to comply with the Consumer Credit Code, lenders must be able to demonstrate that they
have carried out a reasonable assessment of your ability to service any loan without undue financial
hardship before they can approve you. As a general guide, lenders will be reluctant to lend where the
repayments would exceed one-third of the borrower’s gross income. A person whose repayments
exceed one-third of his or her gross income is considered to be ‘mortgage stressed’. For example, on a
gross salary of $75 000 the one-third guide would suggest a maximum annual repayment amount of
$25 000 ($75 000 × 0.33). At 6 per cent interest on a 30-year mortgage with monthly principal and
interest (P&I) repayments, this would support a loan value of about $347 000.
Note that this is a guide, not a hard and fast rule, as a person on a $75 000 annual income paying
$25 000 in mortgage repayments will probably feel more financial stress than someone on a $750 000
income repaying $250 000 per year.
Employment history
My brother, Ralph, tells a funny story about the importance of having a job in order to borrow money.
Returning home to Australia after a stint working overseas, he was in between jobs and went into the
branch of a prominent bank to get a new credit card with a $5000 limit.
He filled in the application form, including a personal financial statement, which revealed he had
many assets, including a sizeable bank balance, and few liabilities. The one anomaly was that he
didn’t have any employment income because he was having a break from work for a few months
before looking for a new job.
Looking over the application form, the bank teller enquired about why my brother didn’t have a job,
before expressing her disapproval, saying, ‘You realise you have to pay the money back, don’t you?’
‘Er — yes, I’m aware of that’, my brother replied politely. It was no good though; despite being in a
very strong asset position and being able to buy just about anything for cash, without a job his credit
application was denied.
Lenders are very interested in your employment history. This information is used to determine the
stability of your income and also how easy it would be for you to find another job in the event you
were sacked. Clients who have a reliable employment history will be looked upon favourably.
If you have an unstable employment record or have only been with your current employer a short
while, consider rephrasing your application to focus on the time you have been in a particular
industry.
Steve’s investing tip
The property is the security for the loan. What financiers are really lending against is your future salary or income-earning
ability as this is what will allow you to repay the loan.
Qualifications
Your qualifications are also important. People in certain professions — such as accountants, lawyers
and doctors — have access to special loan deals through affiliations with professional bodies. If you
belong to such a body, or a trade union or other club or association, then you may already have a foot
in the door with a lender. Be sure to spend the time researching whether or not a special deal exists
that you can access.
Steve’s investing tip
Most lenders have special offers for professionals. And even if you’re not a professional there’s no harm in asking for the
special deal!
Before supplying any information, it’s worthwhile to think over three issues:
Specifically, what information does the lender require?
Why is that information needed?
How is the information going to be processed?
Answering these questions ensures you’re not just providing information for the sake of it. Instead,
you’re able to see the need, and then craft an answer that ensures your application is viewed in the best
possible light.
Personal financial statement
Your loan application form will include a section asking you to list your assets, liabilities, income and
expenses in the form of a personal asset statement.
This information is partly used to determine your current financial strength (or otherwise), as well
as providing the lender with a list of items that could potentially be used to make up any shortfall
between a fire-sale value of the property and the amount of the loan.
Often estimates are required; avoid providing inflated values as this won’t serve any worthwhile
purpose in the long run.
Credit check consent
A credit check is a key component to your loan approval. This is where the lender will access your
credit file to see what loans you have applied for, and whether there have been any late payments or
defaults.
While uncommon, it is possible for your credit record to have incorrect entries on it. That’s why I
strongly recommend obtaining a copy of your credit history before submitting your loan application.
In Australia, instructions on how you can do this free of charge can be found at:
<www.mycreditfile.com.au>.
Steve’s investing tip
It’s a good idea to review a copy of your credit file to make sure there aren’t any incorrect entries.
Note that you’ll need to send your request for your credit history by fax or post if you want to obtain
the free copy of your file. Otherwise you can pay for an express service and order your credit file
online.
A record is kept every time a lender requests your credit file (including the date, the lender and how
much you were seeking to borrow), so be careful about having an excessive number of enquiries.
Steve’s investing tip
When seeking loan pre-approval, only authorise the credit check to be done after all other criteria have been evaluated. That
way, if your application is refused on other grounds your credit file won’t have unnecessary enquiries on it.
If you have a poor credit history, address the flaw in your credit application. Explain problems in
advance and adopt the strategy of providing more information than is necessary. Never hide any
details in the belief they won’t be discovered.
Putting your best foot forward
Here are four ideas you can use to present your personal information in a positive light:
Prepare a confirmation or proof of income letter on your employer’s letterhead and get your boss
to sign it. Make sure you include your entire package (superannuation, fringe benefits, bonuses
and so on), not just your cash component.
If you are due for a pay increase, make sure you put the higher figure on the form and word the
letter accordingly (for example, ‘I advise that from the next pay adjustment, Steve McKnight’s
salary will be $65 000 per annum’).
Don’t just mention how long you have been employed or what your qualifications are; talk about
how senior you are and how important you are to the business. Remember that banks are looking
for stability.
If you’ve changed jobs frequently, focus on how long you have been in the industry, rather than a
particular job.
Any weaknesses in your application should be directly addressed. Don’t be apologetic and never
seek to hide the truth. Obtaining a financial advantage by deception is a criminal offence.
Property information
In addition to personal information, lenders will also seek data about the property being used as
collateral or security for underpinning the finance.
Not all properties are equal. Depending on the location (city or rural), condition (good or poor) and
usage (residential or commercial), the lender may impose additional requirements. For example, you
may be required to come up with a larger deposit, the interest rate may be higher or you may need to
offer additional collateral.
The lending organisation wants to minimise its risk of suffering a loss if you default. The more
secure the collateral behind the loan, the happier a lender will be.
Loan-to-valuation ratio
The lender will calculate an LVR for your loan. The LVR calculation compares the funding sought
against the independently assessed value of the property potentially being purchased. The higher the
LVR, the more risk there is from the lender’s perspective. It is best to keep your LVR at or below 80
per cent if you want to avoid mortgage insurance. Some lenders offer low-documentation loans, which
means you don’t need to provide much financial documentation, but the maximum LVR they’ll
usually accept on such loans is between 60 per cent and 75 per cent.
Mortgage insurance
Almost any potential loss can be insured against, and mortgage default is no exception. Your lender
will seek to insure your loan with another organisation so that if you default they will not suffer any
economic loss. This is an extremely important point: mortgage insurance insures the lender, not you.
If you default on the loan, the insurer pays the lender, but the insurer will then seek to recover this
money from you.
Almost every residential property loan, regardless of the LVR, has mortgage insurance. You will
usually only have to pay the cost where the LVR is greater than 80 per cent. It is often a one-off cost
payable at the beginning of the loan, of usually several thousand dollars, or sometimes it can be added
to the loan and therefore your repayments will increase slightly to cover the cost.
Mortgage insurance is different to mortgage protection insurance. The latter is paid by the borrower
on the basis that if he or she becomes sick or disabled, the insurance company will make the
repayments on his or her behalf.
Make sure you shop around for the best loan product available, as the maximum LVR and also the
threshold where you will need to pay mortgage insurance varies between organisations.
High and low LVR loans
It’s possible to seek over 100 per cent finance, but you will usually need to offer additional security,
such as the equity in your existing home. This is, however, much more difficult since the global
financial crisis hit.
I don’t advocate borrowing money to fund a lifestyle. Be very wary of the trap where lenders
overextend your credit and you use the funds to pay for non-investment-related expenses.
At the other end of the scale, you can also seek finance if you have a poor credit history or no
financial statements. Despite tightening credit in the lending market, there are still a number of lowdoc loans available. You’ll pay a higher interest rate, higher establishment fees and be constrained by
a lower LVR, but finding a low-doc lender is still possible.
Honeymoon rates
Avoid being enticed by cheap honeymoon rates. Going cheap upfront might cost you more over the
life of the loan since lenders usually charge fees that go a long way to recoup the cost of the lower
initial rate.
Registered valuers
The valuation component in an LVR equation will typically be the lower of the purchase price and the
value assessed by an independent registered valuer.
Lenders usually have a number of valuers that they use. Upon instruction from the lender, a valuer
will look at the price of other houses sold in the area. He or she will also take into account the details
of the dwelling (number of bedrooms, land size and so on) and may even inspect the property to
determine its current state.
Valuers are not an overly optimistic group and are extremely conservative by nature, as the threat of
being sued should they come up with the wrong value is an ever-present concern. This is why, in all
but the rarest cases — irrespective of council values, estimated ‘true’ market value or any other
basis — the price paid for a property will almost always be the value used by the valuer.
Behind the scenes
Once you’ve submitted your application form, together with your authority for a credit check, your
lender will begin processing and evaluating the information. You can save yourself a lot of effort by
calculating your debt-to-income ratio and also your LVR using the template below to help determine
whether your application is likely to be successful.
It’s a good idea to regularly phone your lender or broker to see how your application is progressing,
to ensure it is not left at the bottom of the pile.
And finally …
Here are some final suggestions to help with your application:
Never lie or try to hide the truth from lenders. Not only is it a criminal offence to obtain a
financial advantage by deception, if your lender approves the loan and later finds out about your
dishonesty, they can demand that the loan be repaid immediately.
Target lenders that specialise in the type of loan you are applying for.
Don’t say or do anything that flags you as a dangerous risk. For example, when I said to my
banker that I wanted to become financially independent and never work again, he almost had a
fit. Aim to communicate that you see yourself working in your safe, secure and high-paying job
until you retire (whatever age that may be).
Building rapport with lenders takes time. Start networking now!
Getting the lender to say ‘yes’!
Now let’s turn our attention to other issues that are important in most lending situations.
The banking ‘radar’
When discussing this topic at seminars, a metaphor I like to use is the ‘banking radar’. As investors
we want to make sure that we fly under the radar, as when we start appearing as a flashing ‘beep’ our
chances of success start to diminish quickly.
Here are some examples of ‘beeps’ on the radar.
Borrowing more than 80 per cent of the purchase price (beep)
The industry standard for LVRs is 80 per cent, so, while it may be possible to borrow more than this,
doing so flags you as a higher credit risk in the lender’s computer system.
Interest-only loans (beep)
You will need to demonstrate to the financier that you plan to repay the loan. A simple way you can do
this is by using principal and interest loans as opposed to interest-only loans. Possible exceptions
include deals where you plan to only hold the property short term (say, 24 months or less), and
commercial property where the loan term may only be for 10 or so years and therefore principal and
interest loans are going to make your cashflow horribly negative.
I usually recommend you make principal and interest repayments on your mortgage as part of a
sensible debt-reduction program.
Using unrealised equity to fund growth (beep)
If you use unrealised equity to fund growth then you increase your credit risk in the eyes of the bank,
and, while you may get one property settlement across the line, you ultimately hurt your longer term
prospects given your highly leveraged position. This is especially true for those using home equity to
fund deposits as personal debt is always seen as dubious by lenders.
Lack of or inconsistent external supporting documentation (beep)
Make sure that whatever you write down on your finance application can be supported by external
evidence. For example, make sure your stated pay equals what’s recorded on your payslips and that
your annual income corresponds to your income tax return, and that you have all documentation
required.
Poor-quality security (beep, beep)
Lenders don’t really want to foreclose on mortgages, but should they have to do this they want to at
least recover the outstanding loan amount. Therefore, most lenders have a list of postcodes outlining
the areas where they are happy to lend; all you need to do is grab a copy.
Bad credit history (beep, beep, beep)
If you have a bad credit history, expect a rough ride in finding a financier who will lend to you on
attractive terms. Instead, a better long-term option may be to seek a low-doc or non-conforming loan
and then refinance later when your credit history improves.
With the exception of a dubious credit history, it’s doubtful that, in isolation, any of the above
factors will deliver a knock-out blow to your application. However, remember that the more beeps you
register on the radar the harder you will find it to obtain attractive finance terms.
Go outside the system
Another idea to improve your chances of success is to have your application processed ‘outside’ the
system whenever possible. Take the view that you’re a special case and that your application should
be treated differently to others. You don’t want to apply to an organisation; you want to apply to a
person.
For this to happen you must establish a connection with an insider, someone you can count on to get
the deal across the line by answering questions before they arise. I’ve managed to do this consistently
by locating and networking with a central person from all my lenders, whether dealing with a ‘big
four’ bank or individual mortgage brokers.
I’ll send applications direct to my contacts, and while they may delegate the application to other
staff, I know that my contact is someone with the authority to make decisions that may be outside of
normal lending criteria, and that I can call on this person when needed. You might like to say I try to
create win–win outcomes. When I borrow money, my contact might be promoted (as a result of
writing more loans) or earn more money (if this person is paid a commission on each loan written, or
a bonus for reaching a lending target).
Securing loan approval is not so much about getting the right form submitted as it is focusing on
finding the right person. Find the right person and doors that were previously forever shut will open
for you. How do you find such a person? It takes time and effort, and it’s often a hit-and-miss process.
Sometimes you’ll find a great contact, but even his or her powers only stretch so far. Or this person
will be promoted to a new division or resign.
It’s important to start networking before you need a loan. Go to seminars and also business expos.
Many lenders hold information nights or seminars about various issues, such as margin lending or
property investment. Start making enquiries about when the next seminar is and invest a small amount
of time and money networking.
Steve’s investing tip
A great place to go to start sourcing finance is the website <www.PropertyInvestingFinance.com>. They are an Australia-wide
mortgage broking service that I helped establish who specialise in servicing investors wanting to borrow more money with
less hassle.
LEARN THE INDUSTRY
It is critical that you learn as much as you can about the lending industry. Why? Because if you can
communicate in the language lenders use then they’ll begin to treat you with respect, meaning you
won’t be viewed as an outsider. You’ll also know your rights and responsibilities, which will make
dealing with you a refreshing change at the same time as identifying you as a sophisticated investor.
While there isn’t a secret handshake, being able to ‘talk the talk’ will help you to more effectively
communicate with your lender.
A mistake I made early in my investing career was to not understand and compare the different loan
products. It is important to be able to understand which features are available on what products and
how they can save you money. In one case I made a $10 000 mistake by accepting a loan that had only
one mortgage number and a series of sub-loans, when what I really needed was a number of individual
mortgages with separate mortgage numbers.
When your application says the right things and answers potential questions before they arise, your
chances of success skyrocket.
OBTAIN PRE-APPROVAL
Pre-approval is the process of determining a loan figure that the lender is comfortable providing. The
lender will make a preliminary assessment of what it expects to be able to lend to you, based on your
current financial situation.
Unfortunately, pre-approval is not actually a guarantee that you’ll get the loan when the formal
application is made. One issue is that final approval will always be conditional upon the details of the
property that you’re purchasing, which will only become known once you’ve found a deal. Still, to
have at least gone part-way through the process is better than starting from scratch. You will be better
prepared if you have road-tested your ability to secure finance before buying a property, especially if
you plan to rely on a ‘subject to finance’ clause.
SUSTAINABLE INVESTING
Aside from getting a loan to start your property portfolio, you also need to consider how you are going
to finance further acquisitions.
When buying their second, third or fourth investment properties, many investors run into problems
finding finance because, although they have the money to pay deposits (via savings or redrawing
equity), they fail the debt-servicing test because their incomes cannot support any more loan
repayments. Further loans will push their repayments beyond 33 per cent of their income, which most
lenders consider unacceptable.
Steve’s investing tip
Being maxed out means that you can’t borrow any more money.
Clearly I’ve been able to consistently borrow money, and the secrets to my success are:
Having a non-investment source of income. A danger with only having property income is that
lenders will view you as being ‘rent reliant’ and will only take 70 per cent of your earnings into
account when determining your ability to service a loan.
Only borrowing 80 per cent or less of the purchase price. Quite often it is the mortgage insurer
rather than the lender that will reject a finance application. You can reduce the chance of this
roadblock occurring by only borrowing 80 per cent because mortgage insurers have less say in
such loans. This is why borrowing more than you need may seem like a good idea at the time, but
may come back to haunt you later on.
Being correctly structured. For reasons I’ll explain in the next chapter, buying investment
property in your own name places your assets at unnecessary risk, and may cause you to pay
unnecessary tax and limit your borrowing ability. The structure I use allows me to keep
borrowing, gain valuable asset protection and legally minimise my tax.
Dealing with business bankers. Getting out of retail banking and moving to business banking has
been a very big help. Aside from a better level of service, the people you deal with can actually
give you some helpful tips about how to structure your application so it is viewed in the best
possible way. Furthermore, there is the potential to operate outside of normal lending criteria,
meaning deals that might be rejected at a retail level may get the green light.
Running out of finance will quickly stunt the growth of your property portfolio. Not only do you
need to source the right loans, you need to borrow in such a way that you can continually finance your
property deals.
You don’t need to leave getting your loan applications approved to chance. Don’t be passive, and
remember that success comes from doing things differently.
Book bonuses
By registering your book, you will gain access to the following bonus items:
#1 Bonus 67-minute video presentation I recorded called How to get the bank to say yes.
#2 An insider’s peak at a real life finance proposal I prepared for a property deal.
These bonuses are waiting for you right now at <www.PropertyInvesting.com>.
CHAPTER 8 INSIGHTS
Insight #1
Although the global financial crisis changed the mortgage industry and made credit harder to find, the truth is that
lenders need to write loans to keep making record profits. This means they want your business, and it’s your job to
present yourself in such a way so that you look like a good credit risk.
Insight #2
Start preparing and building your finance network before you need the funds. That way, when you do find a great deal it
will be easier to source the right loan at a great interest rate.
Insight #3
Getting a lender to say ‘yes’ is a matter of taking away all their reasons for saying ‘no’.
Insight #4
It’s possible your credit record contains inaccurate information. Make sure you get a copy at
<www.mycreditfile.com.au>, and dispute any inaccuracies.
Insight #5
If you are new to investing, a great place to start is chatting with the friendly folks at
<www.PropertyInvestingFinance.com>.
Insight #6
Although every financier has its own lending policies, there is scope to operate outside the rules if you can get access to
a senior manager with the appropriate approval authority.
LOAN APPLICATION CHECKLIST
Below is a loan application checklist to help you ensure that your application has the best chance of
being approved. Place a in the box when the step has been completed or you have obtained an
answer to the question.
Step 1 Find a mortgage broker
Call a mortgage broker and discuss what his or her experience is.
Is there any fee for using the broker’s services?
Step 2 Find a lender
What is the maximum LVR with no mortgage insurance?
What is the allowable debt:income ratio?
What are the establishment fees (mortgage fees, valuation fees, etc.)?
What are the ongoing fees?
Is a separate mortgage number issued with each loan?
Does the lender do ‘low-documentation’ loans? If so, what are the additional terms?
Can I do a fixed and/or variable loan? What is the longest period I can fix for?
Would I be able to get pre-approval for a block of funds?
Step 3 Preliminary checks
Have you viewed your credit report? Is it what you expected?
Do you have all the documentation necessary for the loan application (financial statements, tax returns, letter from employer,
etc.)?
Do you have a letter from a real estate agent outlining the likely rent?
Do you meet the debt:income ratio requirements?
Do you meet the LVR requirements?
Do you meet the lender’s requirements about property zoning, minimum population, etc.?
Did you specify that your loan is to be processed on the basis of a credit check only being authorised once conditional approval
has been granted?
Step 4 Disclosure and follow up
Did you submit your application to an individual who is senior within the organisation?
Have you followed up with your contact after one week?
Has a valuation been ordered?
Has your loan been approved?
9
The truth about structuring
An important issue you need to think about when buying property is, whose name will it be purchased
in? The easiest option is your own name, but as outlined in this chapter there are better options.
Steve’s investing tip
Your aim should be to control your wealth rather than own it.
LIFESTYLE AND FINANCIAL ASSETS
Some people think your home isn’t an asset. I disagree. By definition, an asset is something that holds
future value, and a home certainly does that. The distinction I prefer to make is between lifestyle and
financial assets.
A lifestyle asset is something of value that you own for your enjoyment, or because it serves a nonfinancial function. Examples include your home, cars, clothes, furniture and jewellery. A financial
asset is something that you own with a view to making money. Examples include shares, property and
managed funds.
Let’s see if you’re able to tell the difference between a lifestyle asset and a financial asset by
placing a in the correct column for the 10 items below.
Lifestyle asset Financial asset
A holiday home
Antiques in your home
A new car
Cash in the bank
Golf clubs
Shares in listed companies
Investment property
Your wardrobe
Money you have in superannuation
Your home
A suggested solution can be found at the end of the chapter.
Be careful not to make lifestyle asset choices based primarily on financial considerations, or to
decide what’s best for your financial assets based primarily on lifestyle considerations, because if you
do your judgement will be clouded.
For example, if you want to buy a holiday home for your enjoyment then you are making a lifestyle
choice. Buy it because you want to (and can afford to), not because you are planning on making
millions from it. Similarly, the more emotion there is in your investing decisions, the harder it will be
for you to buy, hold or sell at the right time.
WHAT IS STRUCTURING?
‘Structuring’ is a term used by accountants to describe the way you own and control your wealth. A
good structure will do three things:
protect your assets
legally minimise tax
maximise your borrowing capacity.
Let’s have a look at each of these.
Asset protection
No-one wants to be sued, but if you are, you don’t want every asset you own to be at risk, which is
why one of the golden rules of structuring is to own your lifestyle and financial assets in separate
structures. That way, if you are sued personally your investments are safe, and vice versa.
Steve’s investing tip
Lifestyle and financial assets should be owned in different structures.
This is even more important if your employment activities cause you to have a higher than normal
risk of being sued — this includes:
professionals giving advice, including doctors, lawyers, accountants and financial planners
tradespeople who might be sued for faulty workmanship, including builders, plumbers and
electricians
those who work in a service industry, where people may be injured by their negligence, including
tourism and catering.
We live in an increasingly litigious world, and if you have wealth someone may try to take it from
you.
Tax minimisation
If you’re like me then you’re happy to pay your fair share of tax, but the thought of paying more than
you have to is about as appealing as having root canal treatment without an anaesthetic.
While you don’t have many options to reduce the tax on your employment income, provided you
have the right structure you’ll be able to split your investment income so that those on the lowest
marginal tax rates receive the biggest distributions. I’m not just talking a few dollars here and there,
I’m talking about thousands and thousands of dollars in tax saved, using completely legal and ethical
means. We’ll look at this in more detail throughout this chapter.
Borrowing capacity
When you buy real estate and borrow in your own name, your income will determine your borrowing
capacity. Once you’ve hit your limit you won’t be able to borrow any more.
There is another option though, which is common in commercial real estate but has a residential
property application too: the property is purchased in another entity’s name, and then those who
control that entity guarantee the debt. Choosing this option means that the loan is not in the name of
the individual (only the promise to repay the debt if the loan defaults), so an individual’s income can
be used to secure multiple loans and borrow much more money. More is written on this later in the
chapter.
WHAT ENTITY SHOULD YOU BUY IN?
Note: I’m definitely not trying to turn you into an accountant, so I’ve limited my discussion to a
general overview. My hope is that the knowledge I’ve provided here will trigger questions you can
ask your accountant.
Okay — you’ve found a property you want to buy as an investment, negotiated a price you’re happy
with, and are about to sign the contract. The purchaser’s name is one of the first pieces of information
you’ll need to give, and this means deciding what entity you are buying in. Your options are:
as an individual
in a partnership
a company
a trust (including a superannuation fund)
a combination of the above.
I’m not planning on boring you to tears with a textbook explanation of how they work, so I have
given just the advantages and disadvantages of each in summary format in the following pages (tables
9.1 to 9.4).
Table 9.1: buying as an individual
How: Sign the contract in your own name. For example: Sam Smith.
Advantage Disadvantage
Set-up costs
Doesn’t cost anything to set up. Just sign your name on the contract and you are away.
Cost to administer
A little more as your tax return will be more complex, but no separate financial statements are needed.
Asset protection
Poor asset protection as there is no distinction between lifestyle and financial assets.
Tax minimisation
Can access the 50 per cent capital gains tax discount, but profit may be taxed at the highest rate. No
opportunities to split income.
Borrowing capacity
Restricted by the income available to service the debt. No opportunity to leverage your borrowing
capacity.
Table 9.2: buying as a partnership
How: Buy in joint names. For example: Mr and Mrs Smith.
Advantage Disadvantage
Set-up costs
Quick and inexpensive to set up. Most solicitors use a standard partnership agreement and tailor it as
needed.
Cost to administer
Needs a partnership tax return and financial statements, however these are not very difficult or expensive.
Asset protection
Very poor asset protection. Unlimited liability and the partners are jointly and severally liable for all
debts.
Tax minimisation
Income split between partners. No flexibility to vary split of profits beyond partnership agreement.
Borrowing capacity
Can pool your capital so there is more borrowing ability than as individuals. Debt still in individual
names though.
Table 9.3: buying in a company
How: Buy in the name of a company. For example: Smith Investments Pty Ltd.
Set-up costs
Advantage Disadvantage
Requires a new company to be created. Easy to do, but can be expensive compared to other options.
Cost to administer
Cost to administer is high as a separate tax return and financial statements are required.
Asset protection
Very good asset protection. The company’s assets are separate from the directors’ and shareholders’
assets.
Tax minimisation
Not eligible for the capital gains discount. Profits are taxed at a flat 30 per cent. No opportunity to split
income.
Borrowing capacity
Debt is in the name of the company and the directors act as guarantors. Allows directors’ incomes to be
used multiple times.
Table 9.4: buying in a family trust
How: Buy in the name of the trustee on behalf of the trust. For example: Smith Pty Ltd as trustee for the
Smith Family Trust.
Set-up costs
Expensive to set up. Ideally a corporate trustee and a family trust will be established.
Cost to administer
Cost to administer is high as a tax return and financial statements must be prepared.
Asset protection
Ownership and control are split so there is maximum possible asset protection.
Tax minimisation
Profits distributed according to the trustee’s discretion so income can be directed to specific taxpayers.
Capital gains tax exemption allowed if gains are distributed to individuals.
Borrowing capacity
Debt is in the name of the company as trustee and the directors act as guarantors. Allows directors’
incomes to be used multiple times.
Advantage Disadvantage
WHY YOU SHOULDN’T BUY PROPERTY IN YOUR OWN NAME
Starting from kindergarten when our mums labelled everything from our lunchboxes to our shoes, we
have a tendency to want to put our name on the things we own — particularly things that we are proud
of. When it comes to real estate, though, the disadvantages of buying property in your own name far
outweigh the benefits.
Asset protection
An illustration that may be helpful here is imagining that your lifestyle assets are brown eggs and your
financial assets are white eggs. Owning all your assets as an individual is like carting around every
egg you own in one big basket. Should you trip and drop the basket, all the eggs — brown and
white — are at risk of being smashed.
Steve’s investing tip
There is no distinction between ownership and control of assets that are held in your own name.
If you are part of a couple and you do decide to own your wealth in your own name, accountants
generally think it’s smart to split ownership of the assets across both partners. Traditionally, the way
this is done is to assign the responsibility for control of the investment assets to the partner with the
higher salary (to maximise his or her borrowing ability), while the lifestyle assets are owned by the
lower income partner.
Steve’s investing tip
Aim to have one partner own the lifestyle assets and the other control the financial assets.
For example, in a situation where one partner works and the other stays at home, the financial assets
should be owned by the partner with the income, and the lifestyle assets owned by the partner looking
after the home. This is exactly what my wife and I have done. Julie owns our family home in her
name, while I control the investment assets through various trusts.
The family home
Deciding who should own the family home can be a tricky issue because for any capital gains to be tax
free the property must be owned by an individual who lives in it as his or her principal place of
residence. But having such an important asset owned by an individual has asset-protection
consequences.
As mentioned above, the ideal situation is for the non-working partner to own the high-value
lifestyle assets, and this includes the family home, while the other party controls the financial assets.
Hang on a minute though — what if there needs to be a mortgage and the non-working partner can’t
qualify for a big enough loan because of lack of income? In this case the property can still be owned
by the non-working spouse, with the income-earning partner guaranteeing the loan.
Tax minimisation
If you take a moment and refer back to the tax rates on page 124, you’ll see that individuals are taxed
on a sliding scale, so the more income a person earns, the more tax he or she pays — all the way up to
a maximum of 46.5¢ in the dollar.
Tax at 46.5 per cent (including Medicare levy) is the highest rate applied to any entity, so if you are
thinking about making serious amounts of money from property then you’d be silly to own the moneymaking assets in your own name, because you’ll end up paying more tax than you would if you were
better structured.
Even if your employment income isn’t close to $180 000 per annum (which is where the 46.5 per
cent tax rate kicks in), don’t forget that all you need is a bumper year where you sell a couple of
highly profitable assets and all of a sudden your income will spike and you may be caught paying
more tax than you have to.
The one attraction to owning assets as an individual is that you will qualify for the 50 per cent
capital gains tax discount.
Borrowing capacity
The amount of money you can borrow is limited to how much debt you can service based on the
income shown on your payslip or tax return.
Steve’s investing tip
The rule of thumb lenders apply is that your loan repayments cannot be more than a third of your income.
While a mortgage broker will be able to give you a more accurate assessment, table 9.5 roughly
indicates your potential borrowing capacity based on your salary.
Table 9.5: indication of borrowing capacity
Salary
Potential borrowing capacity
$50 000
$150 000
$60 000
$180 000
$70 000
$210 000
$80 000
$240 000
$90 000
$270 000
$100 000 $300 000
$110 000 $330 000
$120 000 $360 000
$130 000 $390 000
$140 000 $420 000
$150 000 $450 000
The important point to note is that even if you have the funds to leave deposits, once you’ve reached
the limit of your borrowing capacity — as determined by your income — you won’t qualify for any
more loans and your ability to purchase more real estate will run dry. People in this situation are said
to be ‘maxed out’.
Are you maxed out? If so, there’s no quick fix, but you may find doing one or more of the following
helpful:
Sell poorer performing properties to repay debt, which you can then reborrow for new property
purchases.
Look to increase your income so you can support more debt.
Consider non-traditional finance sources such as money partners, joint venture partners or
boutique lenders.
THE STRUCTURE STEVE USES
I’ve never bought an investment property in my own name. Instead, right from the start I’ve used
trusts (family and unit) because I can control my investments and share in the profits without having
to own the asset.
The key parties in a trust structure are:
Trustee(s): The company and/or individual(s) who control the trust and operate it according to the
trust deed (a written document that outlines the rules for running the trust).
Beneficiaries: Those for whom the trust is operated and who receive a share of the trust’s income.
Asset protection
The ‘corporate veil’ is an important legal principle which says that if a company is sued the assets of
its directors and shareholders cannot be accessed by creditors to pay for the debts of the company, and
vice versa — the company is not liable for the personal debts of its directors or shareholders. That’s
why, even though individuals can be trustees, it’s better to set up a new company because if a trustee
is sued then assets he/she/it owns may be at risk. However, having a company act as trustee eliminates
this problem because the corporate veil principle says that if a company is sued the assets of its
directors and shareholders are safe, and because the only asset in the trustee company is a few dollars
in a bank account, there’s nothing of worth to take.
When establishing a trustee company, I elect to have only one director — me. This gives me total
control because I make all the decisions about what assets the trust buys, holds and sells.
Steve’s investing tip
Setting up a single-director company to act as trustee allows you to control assets without owning them.
Because the company is trustee (rather than me as an individual), if the trust is sued (for example, if
a tenant slips on the stairs) my personal assets are not at risk because the corporate veil principle says
the personal assets of a director are separate from the company’s assets.
On the other hand, if I am sued personally then my personal assets may be at risk but any assets I
control as director of the trustee company will be safe.
Tax minimisation
It’s the trustee who, applying the rules of the trust deed, decides how a trust’s income will be
distributed. And it’s the beneficiary receiving the trust distribution who has to declare it as income
and pay any associated income tax.1
By holding my investment properties in a family trust structure, I’m able to decide which
beneficiaries receive what distributions (if any). This means I can give a bigger trust distribution to
beneficiaries who have lower incomes, and less of a trust distribution to beneficiaries who have more
income. I can distribute to non-working spouses and children, as well as other entities — such as other
family members, companies, other trusts (including superannuation funds) and charities. This allows
me to split the income earned by my investment properties in a tax- advantageous way, meaning I can
legally lower my overall income tax bill.
Steve’s investing tip
Tax on trust distributions is paid by the beneficiary, not the trustee.
Better still, I’m able to allocate the capital income to one beneficiary and the other income to
another. That way, provided the capital income is distributed to an individual, he or she will be able to
claim the 50 per cent capital gains tax discount.
Here’s a simple example that illustrates the tax-saving potential of a trust. Let’s say you are married
with no children. You are employed full time and earn $70 000. Your spouse works part time and
earns $30 000. On 20 June you sold an investment property that was bought in 1995 that will result in
an $80 000 capital gain.
Table 9.6 (overleaf) shows how the tax position would work out depending on whether you owned
the property in your name, in joint names or in a trust.
Table 9.6: different tax outcomes
*The trust distribution would be capital gains income, and so only half of it needs to be declared since the capital gains discount
applies.
As you can see, by using a trust structure you would save $3600 in tax compared with owning it in
your own name, and $1000 compared to owning it in joint names.
Borrowing capacity
Aside from the asset-protection and tax-minimisation benefits, using a trust may also increase your
borrowing capacity. Using multiple trusts and multiple lenders to source loans that I am guarantor for
is one of the secrets to how I have borrowed tens of millions of dollars and bought hundreds of
properties. I continue to use this approach with my investing today. Let me explain how.
Say you find an investment property that you want to buy in a family trust that you’ve just set up.
The purchase price is $100 000. The first step is to sign the contract to buy the property, which you
would do in the name of the trustee on behalf of your family trust; for example, Trustee Company Pty
Ltd as trustee for Your Family Trust.
Next, you’ll want to find a loan. Most financiers are happy to lend to trusts provided the trustee(s)
guarantees the loan. Let’s assume in your case that the ABC Bank is happy to lend you up to 80 per
cent of the purchase price (which is $80 000).
Practically, this means there will be two loans, a mortgage and a personal guarantee:
Loan #1: From you to your trust. The trust doesn’t have any money to start with, so you will need
to lend it the $25 000 needed for the deposit ($20 000) and closing costs ($5000).
Loan #2: From ABC Bank to the trustee on behalf of the family trust. The ABC Bank will provide
an $80 000 loan to purchase the property, being 80 per cent of the price. The loan will be signed
by the director(s) of the trustee company on behalf of the trust.
Mortgage: ABC Bank over the title of the investment property. To secure the loan, the ABC Bank
will want a first mortgage over the investment property. The mortgage documents will be signed
by the director(s) of the trustee company on behalf of the trust.
Personal guarantee: Provided by the director(s) of the trustee company to the ABC Bank. The
trust has just been set up and doesn’t have any income. Therefore, to prove that the loan can be
repaid, the income of the director or directors as individuals is used to support the loan. A
personal guarantee is given by the director(s) to use personal funds to repay the loan if it goes
bad.
Assuming you had income of $100 000, the ABC Bank would allow you to borrow $300 000. If you
had the money for the deposits, you could buy two (nearly three) $100 000 investment properties
before your borrowing ability with the ABC Bank ran out.
Steve’s investing tip
Keeping lifestyle assets out of the name of the person doing the investing ensures that high- worth lifestyle assets (such as the
home) cannot be at risk if the guarantee is ever invoked.
The way to get around reaching your borrowing limit is once the ABC Bank has said ‘no more’,
create a new trust structure and approach a different bank, which will then provide you with a further
$300 000 to invest with.
How is this possible? Well, as long as the loan is not in default, the debt to the ABC Bank is owed
by the trustee company on behalf of the trust; you have no personal liability and do not need to record
the guarantee on your personal financial statement.
Steve’s investing tip
A guarantee to repay a debt is not the same as having the debt in your own name.
When asked by subsequent financiers, so long as the loan is not in default the debt to ABC Bank will
not count towards your borrowing limit, and so you can keep leveraging off your income time and
time again.
To get the most leverage from your borrowing ability you will need to:
Only borrow a maximum of 80 per cent, because then you shouldn’t have any issues with
mortgage insurance.
Have a high income but low or no personal debt in your own name. I’m afraid that if you’ve
already borrowed in your own name or have significant personal debt then this strategy will be of
little use, because any existing debt you have is deducted from your borrowing capacity. That’s
why it is important to have a high income and little or no personal debt.
Is this legal?
Yes — it’s legal and ethical, but if you have any doubts then let me point out:
You are not lying or hiding the truth. If asked you must declare all the loans you are guarantor
for.
Your credit record will clearly note what loans you have applied for, and what loans you are
guarantor for. Even if the application form doesn’t request it, your financier will soon find out.
It might be new to you but this practice is a commercial reality. It’s how billions of dollars worth
of property is bought every year, especially commercial real estate where the dollars and debt are
a lot higher.
When I’ve shared this strategy, some people have told me that their mortgage broker has said that
guarantees are viewed as being the same as debt in the eyes of borrowers. Even though I have dealt
with every major bank in Australia, and many sub-lenders too, I have never come across this. Still, if
some brokers won’t help with this strategy, there are lots of other mortgage brokers and lots of
lenders, so shop around. The team at <www.PropertyInvestingFinance.com> are experts and can help.
Some people have gone into a branch and been told this can’t be done. Retail lending is focused on
everyday home loans, so advanced structuring concepts will be beyond the understanding of most
tellers. If you experience difficulties then ask to speak to the business banker. She or he will deal with
trusts and guarantees every day.
WANT MORE INFORMATION?
Talking about structuring is heavy going at the best of times, so well done if you have been able to
push through. I expect that you have many questions racing through your mind, which is great,
because I’ve managed to get you thinking.
Here’s what I recommend for your next steps:
Get your hands on my detailed product called Wealth Guardian, where expert accountant Mark
Unwin and I explain a lot more about structuring for property investors. It’s an essential resource.
Better yet, after registering this book at <www.PropertyInvesting.com>, you’ll receive a discount
code to save a very generous $100 off the cost of this excellent and highly recommended
resource.
Call the gang at <www.PropertyInvestingFinance.com> on 1300 848 781 and chat about how you
can take full advantage of your borrowing ability. It’s free and there’s no obligation.
Make a time to see your accountant to discuss the following three essential issues:
How your personal and financial assets are protected.
How you can legally minimise your tax.
How you can borrow more money to buy more real estate.
How you structure your lifestyle and investment assets will have a big impact on how safe they are,
how much tax you pay and how much money you can borrow. It’s fair to say that, once again, success
comes from doing things differently.
CHAPTER 9 INSIGHTS
Insight #1
Be careful not to confuse lifestyle assets (which you own to enjoy) with financial assets (which you own to make
money). Financial assets should be bought, held or sold based on the facts, not emotion, as you try to make the most
money, in the quickest time and with the least risk.
Insight #2
The goal of a good accounting structure is for you to control rather than own everything, but to still benefit from the
profits in such a way that you pay the least income tax legally possible.
Insight #3
Buying property as an individual is cheap and easy, but the downside is that you have limited borrowing capacity and
poor asset protection.
Insight #4
Given the poor asset protection, avoid partnerships between entities that have unlimited liability.
Insight #5
Since companies are not eligible for the 50 per cent capital gains tax exemption, avoid buying appreciating assets in a
company structure.
Insight #6
Buying negatively geared property in a trust structure is problematic because trusts cannot distribute losses. However, if
you are planning on buying real estate that makes money then I have found trusts to be excellent in providing good asset
protection and useful tax planning opportunities.
Insight #7
If you plan to have a portfolio that includes multiple properties then be sure to think about your borrowing capacity
when deciding what structure is best.
Suggested solution for exercise on page 160
Lifestyle asset Financial asset
A holiday home
Antiques in your home
A new car
Cash in the bank
Golf clubs
Shares in listed companies
Investment property
Your wardrobe
Money you have in superannuation
Your home
Note
1 The only time a trust has to pay tax is if it has income that has not been distributed.
10
The truth about depreciation
When you drive a new car off the showroom floor its value immediately diminishes by several
thousand dollars because it instantly becomes second-hand. Its value falls further as it clocks up the
kilometres, cops a few dents and scratches, and as newer models with better features are released.
Another way of describing how the car’s worth has fallen is to say that it has depreciated in value.
WHAT IS DEPRECIATION?
Depreciation is an accounting term used to describe the way an asset falls in value due to wear and
tear associated with its use.
Let’s say you had a rental property and the carpet needed replacing. After visiting several retailers
you find a good-quality carpet that is expected to last 10 years. Fully installed it will cost $7500.
Begrudgingly you hand over your credit card and cringe as it’s swiped through the machine.
Given the carpet is going to last 10 years, is it reasonable to allocate the entire $7500 against one
year’s rent? If you did this then the profit for that year would be unfairly low (because the full cost of
an asset that has 10 years life is absorbed in one year), while the profit in years 2 to 10 would be
unfairly high.
Steve’s investing tip
Depreciation aims to match the expense of an asset wearing down with the income generated from its use.
Sorry to sound like a boffin here, but one of the functions of accounting is to produce meaningful
reports so that people can make more accurate decisions. To do this, accountants apply what’s called
the ‘matching principle’, where the income an asset generates is matched as accurately as possible
with the costs associated with earning it.
Returning to the carpet example, to provide more accurate data the $7500 should be spread over the
entire 10-year lifespan rather than being fully absorbed in the year the carpet was bought. Otherwise,
you may get to the end of the first year and decide to sell because the profit was unusually low (or the
loss was unusually high).
Steve’s investing tip
Expensing the entire cost of a major capital item in the year it is acquired will overstate the expense and understate the profit.
DOES REAL ESTATE DEPRECIATE?
A piece of real estate is made up of two components:
the land; and
the building(s) on the land.
Even though land may fall in value with the ups and downs of the property cycle, it does not
depreciate because it doesn’t wear out. That is, the building can be demolished easily enough and the
land restored to its original condition.
Houses, on the other hand, do depreciate in value because:
the internal fixtures and fittings (walls, ceiling, carpet, furniture, light fittings and so on) become
worn, torn and dated through use and the passage of time
the exterior of the building weathers since it is exposed to the elements (sun, rain, wind and so
on).
TAX AND DEPRECIATION
Investors are not allowed to claim an income tax deduction for capital purchases. Instead, these items
(such as a dishwasher, oven or a hot water system1) can be written down so that the cost is apportioned
over the item’s working life.
Taking the earlier example of the $7500 carpet, table 10.1 reveals the cashflow and tax-deduction
consequences.
Table 10.1: cashflow and tax-deduction consequences of purchase
Year 1 Years 2 to 10
Cashflow
−$7500 –
Tax deduction for depreciation* −$750
−$750
*Using the prime cost method (see page 184).
As table 10.1 shows, the cashflow impact of purchasing the carpet is an outflow of $7500 in year
one. However, for tax purposes a deduction is not allowed for the whole amount in the first year, and
instead the expense is apportioned over 10 equal annual deductions of $750.
This means that you are able to claim a $750 tax deduction in years 2 to 10, even though you did not
physically outlay any cash in those years.
Steve’s investing tip
Depreciation allows taxpayers to claim a tax deduction without physically outlaying cash in that year.
I’ve never quite understood it, but some commentators suggest that depreciation is a real bonus for
investors because you can claim a tax deduction even though you haven’t physically outlaid any cash
in that year. While technically correct, you have still paid for the item, just in an earlier year, so it’s a
question of timing rather than receiving money for nothing from the Australian Taxation Office
(ATO).
Types of tax deductions
Depending on the asset, there are two options available for claiming a tax deduction for the wear and
tear on your property.
Buildings and foundations
A residential rental property built after 17 July 1985 may qualify for a ‘capital works’ deduction at the
rate of 2.5 per cent per annum against the construction cost (no write off is allowed for the land
component).2
Example
Andrew purchases a newly built investment property for $200 000, of which $75 000 relates to the
land and $125 000 to the building. Andrew is eligible to claim an annual capital works deduction of
$3125 ($125 000 × 2.5%).
Even if the rental property was built before 18 July 1985, if there have been any new buildings,
extensions, alterations or structural improvements done after that date you may still be able to claim a
capital works deduction on those enhancements. Items that would qualify include:
carports and garages
concreting or earthworks
major kitchen and bathroom makeovers.
Example
Brian owns an investment property which is tenanted by Shane, a plumber. Shane has been a good
tenant, and was mentioning to Brian that it was a hassle to have to keep his dirty work tools inside the
house.
Brian thought about this and has come up with a solution. If Shane is willing to pay an extra $50 per
week in rent, Brian will build a brand new lock-up shed at a cost of $8 000. Shane agrees.
Normally Brian would not be able to claim a tax deduction for depreciation on this shed because it
is a structure rather than a fixture or fitting. However, he is able to claim $200 per annum
($8 000 × 2.5%) as a capital works deduction. Furthermore, Brian will receive more rent, which will
be great for his cashflow, and the shed will also increase the value of his property.
Other depreciating assets
Fixtures and fittings inside your rental property that have a finite life and fall in value through regular
use can generally be depreciated over their useful lives. For example, an investor may claim a tax
deduction for the wear and tear of carpet, appliances such as a fridge or stove, light fittings, furniture
and the like.
You have a choice of two methods of depreciation: prime cost (which gives you an equal deduction
over the asset’s useful life) or diminishing value (which gives you more of a deduction in the early
years and less of a deduction in the later years).
Items costing $300 or less are able to be fully depreciated in the year they’re bought, meaning you
can claim an immediate 100 per cent tax deduction. Accountants tell their clients that it pays to have
invoices itemised rather than bundled as a total.
An unexpected bonus
You might be surprised to learn that, provided you meet all the eligibility requirements, you don’t
have to be the person who actually paid for the item to claim a tax deduction under the capital works
or depreciation rules. Instead, if a previous owner paid for the improvements it is assumed that the
cost of those works are reflected in the purchase price you paid to acquire the property, and as such
you should be able to claim any capital works or depreciation relating to those improvements. This
means you might be able to claim hundreds, or even thousands, of dollars in extra tax deductions
without knowing it!
Steve’s investing tip
You don’t have to be the one who paid for the improvements in order to claim a capital works or depreciation tax deduction.
You’ll need to be able to show receipts to make such a claim. However, in situations where you
purchased a property and were not able to obtain the required documentation to prove the value and
date of the capital works from the previous owner, you can engage a quantity surveyor to provide you
with a ‘schedule of depreciable assets’.
Book bonus
By registering your copy of the book at <www.PropertyInvesting.com> you’ll gain access to a valuable audio interview I’ve
conducted with an experienced quantity surveyor, in which he provides more practical information about how investors can
claim tax deductions for capital works and depreciation. Listen in to find out how you might be sitting on hundreds — or
thousands — of dollars of extra tax deductions without knowing it.
TURNING NEGATIVE CASHFLOW INTO POSITIVE
CASHFLOW
One of the tricks used by those selling negatively geared properties is to demonstrate a way the
dwelling can have negative cashflow before depreciation and positive cashflow after depreciation.
This is done so that the property appears more profitable than is actually the case when looking at the
cashflow impact alone. This is complicated, but if you work through the following example and
figures carefully you will see how it works.
Example
Sally is interested in buying an investment property and recently attended a free wealth-creation event
where she was told she could buy a property for $190 000 and have the tenant and the taxman pay it
off.
The property comes with a rental guarantee of $200 per week, and Sally is able to get an 80 per cent
loan with 6 per cent interest- only repayments. Other annual costs include council rates of $1500,
insurance of $550 and rental management costs of $1000.
When Sally asked whether the investment was negatively geared, the cheerful presenter said, ‘Oh no,
this is a positively geared property that puts money in your pocket’.
Let’s have a look at the figures in table 10.2 to see what’s going on here.
Table 10.2: investment summary
Cashflow summary
Income
Rent
1 $10 400
Expenses
Council rates
$1 500
Insurance
+ $550
Loan interest
2 + $9 120
Rental agent fees
3 + $1 000
Total expenses
= $12 170
Cashflow loss
$1 770
Tax adjustments
Capital works deduction
4 $2 750
Depreciation deduction
5 + $3 600
Acquisition costs
6 + $1 320
Total tax adjustments
= $7 670
Summary tax position
Cashflow loss
$1 770
Tax adjustments
+ $7 670
Total tax offset
= $9 440
Tax saving
7 = $2 832
After-tax position
Cashflow loss
− $1 770
Tax saving
+ $2 832
After-tax positive cashflow
= $1 062
1 $200 × 52 = $10 400
2 ($190 000 × 80%) × 6% = $9 120
3 Allowance for rental management and incidental costs.
4 Building value is $110 000 and attracts a capital works deduction at 2.5 per cent per annum.
5 Property comes with fixtures, fittings and furniture that attract annual depreciation of $3600 per annum under the prime cost
method.
6 Borrowing costs can be written off over five years or the life of the loan, whichever is shorter.
7 Applying a personal tax rate of 30 per cent, the amount of the loss can be used to offset other taxable income and reduce the
overall amount of income tax payable.
In the example, Sally was able to use her depreciation and capital works deductions to turn a pre-tax
cashflow loss of $1770 into an after-tax positive cashflow return of $1062.
However, before being happy with the result, Sally must ask two simple questions:
Does this property require that she keep working in her job?
Answer: Yes, Sally has to keep her job to earn enough income to soak up the $9440 in tax offsets
otherwise they would be treated as carried-forward losses; that is, a loss not soaked up by income
is carried forward rather than triggering a tax refund.
How many properties like this one can Sally afford to own?
Answer: If Sally’s objective is to save tax she should look to buy six properties (assuming she
had the deposit money) as that would just about eliminate her income tax liability.
However, aside from the problems with funding the negative cashflow, unless Sally achieved
good capital growth these properties would end up being poor investments as any cashflow
relates to a temporary tax deduction rather than an investing gain.
TAX DEFERRAL, NOT TAX SAVING
Do you think the ATO hands out money for nothing? No way!
While capital works and depreciation provide you with a temporary tax benefit by allowing you to
defer some of your tax to a later date, it is by no means a freebie cash handout from the federal
government.
Here’s how the government eventually gets its money back.
Cost base adjustments
When calculating capital gains tax, any capital works deductions are subtracted from the amount you
paid for the property. This has the effect of increasing the amount of your gain.
For example, let’s say you bought a new investment property in 2004 for $200 000. The building
component was $100 000. You owned it for five years and claimed a total of $12 500 3 in capital works
deductions. You then sold it for $250 000. Ignoring any purchase or sales costs, your capital gain
would be as shown in table 10.3.
Table 10.3: capital gain calculation
Sales price
$250 000
Purchase cost
Purchase price $200 000
Capital works − $12 500 − $187 500
Capital gain
= $62 500
The good news is that while you were able to claim a tax deduction of $12 500 which you used to
offset the tax on your salary, when it comes time to repay it those capital works deductions are
included as part of the capital gains tax calculation, and so half of the repayment will be tax free if
you qualify for the 50 per cent capital gains tax discount. As table 10.4 reveals, assuming Sally pays
income tax at the marginal rate of 30 per cent, she is able to claim a tax benefit of $3750 but will only
have to repay $1875 when she sells.
Table 10.4: capital gains tax calculation
Initial tax deduction CGT Calculation
Capital works $12 500
$12 500
CGT discount N/A
× 50%
$12 500
$6 250
× 30%
× 30%
Tax deduction = $3 750
Capital gains
= $1 875
Balancing charges
You don’t get off scot-free with depreciation either, because you may have to repay it when you sell.
Unlike capital works deductions though (which are included in your capital gains), recouped
depreciation is treated as income on your tax return under what’s called a ‘balancing charge’.
Building on the example used above, let’s assume that you also claimed depreciation of $1000 per
annum on the internal fixtures and fittings (total $5000). After selling, table 10.5 shows how your tax
return would look.
Table 10.5: balancing charge
Capital gains
$62 500
50% CGT discount
− $31 250 $31 250
Depreciation balancing charge
+ $5 000
Total income
= $36 250
The reason why you have to repay the depreciation is because the value of your property went up,
not down. While you can’t avoid this completely, you can lessen the pain.
If you don’t say otherwise, it is assumed that when you sold the property you sold the fixtures and
fittings for what you paid for them, and this means you will have to repay any depreciation you’ve
claimed.
The way to get around this is to have your sales contract specify how much the buyer is paying for
the land and buildings and how much the buyer is paying for the fixtures and fittings (which you
should include at their depreciated values). By doing this you are increasing the capital gain but
eliminating the need to pay back the depreciation. This will result in a better tax outcome for you
because the capital gains tax discount means you only have to pay back half the depreciation claimed.
An example of this is shown in table 10.6 (overleaf).
Table 10.6: separating fixtures and fittings
As shown in table 10.7 (overleaf), you have reduced your taxable income by $2500 by separating out
the fixtures and fittings, and that’s great! This will save you tax. You have not actually reduced your
income, you have simply benefited from structuring your transaction for the optimal tax outcome. I
have said that you should not make investment decisions solely to save tax, and that is still the case.
But, once you have made an investment, you should still do everything legally possible to minimise
your tax liability.
Table 10.7: change in taxable profit
Without separating fixtures and fittings Separating fixtures and fittings
Taxable profit $36 250
$33 750
It’s been a complicated explanation, so well done if you are still with me. Part of being a
sophisticated investor means understanding that depreciation allows for tax deferral, not tax saving.
That said, there is a loophole you can take advantage of so you pay back less tax than you deferred.
Steve’s investing tip
When selling, make sure the sales contract specifies the separate amounts the purchaser is paying for the property and the
fixtures and fittings. Make sure you sell your fixtures and fittings for their written down values.
FINAL THOUGHTS ON DEPRECIATION
I see cashflow and quick lump-sum gains as the meat and potatoes of a good property investment
strategy, and depreciation as gravy on top. My four parting comments on depreciation are given
below.
Depreciation is not money for nothing!
Depreciation is not a non-cash bonus. It’s an expense that is allowed because the asset is deteriorating
with use. Anyone who thinks that an expense is a good thing is a fool.
Steve’s investing tip
Depreciation allows for tax deferral, not tax savings.
One day you will have to replace the asset
Remember Ansett airlines? One of the reasons it went broke was because the company that owned it
claimed the juicy depreciation tax benefits without setting aside cash reserves to replace the fleet. As
the fleet aged, it cost more to run and Ansett became less competitive. Make sure you don’t make the
same mistake by pocketing the extra tax deduction without setting aside money to replace the asset
when needed in order to attract good tenants and above-market rents.
Beware the wolf in sheep’s clothing
While it’s always attractive to pay less tax, watch out for properties that rely on depreciation to make
them cashflow positive. These are wolves in sheep’s clothing that look good at first glance but will
keep you having to work in order to soak up the tax offsets.
There is an alternative
Don’t forget that there are other ways to invest in real estate where you can get genuine positive
cashflow and depreciation benefits. Focus on them and leave the marginal deals to less skilled
investors.
Further recommended resources
The ATO’s Guide to Depreciating Assets is a great resource if you want detailed information on depreciation. You can
download this for free from <www.ato.gov.au>.
My audio interview with an experienced quantity surveyor is available for free when you register your copy of this book at
<www.PropertyInvesting.com>.
CHAPTER 10 INSIGHTS
Insight #1
Depreciation is an accounting term that describes how an asset’s value decreases as it wears out with use. How can an
asset going down in value be a good thing? You should be investing to make money, not save tax.
Insight #2
Depreciation allows for tax deferral, it’s not a tax saving. That said, there is no point paying more tax than you have to,
so it pays to see how much capital works and/ or depreciation you may be entitled to. You never know; you might be
able to claim hundreds or even thousands of dollars of extra tax deductions and not know it.
Insight #3
When selling, you may be able to save tax by specifying separately how much the purchaser is paying for the house and
land and how much for the fixtures and fittings. Fixtures and fittings should be sold at their written down values. Talk to
your lawyer or accountant for more information.
Insight #4
Cashflow is the meat and potatoes of your investing. Depreciation is gravy on top.
Insight #5
I’ve written this chapter to open your eyes to issues many investors are ignorant of. If it has prompted you to think about
how you’re investing or if you have specific questions, make a time to visit your accountant.
Notes
1 Defining what can be expensed and what has to be depreciated has been argued about for many
years in the courts. Best to see your accountant for clarification.
2 Other types of property — for example, apartment buildings, shops and offices — have different
dates for when capital works deductions apply. See your accountant for more information.
3 ($100 000 × 2.5%) × 5 years
11
The truth about selling
Real estate is not an egg that you sit on and wait patiently until it hatches. You can’t just sit around
and wait for something to happen. Just as there’s a right time to buy, there’s also a right time to sell,
and that is when you can earn a better return elsewhere.
Steve’s investing tip
The right time to sell is when you can earn a better return elsewhere.
Choosing to sell is quite controversial. Many believe selling should be avoided at all costs because
you’ll only trigger capital gains tax.
Instead, refinancing is seen as a better option because you can access most of your equity without
any tax consequences.1
It’s true that selling has its drawbacks, but I’m certain that your chances of becoming financially
free are almost non-existent if you eliminate it as an option.
PROPERTY LIFECYCLE
Just like groceries, investment properties have a ‘best before’ date; if you hold on to them after this
time their quality and appeal diminish. To explain this concept, I’ve created a model called ‘The
Property Lifecycle’ (see figure 11.1).
Figure 11.1: The Property Lifecycle
Phase one: pre-purchase
The pre-purchase phase encompasses the many hours spent searching for and analysing potential
deals. It’s time-consuming work and you don’t earn a single dollar of profit for your efforts. The prepurchase phase is represented in the diagram by the line remaining flat, indicating time spent but no
financial return.
Phases two and three: purchase and growth
Although your pre-purchase efforts don’t create profit until after you’ve bought, your homework
should mean you buy better quality assets that will make good profits (in the form of positive
cashflow and/or capital gains from day one). You can see the line in the diagram starts its ascent as
your returns come rolling in.
Phases four and five: maturity and decline
In time you will find your cashflow and capital gain returns plateau and then start to decline. This is
because you need a bigger dollar increase to maintain the same percentage return.
Steve’s investing tip
As your property appreciates faster in value than rent, your cashflow return falls.
Let’s say you purchased an investment property for $100 000. It had rent of $5000 per annum and
promised annual appreciation of $10 000. Table 11.1 (overleaf) illustrates how your property
performed over three years.
Table 11.1: property performance over three years
See how the property’s rental, capital gains and total returns decrease over time? This decrease is
also shown in figure 11.2.
Figure 11.2: total return over time
This decline is caused by the following factors:
The additional capital appreciation isn’t adding any extra cashflow (and so the rent return falls).
As the property’s value increases, more annual appreciation is needed to maintain the same
percentage return — if this isn’t achieved the return falls.
Another way of demonstrating this would be to work out how much rent and capital gains are needed
to maintain the 5 per cent rent return and the 10 per cent capital growth (see table 11.2).
Table 11.2: gains required to maintain growth
Although the numbers are simple, this example illustrates a phenomenon I call ‘lazy money’, which
is where you have untapped potential in your investment property that is earning low or no profit, and
so the overall return is dragged down.
Do you have lazy money in your portfolio? Your job is not to own the nicest looking properties, it’s
to maximise your money at all times. Once your return falls below what you can earn on other
investments, it’s time to seriously think about selling and reinvesting in more profitable assets.
Steve’s investing tip
Lazy money drags your return lower because the additional equity doesn’t contribute much, if any, additional income.
FAST-TRACKING USING COMPOUNDING RETURNS
Have you ever wondered why interest on home loans is calculated daily rather than weekly, monthly
or quarterly? It’s because the more often the loan compounds, the higher the total interest is, meaning
the lenders make more money just by calculating interest more often. Calculating interest daily means
the balance compounds 365 times a year, versus 52 times if the interest was calculated weekly, 12
times for monthly and 4 times for quarterly.
Steve’s investing tip
To cease to move forwards is to go backwards.
But you can also use this to work in your favour. Returns on your investments will also compound,
meaning that you earn returns on your returns! Table 11.3 and figure 11.3 show the difference in the
balance of $200 000 invested at 7 per cent compounding over different periods after one year.
Table 11.3: investment value after compounding over different periods
Figure 11.3: investment value after compounding over different periods
The difference may only seem like a few dollars, but remember this is only one year and one
investment; multiply this by a number of years and a number of properties and you’ll see a dramatic
increase in returns.
Real estate investing sometimes feels like playing a game of snakes and ladders. The ladders are
unexpected gains and tricks you can use to fast-track your returns, while the pesky snakes are
setbacks, delays and financial losses. Selling can be a significant ladder in your investing, because it
will allow you to fast-track your wealth creation through increasing the rate at which your returns
compound.
Steve’s investing tip
The faster your returns compound, the more wealth you’ll create.
Let’s say you buy an investment property for $100 000 and its performance is as shown in table
11.1. That is, at the end of year three your property has appreciated in value by $30 000, while the rent
is still $5000 per annum.
Another way of looking at this is to say that your capital appreciation ($30 000) represents six years
of rent (6 × $5000 = $30 000), so you can either wait six years to access this money or you can use that
equity now to buy other profitable investments to increase the rate at which your returns compound.
Of course, you don’t have to sell; you could also refinance, but I’ll explain why selling may be better
later in the chapter.
What does your current portfolio reveal about you as an investor? Are you sitting on a large amount
of unused equity? If so, you are kneecapping your wealth-creation potential in two ways: first, by
dragging down the returns on your investments, and second, you are missing out on the opportunity to
reinvest and increase how often your returns compound. If you could be making more money, why
aren’t you?
REASONS WHY YOU WOULDN’T SELL
Those who believe you should never sell put forward the following four arguments.
Why pay tax unless you have to?
Income tax laws are quite friendly to investors because you are not taxed on any capital gains you
have made until you sell the asset. It’s simple then: don’t sell and you won’t be taxed.
You can always refinance your equity
Provided you have the income to service the debt, most financiers will be happy to lend against any
untapped capital appreciation. Furthermore, because you have only refinanced rather than sold the
property, there is no capital gains tax to pay.
You can miss out on future gains
It’s said that property values trend up over time, so if you sell you’ll miss out on the future capital
appreciation.
The cost of buying back in
If you plan to sell and buy another property then you’ll have to pay tens of thousands of dollars in
stamp duty. This can be saved if you hold and don’t sell.
REASONS WHY YOU WOULD SELL
There’s no doubt that selling has its drawbacks, but there are also many advantages.
Investment focus
The focus of your investing should be to make money rather than save tax. If you decide to keep an
asset because it saves tax, when selling would increase your wealth, you are making decisions based
on the wrong criteria.
Cash is king
A profit that only exists on paper isn’t real (hence it is called an unrealised gain). One of the lessons
learned from the global financial crisis, where asset values plummeted and wealth quickly evaporated,
is that a profit hasn’t been made until it has been converted into cash.
Selling also provides a lump-sum cash injection you can use to repay other debt or put towards
deposits on other properties you buy.
Refinancing isn’t quite so easy
Saying you can refinance your capital gains isn’t quite as easy as it sounds. Issues to weigh up
include:
Finding a lender. If you have an existing loan then you will need to refinance through the same
lender. There are no guarantees they will lend you the money, and if they don’t you will need to
refinance the entire loan, which can be costly.
Part-lending only. Most financiers will only lend up to 80 per cent of any equity, with the
remainder kept as a safety buffer just in case values fall. This means that even in the best case
scenario, 20 per cent of your equity will remain as lazy money.
Valuation. Any refinancing will be subject to having your property revalued. If the valuation
comes in lower than expected you’ll receive less finance.
Increased credit risk. As you borrow more money you become more exposed to an adverse
movement in interest rates. Your return would need to increase at the same time to compensate
for this extra risk.
Lack of sustainability. Refinancing is like a sugar rush that gives you a quick injection of cash.
Once it is gone though you will find it harder to borrow because you are carrying more debt
without an increase in income.
You can recycle your debt
Repaying debt will have the following positive outcomes:
Unlike refinancing, when you sell the profit will flow through to your tax return, and you can use
this extra income to demonstrate you can service more debt. This will help you buy more
property.
The money you repay can be reborrowed to purchase other investment properties.
It proves to financiers that you know what you’re doing, and as your reputation grows you will
find the credit application process a lot easier.
It’s a tax deferral, not a tax saving
Deciding not to sell won’t save tax, it simply defers the payment to a later date. Furthermore, if the
laws governing how property is taxed become less attractive (for example, the 50 per cent capital
gains tax discount is removed), by not selling you could actually end up paying more tax.
You can fund your financial freedom
What are you going to use to fund your financial freedom?
The option suggested by those who advocate never selling is to draw down on your equity, but this
has never made sense to me because:
At a time in your life when you don’t plan on working again, or on working less, you are going to
increase your interest bill by borrowing more money. This means that you will need to draw
down more debt to pay the interest. And so a nasty interest–drawdown–interest–drawdown cycle
begins.
Interest on borrowings used to pay for lifestyle expenses is non-deductible. This will require that
you draw down even more money because you will be repaying that debt with before-tax dollars.
It’s likely that sooner or later you will need to sell a property to relieve the financial pressure of
all the additional non- deductible interest on your lifestyle drawdowns. But guess what nasty
consequence selling creates? That’s right, it triggers a realised capital gain and you will have to
draw down even more money to pay the tax.
The better way to fund your financial freedom is:
Use recurring positive cashflow income from properties where the cash received is more than the
cash paid.
Use cash reserves where there are no interest or tax consequences of spending the money.
Take a moment to look back over the reasons for selling versus the reasons for not selling. Which do
you think provides the most sustainable way to invest, and the best type of income to fund your
financial freedom?
The truth is that the only reason you wouldn’t sell is because you didn’t want to pay tax. However,
as mentioned in chapter 6, trying to save tax accounts for why so many investors own so few
properties. What is the focus of your investing? What should it be?
CAN’T BORROW ANY MORE MONEY?
I often encounter investors who are in a pickle. They want to buy more property, have cash to leave as
deposits, but can’t borrow because they are maxed out and financiers won’t lend them any more
money.
When I suggest selling as an option to fix the problem (because the debt is repaid and the profit
flows through to the tax return, thereby allowing more money to be reborrowed), the typical answer is,
‘But I don’t want to sell…it’s been a great asset’.
My response is to tell them this story: apparently the way small monkeys are caught in the forests of
Asia is that poachers poke a few peanuts into large glass bottles. The monkeys come at night and reach
into the bottle to grab the peanuts, however the neck of the bottle is not big enough to allow the
monkey’s clenched fist to come out. It gets worse — the bottle is so heavy that the monkey is not
strong enough to drag it away. Freedom is at hand though (no pun intended), because all the monkey
needs to do is let go of the peanuts and it can escape. Sadly, the monkey isn’t willing to do this, so all
the poacher needs to do is catch the monkey in a sack while it shrieks at the bottle and the peanuts.
Are you shrieking at your property portfolio at the same time as being trapped by it? When you take
away the emotion, all that is left is doing what is in your best interests financially, and if that means
you need to sell, then so be it.
Very few investors believe that selling is a good idea, but then again very few investors ever
actually manage to use real estate to become financially free. You’ll need to make up your own mind,
but you know what I say: success comes from doing things differently.
CHAPTER 11 INSIGHTS
Insight #1
The right time to sell is when you can earn better returns elsewhere.
Insight #2
In time you will find your cashflow and capital gains returns plateau and then start to decline. This is because you need a
bigger dollar increase to maintain the same percentage return.
Insight #3
If you have large amounts of untapped equity then it’s highly likely that you have lazy money. In other words, you have
the potential to be earning much better returns. If you could be earning more money from your investments, why aren’t
you?
Insight #4
Maximising your return, not saving tax, should always be the motive driving your investment decisions.
Insight #5
It’s not smart to use borrowed equity to fund your financial freedom. The better options are positive cashflow and gains
that have been converted into cash.
Insight #6
Don’t be a monkey investor. If you have to sell to achieve your investing goals, then so be it.
Note
1 Under Australian tax law a capital gain is only taxed when you sell the asset. You can borrow
against the equity without any tax consequences.
Part III
Strategies for making money in property
Introduction to part III
Now that you’re aware of the different ways to make money in real estate, as well as the positive and
negative gearing models, this part will focus on seven property investing strategies you can use to
make cash and cashflow profits.
Cashflow profits
Rentals (chapter 12)
Vendor financing (chapter 13)
Lease options (chapter 14)
Lump-sum cash profits
Simultaneous settlements (chapter 15)
Subdivisions (chapter 16)
Renovations (chapter 17)
Property developing (chapter 18)
Your choice of which strategy to implement depends on two factors:
The profit outcome you want to achieve (capital gains, lump-sum cash or positive cashflow
returns).
The needs of the person who’ll be paying you money in exchange for the use or ownership of
your property.
A word of caution
Part III is an outline, as opposed to a complete guide, to seven strategies that can help you to
maximise your property returns.
My aim is to help you to appreciate that there’s a lot more to the world of real estate investing than
simply buying a property and renting it out. If you’re interested in finding out more about these
strategies then I encourage you to ask questions in the discussion forum at
<www.PropertyInvesting.com/forum>.
With this in mind, let’s start by looking at rentals as it is the most common way that people invest in
real estate.
12
Buy and hold (rentals)
The concept behind the ‘buy and hold’ investment strategy is straightforward — buying a property and
renting it out while it appreciates in value. However, there is a lot more to being a successful investor
than holding and hoping. In fact, with a little skill and extra effort, you’ll be able to manufacture your
own profits and supersize your returns.
TYPES OF BUY AND HOLD PROPERTIES
There are different types of buy and hold properties that you can invest in. Let’s have a look at them.
Residential rental properties
When I say ‘residential rental property’, what comes to mind? A home that’s leased to a tenant in
exchange for paying rent? But what type of home? As you can see overleaf, there are many different
types.
Steve’s investing tip
A residential rental is a home to a person.
Examples of residential property include:
single family houses (on a separate parcel of land)
duplexes (two houses on separate titles that share a common wall)
flats (usually clusters of ground-floor dwellings that are not detached)
units (usually clusters of ground-floor dwellings that are detached)
apartments (usually dwellings within a large multi-storey complex).
Commercial rental properties
Commercial property is real estate leased to a business.
Steve’s investing tip
A commercial rental is a home to a business.
Types of commercial property include:
offices
retail sites (where goods are offered for sale to the general public)
industrial sites (typically where goods are manufactured or assembled, such as a factory)
hotels and motels, including bed and breakfasts
caravan parks.
Other rental properties
There are also many other types of rental properties that don’t quite fit into either the residential or
commercial categories, including:
self-storage facilities
rural and farm land
vacant land
retirement accommodation
holiday accommodation
public housing (dwellings owned privately and leased back to government organisations), which
includes Defence Housing Australia (DHA) properties and public sector accommodation.
As you can see, there are many opportunities other than simply buying single family houses. Sure,
each class of property carries with it different risks and rewards, but there’s certainly no secret
handshake or special prerequisite that precludes you from purchasing commercial or other property
types rather than just residential real estate.
People sometimes ask me what type of property I prefer, and my answer is always, ‘I don’t
discriminate … as long as it makes a profit, I’m interested in owning it’.
HOW YOU CAN MAKE A PROFIT
The two ways you can make money from rental properties are:
capital appreciation (capital gains)
positive cashflow returns.
Capital appreciation (capital gains)
You can profit from capital appreciation if your property increases in value over and above the total
costs of:
acquiring it (includes purchase price and purchase costs)
holding it (any annual negative cashflow from more cash out than cash in)
selling it (agent’s commission and other sales costs)
inflation (erosion of buying power over time).
Most investors buy, hold and hope that the general property market increases in value, and their
investments along with it. This is a hit and miss approach though because, as outlined in chapter 7,
property has gone up in value only about one-third of the time over the past 30 years.
Smart investors don’t just sit around and wait for capital appreciation. Instead they manufacture
their own capital gains by buying problems and selling solutions. Examples include:
buying vacant land and subdividing it and/or building on it
buying run-down properties and renovating them
buying vacant properties and renting them out
buying blocks of units and selling them individually.
Steve’s investing tip
The secret to manufacturing capital gains is to always add more in perceived value than actual cost.
One of the biggest myths in property is that location drives price growth. If this were true, why do
the less desirable suburbs sometimes have the biggest percentage increases in value? The truth is that
scarcity, not location, drives prices higher. The key to maximising your growth returns is to think of
the person who will purchase the property from you, and then do what’s needed to make the property
more appealing or easier to use for that person.
In chapter 28 you’ll find a great example of how Ballarat investors Dean and Elise Parker
manufactured $76 522 in capital appreciation by selling some of the cheapest homes in the district.
Positive cashflow returns
Positive cashflow returns can either be bought or they can be created.
Buying positive cashflow returns
The first edition of this book contained a very handy formula which I called, ‘The 11 Second Solution’
(shown in figure 12.1, overleaf).
Figure 12.1: The 11 Second Solution
Using the weekly rent, The 11 Second Solution calculated the maximum purchase price you should
expect to pay for a property and still potentially achieve a positive cashflow outcome.
For example, if a property was rented for $200 per week the maximum you would pay for it would
be $100 000.1
Mathematically, The 11 Second Solution calculated a purchase price that provided a 10.4 per cent
rental return. This was thought high enough so that there would still be a positive cashflow surplus
after interest and ownership costs were deducted.
While easy to apply, finding deals that pass The 11 Second Solution has become increasingly harder
because values have increased much faster than weekly rents. So I now use …
. . . STEVE’S NEW 1 PER CENT RULE
One of the few bonuses of the global financial crisis was that home loan interest rates fell to 49-year
lows. Furthermore, because interest is the biggest cost for property investors, the huge savings from
rates being slashed has meant that it’s possible to again buy positive cashflow properties.
If you tried to apply The 11 Second Solution in the current market then you’d get a false negative,
meaning being told the property wouldn’t be positive cashflow when it actually might be. This is
because a 10.4 per cent return is too high given interest rates have fallen to such lows.
Luckily, I’ve created a new formula which is almost as easy to apply and which is more adaptable as
the market changes. I’ve called it ‘The 1 Per Cent Rule’, and it has four steps, as shown in figure 12.2.
Steve’s investing tip
Interest rates won’t be low forever, so your window of opportunity to buy positive cashflow properties won’t last long!
Figure 12.2: The 1 Per Cent Rule
Step one: what interest rate can you borrow at?
The first step is to find out the percentage interest rate you can source to finance your real estate
purchases. At the time of writing it will probably be between 6 per cent and 7 per cent. If you don’t
know your rate, base it on the standard variable home loan rate from one of the major banks as a
starting benchmark, or for something a little more specific to your situation call the gang at
PropertyInvestingFinance.com on 1300 848 781.
Step two: to derive your 1 Per Cent Rule, simply add 1 per cent
The next step is to add 1 per cent to whatever rate you can borrow at. For instance, if you can access
finance at 5 per cent, your 1 Per Cent Rule would be 6 per cent (5 per cent + 1 per cent = 6 per cent). If
you can access finance at 5.5 per cent, your 1 Per Cent Rule would be 6.5 per cent (5.5 per cent + 1.0
per cent = 6.5 per cent).
Steve’s investing tip
Your ‘1 Per Cent Rule’ (your borrowing rate + 1 per cent) becomes your minimum return on investment.
Step three: calculate the target property’s ROI
Return on investment (ROI) is a calculation that reports how much income is generated for every
dollar of assets. It can either be expressed in dollar or percentage terms.
The formula for calculating ROI is:
Where:
Annual rent = Gross rental income (meaning rent before any expenses)
Purchase price = Contract purchase price before closing costs
If you want to be more accurate you could include an allowance for closing costs (say, 5 per cent) in
your purchase price, but to reduce complexity and increase the speed of the calculation I generally
only take closing costs into account in the second phase of my due diligence, which only kicks in if
the deal first passes the 1 Per Cent Rule.
Okay, now it’s your turn! Using the ROI formula provided above, have a go at calculating the
missing numbers in the table below.
A solution can be found at the end of this chapter.
As the table above reveals, the ROI formula can be used to calculate more than just the percentage
return. You can also:
use the purchase price and ROI% to calculate the annual rent
use the property’s annual rent and yield (ROI) to calculate value (purchase price).
Step four: decision time
Having completed steps one to three, you now have enough evidence to make a decision about whether
or not the property is likely to be cashflow positive.
The final step is to compare the property’s ROI with your 1 Per Cent Rule, bearing in mind the
following guidelines:
If the property’s ROI is greater than your 1 Per Cent Rule, the project is likely to have positive
cashflow and can progress to the second round of your due diligence process.
If the property’s ROI is less than your 1 Per Cent Rule, the project is unlikely to have positive
cashflow and should be discarded.
Alternatively:
If your 1 Per Cent Rule is less than the property’s ROI, the project is likely to have positive
cashflow and can progress to the second round of your due diligence process.
If your 1 Per Cent Rule is greater than the property’s ROI, the project is unlikely to have positive
cashflow and should be discarded.
Key assumptions
The key assumptions that underpin my new 1 Per Cent Rule are that:
you will only borrow 80 per cent of the purchase price on an interest-only loan at the interest rate
you nominated in step one
7 per cent of the annual rent will be spent on management fees
2.5 per cent of the annual rent will be spent on repairs
5 per cent of the annual rent will be spent on other costs.
If you operate outside of these assumptions you may arrive at the wrong conclusion.
Steve’s investing tip
The extra 1 per cent you add is the minimum. If you plan to borrow more than 80 per cent of the purchase price, or if there
are unusual expenses, you will have to increase your required ROI to compensate.
1 Per Cent Rule case study
Let’s put the 1 Per Cent Rule through its paces with a case study. While searching
<www.realestate.com.au> for houses for sale and trying to find something that had all the features I
was looking for, I came across a property in Ipswich, Queensland. It was an inner-city property, near a
university and public transport. The important details were:
rent of $750 per week
asking price of $435 000.
Let’s apply the 1 Per Cent Rule.
Step one: your borrowing rate
I’m going to assume that you can borrow money to purchase real estate at 7 per cent interest.
Step two: add 1 per cent
Your 1 Per Cent Rule would then be 8 per cent, meaning that you are only interested in a deal that has
a return on investment of 8 per cent or more. Anything less than 8 per cent will probably result in a
negative cashflow outcome.
Step three: calculate ROI
Calculate the return on investment by filling in the boxes on the following page.
Your minimum required return should be 8.97 per cent (see the end of the chapter for the completed
calculation).
Step four: comparison
As the return on investment (8.97 per cent) is higher than your 1 Per Cent Rule (8 per cent), this
property is most likely going to have positive cashflow and should be flagged for further
investigation.
Testing the numbers
To demonstrate that there is likely to be a positive cashflow outcome, here’s how the numbers might
look using the key assumptions behind the model (table 12.1).
Table 12.1: cashflow calculation
Annual rent
$39 000
– Expenses
Interest
$24 360
80% loan, 7% interest-only repayments
Rental management
$2 730
7% of annual rent
Repairs
$975
2.5% of annual rent
Other costs
$1 950
$30 015
5% of annual rent
= Annual positive cashflow
$8 985
How do you use the 1 Per Cent Rule?
The best way to use the new 1 Per Cent Rule is as a ‘first pass’ filtering tool to work out whether a
property warrants further investigation. In particular, I use it when researching on
<www.realestate.com.au> by sourcing deals that have the required information (that is, rent and
purchase price). If I find a potential deal that lacks the required information, I either call the agent or
else do further research on the internet. For example, it is not unusual for the rental figure to be
missing. In this case, I often click the ‘rental’ tab on <www.realestate.com.au> to try to find what
similar properties rent for. Doing this also allows me to test the accuracy of the likely rental figure
provided by the agent.
CREATING POSITIVE CASHFLOW PROPERTIES
One day interest rates will increase again, and it will be difficult to buy positive cashflow properties.
When this happens you can still create a positive cashflow property by:
Paying down debt. Reducing debt will decrease the interest and increase your cashflow.
Increasing the rent. Look for ways of increasing the rent using strategies that allow the tenant
better use or enjoyment of the property in return for a financial reward for you.
Using multi-step investment. Instead of buying a positive cashflow property from day one, you
can look to create that outcome by combining other investment strategies to release a lump-sum
gain, and then use that lump-sum gain to pay down debt on the remaining property. For example,
you could:
buy a rental property on a large enough parcel of land to subdivide off a new block at the
rear; then
sell that new block for a lump-sum profit; then
use the profit to pay down the loan on the rental property for a positive cashflow outcome.
Renting out by the room. Renting out individual rooms can give you a higher return than renting
out the property to a single tenant.
David, an investor I’ve trained who lives in Melbourne, bought a cashflow gem. He paid $285 000
for a six-bedroom house (shown in figure 12.4). After converting it to eight bedrooms, he rents the
rooms out for an average total of $700 per week and, once all costs are paid, pockets a very tidy
positive cashflow return of around $600 per month.
Figure 12.4: six-bedroom house
Reproduced with permission from David Solomon.
Before buying, a rental manager appraised the rent at $290 per week if he rented the property to a
single tenant. Clearly the return is much better renting it by the room!
IDENTIFYING THE REAL ASSET
I was taught in accounting school that an asset is something that, when used, generates income.
Furthermore, if you could put an asset in its best operating environment you stood to maximise your
income-earning potential.
That’s great theory as an accountant, but as a property investor I had to learn how to apply this
definition in a practical way. In doing so I made an important discovery that resulted in me
questioning what I’d been taught. The discovery was:
Steve’s investing tip
When it comes to property, the asset definition changes depending on the profit outcome you’re trying to achieve.
Asset definition if you desire capital gains returns
The best way to maximise future capital gains returns is to buy a property with the person who is
going to buy it from you in mind, and then add more perceived value than actual cost to improve the
use or enjoyment of the property for that person. That is, you buy problems, fix them in a costeffective way, and then sell the solution to someone who doesn’t know how to or can’t be bothered
fixing the problem themselves.
A great example of this is Martin, a friend of mine who develops property in Adelaide. His niche is
low-cost housing; he buys large blocks of land (sometimes with perfectly good houses on them),
demolishes the house and builds budget homes, which he sells to first home buyers for a healthy
profit. In Martin’s case, the primary asset is the land (as shown in table 12.2).
Table 12.2: the focus of a capital gains investor
Desired outcome
Make money via capital gains
Achieved when
The property appreciates in value
Strategy for capital appreciation Property investing
Primary asset
Land
Secondary asset
Building
Ancillary item
Tenant
The people buying his homes could purchase the problem block, demolish and rebuild, but they
don’t know how, don’t have the money or can’t be bothered. Instead, they pay a premium for Martin
to solve the problem for them.
Asset definition if you desire positive cashflow returns
A radical change in thought is needed when you’re a positive cashflow investor, because the reliability
of your income stream (and thus your ability to achieve financial independence) depends on the
quality of the tenant you attract.
With cashflow as your focus, the accounting definition needs to be refined so that you recognise the
tenant as the primary asset, the building (where the tenant lives) as the secondary asset and the land
(where the building is located) as the ancillary item (see table 12.3).
Table 12.3: the focus of a positive cashflow investor
Desired outcome
Financial independence
Achieved when
Passive income is higher than living costs
Strategy for positive cashflow Property investing
Primary asset
Tenant
Secondary asset
Building
Ancillary item
Land
In a practical context, as a positive cashflow investor you don’t care much where the property is
located, so long as:
the numbers stack up and it’s likely that you’ll earn a positive cashflow return
it’s inhabited by a good tenant who regularly pays the rent.
Why you need to choose
Irrespective of which investment outcome you desire, the land, building and tenant are all important
variables upon which your success is dependent. However, you must choose whether you want capital
gains or positive cashflow returns, since your decision will determine which of the three components
is given the majority of your time.
Steve’s investing tip
Investors must choose which is more important — capital gains or positive cashflow returns — and then focus on properties
that deliver the required outcome.
The remainder of this chapter looks at tenants in more detail.
PARTNERS IN WEALTH (THE STEVE MCKNIGHT APPROACH
TO LANDLORDING)
Which of the options below best reflects your opinion?
Multiple choice (circle your answer)
Question: In your opinion, who is doing who a favour?
a) The landlord is doing the tenant a favour by providing a place to live.
b) The tenant is doing the landlord a favour by paying rent.
c) No-one is doing anyone a favour.
d) I don’t know … I just want to keep reading.
Of the people I’ve asked, the majority of those who answered a) had a capital gains focus and saw
the tenant as a means to an end. Those who chose b) were more intent on earning cashflow returns and
viewed the tenant as an investing partner.
I believe it’s the tenant who does the landlord a favour. I could own 1000 properties, but without
reliable tenants providing a regular rental income my goal of financial independence would be little
more than a dream. Don’t get me wrong; the land and building are still important, but they’re not as
important as the source of the cashflow.
Steve’s investing tip
Properties are inanimate objects without bank accounts. Tenants — who are living, breathing humans — are the ones with the
chequebooks.
It would be a mistake to think that all tenants are out to cause mischief. Conscientious renters are
happy to pay their rent on time, provided they can:
have a neat and tidy place to call home
deal with a reasonable landlord.
The big stick approach doesn’t work!
Tenancy laws are written to favour the tenant rather than the landlord. For example, before you can
start proceedings to evict a late-paying tenant in Victoria, you must wait at least 14 days. In other
words, tenants can pay their rent up to two weeks late and there’s precious little you can do about it.
Some landlords jump up and down and threaten their tenants with eviction or other nasty outcomes.
I call this the ‘big stick’ approach — but it’s all bluff because when push comes to shove there’s little
or no backup available from the authorities.
Be very careful with what you threaten to do. Tenants either know their rights or they will quickly
find out. If you break the law, a disgruntled tenant may make it his or her mission to cause you
maximum pain.
Win–win outcomes
I’ve come to understand that the best way to get the result you desire is to offer a reward or incentive
system that provides the tenant with a benefit for going above and beyond what’s required. By
focusing on a win–win outcome, I’m able to regularly achieve above-market rents while also reducing
the risk that my properties will be vacant for long periods of time.
The way it works is quite simple — the tenant is given an incentive for paying the rent on time (or
early) and keeping the property in a neat and tidy condition, which is really his or her obligation under
the lease anyway. If the tenant does not meet his or her obligations then the incentive is taken away.
A great example is movie tickets. Let’s imagine that the rent is due on the 15th of each month. Now,
if the tenant wanted to string you out, he or she could wait up until the 29th of each month before
paying and there’s not a lot you could do.
However, let’s say that you make it a rule that the rent has to be paid prior to (rather than on) the
15th in order to qualify for two free movie tickets. All of a sudden the incentive makes the effort of
paying the rent early worthwhile, and at what cost to the investor? Two free movie tickets will
probably set you back around $30 per month, which is $360 per annum.
Only you can decide if $30 per month (which comes out of your positive cashflow profits) is a cost
you’re willing to incur to have a happy tenant who pays the rent early. But remember that if you plan
to fund your financial independence on passive income derived from the tenant a regular and reliable
income stream will be fundamental to your success.
To me, $30 a month seems like an outrageous bargain to secure a loyal customer — especially when
you consider that a rental manager will charge you one week’s rent plus advertising to attract a new
tenant. Sure, tenants still move on, but it’s not uncommon for a client to ask me if I have another
property (for example, bigger, smaller, in another location) that better suits his or her needs before
seeking a new place to live with another landlord.
Finding ideal tenants
In my mind an ideal tenant is someone who:
demonstrates an ability to pay the required rent
has an established rental history of living in the one place for several years
wants to treat the rental property like a home.
Without doubt, the best way to find an ideal tenant is to seek a referral from someone who you
already regard as the sort of person you want to live in your property. We all like to associate with
like-minded people, so it’s likely that friends and associates of an ideal tenant will be ideal tenants in
their own right too.
You might like to offer an incentive for the referral. As I’ve mentioned, most agents require one
week’s rent as a reletting fee, so you could provide at least this to one of your contacts who supplies a
good-quality lead who ends up renting your property.
If you don’t know anyone who would make an ideal tenant, plan B is to rely on potential clients
generated via normal marketing channels (running classified ads or putting a ‘For Lease’ sign at the
front of the property). If you can, it’s a good idea to conduct an interview with your potential tenants
in the place where they currently live, as this can give you an idea of how they will treat your
property.
The essence of successful landlording
I regard my tenants as partners in my wealth, as without them I’d need to go back and work in a job.
This does not mean that I’m passive with my investments — it means that I’m respectful of both my
own and my tenants’ rights. It’s important to understand that landlording is a people business — if
you don’t like dealing with people then find something else to keep you happy.
‘Buy and hold’ is a property investing technique where you purchase a property and rent it out while
hoping for capital appreciation. The amount of your capital gain depends on what the next purchaser is
willing to pay, whereas your rental return will depend on the calibre of your tenant. Irrespective of
which profit you desire, it’s important to identify the key asset and manufacture rather than wait for
your profit. After all, success comes from doing things differently (have I mentioned that already?),
and that means being active rather than passive in your approach to investing.
Book bonus
One of the exciting bonuses for those who register their book at <www.PropertyInvesting.com> is receiving a special report
I’ve written called ‘How to Avoid Troublesome Tenants’. It’s a must-read booklet for every prospective landlord!
CHAPTER 12 INSIGHTS
Insight #1
If capital gains are your desired investment outcome you will need to focus on scarcity and who will buy the property
from you, rather than location. Positive cashflow investors need to pay closer attention to the income yield and the
quality of the tenant.
Insight #2
There are many different types of properties. You’ll do well if you can find a niche in which you can specialise in
solving particular property problems.
Insight #3
The opportunity to purchase positive cashflow properties will only last as long as interest rates will allow. Delay and you
will miss out.
Insight #4
Properties that pass the 1 Per Cent Rule should be flagged for further analysis as they are likely to have positive cashflow
from day one.
Insight #5
You wouldn’t hand the keys to your $150 000 prestige car to just anyone. By the same token you shouldn’t just hand
over the keys to your investment property without first completing some due diligence to determine the quality of your
potential tenant.
Insight #6
Rather than just relying on a rental system that clearly favours the rights of tenants, to achieve the outcome you desire
it’s important to offer additional incentives. Ideally you’d provide rewards for helping the tenant treat the property like a
home and not just a rental property, and for paying the rent early, or at least on time.
Insight #7
I firmly believe that you’ll attract the tenants you deserve. Put in minimal effort and you’ll find tenants who share the
same relaxed attitude when it comes to paying the rent and looking after the property.
SOLUTIONS
Suggested solution for return on investment table (page 219)
Suggested solution for 1 Per Cent Rule case study (page 222)
Note
1 $200 ÷ 2 = $100; $100 × 1000 = $100 000
13
Vendor’s finance sales
Property investors can be passive or active in their approach. Passive investors tend to sit back and let
their investments do the work, while active investors like to roll up their sleeves and achieve aboveaverage returns as a result of buying problems and selling solutions.
In the previous chapter I introduced the idea that (active) investors can manufacture their profits.
It’s time to explore this concept further using two creative cashflow techniques:
vendor financing, which we will look at in this chapter
lease options, which will be discussed in chapter 14.
Vendor’s finance is not a new concept; it’s been an established way of selling property in Australia
for at least 100 years. Within my own family I’ve been able to find a very early example of vendor
financing.
Around 1920, my great grandfather subdivided a large parcel of land in Cheltenham, a bayside
suburb of Melbourne. In those days it was hard to get finance for land, particularly if you were a new
immigrant. Vendor’s finance was a solution many developers used to help purchasers establish a
foothold in the home owner market. As you can see in figure 13.1, special payment terms on most lots
were offered at £1 per month for five years, with interest calculated at 6 per cent and payable
quarterly.
Figure 13.1: vendor’s finance around 1920
WHAT IS A VENDOR’S FINANCE SALE?
When you decide to sell a property you have two choices:
Option 1 is to sell for a lump-sum cash amount, broken down into a deposit with the balance
payable on settlement. For example, selling a property for $100 000 based on a $10 000 deposit,
with the balance, $90 000, being due in 60 days time. This option is the way that the majority of
property is sold.
Option 2, which is not as well known, involves breaking down the amount owing into a series of
instalment repayments over an agreed time frame, instead of a lump-sum cash payment. For
example, you could take the same $100 000 property and sell it on the basis that you receive a
$10 000 deposit and the balance on vendor’s terms, which might be 1300 weekly repayments (25
years) of $173.86. If you’re not paid out earlier, over the term of the contract you’ll receive
$226 018 (1300 × $173.86).
While the nitty gritty varies from state to state, the fundamentals behind a vendor’s finance sale are:
Your client has beneficial ownership of the property. This allows him or her to rent or sell the
property.
You retain legal ownership because title to the property remains in your name until the purchaser
makes his or her final payment due under the contract.
Just like a bank does not pay the repairs or rates on a property that it finances, all ongoing
ownership costs become the responsibility of your client.
You become more like a financier than a traditional landlord in that you don’t receive rent — you
just make a margin on the difference between the repayment you receive from the purchaser and
the repayment you make off your loan.
You lock in your profit at the beginning of the contract, so the purchaser is the beneficiary of any
capital appreciation above and beyond his or her purchase price.
THE FOUR PHASES OF A VENDOR’S FINANCE
TRANSACTION
A great way to expand upon the concept is by discussing the four phases of a vendor’s finance sale
within the context of a real life example.
Phase one: acquire a property
Before you can sell a property on vendor’s terms you must first own it, which means the title of the
property must be in your (or your investment entity’s) name. As such, you’ll also need to organise
appropriate finance, as your client can only sign a contract to buy from you once you’ve settled on
your purchase.
Steve’s investing tip
You are not permitted to refinance a property once a contract to sell the property on vendor’s terms has been signed.
To illustrate how the numbers unfold in a vendor’s finance sale, I’ve reproduced the real life details
of a deal Dave and I completed in table 13.1. In addition to these figures, there were other closing
costs (such as stamp duty) of $2051.40. Table 13.2 is a summary of the final figures.
Table 13.1: one of our first deals
Settlement statement
To: Purchase price
$49 500.00
To: Purchaser’s solicitor costs and disbursements (current bill)
$509.16
To: Purchaser’s solicitor costs and disbursements (prior bill)
$287.25
To: Rate adjustment
$554.81
By: Deposit paid
$1 000.00
By: Loan monies from financier
$37 251.60
By: Balance required to settle
$12 599.62
Total
$50 851.22 $50 851.22
Table 13.2: summary
Initial cash down
Deposit (20%)
$9 900
Closing costs
$7 102
Total cash needed $17 002
We acquired the property on 22 September 2000 and sold it on vendor’s terms a month later.
Summary
In the example, phase one covered the period up until our property purchase settled; that is, until the
title was transferred into our name.
Phase two: sell the property
The person we sold this property to on vendor’s terms was found through a classified ad that we ran in
the local paper. The ad read:
---------Own Your Own Home for Less than $120 per week
Stop renting now.
Owner wants to sell this neat and tidy 3 Bdr family home with large backyard.
Close to school and shops.
Lock up garage. Flexible terms.
Can help with the deposit and finance too.
Call now [mobile no.]
----------
If you’re just beginning, running a classified ad is an excellent way to find potential purchasers.
However, the best source is referrals from your existing customers who have tried and are satisfied
with the vendor’s finance service that you offer.
Anyway, one of the callers who rang about the ad didn’t want to buy the property on offer. Rather,
she was interested to see if we could buy the property that she currently rented and which had just
been made available for sale. Mrs G (I’ll not mention her real name for confidentiality reasons) was a
middle-aged lady who ran her own successful business and had a very good credit record. She’d
approached several lenders to try to buy the property, but due to her age and the fact that she was selfemployed her loan applications were rejected.
Naturally, Mrs G was initially sceptical and she had plenty of questions to ask. I explained that we
buy property and then offer it for sale on vendor’s terms; she’d make her repayments to us, and then
we would make our repayments to the bank. After I’d reassured her by outlining exactly how we make
our profit (down to the last cent) and how she could pay us out at any time, she asked if we would buy
the property and then sell it to her on vendor’s terms.
Steve’s investing tip
It’s critical that you adopt a policy of full and complete disclosure. I sent my clients a summary of what the property cost and
an outline of how much money I make. If your client isn’t comfortable that you are making money, you won’t be able to
build a win–win deal.
How to make money using vendor’s finance
The profit you make in a vendor’s finance sale is derived from one or both of the following:
An interest margin, which is the difference between the interest rate your lender charges you and
the interest rate you charge the purchaser.
A price margin, which is the difference between what you buy the property for and the price at
which you offer it for sale.
A question that I’m asked a lot is, ‘How do I know how much to charge as my margin?’ At first
glance, it might appear that the answer depends on your minimum required return on investment and
how much you are risking by undertaking the investment. However, practically speaking, the margin
you should charge depends largely on how much the purchaser can reasonably afford to repay. The key
is to tailor the terms of your finance to create an outcome where everyone wins.
Steve’s investing tip
The amount that the purchaser can reasonably afford determines how much extra you can charge as a margin.
Interest rate margin
For no good reason, other than it seemed like a fair amount, our standard interest rate margin was plus
2 per cent on what our lender charged us. In unusual cases, Dave and I reserved the right to vary this
interest margin, depending on the unique circumstances of our client. In reality, though, there was
only one occasion where we varied beyond our usual 2 per cent. This occurred when we sold a
property on vendor’s terms to an ex-bankrupt who went broke as a result of a failed marriage. Within
the boundaries of making sure that it was still comfortably affordable, we charged him a 3.5 per cent
interest margin for the first year (because it was a bigger risk) and then reduced the rate back to 2 per
cent thereafter.
If you think a 2 per cent margin sounds like too much to charge, consider this: interest rates on
second mortgages are routinely 10 per cent or more higher than the standard variable rate.
Price margin
When Dave and I began selling properties on vendor’s terms we were buying properties for around
$44 000 and then selling them for $65 000. At first glance this is nearly a 50 per cent profit, but there
were some important additional factors that made this mark-up more reasonable.
First, our purchase price needed to be increased to reflect our closing costs and loan set-up fees. By
the time we’d paid these charges and arranged a new contract for the sale on vendor’s terms, $44 000
was closer to $50 000.
Second, the price margin is not a profit that is made as a lump sum on day one. Instead it’s earned
over the term of the contract — usually 25 years. So in the example of Mrs G, if the contract went for
the full term I’d make $840 per annum ($21 000 ÷ 25 years). Put another way, in this example the
property needs to appreciate at just 1.91 per cent per annum and Mrs G will make back the price
margin.
What the price margin really offers is a minimum profit in the event that your client refinances
early in the contract and you are paid out.
What is a fair price margin?
This is a difficult question to answer. Charging too little or too much can turn a good deal sour for
either the investor or the purchaser. The majority of your profit in a vendor’s finance sale is derived
from the interest margin, so what you add as a price premium just needs to make the effort involved in
setting up the deal worthwhile, in the event that your client decides to refinance early.
Keeping it affordable
The critical success factor in a vendor’s finance sale is keeping your client’s repayments within
affordable guidelines. You can do this by varying the interest and/or price margin, and tailoring the
sale to meet the specific circumstances of your purchaser.
For example, in constructing the terms for Mrs G we made it a point to keep her weekly repayments
much less than the $130 per week she paid to rent the exact same property. Being a reasonable credit
risk, we set our interest margin at 2 per cent, which meant that her initial interest rate was 9.5 per cent.
We then decided that, in this case, a price margin of around 25 per cent would be fair, so we put a
circle around $63 000 as a possible selling price.
However, before making this formal, Dave and I went back to check that the repayment under these
parameters was affordable. Mrs G was able to access the $7000 First Home Owner Grant and offered a
deposit of $6500, with the other $500 being allocated to paying her costs for independent legal advice.
Using a financial calculator, I determined that a loan of $56 500 ($63 000 – $6 500) over 25 years at
9.5 per cent interest came to $113.62 per week, which was well inside the $130 guideline. Tables 13.3
and 13.4 (overleaf) summarise the numbers from this example.
Table 13.3: preliminary numbers on the vendor’s finance sale
Table 13.4: cash-on-cash return on the vendor’s finance sale
Our cash-on-cash return
Weekly cash in
$113.62
Weekly cash out
($67.38)
Net cashflow
$46.24 × 52
Annual net cashflow
$2 404.48
Net cash needed
$10 502.00
Annual cash-on-cash return 22.90%
Even though we could have charged more, we felt that at this price we were leaving room should
interest rates go higher, and we also had to remember that Mrs G had to pay for all the rates, repairs,
insurance and so on.
Summary
Phase two covers the sale of your investment property on the terms and conditions you create.
Remember to let affordability determine your margin; if your profit is too low, don’t be tempted to
squeeze the client for more — that’s not going to produce a win–win outcome. If this is the case you
need to find another deal.
Phase three: cashflow
Once you have sold your property on vendor’s terms you’ve created the facility to receive net positive
cashflow for the duration of the contract. It’s wise to encourage your client to pay by using a direct
debit facility straight into your loan account to make the whole process as automated and as easy as
possible for all concerned.
During the life of the loan you’ll need to continue to monitor your investment in addition to
completing some administration in order to prepare periodic loan statements, which are needed under
the Consumer Credit Code.
Summary
Phase three is simply the duration of your vendor’s finance contract.
Phase four: cashed out/termination
Your vendor’s finance contract ends when either:
You receive your last repayment, which can happen at the scheduled end of the contract or earlier
if your client decides to refinance or sell the property; or
You need to rescind the contract because your client defaults on his or her payment obligation
and you need to take back possession.
Steve’s investing tip
If you’d like more information about the vendor’s finance technique please visit
<www.PropertyInvesting.com/strategies/vendorfinance>.
THE HUMAN NATURE OF A VENDOR’S FINANCE SALE
The success or failure of your vendor’s finance sale depends entirely on the quality of the client who
buys your property on vendor’s terms. If you have a good client then you can expect a minimum of
fuss. But the reverse is also true — a bad client will cause plenty of investing headaches.
A bad vendor’s finance experience
While Dave and I tried hard to make a success of all our vendor’s finance sales, even the best made
plans sometimes fail. Once we sold a property to a couple who, on first impression, seemed perfectly
normal. They had good credit records, an established rental history and could demonstrate that the
instalment payments we offered were comfortably affordable. Everything was going well, until one
day they just stopped paying. We phoned them regularly but could only leave messages on their
answering machine. We also sent letters asking them to contact us. Finally, Dave dropped in to see
them. They said that they regretted having fallen behind and promised to pay extra to catch up. And
for a while they kept to their word and did just that.
However, before too long their payments ceased again and a stone wall of silence greeted our every
attempt to contact them. Left with little option, we sent them a letter explaining that unless they kept
to our agreement we’d have to rescind the contract, in which case they’d need to find somewhere else
to live. That approach at least prompted them to phone the office. But rather than looking to work
through the issue, Dave and I were threatened with having our heads punched in, our homes blown up
and our wives assaulted.
Sometimes a person who can’t afford to stay can’t afford to leave either. In a last-ditch offer to
create a win–win outcome, Dave explained that we had $2000 to spend, either in legal fees to enforce
our rights or to help them relocate to another property. The offer of cash changed everything and,
while there was still tension, the couple agreed to move on. They returned to renting; strangely, they
moved into a property that cost more in rent than what their repayments to us had been. We handed
over $2000 cash the day they moved out and then spent another $1000 cleaning up the property before
seeking a new client who wanted to buy the property on vendor’s terms.
In hindsight the lesson I learned from this experience was that a person with a ‘victim
mentality’ — that is, someone who feels that the world owes them a favour — is not a person that you
want to have as a client.
A good vendor’s finance experience
A better story is one family we helped by selling them a property on vendor’s terms. They came to our
attention when Dave was sitting in a real estate agent’s office looking for properties to buy that came
with existing tenants. The agent mentioned that this couple were concerned about losing their home if
it was sold to a buyer who also wanted to live in the property. They had approached the bank to seek
finance in their own right, but had been rejected on the basis that they were contractors without an
established employment record.
Dave asked the agent to approach them to see if they would be interested in buying the property
from us on vendor’s terms, provided we could keep their repayments within affordable limits. After
asking questions and seeking independent legal advice, Dave met with the family and outlined how
vendor’s finance works. Seeing the chance to own a home on fair terms, they sensed this was the
opportunity of a lifetime.
Shortly after accepting our deal, the parents received a call from their child’s school wanting to
know the reason for the tremendous turnaround in their son’s behaviour. Whereas before he was
unsettled and disruptive, he was now attentive and a good class contributor. We later heard that the
day after we’d sold them the property on vendor’s terms, the boy ran to school yelling, ‘We don’t have
to move! We don’t have to move!’
After three years of owning the property it was worth much more than the price they paid for it. Did
we feel upset that we might have charged too little as a price margin? No. At the time we entered this
deal the terms were fair for everyone, and it’s pleasing that, with the benefit of hindsight, we can say
that there was a genuine win–win outcome.
A properly constructed vendor’s finance sale has the power to transform lives. This example, again,
underpins the importance of focusing on the needs of people first, and letting the profit take care of
itself.
VENDOR FINANCING IN TODAY’S PROPERTY MARKET
The need for vendor financing diminished with the introduction of low-doc loans, however since the
global financial crisis it has become more difficult to source finance, and interest in vendor’s finance
sales is picking up again. However, with house prices increasing so much you will need to be extra
sure that the purchaser can comfortably afford to make the repayments.
In fact, instead of a term lasting for 25 years, a smarter way to use this technique in today’s market
is to use vendor’s terms sales as a form of bridging finance — a temporary measure while the
purchaser proves his or her creditworthiness and then refinances to access a cheaper rate. There is
certainly no shortage of potential buyers.
Here’s a list of people that a major lender may reject but who might, nevertheless, be a good credit
risk:
self-employed business owners
employees who have not been with an employer long enough
people who are paid in cash
employees with a disjointed employment record
people who have received a workers compensation payout
new Australians
people who have one or two blemishes on their credit records
ex-bankrupts who went bankrupt for personal reasons
short-term unemployed workers, such as seasonal employees
older citizens (they are often ignored by the banks).
But be warned — there’s a tendency for people to overstate what they can afford to repay. You
won’t be doing anyone any favours by creating a deal that places your client on the edge of a financial
cliff. Be sure to consider the impact of a rise in interest rates and help your client to quantify the
likely extra costs for the rates, insurance and so on. Just because there’s a dollar to be made doesn’t
justify going ahead at all costs. You need to be satisfied that you’re offering a true win–win outcome.
Steve’s investing tip
While it’s not realistic to expect that all your deals will turn out as planned, if you ignore the warning signs or your gut
feeling then financial disaster won’t be too far away.
Vendor’s finance is a niche market. You’re looking for clients who can demonstrate that they are
either good credit risks but don’t qualify for regular finance or they might have had one or two black
marks on their credit file yet can demonstrate they have learned their lesson and are ready to move on.
THE CRITICAL SUCCESS FACTORS IN A VENDOR’S FINANCE
SALE
Let’s see what you can do to give your vendor’s finance sales every chance of success.
It’s all about people
While the essence of a vendor’s finance sale is that the investor becomes more like a financier than a
traditional landlord, the source of the cashflow is the same — it comes from the pockets of everyday
people.
One of the early mistakes Dave and I made was to focus far too much on just getting a deal over the
line rather than meeting the needs of our vendor’s finance purchasers. That’s when we discovered that
the quality of our investments depended almost entirely on the calibre of the person living in the
house. When we shifted our focus to fulfilling our clients’ needs, rather than just our own, we
achieved a level of success and personal satisfaction that we never thought possible.
Steve’s investing tip
Focus on people and let the profits take care of themselves.
Build win–win outcomes
Dave and I once had the opportunity to buy a property that one of our vendor’s finance purchasers
desperately wanted, which was located next door to his best friend. The agent selling the property
knew this and inflated the sales price by an extra $10 000. Even buying at this price and adding our
margin, our client could still afford the repayments, but only just.
Stepping back from the deal for a moment, Dave and I began to question whether or not we were
creating a true win–win outcome given that the property was clearly overpriced. After a lot of thought
we decided not to proceed, but instead of leaving our client in uncertain territory we networked hard
and were able to find him a loan (albeit on a slightly higher interest rate than we were offering) with a
non-traditional lender.
Not all deals will bring dollars directly into your pocket, but if you create enough win–win
circumstances then your success will be a matter of time, not a matter of luck.
Play by the rules
The three rules of vendor’s finance sales that you should never break are:
Keep repayments affordable — never place your client on the edge of a financial cliff.
Always give full disclosure — to both your client and to your financier.
Always comply with the law — and to do this you must know what the laws are, so do your
homework.
As the vendor’s finance laws in each state are slightly different, you’re going to need to conduct
further research before launching into your first vendor’s finance deal. While
<www.PropertyInvesting.com> is an excellent resource, there are some issues that you should
research further:
Privacy laws. You need to be careful about privacy laws when seeking information about
potential vendor’s finance clients, particularly when doing a formal credit check.
Consumer credit laws. Vendor’s finance sales fall under consumer credit laws, so you will have
to meet all the requirements.
The First Home Owner Grant. If eligible, your client may be able to use his or her First Home
Owner Grant to partly fund his or her deposit. You will need to check with the relevant state
authority to see whether this is possible.
THE ARGUMENTS FOR VENDOR’S FINANCE
When you decide to sell on vendor’s terms you decide to invest in people. Presenting a person with an
opportunity to own his or her home is, in many ways, being in the business of delivering dreams.
Providing you sell the right way, which is putting people before profit, you’ll create the potential for a
win–win outcome — an outcome where your client gets a house and you make money in the form of
regular ongoing positive cashflow.
If you create a deal that’s affordable then you’ll find vendor financing to be relatively maintenance
free. There’s no requirement to study stock charts or make sure all your ostriches are in the right
paddock. All you need to do is keep a watchful eye to ensure your clients meet their minimum
requirements under the vendor’s finance contract.
Vendor’s finance is an established way of selling real estate and making money. There is no promise
of getting rich quick. In my opinion it’s not only a fair reward for the risk involved and the capital
contributed, it’s also a great way to invest in property and create ongoing positive cashflow returns.
THE ARGUMENTS AGAINST VENDOR’S FINANCE
Selling using vendor’s finance is not without its weaknesses. While it provides positive cashflow
returns, it takes a lot of time and effort to set deals up in a win–win way. You really must enjoy
dealing with people to get a benefit from vendor financing.
Another fair criticism is that it takes many vendor’s finance sales to provide enough cash to enable
you to become financially independent. I have never advocated the use of vendor’s finance as a ‘getrich-quick’ scheme. If you’re looking for a quick fix to your financial problems, this is not the answer.
As a vendor’s finance sale has a finite life, you must accept that one day your interest in the
property will end. That’s why it’s important to take some of your positive cashflow and reinvest it in
other investments designed to keep meeting your financial goals.
THE FINAL WORD ON VENDOR’S FINANCE SALES
It’s been many years since I last sold a property using vendor’s terms. This is because for the same
time investment I can make more money using other real estate strategies.
That said, vendor’s finance was an important technique in my early years as an investor as it
allowed me to purchase multiple properties with small net cash outlays.
With the global financial crisis making sourcing finance trickier, vendor’s finance is becoming
more popular again, but it should only be used if you are more focused on people than profit, and if
you are committed to securing win–win outcomes.
Vendor’s finance is an advanced property investing strategy— similar to what options trading is to
the stock market. There are plenty of pitfalls for the novice or unwary investor and it’s easy to make
expensive mistakes. Before using this technique there are many issues that you need to consider. It is
beyond the scope of this book to discuss them all, so make sure you do more research and have all
your questions answered before using this technique.
CHAPTER 13 INSIGHTS
Insight #1
In a vendor’s finance sale you become like a bank where you make the majority of your profit from interest while the
purchaser takes on the risks and rewards of ownership.
Insight #2
Provided the purchaser meets strict qualifying criteria, vendor’s finance offers a relatively high return for the risk
involved. Avoid people with a ‘victim mentality’ and always ensure the purchaser can comfortably make his or her
repayments.
Insight #3
It’s not just the financially challenged who’ll be interested in vendor’s finance. There are a huge number of people in
every market who want to own a home but fail to meet the major financiers’ strict lending criteria.
Insight #4
Vendor’s finance is a volume business. If you only plan to do one or two then you may find the effort too much for the
return. But once you get started you’ll quickly discover it’s a strategy that can help you fast-track your financial
independence.
Insight #5
Vendor’s finance is about investing in people. If you can’t create a win–win outcome then it’s better to avoid the deal
rather than proceed knowing that it’s likely you’ll encounter financial headaches in the not-too-distant future.
14
Lease options
In the process of following up leads (people who responded to our classified ads), I’d occasionally
meet good-quality people but, because of their circumstances, providing vendor’s finance would not
have resulted in a win–win outcome.
For example, some clients did not have the necessary deposit, or a large part of their regular income
included government rent assistance, which would cease if they owned rather than rented. I could see
the potential in helping these people, but in order to do so I needed to implement a different
investment strategy. That’s when I devised a ‘rent to buy’ plan that I nicknamed ‘HomeStarter’.
MY ‘HOMESTARTER’ APPROACH
For clients who wanted to own a property but had no deposit, I offered them the opportunity to live in
one of our investment properties on the basis of a slightly higher than normal market rent, with the
possibility of purchasing the property later.
In return I’d channel $50 per month ($600 per annum) into a notional holding account. Furthermore,
if the client did what was required for 12 consecutive months, I’d provide an additional $600 bonus.
There was a catch though. The balance in the holding account could only be used to match, dollar for
dollar, the money the tenant had independently saved and wanted to contribute as a deposit when
buying the property from me on vendor’s terms. If the tenant paid the rent late, didn’t keep the
property in a neat and tidy condition or decided not to proceed with the purchase, any money in the
holding account was forfeited.
HomeStarter worked well up until the introduction of the First Home Owner Grant, at which point
those eligible for the grant were able to gain instant access to a deposit. This has largely made the
HomeStarter program redundant, however if the grant is withdrawn I can foresee it becoming relevant
again.
THE MORE FORMAL LEASE OPTION MODEL
There’s a more formal lease option model based on a system that works well in the United States. It
contains two components:
a call option that allows (but does not compel) the tenant to purchase the property at a future date
for an agreed price
a residential lease over a property.
Let’s look at these two concepts in more detail.
The call option component
The call option component provides the tenant or occupier with the right (but not an obligation) to buy
the property, on or before a future specified date, for an agreed value.
In exchange for this right, the investor charges a once-off, non-refundable call option fee, usually
determined by the perceived risk to the investor, but not normally more than a few thousand dollars.
Should the tenant or occupier decide to exercise his or her option to buy the property then his or her
call option fee is credited against the agreed purchase price under the option agreement.
The residential lease/licence to occupy component
Until the date when the option must be exercised or it will lapse, the person living in the property has
much the same obligations as a tenant. He or she must pay the rent on time, and in return the landlord
must maintain the property in good repair.
The rental payment set by the lease option investor is usually at a market premium (say, plus 20 per
cent). This may appear a little draconian at first, but a portion of each rental payment is deducted from
the agreed sales price under the option contract.
This may all sound a little complicated, so let’s look at how a lease option works using an example
contributed by a professional investor with plenty of practical lease option experience.
A CONTRIBUTION BY LEASE OPTION EXPERT TONY
BARTON
Hi, my name’s Tony Barton and I’m pleased to be able to contribute this information about how I’ve
profited from lease options.
I started investing in property at pretty much the same time as Steve. In fact, I can share a little
secret and reveal that we were even at the same breakthrough investing seminar back in May 1999.
Whereas Steve adopted vendor finance as his early niche before moving on to conventional buy and
hold properties, I turned to lease options and have since created many opportunities where everyone
in the deal has profited.
My niche is investing in three-, four- or five-bedroom ‘cosmetically challenged’ family homes on
500 to 800 square metres of land. Ideally the property will have a carport or garage, be fenced, and be
close to public transport and other important amenities.
Most of my clients fall into the demographic of your average blue-collar, working-class family,
earning less than $60 000 per annum. For one reason or another, usually their lack of ability to save
money for a deposit or a bad credit history, my clients cannot access finance to buy their own home
using conventional lending means.
I write this to illustrate that I invest in a specific market in terms of the houses I buy, the areas
where I invest and, most importantly, the people I aim to help.
Typically I find houses in outer urban areas of Victoria, where the population is greater than 15 000
persons and prices for the average home are about 30 per cent of Melbourne’s median home value.
Affordability is crucial in determining where I buy my houses. It would be ridiculous for me to try to
place a family of four that earn $35 000 per annum into a house that is worth $300 000 and expect a
positive long-term outcome. It’s important to match all the pieces in the investing jigsaw together in
order to create (as Steve says) ‘win–win outcomes’ for everybody.
As a summary, my lease option strategy provides middle-of-the-road families with the opportunity to
enter the housing market without needing to enter into large amounts of debt or come up with a
substantial deposit.
The lease option strategy has allowed me to acquire multiple properties without necessarily having
to use further cash outlays. For example, as the lease is a long-term contract and my clients have the
intention of one day owning the property, they often make substantial improvements to the
cosmetically challenged state of the property. Even though they pay and do the work (with my
approval), I’m able to borrow against the additional equity they are contributing to the property and
then use that money to buy more properties.
Of course, in order to do this in an ethical manner, I need to provide my client with full disclosure.
However, working through this issue, because my clients have a fixed, agreed purchase price at the
time of the contract, any improvement to the value of the property also benefits them.
If you can appreciate this point then you’ll begin to see the power of lease options for everyone
involved in the deal.
An example
Here’s an example of one of my early lease option deals. I realise that property prices have increased
substantially over the past decade, but it remains a great illustration.
In November 1999 I acquired a property in Ballarat (coincidentally the same city where Steve and
Dave started investing) for $54 000 (including closing costs).
Having run my own classified ad and found a client base that wanted to avail themselves of my lease
option services, I then structured the following deal:
call option price of $68 850 that the client could exercise on or before 30 November 2024 (so,
over the next 25 years)
a base weekly rent of $170 with increases for inflation and upwards movements in interest rates
an option fee of $2000.
Between November 1999 and May 2002 the person living in the property made his rent payments as
required and renovated his home with my permission. He did a thorough internal repaint, landscaped
the gardens and also put in a $4500 split-system air conditioner.
In May 2002 he decided to exercise his option, arrange for alternative finance and cash me out.
After deducting his option fee and the appropriate amount from his weekly rental (which I calculate
using a formula), his final option exercise price was reduced to $64 000. While disappointed to lose
my income stream, I was delighted to later find out that the bank had valued his property at $95 000.
The result was a win–win outcome, which Steve so rightly points out is critical. In addition to a
capital gain of $10 000 I earned when my client exercised his option, I also enjoyed a regular positive
net cashflow income of approximately $70 per week for two and a half years. Table 14.1 (overleaf)
shows a summary of the numbers.
Table 14.1: lease option investment summary
Initial cash down
Deposit
Closing costs and legals
$10 200
$3 000
Initial cash needed
Less option fee received
$13 200
($2 000)
Net cash needed
$11 200
Annual cash-on-cash return
Net weekly cashflow
$70
×52
Annual positive cashflow
Net initial cash needed
$3 640
÷$11 200
Annual cash-on-cash return
32.50%
Project cash-on-cash return
Net cashflow, 30 months
$9 100
(June 1999 to November 2001) Capital gain $10 000
Total positive cashflow
Net initial cash needed
$19 100
÷$11 200
Project cash-on-cash return
170.54%
Annualised projected cash-on-cash return 68.22% pa
A bad deal turned good
While everybody hopes that their investments will have a happy ending, I’ve learned far more and
made substantial amounts of money from making mistakes. In short, deals that turn sour offer the best
learning possibilities and allow for you to finetune your investing system.
Let me share one such ‘bad’ experience.
When I first started buying houses I bought as many as I could afford. Actually, I had the whole
system for buying properties pretty much mastered. However, where I fell down was finding clients
who wanted to live in the properties under my lease option strategy.
One house I’d acquired sat vacant for 120 days and the negative cashflow associated with having to
pay the loan interest was hurting my profitability. As I was eager to have it rented as soon as possible,
I put clients into the property without doing the stringent checks that I do today.
These clients didn’t have an established rental history and I requested a slightly higher than normal
option fee of 4 per cent of the purchase price ($3200) to compensate for the additional risk. Having
purchased the property for $78 000, I set their option price at $102 000, which they could exercise at
any time during the term of the lease (which was 25 years and 51 days). The periodic rental was set at
$195 per week.
As the clients appeared both enthusiastic and grateful for the opportunity, and they certainly
appeared to have the ability to easily afford the rent, I decided to approve their application without
properly investigating their lack of rental history.
A few months into the lease agreement I received a number of phone calls at my office from
disgruntled neighbours in the street, to complain about late night parties and noise coming from the
house, and the once- quiet street had been turned into a carpark where multiple cars were parked in
the driveway and on the front lawn and nature strip. In fact, anywhere with enough spare land had
either a parked car or the sum of a dismantled car’s parts.
I made initial enquires with the tenants, who promised to ‘keep the peace’ with the neighbourhood
and remove the cars from where they were not allowed to be under the terms of the lease. Progress
was immediate as the tenants did everything I requested promptly after our telephone conversation.
However, three months further down the track I began to receive more irate telephone calls from the
neighbours. It seemed the property had become a halfway house and the noise, parties and cars were
back in even greater numbers. I took more of an interest and decided to telephone the tenants to tell
them I would be coming to do an inspection in 48 hours.
Even though my clients’ payments were in advance, upon arrival at the house the noise, cars
and — even more strangely — my clients had all disappeared without a trace.
What they did leave behind though was a huge general mess both inside and outside the house.
Everything needed cleaning — the ceilings, the carpets, the walls, the windows. There was a hole in
one of the walls in the kitchen where, apparently, the tenant had been completing some creative
cooking.
While I was initially alarmed at the cost of cleaning the house and the necessary repairs (luckily
these were covered by insurance), the whole experience taught me to:
Never rent a property to someone without an established rental history.
Always pay a rental manager to handle the inspections and rent collection in order to free up my
time to help more people, rather than having to take on the burdensome task of managing real
estate.
Within three weeks of the property being cleaned, repainted and repaired I was able to lease option
it to a new tenant, a couple with an excellent long-term rental history.
They loved what they saw and moved into the property, paying a new call option fee ($2500) and,
since I had spruced up the house, they agreed to a rent that was $10 higher than what my last tenant
paid. I was also able to increase the option exercise price to $112 000, so in the end I actually had a
better performing investment once I was able to put the bad experience behind me. Table 14.2 is a
summary of how the numbers on the deal turned out.
Table 14.2: lease option investment summary
Initial cash down
Deposit
Closing costs and legals
$15 600
$4 680
Initial cash needed
Less initial option fee received
$20 280
($3 200)
Net cash needed
$17 080
Projected annual cash-on-cash return
Net weekly cashflow
$97
×52
Projected positive cashflow
Net initial cash needed
$5 044
÷$17 080
Annual cash-on-cash return
29.53%
Amended annual cash-on-cash return
New net weekly cashflow
$107
×52
Projected positive cashflow
$5 564
Net initial cash needed (Deducting 2nd option fee of $2500) ÷$14 580
Annual cash-on-cash return
38.16%
My final piece of advice is to reinforce the need to see lease optioning as an investment in the
person first and the property second. If you can set up a win–win outcome then you’ll find the lease
option technique to be a relatively hassle-free way to earn substantial investment returns.
THE DIFFERENCE BETWEEN A VENDOR’S FINANCE SALE
AND A LEASE OPTION
The fundamental difference between a vendor’s finance sale and a lease option is the status of the
person occupying the property. In a vendor’s finance transaction your client signs a contract to buy the
property and is making repayments. Under a lease option, there’s the opportunity to purchase at a
future date but no obligation. Until the option is exercised the occupier pays rent.
Clients buying using the lease option strategy will only become entitled to receive the First Home
Owner Grant once they exercise their right to purchase the property.
Steve’s investing tip
Under a vendor’s finance sale there is a contract signed for the purchase of a property, whereas under a lease option there’s
only the right, rather than an obligation, to buy.
CRITICAL SUCCESS FACTORS IN A LEASE OPTION
The factors that determine the success or otherwise of a lease option are much the same as those
affecting a vendor’s finance contract. Let’s have a look.
Prequalifying leads
The reliability of your income stream depends entirely on the quality of your lease option client. Like
vendor financing, lease option agreements can last for up to 25 years, which is a long time to be
investing in a person. It’s critical that you research the needs and abilities of potential clients:
Don’t ‘max out’ your clients by placing them in a property where they can only just afford to pay
the rent. Conditions that exist today won’t prevail forever, so when you invest for the long term
you need to allow some leeway for increases in market rent and inflation adjustments.
Check the details of your potential client’s previous tenancy. It may be tempting to do a deal with
just about anyone who’s interested, yet that could be a massive mistake. The amount of financial
distress you suffer is inversely proportional to the amount of time and effort you invest to ensure
you have a quality client. You don’t want someone with a checkered rental history and who
occupies a prime place on the tenant blacklist.
Be sure you know who’ll be living in your property and specify this in the lease agreement.
Relatives, friends and pets of your clients may create problems.
The right property
While the real asset in a lease option is the person, the underlying property is also important. You may
not need a five-star home, but it’s certainly wise to only buy properties that are structurally sound.
Empower your client to make cosmetic changes to his or her heart’s content (subject to you first
agreeing of course), but as far as structural problems go expensive repairs may mean that your client
loses interest in the property and leaves rather than stays for the long term.
The lease option technique works for houses at all price ranges provided the rent can be set at a level
that delivers a positive cashflow return to the investor and is within affordable limits for the client.
Win–win deals
The details outlined in Tony’s earlier example are only one of an infinite number of ways that a lease
option can be structured.
Steve’s investing tip
Successful lease optioning is not so much dependent on the property but the person who will become your client.
KNOW THE LAWS!
It’s critical that you know the laws in the area where you plan to invest. For example, in some states
you’re not allowed to pass on the costs of rates to the tenant, which means that you need to approach
this issue from a different (yet perfectly legal) angle in order to overcome it. Be sure to get
appropriate legal advice before jumping into the deep end of the investing pool.
WHO WOULD BE INTERESTED IN A LEASE OPTION?
Not everyone has a deposit saved. Those who want extra time to save a deposit but the ability to live
in their future home would find a lease option very appealing, especially as they have locked in the
price they will pay to own the property, which will be reduced with every rent payment made.
LEASE OPTIONING IN TODAY’S PROPERTY MARKET
The federal government’s First Home Owner Grant means that fewer people are interested in lease
options because they can use the money they receive from the government as a deposit. However, as
credit has become tighter in the aftermath of the global financial crisis, and as the federal government
has wound back the First Home Owner Grant, lease options will become more popular.
If I was going to invest using lease options then my preferred model would be to use them as a form
of bridging finance for the purchaser. Ideally the purchaser would exercise the option to pay me out
within the first five years, as that will provide good income in the short term and a handy lump-sum
gain upon the option being redeemed.
SANDWICH LEASE OPTIONS
Instead of using the traditional model where you buy a property and then lease option it to another
person, a more complicated variation has appeared. Rather than buying the property, you take out a
lease option and then you on-sell this right to another person for more than you paid, to make a profit.
That is, your profit is sandwiched between two lease options — one for your entry, and the other as
your exit.
This technique would be attractive if you wanted to start investing but lacked the capital, since your
entry costs could be quickly recouped provided you found someone who wanted to lease option the
property from you. However, to be honest it sounds like a lot of hard work and there are easier ways of
making money from real estate.
THE FINAL WORD ON LEASE OPTIONS
A lease option is a valuable investment strategy for a niche market of potential clients. It’s
appropriate to use when your clients want to own their home one day but, for the time being, are happy
just to rent.
By using a lease option, the investor receives a guaranteed long-term, above-market rental return
and almost entirely eliminates the possibility of crippling vacancies. Clients obtain peace of mind
knowing they have a secure lease, with the added bonus of eventually owning the property if they so
desire.
Steve’s investing tip
The key to sustainable investing is to only venture into deals where there’s a chance for everyone to win.
CHAPTER 14 INSIGHTS
Insight #1
A lease option is a strategy that combines a residential lease with an option for the tenant to buy the property at an
agreed price, on or before an agreed date, as negotiated at the beginning of the deal.
Insight #2
The rent charged is usually set at a market premium, perhaps up to 20 per cent higher. However, a portion of the rent is
then credited against the option price provided the client goes ahead and purchases the property.
Insight #3
The client is charged a once-off, non-refundable option fee at the beginning of the tenancy to help cover the investor’s
initial deposit and legal costs. This fee is also deducted from the option price if the client decides to purchase the
property.
Insight #4
A great way to encourage the tenant to increase the equity in the property is for the tenant to complete some general
cosmetic upgrades. Because the title is in your name, you’re allowed to borrow a portion of the additional equity, which
you can then use to fund the deposits on other investment properties.
Insight #5
Just like under the vendor’s finance strategy, the strength and reliability of your cashflow with a lease option strategy
depends entirely on the quality of the person — rather than the property — you invest in.
15
Simultaneous settlements
The investing techniques we have covered so far in part III have had a cashflow focus. It’s now time to
turn our attention to strategies that can be used to make lump-sum gains. We are going to look at:
simultaneous settlements (this chapter)
subdivisions (chapter 16)
renovations (chapter 17)
developing (chapter 18).
WHAT IS A SIMULTANEOUS SETTLEMENT?
If you’re someone who wants to make a start in real estate and you have a lot of time but very little
money, making lump-sum gains through simultaneous settlements might be the opportunity you’ve
been searching for. Also known as ‘flipping houses’, here’s how it works.
Step 1 With time on your side, you can search for ‘diamond in the rough’ deals — properties you
can acquire at a significant discount because the vendor has an urgent need to sell.
Step 2 Buy it.
Step 3 Sell it to someone before having to close on the deal.
Step 4 Set up simultaneous buy and sell settlement dates so, after solicitors swap a lot of paper,
you receive a lump-sum cash profit and the person buying from you obtains the property title in
their name.
Table 15.1 is an example.
Table 15.1: simultaneous settlement example
Your purchase
Contract signed
15 September 2009
Purchase price
$150 000
Settlement date
15 January 2010
Your sale
Contract signed
20 October 2009
Your sale price
$180 000
Settlement date
15 January 2010
Your profit
Buy/sell margin
$30 000
Closing and sale costs ($10 000)
Total profit
$20 000
While it may seem simple, in reality there is much more to the process of flipping. Bargain
properties, especially in a booming market, aren’t that easy to find, and there’s another problem:
flipping properties in Australia seems to attract double stamp duty, which seriously erodes potential
profits.
My experience
While I’ve never flipped a property, I have had many opportunities to do so but chose to go through
with the purchase rather than on-selling the property. One example that comes to mind is a block of 21
positive cashflow units on the Sunshine Coast that Dave and I bought for $530 000.
Our problem was that, as usual, we didn’t have enough money right then and there to buy the
property. The block had a huge positive cashflow return and we didn’t want to miss out, so we tried to
negotiate creative terms — which, in this case, involved a six-month settlement period. The vendor
agreed and we signed the contract to purchase the property. In September, as settlement time drew
nearer, the agent faxed us a press clipping saying how property in the area had boomed, and hinted
that we could quite easily sell the property for up to $700 000.
If we’d decided to sell, after closing and sale costs we stood to make about $130 000 — not bad for
just signing a contract and waiting while a property boom happened around us. While it was tempting,
we didn’t take the bait, and instead we went on to acquire the property on the basis that we were
looking to secure ongoing cashflow rather than a once-off capital gain.
CRITICAL SUCCESS FACTORS IN A SIMULTANEOUS
SETTLEMENT TRANSACTION
The critical success factors in a simultaneous settlement are looked at in the following pages.
Finding undervalued properties
Finding cheap properties, especially in a ‘hot’ market where prices are rising daily and properties are
selling quickly, is no easy task. Like most creative investments, the time you allocate to sourcing
opportunities will have a direct impact on your success. If you’re already stretched for time because
you’re working long hours in a job, then flips are unlikely to feature greatly in your property investing
portfolio.
On the other hand, if you have lots of time it may only take one or two lucrative deals each year to
potentially replace your normal salary.
Negotiating a long settlement
The longer you have to find a potential buyer, the better. This means that you will need to negotiate a
longer settlement period, and not every vendor will be willing to do this. For example, the vendor may
need to sell and get access to the funds to buy elsewhere.
Nonetheless, sometimes you can get the deal over the line by offering one or both of the following:
a slightly higher purchase price
if the property is (or will be) vacant, agreeing to rent it so the vendor at least has some cashflow
to offset his or her costs.
Finding a buyer
To be a successful flipper you must dispose of your interest in the contract before having to settle on
the property.
While you might be able to locate a cheap property, your eventual success remains dependent on
finding someone who wants to buy it from you. That’s why it’s critical for flippers to maintain a
database of investors who are time-poor but are happy to pay for you to bring them deals.
Affordability
If you can’t flip the property before settlement date then you’ll have to buy it. This means that you
have to be conscious of the financial implications on your wealth-creation plans should this happen.
Profitability
Flipping in Australia is not as straightforward as it might seem. There are two significant issues that
will impact on the profitability of a simultaneous settlement. They are:
Stamp duty. You may find that even though you dispose of your interest in the contract before
settlement, you will still be liable to pay stamp duty on your purchase. The folks that drafted the
stamp duty legislation included some catch-all clauses, so if you acquire a property, stamp duty
is levied regardless of whether or not you on-sell it during the settlement period.
While there may be ways around this, such as buying an option to purchase the property rather
than agreeing to buy the actual property, the legalities are complex and you should consult a
lawyer before setting up a flip deal.
Capital gains tax. You should also be mindful that if you buy and sell a property within a 12month period then you won’t be eligible for the 50 per cent capital gains tax discount. This means
that if you’re already paying tax at the top marginal rate, up to 46.5 per cent of your profit will be
redirected back into the government’s tax coffers. The exception would be if you negotiated an
extremely long settlement period — for example, 18 months — and then signed a contract to onsell the property in the last six months of the settlement period.
Property options
Instead of agreeing to purchase the property, another strategy you could use is to take out an option to
buy it. This is similar to the lease-option concept explained in the previous chapter, but there is no
rental component. Instead, you leave a lump-sum payment (the option fee) in exchange for the
transferrable right to buy the property for an agreed price on or before an agreed date. Then, after
you’ve found someone who you can on-sell the option to, you pass on the right to buy the property to
that person in exchange for a fee.
Theoretically, because stamp duty is only payable on the transfer of title, and because title does not
transfer under this option arrangement (just the right to buy), there may not be any duty payable. Of
course, you should make your own enquiries regarding the circumstances of your transactions, and
professional legal advice is a necessity. Furthermore, I’m told the relevant state authorities are
looking at these scenarios very carefully.
THE FINAL WORD ON SIMULTANEOUS SETTLEMENTS
Simultaneous settlements may seem like a very good idea on paper. In reality, though, there are many
dangers that need to be mitigated, and a lot of time needs to be invested before you’ll see the fruits of
your creative endeavours. I feel that flipping is a strategy that would work far better in a buyer’s
market, where there are many motivated sellers who might be willing to accept creative alternatives.
In a seller’s market — where the vendor calls the shots — seeking to negotiate a discount on price or
asking for unusual settlement terms won’t be popular if properties are being listed and sold within a
matter of days.
In any event, a potentially more attractive alternative is to sell the details of the deal to an investor
in return for a spotter’s fee. That way you don’t have to sign a contract or come up with a deposit, and
there’s no risk that you’ll be left having to acquire the property if you can’t find another buyer.
CHAPTER 15 INSIGHTS
Insight #1
A simultaneous settlement sale (or flip) is a strategy designed to earn quick cash profits rather than ongoing positive
cashflow.
Insight #2
Simultaneous settlement is a strategy that’s difficult to use successfully in a market that has rapidly booming prices and
where vendors are asking for quick (30-day) settlement periods.
Insight #3
Any profit you earn is likely to be heavily eroded by stamp duty. A possible way around this is to use an option
agreement rather than signing a contract to purchase the property.
Insight #4
Unless you can negotiate an extra long settlement, you will pay tax on your entire profit. The 50 per cent capital gains
tax discount will usually not apply because in most cases you will not have owned the property for longer than 12
months.
Insight #5
For people who are time-rich and money-poor, sourcing properties and then selling them to investors for a spotter’s fee
can be potentially lucrative. You can do this without having to sign a contract or pay a deposit.
16
Subdivisions
Subdividing properties is a lot like buying a whole cake for $20, slicing it up into eight pieces, and
selling them individually for $4 each. That is, the sum of the parts is worth more than the whole.
Taking a property and splitting it into two or more smaller titles is a great way to make quick lumpsum cash profits. For example, let’s have a look at how I recently made $130 643.
A SUBDIVISION DEAL
How I came to own the property in figure 16.1 (overleaf) is quite a story.
Figure 16.1: property in Gissing Street, Blackburn South
At the time I didn’t live far away and would occasionally drive past the site on my way home from
work. Being vacant and located on a corner with two street frontages, the block seemed ideal to
subdivide into two, maybe even three, separate lots.
As it happened, I was driving past one Friday afternoon when I noticed an advertising board that
said the property was going to be auctioned the following day at 10 am. Even though I hadn’t done any
research, I was still interested to see what price the land would fetch at auction.
Steve’s investing tip
If you want to be able to spot great deals then you need to know what price represents exceptional value. You can do this by
keeping a close eye on sale and auction results.
The sun was out the following morning and I decided to mix business with pleasure by taking my
four year old daughter out for a walk and to watch the shenanigans. As I was heading out the door I
decided to grab my chequebook, because you just never know what’s going to happen at an auction.
It’s lucky I did!
Arriving at the auction and still holding my daughter’s hand, the first task was to flick through the
sale contract, and in particular the vendor’s statement, which (in Victoria) outlines important issues
potential buyers need to know.
Strangely, although the board out the front said the property was 947 m 2, the title said the block was
997 m2. Fifty square metres is a fair chunk of land to go missing.
Let the games begin!
There were about 30 people at the auction, mostly neighbours and onlookers. The auction started with
little fanfare as two bidders raised each other in $5000 increments. At $415 000, the agent declared the
property was on the market.
Having attended other auctions and kept a close eye on sales prices in the area, I knew that $415 000
was an absolute bargain. It was time to make my move, and up went my hand.
I’d met the real estate agent before at other house inspections, and he’d previously told me that he’d
read the first edition of this book. As I made my bid the agent stopped the auction and said, ‘Ladies
and gentlemen, I can’t tell you who this gentleman is, but let me just say he’s bought hundreds of
properties and knows extremely good value when he sees it. This should tell you that this property is
an excellent purchase’.
While the agent had hoped his bold statement would work in his favour, I immediately started
bidding hard and fast to frighten off any prospective bidders. I started playing all sorts of games trying
to intimidate other buyers, and was the winning bidder at $447 000 (plus GST). It was a good thing I
brought my cheque book as I had to leave a 10 per cent deposit.
The next step
One mistake I made was to elect for settlement to occur on 1 July. Had it settled on 30 June I could
have immediately claimed back the GST as I purchased the property in a GST-registered entity. As it
was, I had to wait until my next quarterly BAS, and this meant I received a 0 per cent return on
$44 700 (10 per cent of the purchase price).
Steve’s investing tip
If the sales price is ‘plus GST’ you will probably want to purchase in an entity that is registered for GST so that you can claim
it back.
Having acquired the property, the next job was to figure out how to use the land to get the best
possible profit, in the quickest possible time, for the least amount of risk.
Having a great team is important, especially if you are investing outside your area of expertise, as I
was with this deal. Luckily I was able to draw on the assistance of Leon Madigan, a veteran developer
who had built everything from skyscrapers to underground mines to family homes.
Leon and I prepared a feasibility study that analysed three options:
subdividing into two lots and building two townhouses
subdividing into three lots and building three townhouses
subdividing into two lots and selling vacant land.
A summary of our findings is shown in table 16.1.
Table 16.1: feasibility study findings
Cash needed Potential profit
Build two townhouses
$249 386
$17 686
Build three townhouses $260 826
$109 103
Sell subdivided land
$119 058
$142 906
Not surprisingly, we decided to subdivide and sell the land as two lots (as shown in figure 16.2) as it
required the least cash and was the most profitable option.
Figure 16.2: subdivision of property
We could have tried to subdivide into three lots, however given the smaller blocks of land there would
have been a lot more red tape and regulations to adhere to, including having to submit plans which
would have restricted what the buyer could have built. A two-lot subdivision was the simplest and
quickest option.
Steve’s investing tip
Sometimes the highest profit alternative is not the best, particularly if it takes longer and has more risk.
A spanner in the works
Do you recall that I said it is unwise to mix lifestyle and financial assets? Well, Leon and I were about
60 per cent of the way through the process of subdividing when an unexpected spanner was thrown
into the works. My wife and I had decided that we needed a bigger house, and as we looked around at
what was available for sale, building our dream home on the block of land at Gissing Street seemed
like a better and better option as each day passed.
We ummed and aahed about what to build for nearly a year before having final plans drawn up.
Luckily I was sitting down, because I almost passed out when I was told it would cost $700 000 to
build plus a further $80 000 if we wanted a pool.
Assuming we could sell the subdivided land for a total of around $700 000, and adding on the cost of
building, there was little doubt that having a home worth $1.4 million would have been a textbook
case of horribly overcapitalising. We could buy another house in a better suburb for less money and
not have the hassle and frustration of building.
Our procrastination cost us dearly in two ways:
an additional 12 months in interest
the property market softened as the global financial crisis took hold and our potential sales prices
fell.
A happy ending
With the idea of building a dream home shelved, I sheepishly rang Leon to restart our subdivision
plans. After the inevitable delays and frustrations when dealing with the council, we managed to split
the original title into two new lots:
lot 1 (facing Gissing Street) of 572 m2
lot 2 (facing Marama Street) of 425 m2.
You don’t need to have a separate title to sell a subdivided block of land. A contract can be
conditional upon a new title being created, which is how I sold lot 1 for $369 000 many months before
the new title was issued.
Although lot 2 was also for sale for $329 000, the feedback the agent received was that buyers were
not willing to commit until
the title had been issued. This worked out in my favour though, because the winding back of the
First Home Owner Grant created a frenzy.
It turned out that four parties were interested in lot 2, so I advised the agent to ask all potential
purchasers to submit their best and final offers. This approach worked well as the offers came in at:
$329 000
$332 000
$345 000
$362 000.
Had this property gone to auction and the $345 000 offer been the highest that bidder would go, the
purchaser who paid $362 000 could have bought for a lot less and my profit would have been a lot
lower.
A summary of the numbers is provided in table 16.2.
Table 16.2: subdivision investment summary
Sales prices
Lot 1
$369 000
Lot 2
$362 000
– Sales commission
$14 620
Purchase price
$491 700
Closing costs
$24 402
$716 380
Holding and subdivision costs $44 680
Net GST payable
Lump-sum cash profit
$24 955
$585 737
$130 643
How many deals like this would you need to do each year to replace your annual salary?
THE ART OF SUBDIVIDING
It’s not only land that can be subdivided. Often blocks of units can be ‘strata titled’, which means
separating each unit onto its own title. For example, you could buy a block of eight units, subdivide
and then sell the eight properties individually.
I did this recently with a block of three one-bedroom units I bought in Ballarat (shown in figure
16.3). They were purchased as one parcel on one title for $250 000, and I renovated and subdivided
them and sold each unit separately for just over $130 000.
Figure 16.3: three one-bedroom units
Figure 16.4 shows the area allotted to each unit, which is the dwelling and car spaces. The remaining
space (mainly the driveway) is called the common area and must be looked after by all owners as a
collective.
Figure 16.4: area allotted to each unit
The subdivision process
Each state may have more or fewer steps, but in general this is how a subdivision is processed.
Step one: council enquiry
If you find a parcel of land or property that you think has subdivision potential then the first place to
go is the local council’s planning department. Often you can have a chat to a planner over the counter,
and he or she will give you general information about what you can do.
Be aware that what you are told may not actually be correct. The council will often tell you what
they want as opposed to what the law will allow you to do. An independent town planner will give you
a more accurate assessment, but you’ll need to pay for it. The cheaper starting option (it’s free) is the
local council.
Step two: planning application
If you want to go ahead and subdivide then you will need to submit a planning application (or similar
document, as different states have different names for the process) to the council which outlines
exactly what you want to do.
The council will then pass this on to one of their internal planners, who will address:
state government planning regulations
local council planning regulations and guidelines
(usually) utility company requirements.
In some cases the council will make you obtain the consent of water and power authorities.
Step three: property survey
The council will require you to do a survey of the property, illustrating how you plan to split up the
land and/or dwellings. You will need to separately brief, engage and pay a surveyor to do this. Look
around, as a good surveyor will know the state and local laws back to front and can help you speed up
the application by avoiding rework.
Step four: meeting council requirements
If everything is to their satisfaction, the council will issue their planning permit. At this point they
may impose conditions on the permit. For example, there was a condition on the Gissing Street permit
that certain trees be maintained, and for an implied easement to be created so that lot 1 could access
the sewer mains that were at the rear of lot 2.
Step five: lodging the new title
It may be different in other states, but the final step in Victoria is for the council to stamp the
drawings prepared by the surveyor as final, and for these drawings to be lodged at the Land Titles
office.
Delays and fees
Although the concept of subdividing is straightforward, the process to make it happen is strangled by
delays and red tape. You will need to deal with various layers of government bureaucracy where noone is ever in a hurry, and all the while you will be paying interest. You will also be routinely told
conflicting information.
It can be expensive. To justify their existence, each government department and utility company
will charge you a fee. They get you at every stage — application, lodgement and processing — and
there is nothing you can do to stop it.
Tips and tricks
Here’s a handy list of pointers I wish I’d known before I started subdividing:
Setbacks. The setback is how far back from the road a house must be. While most setbacks are
three metres or less, some (like Gissing Street, which had a 7.5 metre setback) can be much more.
Larger setbacks decrease the amount of useable land and will impact on the price and saleability
of your subdivision. Figure 16.5 shows the new title issued for the Gissing Street subdivision.
The shaded area represents the zones that cannot be built on, to maintain the setback and protect
trees.
Covenants and overlays. There may be special rules that prevent you from subdividing. These
include covenants relating to minimum lot sizes, or overlays imposed by the council to retain the
character of the area. An example that comes to mind is a ‘significant landscape overlay’, which
one local council I dealt with imposed on certain properties within its municipality. The
impositions for houses within that significant landscape overlay area include:
minimum front setback of six metres
minimum side setback of three metres
maximum of only 25 per cent of the site could be built on
severe restrictions on removal of trees.
Crossovers. When subdividing a property you need to provide street access, and this may mean
creating a new crossover (driveway). The position of the crossover may be contentious, and you
need to consider positioning of power poles, drains, trees and so on.
Easements. An easement is an area set aside for the benefit of another person. Most often,
easements are created so that a property can access sewerage, stormwater and power. Generally
speaking, you are not allowed to build over an easement because the area may one day need to be
accessed. Most properties have easements running along a side boundary, however a few have
easements crossing the property, and this severely restricts what can be built on the site.
Timing. You don’t need to wait for a new title to be issued in order to sell a subdivided block or
dwelling. A contract can be written up so that it is conditional upon the new title being issued by
a certain date.
Figure 16.5: Gissing Street setbacks
Reproduced with permission of Dickson Hearn.
The concept behind subdivisions is simple: split the property into parts and sell them individually
for more than what you paid for the entire site and make a quick and attractive lump-sum cash profit.
But you won’t get paid for sitting around twiddling your thumbs. Your success will come from doing
things differently, and this means carefully and actively managing the bureaucratic process, otherwise
your subdivision will suffer delays and your profits will be eroded by unnecessary interest costs.
CHAPTER 16 INSIGHTS
Insight #1
You make a profit from subdivisions by selling off the slices for more than you paid for the entire pie.
Insight #2
While land appreciates and buildings depreciate, in most cases you can subdivide off surplus land without a dramatic
impact on the resale value of the building.
Insight #3
Not every property can be subdivided. State and local council planning laws and regulations may impact on your plans.
Insight #4
Avoid delays by being proactive in managing the subdivision process. Otherwise your profits will be eroded by
unnecessary interest payments.
Insight #5
How many Gissing Street–type subdivisions would you have to do each year to be able to replace your salary?
17
Renovations
When renovating properties the key to success is to add more in perceived value than actual cost. It
sounds so simple but as you will soon see based on my first reno experience there is more to making a
profit than you might expect.
MY FIRST RENO DEAL
You have already read how Dave and I purchased our first investment property — the three-bedroom
weatherboard home in West Wendouree. Not long after, we made another trip to Ballarat, this time
with our wives to show off our wonderful new investment property. We’d also arranged for Micky G,
the real estate agent who’d sold us our first property, to schedule more inspections, including a few
houses that we had not been able to get through on our last trip.
Once again (this was now surely more than a coincidence) it was the last house that Mick showed us
that we found to be the most interesting. The property was an unusually shaped federation
weatherboard house. It had four bedrooms with two living areas — one of which was a large upstairs
loft. The property was within easy walking distance to the city mall and was situated on a massive
corner block of land. A possible option that Dave and I immediately identified was to subdivide the
backyard and sell it off to a developer.
Yet not everything was positive. The exterior of the house needed repairs, the grounds were a jungle,
and student tenants had run riot inside, turning everything they’d touched to grunge. There was more
dust than wool in the carpets, all the window sash cords were broken and new light fittings were
needed throughout. All in all, the property was screaming for some urgent tender loving care.
Mick advised us that the house had been passed in at auction the week before as it had failed to meet
the vendor’s reserve (minimum sale price) of $83 000. When Dave and I looked at the property we
saw huge potential. But all our wives saw was hard work, and they suggested that the rejection by the
local market was a sign to leave this deal alone. Hang on! We were professional investors from
Melbourne! We convinced them this house was a great opportunity just waiting to be harvested. If
only we’d listened …
In an effort to negotiate we submitted an offer of $78 000, but Mick was adamant the owner
wouldn’t take anything less than $83 000. With other buyers looking through the property at the same
inspection time, we didn’t want to miss out on the deal, so we agreed to pay full price.
Our ‘back of the envelope’ plans (as shown in table 17.1) were to spend three months and $17 000
renovating the property and then quickly sell it for what Mick said would be a good price — around
the $140 000 mark (after allowing for sale costs). Dave and I signed the contract to purchase our
second investment property on 27 July with a 30-day settlement period.
Table 17.1: expected investment outcome
Expectation
Project length
90 days
Purchase price
$83 000
Closing costs
$3 000
Renovation cost
$17 000
Total cost
$103 000
Sale price
$140 000
Sale costs
$7 000
Net after-sale proceeds $133 000
Profit
$30 000
As we were short on cash, Dave and I decided to team up with my father, who’d just retired from his
job after 40 years and was looking for a project to sink his teeth into. Although not a builder, Dad is
certainly capable of doing minor home renovations and possessed an array of powertools that would
put most tradespeople to shame. Even more importantly, he had the time and money to throw at the
project.
Turning pear shaped
I’m here to tell you that as a renovator, I make a great accountant. Every time I lifted a hammer or a
paintbrush, all I seemed to do was create more work.
Dad, who crowned himself ‘one coat Macca’, boasted how he was a skilled painter. Sadly, it turned
out that he wasn’t as blessed as he’d led us to believe. By the end of the job we’d renamed him ‘one
more coat Macca’, as several of the rooms had to be painted three times after we’d run out of his
custom-tinted paint. It was impossible to match the paint shades, so we had to start again from
scratch.
Instead of taking three months, we ended up allocating every weekend for six months to the jobs of
stripping back wallpaper, painting, landscaping and repairing window sash cords. And all we did was
the cosmetic work. The major tasks — such as putting in a new kitchen, polishing the floorboards,
laying down cork tiles, painting the exterior of the house, landscaping the front garden, fixing the roof
and fitting marble hearths to the fireplaces — were all left to expert subcontractors.
At the end of the project we were well over budget in dollars and time. It was mid January and the
total cost of the house after repairs and closing costs had ballooned to $111 402. Exhausted and
frustrated, we all agreed to sell the property as soon as possible and put the whole experience behind
us.
We’d had a run in with Mick’s boss, so we went with another agent in town who was impressed with
what we’d done and said that we should ‘put a circle around $140 000 as a fair sale price’. Our fully
renovated dream home sat on the market without any interest at all, until on 2 March an out-of-town
buyer offered us the pitiful sum of $125 000. Even worse, we’d later discover that the agent we chose
(he seemed like a good negotiator from other dealings we’d had with him) actually told the potential
purchaser to submit a low offer as the vendors ‘were starting to get a little desperate’.
The whole process had been a disaster. Not only had we channelled much more money into the
house than was budgeted, we had a dodgy agent and I was sick to death of the smell of paint. Being
upset at the treatment we’d received, I couldn’t bear the thought of paying a shyster a commission and
so we rejected the offer and listed the property with another real estate agent. The innocent purchaser
was left confused. The agent had told him the deal was basically stitched up when, in fact, we hadn’t
ever agreed to his offer, much less signed a contract.
Finally on 21 March our new agent coaxed an extra token $2555 out of the same purchaser, and we
agreed to sell. We all breathed a collective sigh of relief.
Table 17.2 is a summary of the financial details. The figures don’t account for the mental pain and
suffering caused by this property debacle.
Table 17.2: expected and actual investment outcome
Expectation Actual outcome
Project length
90 days
188 days
Purchase price
$83 000
$83 000
Closing costs
$3 000
$2 821
Renovation cost
$17 000
$25 581
Total cost
$103 000
$111 402
Sale price
$140 000
$127 555
Sale costs
$7 000
$7 364
Net after-sale proceeds $133 000
$120 191
Profit
$30 000
$8 789
Being accountants, the one thing we did do well was keep track of the numbers. After sales costs, we
made a total profit of $8789.20, or $2929.73 each. When you convert this sum into an hourly rate and
factor in the risk, we’d have been better off flipping burgers at McDonald’s.
Learning experiences
Making mistakes often provides the best learning opportunities, and from this deal I discovered:
You should stick to what you are good at. A mistake I see many renovators make is they swap one
job for another, meaning they exchange their day job for being a DIY handyman. Although their
deals are often profitable, this is because they don’t charge a labour cost; rather they make money
from their investing skill. I often wonder how many great deals passed me by as I spent my time
painting walls and digging gardens.
You should just manage the team. Rather than physically doing the work you should look to
manage your team. There is only one of you, and if you do the painting and the floor sanding then
you can only do one deal at a time. However, if you manage a team you can easily handle
multiple projects simultaneously.
You shouldn’t rely on gut feel. There is a world of difference between making a deal look good on
paper and banking a real life profit. Often the best case scenario is assumed (highest selling price,
lowest reno costs, quick renovations and so on). It is a lot smarter to be realistic and conservative
rather than optimistic and gung-ho.
You have to be in the game to profit. Although there wasn’t a great financial return, having a go
provided valuable experience that could never be gained from reading a book or attending a
seminar.
THE RENO FORMULA FOR SUCCESS
If you want your reno projects to be profitable, the formula to apply is: always add more in perceived
value than actual cost.
Steve’s investing tip
You’ll make money from renos provided you add more in perceived value than actual cost.
For example, if renovating the kitchen would increase your property’s value by $40 000 (perceived
value), and the works were quoted at $25 000 to complete (actual cost), then it would make sense to
update the kitchen because your reno profit would be $15 000 ($40 000 – $25 000).
Humans perceive based on sight, sound, smell and touch. Therefore, anything in a property that you
can see, hear, smell or feel should be targeted for renovation, while less obvious improvements (such
as re-plumbing and re-wiring) should be avoided if possible because the cost of improvement won’t be
fully recouped in a higher sales price.
There’s a problem though: you’ll probably have limited amounts of time and money. So, rather than
trying to do everything, you’ll need to prioritise based on what’s going to give you the biggest profit
bang for your reno buck.
Areas to target
When you renovate a property you are telling a story about how great it would be to live in the
dwelling. A good story has three elements:
once upon a time (how the property looks from the outside)
the main plot (the interior)
happily ever after (a feel-good experience about a happy life living in the property).
Once upon a time
Humans are quick to judge. For example, it’s often said that you will form an opinion about whether
or not you like someone within a few minutes of meeting them for the first time. The same can be said
for properties too.
For example, I once spent my entire budget renovating the interior of a group of flats while leaving
the exterior in original condition. While the kitchens and bathrooms were masterpieces in comfortable
living, the ugly 1970s brown brick exterior caused many potential buyers to keep driving because they
couldn’t see themselves living there.
Potential buyers have already begun making up their minds about whether they like a property well
before they walk through the front door. Some factors — such as the car trip to view the property, the
weather and how the person’s day has gone — are outside your control. However, you can certainly
positively influence how a buyer feels by presenting the property as an appealing place to live.
Steve’s investing tip
The attitude I adopt to minimise my emotional attachment is to inspect real estate thinking I don’t want to buy it, and it’s up
to the agent and property to convince me otherwise.
If your property has curb appeal then potential purchasers will already have a strong emotional
attachment to the property as they walk through the front door, and this means they will tend to
overlook or forgive internal imperfections, instead adopting an attitude of ‘that’s something we can
fix after we move in’.
On the other hand, if your property is ugly and potential buyers are neutral or emotionally
disconnected, then every internal blemish is another reason not to buy.
You certainly don’t need to make your property look like a palace. Neat and tidy is enough, with
perhaps a landscaping feature to draw the eye away from any rough patches in the garden. Table 17.3
shows some possible exterior renovations.
Table 17.3: possible exterior renovations
Ideas to add more perceived value than actual cost
Get rid of clutter
Tidy the gardens
Plant annuals in the garden that are in flower (it adds
colour)
Add a nice letterbox (including number)
Install a good front door and doorbell
Things to avoid because they add more cost than perceived
value
Re-roofing
Guttering (unless it is awful)
Major landscaping
Garden lighting (most inspections are done during the
day)
Security doors that make the property look like Fort
Add porch lights
Remove stains from concrete
Have no cars parked in driveway
Knox
Awnings
Figure 17.1 shows an example of what to avoid. This property had been listed for sale and the
owners decided to do a spring clean. Sadly, they left this junk on the nature strip for weeks. The
property didn’t sell.
Figure 17.1: poorly presented property
On the other hand, figure 17.2 shows a property that presents well from the street. Even though there
is a lot of exposed brick, the garden softens it.
Figure 17.2: well-presented property
The main plot (interior)
Real estate agents tell me that men buy houses and women buy homes. Therefore, because homes sell
for more than houses, it’s smart to renovate your property with the female buyer in mind. Table 17.4
shows some possible interior renovations.
Table 17.4: areas for possible interior renovations
Areas that add more perceived value than actual cost Areas to avoid because they add more cost than perceived value
Kitchens
Bathrooms
Living rooms
Bedrooms
Sheds
Studies
Laundries
Carports and garages
My wife reliably informs me that a modern woman needs a modern kitchen, and — while I’m not
sure exactly what she means — I’m smart enough to realise that a grungy kitchen and a dirty
bathroom are going to hurt my sales price.
With relatively little effort you can modernise and increase the appeal of these areas and create an
inviting and pleasing atmosphere. I certainly wouldn’t be going crazy with a sledge-hammer and
starting again from scratch. It will be more cost effective to keep the structure or framework in place
and renovate around it. Examples include:
keeping the frame of the kitchen but updating with new cupboard doors, bench tops, knobs and
tapware
adding a new kitchen sink
giving existing appliances a thorough clean rather than paying for new appliances
retiling bathrooms and replacing taps rather than trying to remove baths or remodel showers
updating lighting to provide a more modern feel.
Other reno tips include:
paint using neutral colours to give the appearance of more light and space (make sure there are no
paint fumes during inspections as this is off-putting)
replace curtains with timber venetians
the look and smell of new carpet is appealing to many buyers and speaks of a fresh start.
If you can, avoid spending money on areas you can’t see, hear, touch or smell as they will add more
cost than perceived value. This includes:
wiring
plumbing
stumping
roofing
‘standard’ items that people will not pay extra for, such as the oven, dishwasher, hot water
service, toilet and fences.
Happily ever after
The happily ever after comes from presenting the property as a wonderful place to live. This is done
through home staging, where you maximise the selling appeal of the property by presenting it in the
best possible way. Katrina Maes, author of the excellent resource Finishing Touch, says the four steps
to successful home staging are:
De-clutter and de-personalise. Try to view each room through the eyes of someone walking
through your house, and make it as ‘person neutral’ as possible. For example, you’ll want to take
away personal photos so people can see themselves in that space. If they are walking in and
seeing a lot of your personal things, it’s harder for them to picture living in that space.
Squeaky clean. A clean house appears fresh and ready to live in, while dirt and grime places
doubt in the minds of potential buyers. Go to the trouble of fixing scratches and chips in the
benches and paintwork, because if the small things aren’t working properly, potential buyers will
worry whether the bigger things such as the plumbing and electrics work.
Themes and matching. Your house tells a story, and you want the story to have a theme and make
sense. This means carrying the theme from one room into another. Do this subtly using colour
and knick-knacks. For example, the colour of the cushions in the lounge room could be matched
with the colour of the doona in the bedroom.
Dressing. Choosing and placing the right furniture in the right place can make a room look more
inviting and spacious. For example, if your dining room is a little crowded, avoid putting all your
furniture against the walls. Instead arrange an armchair and a sofa around a coffee table. Even if
it’s not functional, it will look more inviting and appealing.
Correctly staging a property can add tens of thousands of dollars to your bottom line. The ‘before’
and ‘after’ photos in figure 17.3 show just how much extra appeal can be created by home staging.
Figure 17.3: home staging — before and after
----------
Highly recommended resource
Katrina Maes has written Finishing Touch, an excellent how-to guide for people who want to sell their properties faster and
for more using cost-effective home-staging ideas. It walks you through exactly what to do. It’s great — even an aesthetically
challenged, colour-blind person like me can do it!
Better yet, Katrina has generously offered those who register their book at <www.PropertyInvesting.com> a fabulous $50
discount off the cost. Details of how you can claim your discount will be emailed after registering.
‘We sold for $540 000 on auction day. The original valuation was $480 000. We simply applied Katrina’s system.’
John Welsh, Brisbane
----------
The importance of accurate number crunching
Your reno project will succeed or fail based on the accuracy of your financial assumptions. For
example, while you have control over your purchase price, you have less certainty with your reno
budget, and less certainty again with your end sale price.
Steve’s investing tip
Your reno project will succeed or fail based on the accuracy of your financial assumptions.
Dean and Elise Parker, investors I trained on the basics of property investing and who have since
gone on to become masters at renovating, have a really handy guide for crunching the numbers on a
simple cosmetic renovation. Their rule is that the sales price of the renovated property must be at least
135 per cent of the purchase price. That is:
Purchase price × 135% = Sale price
135% is the sum of:
Purchase price
100%
Closing costs
5%
Reno costs
10%
Holding costs
4%
Selling costs
4%
Profit
12%
For example, let’s say you came across a property that had renovation potential and was for sale for
$200 000. You could use Dean and Elise’s formula to quickly calculate a reno budget and see if there
was enough profit to make it worthwhile. This is shown in table 17.5.
Table 17.5: minimum sale price calculation
Percentage of purchase price Dollar allowance
Purchase price
100%
$200 000
+Closing costs
5%
+$10 000
+Reno costs
10%
+$20 000
+Holding costs
4%
+$8 000
+Selling costs
4%
+$8 000
+Profit
12%
+$24 000
=Minimum sale price 135%
=$270 000
Having applied the formula, the two essential questions that must be answered are:
Can you complete your desired renovation on a $20 000 budget?
After completing the reno, can the property be resold for $270 000?
It is vitally important to get accurate information about the likely resale value, and the best way to
do this is to keep a keen eye on what properties are selling for in the area. A good idea is to keep a
deal journal, where you note down every property for sale and the price it attracts. One important
observation I’ve made is that as the economy softens buyers are less willing to pay a premium for
comfort and instead look for affordability.
Steve’s investing tip
In harder economic times, buyers prefer affordability over comfort.
If you can find an area where properties pass this test then you have found your very own goldmine!
Are you interested in renovating properties? If so, I would definitely recommend Dean and Elise’s
step-by-step ‘Complete Renovation System’. Included are other useful formulas, checklists for
estimating reno costs, step-by-step instructions and plenty of case studies. Details of this great product
can be found on page 436.
ARE YOU AN INVESTOR OR A RENOVATOR?
Reality television and Bunnings have a lot to answer for, especially the small army of DIY renovators
who now think they can tackle any project. Unless you are especially gifted in using powertools and
want to spend your weekends covered in dust, I highly recommend that you spend your time managing
your team rather than doing the work yourself. As mentioned earlier, your profit should come as a
result of investing skill, not labour savings from doing the work in your spare time rather than paying
tradespeople.
Steve’s investing tip
You can’t get a full-time outcome from a part-time effort.
Dean and Elise really are masters at renovating. They do the planning and running of the investment,
and pay the experts to do the hammering, sawing and painting. This allows them to spend their time
doing what’s really important: managing their investments and finding the next highly profitable deal.
Renovating properties can result in very attractive lump-sum cash gains, but if you want to be able
to undertake multiple profitable projects at once your success will come from doing things
differently — and that means having structure and control rather than relying on luck and gut feel.
Book bonus
Dean and Elise have kindly contributed a renovation case study. It’s available as a free bonus that can be accessed after
registering your book at <www.PropertyInvesting.com>.
CHAPTER 17 INSIGHTS
Insight #1
The secret to making money from renovations is to always add more in perceived value than actual cost.
Insight #2
The more accurate you are with your assumptions about your reno costs and end sales price, the more accurate your
profit estimate will be.
Insight #3
Your reno profit should be based on your investing skill, which is demonstrated by selecting the right property,
competently budgeting and managing the project, and selling at your expected price. Avoid swapping one job for
another by adopting a DIY attitude to save on labour costs.
Insight #4
Nicely renovated areas, such as kitchens and bathrooms, will naturally add a lot of extra perceived value. Spending
money on structural improvements that can’t be seen or won’t be appreciated will add more cost and eat into your
profits.
Insight #5
Doing a reno without staging the home for sale is like going on a date in your tracky daks: it doesn’t matter how good
the product is, you won’t get much interest.
Insight #6
The more accurate you are with your assumptions about your reno costs and end sales price, the more accurate your
profit estimate will be.
Insight #7
Accountability is good. Get someone to check over your assumptions and ask questions. You may have missed
something obvious.
18
Developing
Strictly speaking, property developing encompasses anything done to improve the value of the land
and/or dwelling on it, and includes renovation, subdivision and building works. Your profit is made
when the developed property is sold for more than the total cost of acquiring, improving and
temporarily holding it.
As we’ve already covered subdivisions (chapter 16) and renovations (chapter 17), let’s turn our
attention to the building side of property development.
NAIVE THINKING
I used to think property developing was a game for high-rolling gamblers who liked to speculate on
real estate, but my opinion changed forever after meeting Marty Ayles.
Marty’s an expert property developer and also a licensed builder with over 10 years experience. As
figure 18.1 shows, Marty’s niche is buying average-looking houses on developable parcels of land,
demolishing, subdividing and then building multiple new homes.
Figure 18.1: property subdivision and development
Far from speculating, Marty has a cookie-cutter approach that involves what he calls ‘The 6 Ps of
Property Developing’.
THE 6 Ps OF PROPERTY DEVELOPING
#1 Product
The first ‘P’ relates to what you are going to build.
Steve’s investing tip
Your aim is to make the most profit, in the quickest time, for the least risk.
Aside from the size and shape of the land, how the property is zoned will have a big say in what can
and can’t be built. You can’t just wake up one morning and decide you want to build offices on a block
of residentially zoned land.
Steve’s investing tip
While it’s possible to get a property rezoned, it’s a time-consuming and expensive process and there’s no certainty it will end
in success.
Furthermore, each state has its own building code which spells out restrictions on how a site can be
developed. These include:
setbacks (minimum distance from front, rear and side boundaries)
private open space
overshadowing
overlooking and privacy
height
site coverage
significant trees
crossovers.
The key point to appreciate is that you can’t just build whatever you like. Instead, you will need to
submit a planning application to the local council that shows exactly what you plan to build and
clearly demonstrates that it meets all the required parameters. If you don’t comply then you can
always request dispensation, but success should not be assumed.
As a general rule, you’ll want to build as many dwellings as possible on a site. This is because the
building cost will be relatively fixed, as will the sale price, so amortising the land component across
more properties will increase your profit margin.
An unusual development site I bought for $318 000 was 1008 m2 of land that was the carpark for the
local bowling club (see figure 18.2). While the council preferred three dwellings on the site, a strict
interpretation of the building regulations allowed four dwellings.
Figure 18.2: bowling club site
Table 18.1 reveals that if I only built three dwellings then they would need to sell for a total of
$79 500 more ($26 500 each) just to cover the higher land apportionment. When you add in the extra
building cost because the dwellings were larger, a higher profit could be earned by building four
smaller dwellings.
Table 18.1: three dwellings vs four dwellings
Three sites Four sites
Land cost per site $106 000 $79 500
#2 Potential target market
Before you build anything you need to think long and hard about how and by whom the property will
be used because different target markets have different needs.
Potential target markets include:
students
singles
married, no kids
married, kids
empty nesters
retirees
investors.
Each target market has different needs and a different budget. For example, first home buyers prefer
affordable, no-frills housing, families will need space and older persons prefer single-storey homes as
it is harder for them to get up and down stairs.
If you can build the right housing product for the right person then you will find it sells quicker and
for a higher price.
#3 Price
The four financial variables in a property development are:
purchase price
holding costs
construction costs
sales prices.
While you will know the purchase price and can be reasonably accurate with the holding and
construction costs, there is always uncertainty about what your finished product will sell for.
Pre-selling — where you sell before construction has finished — is one way to reduce the
uncertainty of what your development will sell for. However, the downside to pre-selling is that it’s
almost impossible to get a premium price given most buyers lack vision and aren’t emotionally
excited about a set of drawings or a half-finished site.
Steve’s investing tip
Pre-sales provide certainty but come at a price as you often need to offer a discount.
Another downside to pre-selling is that you often need to discount the sales price to compensate
buyers for the long wait while the dwelling is constructed.
Construction finance was one of the big casualties from the global financial crisis; it became quite
difficult to fund building projects. Whereas once upon a time lenders would finance 80 per cent of the
end value (value after construction), it was tricky to negotiate 70 per cent of actual cost.
Not only did developers need to chip in more cash, financiers were more insistent on pre-sales. This
causes problems because it’s hard to get pre-sales if the project hasn’t started, and it’s hard to start
without third-party funding.
#4 Position
The position of the property is important because it impacts on the price and appeal for your desired
target market. Avoid properties on main roads, as these are traditionally harder to sell, and instead
look for sites that are close to shops and transport.
One area I like to focus on is properties within two kilometres of a train station. With the cost of
fuel increasing, more and more people will look to leave their cars at home and catch public transport,
and so walking distance to a train station will be a major bonus.
#5 Presentation
Homes that are well presented are more appealing and sell for higher prices. Suggestions for
enhancing presentation include:
attractive street appeal
tasteful landscaping
room layout and floor plan design
interior design, including colour scheme
lighting.
If you are pre-selling then it’s a good idea to get an artist’s impression to help potential buyers have
a vision for the finished product. For example, figure 18.3 shows an artist’s impression of the finished
product of one of my developments, while figure 18.4 (overleaf) shows how it looks now. Which
image do you think will create more positive emotion for potential buyers?
Figure 18.3: artist’s impression of development
Source: Seed Architects
Figure 18.4: partly finished development
#6 Promotion
Promotion refers to how you hope to attract potential buyers to the property. If you are going to use a
real estate agent to manage the sales campaign then four questions I suggest you ask are:
What fees and commissions are charged? A sales commission of between 2 per cent and 3 per
cent is normal, as is a marketing budget of up to $2500.
How many buyers does the agent have on his or her database right now looking for new
dwellings? Be careful, as many agents say they have interested buyers but this can be just bait to
attract your business.
How many similar properties has the agent sold in the last six months? Get addresses and sales
prices. This will help you determine what target market is most active and how accurately you
have priced your development.
What can I do to sell the property for more money? Allow the agent to contribute fresh ideas so
you can leverage off his or her experience.
CRUNCHING THE NUMBERS
Return on investment (net profit ÷ total cost) is the financial rule of thumb used to determine whether
a building project is viable. Guidelines are shown in table 18.2.
Table 18.2: return on investment guidelines
More experienced investors can accept projects with lower ROIs because they will be more accurate
with their assumptions.
A dollar saved is a dollar made
Marty Ayles’s developing niche is low-cost housing, and he’s the master of eliminating unnecessary
construction costs under the slogan of ‘a dollar saved is a dollar made’. Marty deliberately targets first
home buyers who are motivated by affordability, because they prefer cost savings to more expensive
luxuries. For example, one of the clever ways Marty has reduced his building cost is to move the
laundry into the garage. This reduced the size of his homes and the cost saving was split between
discounting the sales price and increasing his profit.
Key assumptions
The more accurate you are with your cost and time estimates, the more secure your development
profit will be. While you can control what you pay to buy the property, underestimating the
construction costs and overestimating the end sales prices will quickly sink your potential profit.
Another whammy to watch out for is time blow-outs that cause you to pay higher than expected
interest.
SMALL DEAL: $77 000 PROFIT IN 12 MONTHS
Marty has kindly contributed the following case study as an example of a small development deal that
made a profit of $77 000 in 12 months — start to finish.
G’day, I’m Martin. I’m 33, live in Adelaide and specialise in bulldozing average-looking houses and
building multiple new homes. While I’ve built houses that cater for all spectrums of the property
market, I’ve found the best way to make money for the least risk is to construct low-cost
accommodation targeted to first home buyers.
The easiest way of showing you what I do is to run you through a quick case study. This property
(shown in figure 18.5) is located in Sturt — a suburb in Adelaide that’s about 18 kilometres from the
CBD, 3 kilometres from the beach, and a 10-minute walk to a major Westfield shopping centre.
Figure 18.5: property to be developed
I’d targeted this area because the numbers worked, meaning provided I could buy a house for the right
price, I knew what my construction costs would be and the likely end sales values and so had
confidence that I could make my desired profit.
While many people wait for a property to have a big ‘For Sale’ sign out the front, I take the view
that every house is potentially for sale provided I can convince the vendor to sell.
Sometimes, if I see a property I like, I’ll be bold enough to go and knock on their door and ask them
if they’d like to sell. On this occasion, though, I’d organised for a letterbox drop where a flyer was
delivered to 3000 homes.
Shortly thereafter my phone rang. A couple who had received the flyer were literally about to list
their property for sale with an agent but thought they’d give me a call first to see if they could avoid
paying agent’s commission. My biggest concern was the land size, because in order to complete my
‘standard’ two-dwelling development I need a minimum of 700 m2 of land. Luckily this property had
760 m2.
I organised a time to meet up at their home to do an inspection, which, to be honest, was done in
record time as I was planning on demolishing the house anyway. At the meeting I found out that one of
the motivating factors for the vendors to sell was that they had bought elsewhere, and so a hassle-free
sale with a settlement date to coincide with their purchase was exactly what they wanted.
The vendors, a couple in their early 40s, had already been given three appraisals from agents about
what the property might be worth, and since one of my policies is to always pay a ‘fair price’, we soon
agreed on a figure of $315 000.
Interest starts ticking over the second you become the new owner, so it’s smart to get a head start on
the documentation so you can start building as soon as possible.
For instance, as soon as the contracts were signed I ordered working drawings to be created which
would be lodged with the council the second I became the new owner. I also arranged for the property
to be demolished within a week of settlement.
I have a track record with my financier, so given the small scale of this development I didn’t need
any pre-sales to secure finance. This meant that I could push through with construction and sell closer
to completion when it is much easier to get higher sales prices (compared to only being able to show
plans). The ‘product’ I chose to build were two three-bedroom, single-storey homes. The shape of the
block meant they could be built side by side (see figure 18.6).
Figure 18.6: development under way
I chose this product because first home buyers will happily pay $400 000 for a new home in Sturt, and
given I paid $315 000 for the land, I had to make sure I didn’t go overboard on my construction costs
or else my profit was at risk.
In other words, I had a ceiling on my sales price, a floor on my purchase price, and I had to make
sure my building and holding costs were low enough to make my desired profit. Had I been able to get
higher sales prices, I may have been able to build fancier homes (for example, double storey rather
than single storey), but this wasn’t the case here.
It took six months to build the new dwellings (shown in figure 18.7), and as construction came to an
end I engaged a real estate agent to sell them. Given the first home buyer frenzy, they sold like
hotcakes. Table 18.3 is a summary of how the numbers worked out.
Figure 18.7: the finished product
Table 18.3: investment outcome
While Adelaide is my chosen area of expertise, houses and deals like this can be done everywhere. Just
be careful to make sure your numbers work.
Want more Marty Ayles?
Once or twice a year, Martin runs a unique seminar that includes a guided tour of projects he has on the go plus interactive
training on the finer points of his approach to property developing. Numbers are strictly limited, so if this is of interest to you
then visit <www.PropertyInvesting.com/bustour>.
NINE TIPS FOR FIRST-TIME DEVELOPERS
As we start to wind down our discussion on property development, here are nine tips for first-time
developers.
1 Cash reserves
If you’re planning on developing property then you’ll need access to significant cash reserves (either
savings or equity). Many incidental costs (such as minor consultants) are unlikely to be financed and
must be paid for from your own pocket.
2 Construction finance
Another reason why you need access to cash is that most construction financiers require you to
contribute the first percentage before they lend a single dollar.
For example, if your cost of construction is $200 000, the lender will finance the last 70 per cent, not
70 cents in every dollar spent. In other words, you will need to contribute the first $60 000 and then
the lender will contribute the last $140 000.
3 Borrowing ability
Don’t assume that you can borrow the same amount of construction finance as you could for
residential property using home loans.
Securing construction finance takes a lot longer than applying for a home loan, and you will need to
demonstrate your ability to deliver the project on time and budget. Most lenders will fund
developments of three or fewer dwellings, but if you are planning on building more dwellings then
you may be in for a fight.
For this reason it is smart to always include a ‘subject to finance’ clause in your offer.
4 Interest rate and fees
The interest rate on construction finance is usually 2 per cent higher than home loans to compensate
the lender for the extra risk. The application fees are usually higher too, in particular the cost of the
valuation since a cost estimate may need to be done by a quantity surveyor.
5 Finding land
If you are having trouble finding vacant land then remember that it’s relatively easy to bulldoze a
house. Problem solved.
6 Restrictions
You can’t just build whatever you want. Your housing product needs to be sensitive to how the land is
zoned, and will need to comply with state government and local council regulations.
In particular, be mindful of restrictions that give you ‘dead land’ — which is land you can’t build
on. This includes setbacks, easements and private open space considerations.
7 Management
Your profit will live or die by how well you manage the development. Naturally, you don’t have to be
the builder, but you must coordinate your team and ensure the project runs with minimal hiccups and
delays. Otherwise you will suffer a significant cost blow-out which cannot be recouped through higher
sales prices.
8 Profit margin
Some developers cut their margins fine at the time of buying and speculate that values will increase
during the time it takes to construct the new dwellings. This is a high-risk approach.
9 Long pay day
Although developers can pre-sell to secure a sale, pay day isn’t until the construction has been
completed, which can take up to 18 months. Until then you will be paying expenses and incurring
interest. This necessitates careful cashflow management.
The reason why so many developers go broke is because they fail to adequately manage their
cashflow and end up with stock that can’t be sold. If loan payments can’t be met then the bank steps in
and disposes of the property at fire-sale prices.
While there are many risks associated with property developing, the rewards are well and truly
worth it provided you follow a system and manage your projects well. You’ll need to be an active
investor with access to good cash reserves, but an approach that will see you do well is to always
remember that success comes from doing things differently.
CHAPTER 18 INSIGHTS
Insight #1
Property development is an investing strategy that releases lump-sum cash profits. The formula for success is to always
add more in perceived value than actual cost.
Insight #2
You can’t just build whatever you want. How a property can be developed depends on its zoning, and whatever is built
must comply with government regulations.
Insight #3
You can maximise your profits by matching the right housing product with the right potential purchaser and selling for
the right price.
Insight #4
A dollar saved is a dollar made. Construction cost savings that don’t impact quality can quickly boost profits.
Insight #5
It’s the unknowns in property developing that are most dangerous, and the biggest unknown is the price a dwelling will
sell for once complete. Pre-sales provide certainty, but they come at a cost as you often need to discount the price to
attract buyers who are willing to put up with the delay during construction.
Insight #6
A development project lives or dies depending on its budgeted return on investment. If you are starting out then look for
a minimum ROI of 20 per cent.
Insight #7
Construction finance is an unusual beast so it’s smart to ensure any offer you make is subject to finance approval. That
way you can pull out if you don’t get the amount of finance you desire or terms that are acceptable.
Insight #8
Don’t develop property unless you have access to significant cash reserves.
Part IV
Your next purchase
Introduction to part IV
So far I’ve outlined so much theory that, provided you retained and understood it, you would easily
qualify to become a recognised expert on the topic of real estate investing.
However, while you could be classed as a theoretical guru, unless you can translate what you know
into an investing profit, you’ll be forever destined to trade your time in exchange for money by
working in a job.
Steve’s investing tip
All the knowledge in the world is useless unless you have a practical context in which to apply it.
Part IV is dedicated to providing information that will help you to answer important questions, such
as:
How can I turn my theory into practice?
Do I have what it takes to be successful?
How and where can I find the money to get started?
What investment property should I purchase, and in what area, to maximise my profit potential?
19
Planning for success
Towards the end of November 2000, Dave Bradley and I met at my house to discuss the latest
developments in our accounting and property investing businesses. The meeting was going to be a
defining moment that would demonstrate the power and importance of having a plan.
We owned two investment properties at the time and, based on a net return of $50 per week,
calculated that we needed to acquire a further 26 properties, at which point our investment income
would cover our rather basic lifestyle requirements. While we wouldn’t be living like kings, we’d at
least be well on the way to being free from the need to work in our accounting practice.
It all seemed pretty easy on paper when we broke down the responsibilities for buying our targeted
26 properties. Dave would need to acquire 10 deals, while I would need to find and buy 16 houses.
This was all on top of our work obligations to our accounting clients, plus the ongoing (and
increasing) management involved as we purchased more properties.
Having read about effective goal setting, Dave and I understood the importance of establishing a
deadline. For no good reason we chose the end of February 2001 as our target, which gave us 90
days — less the Christmas and New Year’s holidays — to get busy. We then further broke down this
time frame into the number of properties we had to buy each month. Table 19.1 shows our targets.
Table 19.1: our plan for acquiring 26 houses in 90 days
The going was by no means easy, especially since the whole country generally shuts down from
around 15 December until 15 January. When we tallied up our purchases at the end of February we’d
only acquired 18 properties. While a little disappointed that we fell short of our goal, to average a new
property every five days was still an impressive effort.
Our lesson from this experience was that impressive results can be achieved when you:
think big
set a goal
break it down into mini steps
take immediate and massive action.
Without a plan, we managed to achieve slow and steady progress, yet when we took the time to set
some goals — challenging goals — even though we fell short of our expectations our results were
very impressive.
If you don’t have a plan and are wondering why you have trouble gaining momentum, now you have
your answer. If you’re achieving good results without a plan, just think of what you could achieve if
you formalised your commitment and set some objectives outside your comfort zone.
THE PATH OF LEAST RESISTANCE
I invite you to complete an important practical exercise to illustrate the path of least resistance.
Step 1
Take a pen and place a dot in the top-middle of figure 19.1. Write the word ‘NOW’ to the right of the
dot. This first dot symbolises your current position on your road to financial independence.
Figure 19.1: your path of least resistance
It doesn’t matter how old you are, how much money you have in the bank, your marital status or
anything else — we just need a point of reference from which to move forward. Yesterday is gone
forever; let’s focus our attention on tomorrow.
Step 2
Next, draw a second dot in the middle of the bottom of figure 19.1. Write the word ‘FUTURE’ to the
right of it. This second dot represents your ideal wealth-creation position at some point in the future,
perhaps many years from now.
Step 3
Having completed steps 1 and 2, you know where you are as well as having an idea of your destination
too. You also have some idea of what direction you need to head in. Your next step is to identify your
path of least resistance, which is the shortest distance between the two dots.
Have a go at trying to draw the path of least resistance between the ‘Now’ and ‘Future’ dots in
figure 19.1.
Step 4
After you’ve drawn your path of least resistance, go back and draw three small squares evenly spaced
along the line between the ‘NOW’ dot and the ‘FUTURE’ dot. Write A next to the first square, B next
to the second and C next to the third. These are your milestones of achievement.
Be guided but not taught
Your journey to financial independence isn’t something you can achieve overnight. The lessons you
must learn take time and must be experienced rather than taught. However, you can be guided along
your path by people who have already walked the road you’re travelling. The best advice I can offer is
that your success is dependent on developing a realistic goal, turning it into achievable milestones,
and maintaining the necessary focus for as long as it takes for you to achieve success.
A major battle
A major psychological battle must be fought on the road to financial independence well before a
dollar of passive income is ever earned. The powerful emotions of greed and fear are our biggest
enemies. We all know, in our heart of hearts, that get-rich-quick schemes don’t work, but we’re still
attracted to the chance of making a quick profit because we want something for nothing (greed).
We’re also afraid of missing out (fear) on an opportunity that other people seem to be cashing in on.
Instead of applying the necessary focus, we become distracted and unknowingly follow the path of
maximum resistance.
I’ll use the example of a hypothetical investor — let’s call him Andrew — to illustrate the path of
maximum resistance. Andrew is committed to creating wealth. He knows where he’s at today and,
even better, knows how much income he needs to become financially independent. His preferred
strategy to make money (at the moment anyway) is positive cashflow property investing.
Andrew begins on his journey and soon discovers that sourcing positive cashflow property is harder
than it first seemed. With continuing work pressures, it is difficult for him to find the time to look for
deals. As fate would have it, a letter arrives in the mail from a seminar company outlining how to
make a fortune trading shares using a patented ‘black box solution’ that boasts an amazing 99 per cent
success rate.
Frustrated about property being such hard going, Andrew pays $2000 to attend a two-day seminar
where the black box system is outlined and then tested with a number of pre-worked examples. Based
on the historical information given, a starting account balance of $30 000 was turned into $60 000 in
just six months.
Impressed with the ease of use and happy that it didn’t require a lot of his time, Andrew pays a
further $5200 to subscribe to a year’s supply of weekly online wealth-building reports as generated by
the magic black box. Three months later, and after an extensive paper-trading exercise where he
theoretically made $5878, Andrew places his first trade and makes an impressive $544 in just three
hours. The next day he breaks even and the day after he makes a further $950. Growing in confidence,
Andrew becomes less stringent about applying the 16 rules that came with the reports and begins to
rely more and more on his own judgement. He is becoming fixated with the stock market, and every
chance he has he’s online checking the latest prices and seeing whether he’s making or losing money.
That’s when he begins to lose — not a lot, but enough money over a period of time for Andrew to
question whether or not trading shares is really for him. After a correction to the stock market, the
reliability of the magic black box reports are questioned and Andrew becomes disillusioned.
Returning to what he knows best, Andrew throws himself back into his work.
Several more months pass and then one day Andrew’s flicking through the pages of a magazine and
notices an advertisement about the great returns and tax advantages that arise from investing in olives.
Sensing that there is no harm in looking, Andrew sends off the application form to receive a
prospectus. He also books in to attend an introductory free seminar.
Not being a fool, and feeling a little burnt by the ‘black box solution’ experience, Andrew does some
research and discovers that a government organisation has issued a warning that the prospectus prior
to the one that Andrew received contains some potentially unreasonable assumptions.
Confused and frustrated about wasting his precious time, Andrew abandons the idea of olives and
again focuses on his major source of income — his job. Soon after, his hard work is rewarded with a
promotion to a managerial position and a pay increase. Yet when you take out the additional tax and
superannuation, there’s not really a lot more pay, but there is a significant obligation to put in more
hours, including weekend work.
A few months pass by, and then one night while Andrew is relaxing in front of the TV the phone
rings. It’s Simon, an old friend from high school. They talk about old times for nearly an hour before
agreeing to catch up at Simon’s house for dinner, where they also discuss how Simon and his wife are
making an extra $1000 per week from their home-based business.
The dinner is delightful and the company pleasant. As the dishes are being cleared away, the topic
moves on to the business opportunity and Andrew’s friend outlines how he and his wife are making a
lot of money using a multi-level marketing organisation emanating from the United States. Knowing
that an extra $1000 a week would be more than handy, Andrew eagerly signs up, pays his joining fee
and buys the first month’s motivational books and tapes. All he needs to do to earn $1000 per week is
to buy $100 worth of product from the wholesaler and every month sign up two new people under him
and then help the people he signs up to sign up more people.
He allocates each Tuesday night to inviting guests from his circle of friends over for dinner, and
every Thursday night to attending a networking and motivational event. Andrew has mixed success. A
few of his friends are interested, but most are quite rude and question his morality in mixing business
with friendship.
He perseveres and achieves solid results, until his work wins a big tender and all managers are
required to work an additional 12 hours per week for at least the next six months. When the contract
ends, Andrew is so exhausted he books a three-week holiday to the Whitsunday Islands.
When he returns he’s invited to play indoor cricket on Thursday nights. This used to be the night he
went to his once-a-week network marketing debriefing, but he’s happy not to get involved again since
the effort he was allocating was not translating into the extra dollars he was hoping for. Simon calls
twice and leaves messages on the answering machine but Andrew doesn’t bother calling back. Simon
never calls again.
More time passes by and Andrew’s team wins the indoor cricket championship. One of his teammates is a real estate agent, and, over a beer one night, starts talking about how property prices are
primed to really take off. This rekindles Andrew’s interest in property, but this time he’s planning to
make money like the people on his favourite reality TV show, where they renovate houses and sell
them off for a substantial profit in only a matter of months.
Andrew starts looking for suitable real estate and eventually buys a property for $200 000. Over the
next six months he spends every available second of his non-working life renovating. He uses his life
savings of $50 000 to pay for the costs before putting it back on the market and selling it for $310 000.
Delighted with the result, but burnt out after spending his weekends renovating, Andrew reinvests
his profits back into another property — an off-the-plan apartment in town. A major factor in his
decision is the fact that he has to pay a large slab of his renovation profits in tax, so he’s looking for a
more tax-effective opportunity.
All is going well until Andrew’s work fails to win three major tenders and, unfortunately, he is
retrenched. If he leaves by the end of the week the company will pay him $20 000 on top of the annual
leave he’s owed.
Sensing the opportunity for a break, Andrew takes the redundancy package, only to find that people
with his skills aren’t in demand and it’s tough to secure a job interview, let alone a position. His
negatively geared property soon starts to niggle his hip pocket nerve and he decides that, given he no
longer has a job, he can’t afford to keep his investment apartment.
Steve’s investing tip
Uncertainty and lack of focus are the downfall of many investors.
Contacting the agent he bought it from, he lists the property for sale and is lucky that a buyer comes
along and offers what Andrew paid for the dwelling. After agent’s commission and interest payments,
Andrew loses about $20 000.
Times are starting to get tough, and instead of applying for management positions Andrew starts
submitting his résumé for rank and file jobs. He is starting to really see how dependent he was on his
job. This is a worrying realisation because Andrew made himself a promise that, unlike his father, he
wouldn’t be working until 60 or relying on the pension in retirement.
Just last week Andrew received two lucky breaks. Firstly, he was offered a job. It carried less salary
than he previously earned but he was under no obligation to work weekends. Secondly, he was reading
the paper when he noticed an article explaining that organic food was becoming more and more
popular. There was a 1800 number to call to find out how to make money as a distributor.
Hardly able to contain his excitement, Andrew is planning to take the job and call the number to see
what needs to happen for him to become a distributor. He’s telling anyone who’ll listen that he thinks
this is his next big opportunity.
Andrew’s path is shown in figure 19.2. He is similar to the many people I meet who express an
interest in wealth creation. He has the passion and he’s certainly intelligent — all he lacks is focus.
Instead of having a path of least resistance, he lurches from opportunity to opportunity and ends up
travelling a great distance only to end up frustrated.
Figure 19.2: Andrew’s path of maximum resistance
Any of his chosen paths could have created wealth — provided he applied himself and stuck with an
investment strategy. By switching from one strategy to another, all Andrew achieved was a path of
maximum resistance.
YOUR PERSONAL WEALTH-CREATION PLAN AND PATH OF
LEAST RESISTANCE
I’d like to help you to create your own personal wealth- creation plan and, in doing so, identify your
path of least resistance when investing in positive cashflow real estate. All that’s required is that you
complete the following five steps and fill in tables 19.2, 19.3 and 19.4.
Step 1: Where are you now?
Table 19.2: current income details
Step 2: What’s your ultimate money goal?
Table 19.3: future income details
Step 3: By when?
Table 19.4: your deadline
Step 4: Complete your money goal
Now bring together steps 2 and 3 to complete your money goal.
My money goal
Annual passive income of $____ by ___
Step 5: Commercial property
Assuming you can source an 8 per cent return, how much debt- free commercial property do you need
to own to achieve your money goal?
Annual passive income of ____÷ 0.08 = $____
Only once you’ve decided how much passive income and commercial property you require and by
what date can you begin to frame an answer to the next question, which is, ‘What’s the best way to get
there?’
The best way I know is to invest in residential property to make lump-sum cash gains, and then once
you have acquired enough capital, switch over to commercial property for the rental return.
MAKING THE NECESSARY SACRIFICE
If you decide to follow my approach to fund your financial independence then you can expect your
journey to be difficult and to require significant sacrifices. For example, when I started investing I
lived off a monthly allowance of $400 derived from my wife’s salary while the majority of my
property profits were reinvested back into buying more real estate.
Julie and I chose to rent rather than own a home as our weekly rent expense was cheaper than
making loan repayments. Most of my friends and family had been living in their own home for several
years; Julie and I had to suffer the hassle of rental managers inspecting our place every six months and
the possibility of being told to move on when our lease expired.
It’s impossible to say what you’ll need to sacrifice and I can’t promise that adopting a positive
cashflow approach will make you an overnight millionaire, but with patience, commitment and
delayed gratification you can become rich enough to buy back the time you’d otherwise spend
working in a job.
Steve’s investing tip
Financial independence does not arise by fluke or by chance. It is earned.
HOW LONG WILL IT TAKE?
Only you can answer this question, however I’m reminded of a true story that might help you
understand that, whatever the timeline, it’s something that you decide rather than something that’s
decided for you.
Before we set up our own accounting practice, Dave and I were employed as managers in a small
firm of chartered accountants. One of the last clients we worked with was an electricity company in
the process of becoming privatised. There was plenty of money to be thrown at contractors, and given
that the CEO was friends with one of the partners, the job of writing internal tax manuals was created
and awarded to our firm. Dave and I were both confident that the documents, which we spent weeks at
the company’s site writing and billing over $150 an hour for, would never be read. The task wasn’t a
lot of fun since the employees all knew they were about to be retrenched. Motivation levels for
everyone plummeted to new lows with each day that passed.
There was ample time for Dave and me to reflect on our own employment positions in the firm we
worked for, and we came to see that our jobs were no long-term certainties either. That’s when the
idea for Bradley McKnight – Chartered Accountants was born. At least we were assured of job
security when we worked for ourselves.
Dave and I began to wonder how long it would take us to set up the necessary infrastructure, at
which point I grabbed a marker pen and assumed a lecturing position in front of the whiteboard.
‘Dave, as I see it we have two choices’, I said.
I drew a stick figure at one end of the whiteboard and a finish line at the other end. ‘We can either
sprint to our goal,’ I said pointing to the diagram I’d just drawn, ‘or we can hurdle it and do it the hard
way.’ As I said this I drew another stick figure under the first one and a series of hurdles leading up to
the finish line.
‘Which one will lead us to our goal the fastest? Sprinting or hurdling?’ I asked.
Dave replied, ‘Sprinting, obviously’.
‘Exactly!’ I exclaimed. ‘So let’s remove as many of the hurdles as we can before the race begins
and we’ll get to our goal even sooner.’
Over the course of several years of investing together, Dave and I often reflected back on this
conversation. What we found was that many of the hurdles we’d been forced to jump had not only
slowed us down, but they had been left there by choice rather than by necessity.
Take some time to consider what’s holding you back. Is it something that can be easily overcome, or
are you inadvertently making life unnecessarily hard for yourself?
THE PLATEAU EFFECT
The plateau effect can occur at any time — sometimes even before you’ve purchased a property. It’s
characterised by a distinct feeling that you’re stuck in a rut, resulting in immense trouble gaining
momentum. For most investors the plateau effect is preceded by one of the following events:
the lack of a long-term investment plan
cashflow shortfalls given that you have existing property investments that are negatively geared
unlimited imagination, but very limited finance
an inability to locate deals
negative experiences with current investments
fatigue or boredom with the idea of property investing when once it was exciting and
exhilarating.
Unfortunately, without immediate correction, the plateau effect can be fatal, which helps to further
explain why so many property investors own so few properties. If you’re suffering from the plateau
effect right now then I’m a messenger of both good and bad news.
Okay, first the bad news. Everyone experiences a property investing plateau sooner or later — noone is immune. Now the good news! The plateau can be overcome provided you adopt the right
attitude and seek assistance where necessary. A plateau arises from the combination of a lack of
knowledge, limited time and/or a shortage of money.
A vital point to remember is that you can always help yourself by taking action, whether it be
ringing up to source finance, or calling agents and asking them about the properties they have
available for sale. The worst thing you can do is to accept the reasons for your lack of momentum, as
this will justify a decision to stop trying.
An even poorer option is to assign control of an element critical to the success of your investment to
someone who does not have an interest in seeing it come to fruition. Relying on someone to make
things happen on your behalf is a sure way of stalling.
Steve’s investing tip
Your only certainty is that by doing nothing, nothing will happen.
If you’re experiencing the plateau effect then you’re probably also severely frustrated because you
know it’s possible to make a lot of money in real estate, but you just can’t seem to locate all the pieces
to the wealth-creation jigsaw. Stick at it though; success will come in time.
Steve’s investing tip
You can find support from like-minded investors at <www.PropertyInvesting.com/forum>.
No doubt there will be many investors who have been through your situation before and can offer
assistance or, at the very least, encouragement. Going it alone will make your life unnecessarily
complicated.
THE NEXT STEP
I can distinctly remember the slogan at one of the places where I worked as an accountant. It was a
picture of a yacht with a caption underneath that read, ‘How do you know where you’re going if you
haven’t charted a destination?’ Well, before you ever invest in a property, you must first decide why it
is that you want to make money. Once you have a reason for investing, you can start to target
investments that will help you achieve your goals.
Investing without an outcome in mind will create two results:
You’ll follow the path of maximum resistance.
Eventually you’ll plateau out.
If you haven’t already done so, go back now and complete the planning exercises in this chapter. I
know it’s a pain but if you want to get the full benefit from this book then you have to remember that
success comes from doing things differently and not just glossing over.
CHAPTER 19 INSIGHTS
Insight #1
Only once you know where you are now and where you want to go can you plot the quickest path to get there.
Insight #2
Achieving financial independence is by no means easy, but it’s also no fluke. By breaking down your financial goals
into the amount of debt-free commercial property you need to own, it will become more than a dream.
Insight #3
If you think you know all the theory about goal setting but you’re investing without any kind of plan then, I’m sorry, but
you don’t currently have what it takes to achieve massive success. You might be achieving some good results, but these
will only ever be a tiny fraction of what you could achieve if you had better focus.
Insight #4
Expect periods when times are tough and progress is slow. Understand that the way through these difficult periods is to
continually take action — even when you can’t be bothered or are just about ready to give up.
20
The Asset Zoo
Before moving on to talk about what property you should buy next, let’s first examine what assets you
already own to make sure you have a good foundation to build a better and brighter financial future.
THE CHICKEN OR THE NEST EGG?
What comes first: the asset, the investing strategy, or the intended financial goal?
The asset first
Putting the asset first means your buying decision will be based on the value or potential of the
property, rather than how the dwelling fits into your overall investing goal. The danger with this
approach is that you could easily end up with a portfolio that is fractured or lacks consistency.
I’ve seen this many times with property investors who own two or three properties in two or three
different states. The buying decision is made because the house seemed cheap, or because the investor
heard it was a good area to buy in. While you can make money doing this, it is difficult to maximise
your returns because you’ll spend more time managing your portfolio, which will mean you have less
time to find other deals or relax.
The strategy first
Other investors prefer to only buy properties that fit within their chosen investing strategy (such as
rentals or renovations). While this can be effective because focus brings clarity, when you only know
how to make money one way your lack of flexibility may mean you miss out on better ways to realise
higher profits.
Steve’s investing tip
When you only know how to use a hammer, the solution to every problem is a nail.
Furthermore, if you only know how to make money one way, should that strategy become
ineffective (for example, growth- focused buy and hold investors during periods when the market is
flat), you won’t make any money.
The intended financial goal first
The best option is to decide what return you want from your investments, and then to acquire assets
and implement the best investing strategy to deliver the highest profit, in the quickest time, with the
lowest risk. Table 20.1 gives some possible financial goals, and how they might be achieved.
Table 20.1: possible financial goals
Financial goal
Asset class Strategy
Long-term capital gains Shares
Quick lump-sum cash
Cashflow
Buy and hold; growth
Property
Buy and hold; growth
Shares
Share trading, derivates
Property
Renovations, subdivisions, simultaneous settlements, building
Cash
Interest
Shares
Dividends
Property
Rental, vendor’s finance, lease options
What not to do
The lesson to apply from this discussion is: don’t let your assets determine your strategy or financial
outcome. Instead, choose your desired financial return and then select the right asset and strategy to
realise that outcome.
Steve’s investing tip
First decide your intended financial outcome, and use your choice to guide you as to what property and what strategy is best.
THE ASSET ZOO
Let’s take a look at your current asset portfolio, but rather than analysing numbers, let’s instead use a
handy matrix I’ve created called ‘The Asset Zoo’ (see figure 20.1, overleaf).
Figure 20.1: The Asset Zoo
The matrix is split into four squares, with each square given the name of an animal depending on the
investment’s passive efficiency and growth potential. Let’s have a look at The Asset Zoo.
Axes
Passive efficiency: the number of hours you have to work to earn the return.
Growth potential: the growth potential to increase the current return (capital gains and income).
Squares
Tortoise: Characterised by being slow moving, assets in this category have low growth potential and
require a lot of labour hours to earn and maintain.
Elephant: Big, bulky and slow moving, elephant assets provide strong growth potential but require a
lot of labour hours to earn and maintain.
Gazelle: Nimble and fast, gazelle assets deliver low returns but don’t require a lot of labour hours to
earn and maintain.
Lion: King of the jungle, lion assets deliver strong returns and don’t require a lot of labour hours to
earn and maintain.
Right! Let’s see how you go with trying to allocate the generic assets below into their right ‘animal’
squares. Fill in the last column with what you think is the appropriate animal for each asset.
Asset
Qualities
Your job
High income; low growth potential
Cash
Low return; low growth potential
Growth shares
Low return; moderate growth potential
Income shares
Moderate return; low growth potential
Share trading
Moderate return; requires time input
Square
Negatively geared growth property Negative cashflow return; moderate long-term growth prospects
Lump-sum cash properties
High return; require many hours of input to earn
Positive cashflow properties
Low return; low growth
Leveraged commercial property
Low return; moderate growth
Debt-free commercial property
High income; moderate growth
In truth, every asset is slightly different, so it will be up to you to categorise each one in the square
you think fits best. That said though, below are my suggested classifications for the generic asset
classes, and my reasons why.
Your job
Ranking: tortoise (low passive efficiency, low growth)
The weakness with employment income is that you need to work to earn it, and since there is only one
of you, and you have a maximum of 24 hours each day, you have a limited ability to earn more money.
In summary, employment income is slow and steady and requires a lot of hours to earn.
Cash
Ranking: gazelle (high passive efficiency, low growth)
The passive efficiency of interest is high because your return is based on the amount of your deposit
and the rate applied, not by your labour hours. However, compared with other investments, the return
from interest is low and there are no opportunities for capital gains.
Growth shares
Ranking: gazelle/lion (high passive efficiency, moderate growth)
Investing in shares is a highly passive form of investing as you are purchasing an interest in a business
without having to work in it. Typically high-growth shares offer lower income returns. The combined
profit determines whether the asset is a gazelle or a lion.
The exception here would be when you purchase shares using margin loans. In this case you need to
keep working to pay the interest, and so the category changes to elephant.
Income shares
Ranking: gazelle (high passive efficiency, low growth)
Again, it doesn’t take any labour hours to invest in shares since your return is generated by others
(management and employees) on your behalf. Some types of shares offer predominately income
returns, and in this case the capital gains are typically low.
Share trading (including derivatives)
Ranking: gazelle/elephant/lion
Many share trading systems are marketed as magic black-box solutions, but I’m yet to see a system
that doesn’t require at least a couple of hours a day to ‘manage’. Depending on the number of hours
involved to ‘pick’ stocks to trade and the returns achieved, this form of investing could be a gazelle
(low returns, low hours), elephant (high returns, high hours) or lion (high returns, low hours).
Negatively geared growth property
Ranking: tortoise/elephant
Negative gearing relies on earning other income to soak up the loss from your property. Therefore,
because you need to keep working this form of investing ranks as an elephant during periods of
significant growth, and a tortoise at other times.
Lump-sum cash properties
Ranking: elephant/lion
If you are the one doing the work, investing in property for lump-sum profits will be time consuming
and so the passive efficiency will be low (hence the elephant ranking). However, where you have a
team and the process is largely automated, the returns can be high without much labour input and so
the investment would rank as a lion.
Positive cashflow properties
Ranking: gazelle/lion
Positive cashflow properties that are looked after by competent rental managers won’t take up much
of your time after purchase, so the ranking (gazelle or lion) depends on the combined income and
growth returns.
Leveraged commercial property
Ranking: tortoise/elephant
As the name suggests, leveraged commercial property means some of the purchase price is financed
using debt. To qualify for finance you will need employment income and so you will need to maintain
your job. This makes the passive efficiency low.
Growth in commercial property has more to do with the tenant, length of lease and yield than
location, which is why it’s not likely to increase in value as quickly as residential real estate. If the
after-interest income return is low or negative then the asset would be a tortoise. If there is steady
growth then the asset would be an elephant.
Debt-free commercial property
Ranking: gazelle/lion
My preferred wealth-creation model for financial freedom is:
Step 1 Use your savings to purchase quick-cash property deals.
Step 2 Add more value than cost, then sell.
Step 3 Repeat steps 1 and 2 to build your investing kitty.
Step 4 Purchase debt-free commercial property to gain reliable income and growth.
Without any debt, the income return will be high, and because investing in commercial real estate is
largely automated, the passive efficiency is high too.
The combined income and growth returns will determine whether the asset is a gazelle (lower
returns) or a lion (higher returns).
Who’s in your zoo?
It’s time to plot every asset and source of income you have on the chart opposite. Once you’ve done
that, keep reading.
What types of animals do you have in your Asset Zoo? Are you cultivating tortoises? Do you have
an elephant farm, a herd of gazelles or a pride of lions? Or do you have an entire zoo with many
different animals?
Investors often start by purchasing tortoise and elephant assets because they have been told to work
hard and invest for the long term. However, as you grow in skill, confidence and monetary backing,
your asset portfolio should evolve from buying tortoises and elephant investments to acquiring
gazelles and lions.
While it is possible for an investment to change its character over time, experience shows that it is
better to buy a new asset than to sit around and wait. This is particularly so for underperforming or
loss-making assets, which are often held far too long and cause investors to miss out on better
opportunities.
Steve’s investing tip
It will be easier to buy a new asset than to wait for an investment to change its character.
Questions to think through from this analysis include:
Are you frustrated by your lack of progress and have now discovered you have tortoise and
elephant investments, which are slow moving by nature?
Does the animal best represented by your portfolio also reflect your own attitude toward
investing and money management?
Do you only know how to acquire one type of investment?
Do you have assets that you purchased thinking they would be one type of animal, only to find
they are another?
Does your investment portfolio reflect your stage in life and your attitude towards risk taking?
Are your assets suitable to fund your needs when you no longer earn employment income?
Do you have growth assets when you need income assets, or vice versa?
What can you do to increase the efficiency of your assets so you can continue to generate returns
without increasing the hours worked to earn them?
MIXING UP THE ANIMALS
While it’s normal to have different types of animals in your portfolio, avoid having pets or favourites.
Remember that as an astute investor it’s your job to maximise your returns, and just like in the
African savannah, it’s survival of the fittest. Poorer performers need to be ‘sacrificed’ for the sake of
remaining lean and efficient.
Diversification
Financial planners often talk about diversification (spreading risk across multiple assets) as a solution
to reducing risk, because if one asset underperforms or fails then other assets remain to carry the
burden.
Steve’s investing tip
Diversification means not having all your investing eggs in the one basket.
While I see the sense in this, I don’t agree that you need to own a range of different classes of assets.
In fact, from my experience the opposite is true: there are riches in the niches.
For example, in regards to property, you can diversify your portfolio by:
owning different types of dwellings (houses, units, apartments)
investing in different markets (suburbs, states, countries)
choosing different types of property (residential, commercial, other)
using different strategies (buy and hold, quick turn, positive cashflow)
having multiple tenants (rent by the room or blocks of apartments)
using multiple lenders
having a mix of interest-only and principal and interest loans.
You can also reduce your risk using insurance. For example, the risk of having a bad tenant can be
covered by landlord insurance, and the risk of the house burning down by home insurance.
Furthermore, an approach I’ve adopted is to insure my life for the amount of debt I owe so that if I die
my wife can pay out the debt using insurance and enjoy even higher cashflow.
Steve’s investing tip
If you can’t afford insurance then you can’t afford to invest.
A point I do agree with financial planners on is that it’s unwise to have all your money invested in
one asset, because if that asset fails you can lose any profit and some of the money you invested. For
example, when I talk about owning commercial property debt free, it’s smarter to have two $500 000
properties than one $1 000 000 property, and two tenants rather than one tenant.
THE FINAL WORD ON THE ASSET ZOO
By mapping out your asset portfolio you are now in a much better position to think about what kind of
property you should buy next. You have already distinguished yourself from most property investors
(who adopt a ready–fire–aim approach by purchasing first and thinking second) by demonstrating that
success comes from planning and doing things differently.
CHAPTER 20 INSIGHTS
Insight #1
The first step in thinking about your next real estate purchase is to decide what kind of investing outcome you want.
Only then can you gain clarity about what type of property you need and what strategy is best to make the most profit,
for the least risk, in the quickest time.
Insight #2
Different assets have different qualities. Some assets deliver income but require a lot of your time and effort. These are
tolerable in the short to medium term, but if you want to achieve financial independence then you will need to acquire
assets that generate an income return with minimal time input. Such things exist — you just have to look for them.
Insight #3
If you have invested without a predetermined plan then it’s likely you’ll have a portfolio that’s a bit all over the
place — there might be lots of different animals in your zoo. Such a portfolio is inefficient because it requires more time
to monitor and manage.
Insight #4
If you’ve come to the realisation that you have the wrong ‘type’ of assets (for example, too many elephants), experience
shows you may be better off selling and reinvesting than waiting and hoping for the asset to change by itself. If a
leopard can’t change its spots, what hope does an elephant have of becoming a lion?
Insight #5
It’s unwise to have all your money invested in one asset, because if it fails you can lose any profit and some of the
money you invested. However, rather than own different classes of assets, I’ve been able to diversify (spread the risk)
within my property portfolio by owning multiple dwellings, using different investment strategies with different time
periods, and by selling and recycling debt rather than refinancing.
Insight #6
Seriously think about insuring your life for at least the amount of debt owed in your property portfolio. That way, when
you die your estate can enjoy the fruits of your investing without the burden and hassle of the debt. If you can’t afford
insurance then you shouldn’t be investing.
21
Finding the money to begin investing
If you’ve established your investing goals and feel that investing in property is your path, then
congratulations — this step alone separates you from the majority of property punters who are simply
out to make money without any real reason or purpose for doing so.
Your next step is to try to find the cash needed to pay for the deposit, closing costs or perhaps even
renovation expenses (if that’s your strategy of choice) on an investment property. The source of cash
to pay for all these costs can be any combination of:
your savings
your equity
the money raised from public or private financiers.
YOUR SAVINGS
It doesn’t matter how much you earn, what’s important is how much you keep. Being able to pay for
the deposits and closing costs as you acquire more and more properties will require your savings
account to be regularly topped up. To increase your savings you can:
earn more
spend less.
If you’d like to know more about good money habits then more information can be found in chapter
5.
YOUR EQUITY
Just because you don’t have savings doesn’t necessarily mean that you can’t begin to invest in
property. If you have access to equity then you can still make a start towards building your property
empire. Equity, sometimes also called ‘net worth’, is the difference between the value of your assets
and the total of your liabilities, or perhaps more bluntly, what you have left over when you pay out all
your debts.
For example, if your investment property was worth $300 000 and you had a $120 000 mortgage,
then your equity would be $180 000 ($300 000 − $120 000). The largest untapped source of equity for
many people is their home. Take my friend Allan for example.
Redrawing equity
Allan runs a recording studio in Melbourne and nearly all of his available cash is spent maintaining
and upgrading his equipment. He likes the idea of property investing, but believes his lack of cash
prevents him from buying anything.
Allan bought his home for $320 000 with an initial mortgage of $256 000. Now, after repayments
and the passage of time, he owes $230 000. As shown in table 21.1, despite his lack of cash Allan
could access up to $26 000 in the form of redrawn equity and use it to pay for deposits and closing
costs on a potential property investment.
Table 21.1: Allan’s available redrawn equity
Allan’s property value
$320 000
Bank’s maximum lend*
80%
Bank’s maximum loan
$256 000
Less Allan’s current loan
$230 000
Equity available for redraw $26 000
*The maximum amount that a financier will provide depends on its credit lending policy.
There are some substantial benefits in using equity. Let’s have a look.
The velocity of money
Allan currently pays interest at 7.5 per cent per annum on his mortgage. As such, provided he can
invest and earn an after-tax return of more than 7.5 per cent, he is really accessing his equity at no
cost.
Interest deductibility
Interest on your home loan is not normally an allowable income tax deduction. However, provided you
apply the redrawn funds to certain investing activities (such as buying investment property), you can
claim a deduction for the interest on the redrawn component. I’ll touch on this issue again later.
Generally easily accessible
With the evolution of more flexible loan products, it’s now much easier than before to redraw your
equity. All that’s usually required is for you to fill in a few forms and perhaps pay a few loan fees. In
fact, since borrowing more money provides additional profits for loan companies, many financiers
allow you to redraw without extra fees.
Refinanced equity
However, be mindful that there’s a huge difference between redrawing equity, which is quite easy, and
refinancing equity, which can be more problematic. By redrawing equity you’re borrowing back the
loan principal you’ve previously repaid.
On the other hand, refinancing your equity means you’re seeking to have your property revalued,
which will allow you to borrow previous principal repayments plus a portion of any independently
assessed capital appreciation.
To illustrate the point let’s imagine Allan’s house increased in value to $400 000. If he could
refinance, his available equity would be $90 000, as shown in table 21.2.
Table 21.2: Allan’s available refinanced equity
Allan’s property value
$400 000
Bank’s maximum lend*
80%
Bank’s maximum loan
$320 000
Less Allan’s current loan
$230 000
Equity available for redraw $90 000
*The maximum amount that a financier will provide depends on its credit lending policy.
Compared to redrawing equity, there’s a lot more red tape involved when you try to refinance your
loan, and this makes the process potentially expensive and time consuming. Furthermore, it’s wise to
remember that refinancing your equity carries an element of risk. Higher debt means bigger interest
repayments, and, for many investors, the thought of risking the family home means they’d rather not
touch the equity and still be able to sleep peacefully at night. Nevertheless, if the money is sensibly
invested and diligently monitored, the risk of losing your home can be dramatically reduced, and this
can mean that the benefits of refinancing may outweigh any potential downfalls.
A comment on the tax deductibility of interest on redraws
In Australia, property investors are allowed to claim a tax deduction for costs associated with earning
assessable income, but only to the extent that these costs are not of a private nature. This means that if
you borrow money to buy an investment property the interest that you pay on the borrowed money is a
tax deduction — as are the council rates, insurance costs and expenses that qualify as repairs and
maintenance.
Tax deductibility of interest on borrowings
This is a bit of a minefield but, generally speaking, it’s the reason for borrowing money that
determines whether or not you can claim a deduction for the interest. Let’s look at two examples using
Allan as an illustration:
Example 1: Allan borrows money to finance the purchase of his home (principal place of
residence). Even though he may regard it as an investment, the tax authorities view it as a private
matter and the interest is not deductible.
Example 2: If, instead of being Allan’s principal place of residence, the property was rented out
to a tenant, then, so long as Allan intended for his investment to make money, the interest on his
loan would now qualify as a tax deduction.
Interest deductibility on redraws/refinancing
Unfortunately, the discussion needs to become a little more complex. Let’s imagine that Allan decides
to refinance his home to access all of his $90 000 equity (as shown in table 21.2).
Provided Allan applied all of the $90 000 to acquiring income-producing assets, even though his
house is a private asset he should nevertheless be able to claim a tax deduction for the interest
applicable on the redraw: $6750 ($90 000 × 7.5%). The interest on the remainder of his loan
($230 000 × 7.5%) would not qualify as a tax deduction.
On the other hand, if Allan had decided to invest $70 000 in assets and then spend the remaining
$20 000 on a trip around the world, the interest on the portion he spent on his holiday ($1500, or
$20 000 × 7.5%) would not be deductible. Of the total $24 000 per annum that Allan would pay in
interest, $18 750 of it would be non-deductible, as shown in table 21.3.
Table 21.3: summary of Allan’s loan and interest portion
Loan portion Annual interest at 7.5%
Allan’s loan
$320 000
$24 000
– House
$230 000
$17 250
– Trip
$20 000
$1 500
Subtotal
$250 000
$18 750
Private portion
Investment assets $70 000
$5 250
Total
$24 000
$320 000
Repaying in after-tax dollars
The true cost of meeting the interest payment is worsened by the fact that, having lost its tax
deductibility status, Allan must now repay the money using after-tax dollars. If Allan was on the top
marginal tax rate then he’d have to earn $35 047 ($18 750 ÷ [1 − 0.465]) to have $18 750 in after-tax
funds.
The bottom line
The idea of redrawing or refinancing your loan works well provided you plan to use the funds for
investment purposes. However, if you plan to use your equity to pay for living expenses then you’ll
lose the tax deductibility of the interest on the additional loan.
That’s why I believe that the argument for funding your financial independence using equity is both
flawed and dangerous. Once you’ve retired and you have little or no salary income, I would have
thought that the last thing you’d want to do would be to create a situation where you have substantial
loans of which an increasing portion of the interest must be funded from post-tax earnings.
I guess this summarises the difference between the hype that sells property and the reality that
investors must come to grips with at the coal face of trying to make money.
Steve’s investing tip
Interest on mortgage redraws is not deductible where the loan funds are spent on lifestyle expenses.
THE MONEY RAISED FROM A PUBLIC OR PRIVATE
FINANCIER
The final source of cash for your investing can be money lent by a public or private financier.
Public financier
Provided you can meet their lending criteria, banks and major lenders will be more than happy to
provide money to finance your property acquisitions. The two critical pieces of information a bank
will try to ascertain are:
How much money do you want to borrow as a percentage of the value of the property?
What is your ability to repay?
The lender’s risk increases as you borrow more money compared with the value of your investment
(the loan-to-valuation ratio, or LVR). The industry benchmark is if you keep to an LVR of 80 per cent
or lower then you should have relatively few problems.
If you’re seeking finance then I suggest you use the services of a mortgage broker to help you shop
for the right loan for your circumstances. This will save you a lot of time and it’s usually a free
service as the broker is paid a commission from the lender. Just bear in mind the potential lack of
independence here by keeping abreast of the interest rates and fees associated with the loan.
Private lenders
Another potential source of money is private lenders — people with cash who are looking for abovemarket returns. Some private lenders will just require a set return, however a few might be interested
in becoming your investing partners and sharing the risks and rewards of the investment. There are
plenty of people in the marketplace labelled ‘time-poor, money-rich’ because they have a lot of cash
but little time to invest. That’s why, if you have the time but not the money (that is, you’re time-rich,
money-poor), teaming up with a money partner could take your investing potential to new heights.
Where do you find such people? A great place to start is to approach your accountant to see whether
he or she knows anyone who might be interested. Another idea is to attend seminars and network with
the attendees — I’ve seen this happen successfully many times.
HOW MUCH MONEY DO I NEED TO GET STARTED?
This is a common question I’m asked. The answer is that it depends on:
What type of property you plan to buy. Generally the more expensive the property, the more
money you’ll need.
Your planned investing strategy (see part III). Some strategies such as vendor’s finance or lease
options can be structured so that little, if any, money is needed.
The purchase terms you negotiate or the way you structure the deal. If you can negotiate a second
mortgage or use investors to put up the money then you could structure a low- or no-money-down
deal.
Steve’s investing tip
Just because you don’t have the funds to invest doesn’t mean you can’t make a start. There’s always a way to solve a
problem.
HOW TO BUY PROPERTY WITH LITTLE OR NO MONEY
DOWN
It was best-selling American author Robert G Allen who, with the publication of his book Nothing
Down for the 90s, popularised the phrase ‘nothing down’. In its simplest form, nothing down means
being able to purchase a property without needing to fund the deposit or, in the ideal circumstance,
any closing costs either.
Note that I have deliberately chosen to use the word ‘fund’ rather than ‘pay’ because, as an investor,
you cannot avoid these costs, only seek to defer them or else have someone pay them on your behalf.
The way you structure this outcome becomes the method you implement to successfully negotiate a
nothing-down deal.
As you would expect, nothing-down deals are enormously popular with investors who don’t have a
lot of cash to invest. If this sounds like you then before you become wildly excited by what I’ve just
written I’d like to remind you of the lesson from chapter 5 — namely that if you lack cash now you’re
likely to have a spending rather than an earning problem.
That said, let’s look at eight strategies you can implement to potentially acquire a property with
little or no money down.
Strategy #1: 100 per cent plus financing
As the global financial crisis unfolded, lenders became more conservative and it was harder to find
finance for more than 85 per cent of a property’s purchase price. As credit becomes more readily
available, sourcing higher loan-to-valuation loans will be easier. Until then, if you want to borrow
more than 85 per cent you will need to offer up additional security.
Strategy #2: use equity before cash
A different variation on the 100 per cent financing theme is to redraw or refinance your equity and
then use that to pay for deposits and closing costs.
This is possibly a neater finance solution, as you will avoid any cross-collateralisation of properties
or, put simply, you will not stand to lose your home if your investment property fails.
Strategy #3: vendor’s finance
In chapter 13 I outlined how you can offer finance services to your clients. Well, you can also ask the
vendor who you’re buying from to sell you his or her property on vendor’s finance too and then rent it
out under a buy and hold investment strategy!
While not the norm, this practice is not unusual in commercial and rural properties. The bottom line
is you’ll never know unless you ask.
Strategy #4: second mortgage
If the person you’re buying from isn’t interested in providing vendor’s finance, then he or she might
be willing to carry back a second mortgage to reduce or eliminate the need for a deposit.
For example, let’s say you buy a house for $400 000 on the basis that your financier provides a loan
for 80 per cent of the purchase price in return for a first mortgage over the property. This being the
case, you’ll need to pay a deposit of $80 000 on top of closing costs such as stamp duty and solicitor’s
fees.
You could go back to the vendor and ask him or her to take back $80 000 of the purchase price as a
second mortgage that you will repay as a lump sum at the end of five years. In the meantime you’ll
pay interest on the second mortgage at, say, home loan interest rates, which will provide a much better
return for the vendor than if he or she had the money sitting in a term deposit.
The terms and conditions of the second mortgage will be whatever you can negotiate.
Strategy #5: long settlements
If the market where you’re buying is experiencing rapid growth then an effective low-down strategy is
a long settlement period with a view to refinancing before taking possession.
For example, let’s imagine that you purchased a property for $250 000 on the basis of a 90 per cent
lend. You don’t have the $25 000 plus needed for a deposit and closing costs, so instead you negotiate
a nine-month settlement period with a low initial deposit of, say, $1000. During this time the property
increases in value to $300 000. The bank revalues the property and gives the green light to lend on the
higher (current market) value.
You can access the equity of $45 000 (90 per cent of $50 000), which pays for your deposit of
$30 000 plus all the closing costs too.
Be careful though: the key here is to get the lender to finance based on the current higher value
rather than the initial contract price. Most lenders require at least six months to have elapsed before
they’ll even consider doing this.
Strategy #6: improve and refinance
This takes the long settlement idea to a further extreme. Renovation doesn’t necessarily have to
involve a full-blown ‘knock down walls and add a second level’ project. Often minor updates and
cosmetic alterations will suffice.
For example, let’s say you bought using the long settlement strategy outlined above. Also included
in your purchase terms was a clause saying that you had the right to early access to complete
renovations.
You then carry out the renovation during the settlement period (without paying any interest since
you don’t yet own the property), and when the job is completed you get the lender to value the
property on the post-renovation status.
Provided your renovation has added more perceived value than actual cost you’ll benefit from being
able to borrow more money.
Strategy #7: money partners
If you don’t have money or a good credit history then rest assured that there are other people who do
have the funds and are more than willing to be your money partner — at the right price. In such a
relationship, you provide the time and your money partner delivers the cash. Profits and losses are
then normally split 50/50.
Strategy #8: sell the deal
If you do have a lot of time but not a lot of money then you could begin establishing a pool of savings
to buy in your own right by becoming what’s known in the industry as a ‘bird-dog’. This involves
finding deals and then selling the details to an investor. It’s an excellent way to kick-start your
property investing career if you lack experience or money.
The nothing-down essence of success
The essence of a successful nothing-down deal is that you never let a ‘No’ stop you from making
progress. Instead you seek a way to approach the problems that will inevitably appear from a different
angle where your lack of cash necessitates some creative (but always legal) negotiation and/or
financing.
Don’t let a shortage of investing capital stymie your property potential. If you run out of cash then
you’ll need to think creatively, which is where joint venture and money partners will become more
relevant. As always, your success will come from doing things differently.
CHAPTER 21 INSIGHTS
Insight #1
There are three potential sources of money to fund your property investing acquisitions: your savings, your equity and
public or private financiers.
Insight #2
If you have the time and money to complete a deal in your own right then I would suggest that you invest for yourself
rather than sharing the profits.
Insight #3
The amount of money you need to get started depends on the value of the real estate you intend to acquire and the
property investing strategy you plan to implement.
Insight #4
Providing you have room to negotiate, there is always a way forward that is only limited by your creativity.
Insight #5
If you have solid money habits but just happen to be temporarily short of cash, you can still invest in property. Just seek
out a money partner who has the resources you lack.
22
Where, what and how to buy
It’s time to start thinking about applying the knowledge you’ve gained to your next property purchase,
and in particular deciding where and what to buy.
LOCATION . . . BAH HUMBUG!
I don’t agree that location is the bee’s knees for property investors. If it was then why do less
desirable suburbs often have the highest percentage growth? Your job is not to buy the prettiest house
or in a trendy location but rather to make the most money in the quickest time for the least risk.
Houses don’t have chequebooks, so if you want to maximise your return then it’s much smarter to
focus on the tenant and/or next purchaser who will be using and buying the property, rather than its
location.
Steve’s investing tip
If you want to make more money then improve the use and/or enjoyment of the property in the eyes of the tenant and/or next
purchaser.
BECOME AN AREA EXPERT
Before buying any property, make sure you know the area like a local. To do this you’ll need to invest
many hours researching, talking with agents, as well as attending open for inspections and auctions.
Keeping a deal diary is a good idea. This is simply a scrapbook where you paste in the advertising
literature, as well as your notes about the property and its price. Your aim is to gain enough
knowledge and experience to spot good value as well as a real estate agent does, and better than most
buyers. The alternative is to breeze in, be taken for a chump and sold an overpriced dud that more
astute buyers wouldn’t touch.
For example, just up the road from my first reno property (chapter 17) was an intriguing block of
vacant land; the only site on the street that hadn’t been developed.
Shortly after my purchase settled I went to introduce myself to the neighbour. His name was Alfie
and he’d lived in the Ballarat region most of his life — about 60 years. I pointed to the vacant block
up the road and asked him if he knew anything about it. It turned out that he knew quite a lot.
Alfie said that there was an abandoned mine in the middle of the property that had been ‘capped’, a
process of pouring in concrete to prevent cave ins. Over the years there had been a few owners who
would buy the property without doing the proper research, seek to build on it and submit plans to the
local council, only to have them knocked back because the land around the abandoned mine was still
unsafe.
A few months later I was walking up the street to the milk bar and noticed that the vacant block was
up for sale as a ‘rate recovery auction’. Apparently the owner had deserted the block and now the local
water board was seeking to recoup a substantial debt — comprising past water rates and interest
penalties — by selling the property.
Unfortunately I wasn’t in town when the auction was held, but soon after I was tidying up the front
yard when a car pulled up in front of the vacant land. The driver and passengers got out and started
walking around the block. Sensing that these guys might be in some danger, I went to warn them only
to find out that they were the new owners.
When I asked them whether or not they knew the property was an abandoned mine site, their faces
went a horrible shade of white as they realised that they had just bought a lemon. A few months later
the property was back up for sale. If only they’d asked the neighbours before buying …
MY SIX-STEP PROCESS
I’ve created a six-step process that will help you make successful purchases. Let’s have a look.
Step 1: where to buy
The question about where to purchase depends on what profit outcome you want from your investing
because some areas are better for growth, while others are better for cashflow.
Once you’ve made your decision, you should assess each potential area using my ‘Area Assessment
Template’, a sample of which you can see on page 386.
This template gets you to grade (from A to E) seven key criteria (see overleaf), and overall as a
whole. Before assigning a grade you must also put yourself in the shoes of the person who will rent or
buy the property.
Desirability
In general, how desirable does the general population perceive it to be to live in the area? For
example, prestige, postcode and social standing.
Population growth
Is the general population in the area increasing or decreasing? How does population growth compare
with other suburbs or towns in the same vicinity?
Infrastructure improvements
Are there infrastructure improvements under way? For example, improved roads, transport corridors,
commercial building, hospitals, schools or land allotments.
Social demographic
What kinds of people are attracted to the area? Compare average incomes to affordability. Look for
signs of changing due to pricing out.
Land and housing development
How much building and development is being undertaken in the area? This can be a good guide to land
values appreciating and highlights an area in transition.
Amenities
Rate the quality of amenities in the area, such as access to public transport, parks, schools, child care
and distance to desired social attractions and meeting points.
Shopping
How well is the area positioned relative to the proximity of established shopping centres that include a
major supermarket chain?
Please note that assigning an area a higher grade does not automatically mean that it will make a
better investment than a lesser assessed location! The logic behind the template is that the more
appealing the place is to live in, the greater the scope for above-average returns for that area.
Step 2: sourcing deals
At this point you know what profit you want and have also pinpointed areas you feel are appropriate
places to invest, and that means it’s time to go shopping! Here are six sources that I regularly use to
find great deals.
Real estate agents
Love ’em or hate ’em, if you want to buy property then the easiest way is via a real estate agent.
They’ll treat you more seriously if you visit in person rather than calling or emailing, and your
ultimate aim is to be placed on their ‘hot list’ so that you’ll get access to deals before they are
advertised to the wider public.
I should point out that real estate agents will generally be more helpful during a flat or down market.
In a boom market, when property sells itself, agents generally hit the cruise button and, unless they
see an easy sale, won’t be so willing to show a new investor the ropes.
The internet
It’s cheap and easy to search online for properties, but hot deals that need to be sold quickly aren’t for
sale long enough to be advertised on the internet, so it’s better to work directly with agents than
spending lonely nights searching for online deals that will make you rich.
The print media
Classified ads are dying a slow death, but some private vendors still take them out to sell property
without having to pay agent’s fees, so it still pays to look. For example, I once picked up 27 units at a
great price after reading an inconspicuous four-line classified ad in The Sunday Age.
Investment groups and seminars
Sometimes deals are advertised through investment groups and contacts met at seminars. Usually the
conversation starts with, ‘I’ve come across this deal … ’.
Pounding the pavement and networking with locals
One of the best ways to locate properties is to get out and pound the pavement in the areas where you
plan to invest. While out and about, ask the locals if they know of anyone who is thinking of selling.
More aggressive marketeers might think about doing a letterbox drop mentioning that they’re private
investors interested in purchasing property.
Thinking outside the square
While a great opportunity occasionally lands in your lap, the best deals really need to be massaged
into existence. To do this you need to work hard to find a solution that meets the needs of the
vendor — which might sometimes require a creative outcome.
Finding good property deals is a lot like fishing. If you only have one rod in the water with one hook
on it, you’ll only ever catch one fish. However, many rods with many hooks might see you find many
deals. Of course, those people without a line in the water will either go hungry or need to shop at the
fish market, where the product isn’t as fresh, the choice is limited and the middleman’s margin adds
to the price.
Step 3: what to buy
Once you have found a potential property, the next step is to assess it, and that’s where my ‘Property
Assessment Template’ may come in handy. This template is shown on page 387.
Putting yourself in the shoes of the person who is renting or buying the property (your intended
target market), you need to grade (from A to E) the seven criteria below and in general overall.
General and street appeal
In general, how appealing does the property appear when compared to others in the same street and
also the immediate vicinity?
Comparative sales
Research comparative sales for similar properties in the same and neighbouring suburbs. Rate the
strength in price growth over the past 12 months.
Cosmetic condition
What is the general exterior and interior condition of the property? Look for cosmetic defects that
detract from the appeal of the property. Consider vegetation.
Structural condition
Locate and rate any structural defects (including plumbing and electrical) that detract from the appeal
of the property.
House layout
How well is the home serviced in terms of bedrooms, bathrooms, living areas, floor plan, positioning
on block, natural and artificial lighting and so on?
Land size
How big is the land allotment? Compare land size in square metres to other blocks in the same area.
Factor in land useability (easements, irregular blocks and so on).
Car parking
How well is the property serviced in its ability to provide appropriate parking? Consider such things
as off-street parking, permits, security and electric roller doors.
Having assessed the area and the property, you can now start to make some observations about the
potential of the investment.
Steve’s investing tip
It is better to have a lower grade house in a better grade suburb than a better grade house in a lower grade suburb.
Some guidelines include:
Cap on potential. Don’t buy a house that’s assessed as better than the area it’s located in. For
example, an A grade house in a D grade location is likely to be a poorer investment than a C
grade house in a B grade location.
Worst house in the best street. Because properties depreciate, it is better to buy a poorer quality
house in a highly graded suburb than the other way round. Otherwise you are paying a premium
for a property’s appeal, which will fade over time.
Diamond in the rough. The potential to add value is summarised by the grading gap between the
house and the area. That is, the bigger the grading gap, the better the potential for adding more
value than cost. For example, upgrading a C grade house in a B grade location holds less appeal
than upgrading an E grade house in a C grade location.
Step 4: crunch the numbers
Before making an offer you will need to make sure you’ve done your numbers to gain clarity about:
the source and amount of cash and finance needed to acquire the deal
how much cash you are going to receive back
how much time it is going to take to get your cash back
how much risk there is that you will lose money.
When crunching numbers, the cash-on-cash return (CoCR) is my formula of choice, because it’s
easy and focuses on cash and cashflow. The alternative is to use return on investment (ROI), however
this uses cost and does not reflect that you’ll borrow the majority of the purchase price.
Table 22.1 shows what accountants and investors like to measure, and table 22.2 shows the
difference between ROI and CoCR.
Table 22.1: who measures what
What accountants measure
What investors measure
Income − Expenses = Net profit Cashflow received − Cashflow paid = Net cashflow
Table 22.2: the difference between ROI and CoCR
Return on investment (ROI) Cash-on-cash return (CoCR)
Net profit ÷ Asset value
Net cashflow ÷ Cash outlay
If you don’t know how to analyse a property deal then software I co-produced called ‘Investment
Detective’ might be the answer to your prayers! It will have you crunching deals like a veteran
investor
in
less
than
10
minutes.
Find
out
more
at
<www.PropertyInvesting.com/InvestmentDetective>.
Step 5: other due diligence
Assuming the numbers stack up you’ll want to start spending some money getting accounting and
legal advice, as well as paying for a building inspection to ensure there aren’t any nasty issues you
don’t know about that could quickly sink your profit.
Step 6: wheel and deal
If you’ve made it this far and the deal’s still looking good then it’s time to make an offer. When doing
this your aim should be to submit price and sale terms that flag you as being serious, while also
including a clause that allows you to back out of the deal if need be. Many investors are nervous about
doing this, so here are five rules I’ve created that I hope will give you more confidence.
Rule #1: Written is better than verbal
In real estate terms, a written offer is always better than a verbal offer. In some states the offer is
made by actually signing a contract. Any counter offer is made by putting a line through the original
offer and then writing in a new figure. This can be scary, but provided you do it the right way and have
a get-out clause then you have little to be afraid of.
Rule #2: Offer price or terms
The key to your success is to submit an offer that creates a win–win outcome.
I believe the common practice of low-balling is a waste of time because, although you may win on
price, the real estate agent and the vendor lose.
When I make an offer I make it known that I am flexible on price or terms, but not both. If you can,
find out why the vendor is selling and then match your price or terms to meet those needs. This will
dramatically improve the likelihood of your offer being accepted.
If the vendor needs a large deposit or quick settlement, then adjust your price accordingly. If the
vendor wants full price, then he or she will need to offer something back to sweeten the deal, such as
carrying back finance or long settlement terms with a low deposit.
Rule #3: Always include a ‘get-out’ clause
A ‘get-out’ clause is a special condition you add to the contract that, if not met to your satisfaction,
allows you to walk away. This is important because you don’t want to spend money (for example,
paying for a building inspection) on a property that someone else might steal from under your nose.
Examples of get-out clauses include subject to finance, subject to building inspection and subject to
legal review.
Rule #4: Include a sunset clause
Avoid submitting open-ended offers and instead include a date when your offer lapses. This will do
two things:
It ensures that the real estate agent begins working immediately and that you are not left in limbo
or at the mercy of procrastinators.
It limits your exposure to having offers accepted when you have moved on to other deals.
Rule #5: Sign your offer
The final rule is to sign all your offers. This demonstrates you are serious and are not afraid to make a
commitment — something that real estate agents admire.
A WORD ABOUT DEPOSITS
It’s standard practice to leave a deposit of 10 per cent of the purchase price at the time of signing a
contract, so if you don’t negotiate anything to the contrary then that’s what you’ll pay.
However, it’s important to understand there’s no law that says you have to put down a 10 per cent
deposit, so if you have a limited amount of savings then lowering your deposit might allow you to buy
more properties. For example, I’ve purchased plenty of real estate leaving only a $1000 deposit.
A word of caution is needed here. Low deposits will not save you from the need to come up with
more money later. While sometimes you can get away with an initial low deposit, when it comes time
to settle on the property you’ll still need to come up with the difference between your initial deposit at
the time of signing and what the bank will lend you. You’ll have to pay for the closing costs too.
Finding and buying property can be scary, but the process will become a lot easier if you follow my
six steps, while also remembering that success comes from doing things differently.
Book bonus
By registering your book you’ll be able to watch a free one-hour presentation I gave on how to find great deals. Electronic
copies of the templates are also available at no charge. Go to <www.PropertyInvesting.com>.
CHAPTER 22 INSIGHTS
Insight #1
Location is only important for lazy investors who want to sit back and wait for general market gains. More active
investors can accelerate their profits by matching the right house, with the right person, with the right area.
Insight #2
Only purchase property in an area that you know like a local. Otherwise you risk paying too much for something more
astute investors won’t touch.
Insight #3
It’s smarter to buy lower quality houses in better areas than better houses in lower quality areas.
Insight #4
Crunching the numbers is essential. How else will you know if you are making the most money possible, in the quickest
time, for the least possible risk?
Insight #5
There’s an art to submitting a compelling offer. You want to make it as attractive as possible while also having a
legitimate ‘get-out’ clause you can use to walk away if your due diligence reveals a fatal flaw.
Part V
Real deals, real people
Introduction to part V
You now know about my success, so it’s time to prove that I’m not an anomaly by sharing with you
the stories of six other investors who have learned, applied and profited from my investing approach.
Although they come from different backgrounds, each person has had to confront and overcome
many of the same fears, doubts and anxieties that you’re facing. I hope you find their contributions
interesting, informative and, above all, encouraging.
23
Peter and Jackie from Tassie
Hi! Peter and Jackie here. We’re in our mid 40s and live in Tassie. We’re pleased to contribute this
chapter and provide more information about how we’ve created a property portfolio from scratch that
today is worth more than $2.5 million.
Our story begins when we owned a travel agency located 40 minutes south of Hobart. Although it
might sound like a dream job, the truth is that it was a lot of hard work for comparatively low pay.
Worse still, because Pete would leave for work at 7:30 am and return home around 7 pm, he saw very
little of our two young children during the week.
Aside from working in the travel agency, we’d become part-time property investors on the side. For
example, we purchased a family home and then after a minor renovation sold it for $50 000 more than
we paid, just 18 months later. We repeated this by purchasing elsewhere, and, after spending $60 000
on renovations, sold for $230 000 more than the price we purchased it for three years later.
Comparing the money we made from property investing with the income earned from the travel
agency (which was only about $50 000 per annum), we decided to sell the business and become fulltime investors. The property boom was in full swing, and at the time it seemed easier to leverage off
Pete’s skills as a qualified builder.
As Hobart house prices edged higher and higher, we purchased a beautiful waterfront block only 20
minutes from the CBD and built a four-bedroom home that we hoped to sell to an executive for a
premium price. Unfortunately, as the property neared completion the boom started to fade, and top-ofthe-market buyers became scarce.
Although we did have a contract to sell the property, it fell through and the finished house on the
beautiful block sat empty for six months. As we were paying two mortgages (our home and the new
dwelling) with no other income, something had to give, so we sold the only thing we could — our
family home — and moved in to the house we’d just built, which we kept on the market hoping to find
a buyer.
It took 12 months to sell, and while we broke even over the project, we learned a valuable lesson
about not targeting the top end of the market where there are fewer buyers.
After selling the waterfront property we were faced with a difficult decision — use our cash to buy a
home elsewhere, or suffer the pain of renting but retain working capital to fund our investing.
For the sake of our financial futures we decided to rent, which may have been financially sensible
but the whole experience is wearing thin because we’ve had to move three times in the past four years.
Soon after we started renting, Jackie read the first edition of this book and we became regular
visitors at <www.PropertyInvesting.com>, where we were relieved to find other people who were
interested in investing.
We signed up for the RESULTS mentoring program (see < www.PropertyInvesting.com/RESULTS>)
and haven’t looked back. Within months of joining we’d purchased a positive cashflow property in
Moranbah (Queensland) for $325 000 which was rented for $650 per week (see figure 23.1 and table
23.1).
Figure 23.1: Moranbah property
Table 23.1: Moranbah property investment figures
Annual rent
$36 010
− Management costs − $3 380
− Finance costs
− $17 736
− Holding costs
− $2 090
− Other annual costs − $2 680
= Net rent
= $10 124
After buying in Moranbah, we bought two local properties that needed renovating. This sounded like a
good idea, especially as Pete was a builder, however the labour savings were soon gobbled up by time
delays and we realised we could be more productive and efficient subcontracting out a lot of the work.
Our good friends Deb and Don, who are experienced property developers, recommended focusing on
building little two-bedroom units (as shown in figure 23.2). We took their advice and that’s what we
are now concentrating on. It’s great because they are cheap to build, sell like hotcakes and make good
profits.
Figure 23.2: two-bedroom unit
Since we now subcontract all the grunt work to tradespeople, a great benefit of being full-time
investors is that we’ve regained control of our time. We get to go on holidays when we like, can help
at our kids’ school, and attending sports days or assemblies is no longer a problem. The smiles on our
children’s faces when they see us visiting their school is priceless.
PETE AND JACKIE’S DEAL
One of the best tips we can give is to form good working relationships with a few local real estate
agents, because sometimes you can pick up good deals before they hit the open market.
An example that comes to mind is a phone call we received from an agent while we were on
holidays, who rang to say he had just listed a three-bedroom weatherboard house on a 1300 m2 block
that was large enough to build two extra units at the back.
We knew that other developers would be interested so we needed to make a decision quickly.
Knowing the agent quite well, we were happy for him to talk to the council on our behalf to find out if
there was anything that would stop us from building two units on the site.
The council, Google Earth and a copy of the title all indicated the deal was a possible goer, and
using templates from the RESULTS mentoring program we did our sums and submitted an offer
which was accepted. The first time we saw the property was when the agent was putting the sold
sticker on the sign.
It was a fairly straightforward development, aside from the removal of a large gum tree, demolition
of the asbestos-clad garage and relocation of the council sewer main (which only cost $14 500 and
could have possibly turned other would-be purchasers off).
The project took just over 12 months from purchase to finish and the units sold within the first week
of completion for well over our budgeted sales price. We are always conservative with our budget
figures in that we overestimate the build costs and underestimate the sale price.
Interestingly, after we had subdivided the existing house, we managed to resell it without the land
for only $8000 less than we paid for the entire site. Our overall profit is shown in table 23.2 (overleaf).
Table 23.2: investment profit
Sales price
$900 000
− Sales costs
− $35 000
− Purchase price
− $293 000
− Renovation costs of existing house − $25 000
− Building costs
− $300 000
− Holding costs
− $58 000
− Other costs
− $12 000
= Profit
= $177 000
Presentation is of utmost importance to receive the best possible price, and we have learned to wait
until the project is complete before letting the agent through or putting it on the market for sale. We
are also great believers in the power of home staging to create a ‘wow factor’. If people only knew
that under the beautiful doona cover is a $10 blow-up mattress! One of our finished properties is
shown in figure 23.3 (overleaf).
Figure 23.3: a property after development
Finding finance has been one of our biggest challenges. Being self-employed hasn’t helped and
sometimes we have to live off our credit cards for months on end until a property settles, and this can
be quite stressful. Furthermore, although Pete is a registered builder, banks class us as owner/builders
when assessing our development projects and this makes it harder to qualify for finance.
You don’t need to be a builder to do what we’ve done. Our profits are driven by investing skill, not
labour savings by doing all the work ourselves. To be a success you’ll need investing knowledge and a
good team.
Pete and Jackie’s investing tip
Supply what the market wants, not what you think it needs.
Speaking of investing skill, something you may want to remember is to always supply what the
market wants, not what you think it needs. For example, two-bedroom units aren’t what we’d choose
to live in, but it is a housing product the market wants, and we can build and sell them for the right
price.
We have done quite well from dabbling in the sharemarket, but our passion is definitely bricks and
mortar. If you look at our bedside tables you will find magazines and books on property investing, and
the CD player always has an investing or motivational topic playing. We firmly believe in the quote
by Earl Nightingale: ‘We become what we think about most of the time’.
Aside from the time freedom, we are also starting to enjoy tangible fruits from our hard work and
recently purchased a great block where we plan to build our dream home.
We see ourselves developing for the next three years and plan to invest the profits into commercial
real estate to create a passive income stream to fund our passions in life, which include being able to
show our kids this amazing world we live in without thinking twice about the cost.
In summary, we took control of our lives by setting a goal, getting educated and taking action. It’s
worked for us, and it can work for you too!
24
Sue from South Australia
Hi everyone. My name is Sue, and I’m a 50-something woman living in Seaton, South Australia. I’m
currently working as an internal information systems auditor with a local software development
company.
On reflection, I’ve been interested in real estate and the stock market since an early age, however I
often felt overwhelmed by how much there was to learn as well as finding the right place to start. One
way I overcame this fear was by becoming an avid reader of all books, articles and forums relating to
property, shares, business, psychology and wealth creation in general.
My first property investment was bought in 1996. It was a one-bedroom unit in South Yarra
(Melbourne) which was to be leased back to a large hotel chain. My partner at the time and I agreed to
buy it on the basis that it provided income plus potential growth over the long term. Although it was
negatively geared and cost us about $50 per week to maintain, the 6 per cent guarantee was attractive
and we bought it.
Things started to change for me in late 2003. It was 10 months after my marriage ended and a friend
gave me a copy of Robert Allen’s One Minute Millionaire. It was a gift far bigger than my friend
realised as my eyes were opened to all sorts of possibilities. By April 2004 I had read the first edition
of this book which, in conjunction with attending property seminars, dramatically improved my
investing knowledge.
The biggest challenges I’ve faced are around mindset and outdated beliefs over money. It can be
hard work convincing family and friends who hold very different beliefs. I had to learn that I was the
master of my own financial destiny and that there was little to be gained from seeking the approval of
those who thought that the path to financial freedom meant having a safe and secure job.
Having sold the negatively geared unit to cash up, I was spending much of my time looking for
positive cashflow property. After spending literally hundreds of hours searching the internet for deals
that met Steve’s 11 Second Solution, I failed to find a single one and concluded that I must be doing
something wrong.
A BIG, SCARY DECISION
After joining the first intake of the RESULTS mentoring program, I soon had a blinding flash of
insight that scared the wits out of me. Although I had a safe job as a public servant in Canberra, I
made a snap decision to relocate to Adelaide and become a full-time property investor. Still, rather
than quitting I negotiated to take six months of long-service leave. That way if everything turned pear
shaped I still had a job to go back to.
I arrived in Adelaide on 5 February 2006, cats and furniture in tow, with nowhere to live and
virtually no friends or family. I just knew I had to be here.
Just days after arriving I had the worst encounter ever with a real estate agent from Salisbury. I’d
been driving around looking at properties before deciding to meet agents face to face to get on their
‘preferred buyer list’ (which is different to their standard email list).
The agent said, ‘If you think you can just waltz into town and “steal” cheap houses, then you’ve got
another thing coming. Besides, all the agents here buy them, so you won’t even get a look in!’
I was crushed. I felt lost and very alone until I scraped myself up off the floor, deciding that if I was
going to make it as a real estate investor then I had to stop taking criticism so personally. After two
months of constant research as well as the disappointment of two potential purchases falling over, I
finally found a promising subdivision deal, albeit in slightly unusual circumstances.
SUE’S DEAL
In the course of my research I was attending an auction of an old bungalow with Mike, my finance
broker. A real estate agent that Mike knew happened to be at the same auction, and after I introduced
myself for the first time, I outlined exactly what sort of property I was looking for. As luck would
have it, the agent had just spoken to a vendor who was keen to sell a property that met my criteria and
was located near the old airport in Hendon.
To be honest, given the proximity to the airport I was concerned about contamination, but decided
there was nothing to lose by going and taking a look. The agent organised an inspection later that same
afternoon.
Upon arrival I was greeted by what could only be flatteringly described as a cosmetically challenged
home — a dirty brown 1950s three-bedroom fibro asbestos house with a metal garage that backed on
to a factory. There had been a partial reno inside, but whatever goodwill this created was quickly lost
by the messy backyard.
Even though the house was ugly, the site had development potential as the block of land was a
rectangular 895 m2 with a street frontage of just over 18 metres. Although there was a factory out the
back, the location was still credible as it was less than 15 minutes to the CBD as well as being
extremely close to golf courses, AAMI stadium and the beach.
Before making a decision I quickly called Mike to ensure that finance wouldn’t be an issue. It
wasn’t, and I started negotiating a price with the agent. It turned out that the vendor had bought the
house less than a month prior but was overcommitted and needed to sell. I submitted an offer of
$258 000, which was $5000 less than the asking price, and it was accepted. With the stroke of a pen
I’d finally bought my first development deal.
I immediately got to work researching what would be the best sort of property to build back on the
site, and after discussion with local agents and other developers it quickly emerged that I’d bought a
bargain. Even better, no-one thought the factory would pose much of a problem for potential buyers.
My due diligence quickly revealed that demolishing the house, subdividing and selling two vacant
blocks of land would not be profitable. Neither would it be profitable to renovate the front property
and build on the back. I was committed to building, and to make my desired profit my construction
costs had to be no more than $140 000 per property, and I had to sell each finished dwelling for no less
than $340 000. Figure 24.1 shows the property before, during and after the building work.
Figure 24.1: before, during and after
Source: S. Owen
Using the finance strategy outlined in chapter 8, I set up a trust structure to leverage off my salary via
acting as guarantor for the loan. You may remember that I was not actually working at this time,
instead I was in the middle of a period of long-service leave. This didn’t impact my lending prospects
though as my bank statements confirmed I was being regularly paid and I could truthfully answer that
I had a job.
One snag I had to overcome was that a neighbour’s carport gutter was overhanging my boundary.
Sadly, I didn’t realise this until construction had commenced, and when I brought it to my neighbour’s
attention, she tried to dispute it despite the title survey clearly showing it was in the wrong position.
It would have been a minor matter, except that I was planning on building to the boundary and
needed the neighbour to relocate the guttering. Unrepentant, the neighbour decided to fight, which cost
me an extra $1250 in legal fees as lawyers exchanged letters, and a construction delay of five weeks
occurred. In the end my neighbour realised she didn’t have a legal leg to stand on and conceded.
The lesson here is to make sure you read and understand survey plans! They’re much more than
pieces of paper with fancy lines!
The sales process also proved a challenge. In particular, I wasn’t happy with the advertisements the
agent proposed and decided to have a go myself using Steve’s teachings about highlighting the
benefits as well the features. This worked as I had one property sold a month before completion for
$360 000. The other sold for $360 100 less than an hour after the first open for inspection. The
outcome is shown in table 24.1 (overleaf).
Table 24.1: investment figures
Sales price
$720 100
− Sales costs
− $18 003
− Purchase price
− $258 000
− Closing costs
− $12 900
− Subdivision costs − $20 000
− Building costs
− $275 200
− Holding costs
− $27 802
− Other costs
− $44 989
= Actual profit
= $63 206
My fear about the factory was unfounded, as the feedback from the buyers was that they liked it
because it provided extra security. Furthermore, my research about what to build for maximum buyer
appeal paid off as potential purchasers said they loved the perceived larger gardens and the neutral
internal decor that created a spacious, open and sunny feel.
One day as I was closing up the finished properties I noticed a couple of ladies looking through the
windows. It turned out they were mother and daughter, and the mother’s deceased husband had built
the old house (the one I’d demolished) with his own hands. As I showed them through, they
commented about how happy she was that the site had been improved, and how impressed she was that
younger women were doing interesting things with property.
I would encourage others who are contemplating this strategy to:
Budget based on working backwards from your likely end sales price, deducting all other costs
and your potential profit to calculate the maximum price you can pay for the property.
Manage your cashflow carefully as until you finish you are constantly paying money.
Get a revaluation as soon as practicable to help alleviate the constant cashflow drain.
Be flexible in approach. I had several options for this property, including moving in if I had to in
order to keep the cashflow manageable.
THE FUTURE
My long-service leave has run out and I am back in the workforce (in a new job) as I need the
cashflow for deposits and to prove loan serviceability. However, rather than being employed until age
65, my job is a necessary stepping stone on the path to bigger and better things.
My longer term goal is to help fund third-world micro loans. In order to achieve this I have a
medium-term vision of building a mix of businesses, including various forms of educational products,
a web presence and mentoring. Property is one of the vehicles to achieving all this. One of my
passions is to encourage people to unlock their potential for the benefit of themselves and others. I
believe each of us has a responsibility to prosper for the benefit of this planet and all who dwell here.
Sometimes I reflect on that courageous moment back in December 2005 when I left Canberra for a
new life in Adelaide. I was terrified at the time but am pleased that I found the courage to try. And
that’s the best advice I could give you: take a step forward, then another, and then keep going. Don’t
stop. Don’t look back.
25
Matt from Queensland
Hi. My name’s Matt Jones. I live in Brisbane, and my big news is that I got married two weeks ago to
my beautiful bride Marisa! My friends joke that it was about time because we’d been going out for
over six years.
My life as a real estate investor began the moment I picked up the first edition of this book in 2005.
I was ready for a change because at the time I was working as a lighting technician in the theatre
industry, and I remember getting a payslip where it was recorded that I had worked 40 hours for which
I had accrued only three hours of annual leave. I didn’t like that calculation and was looking for a way
to create income to reduce my need to work. Steve’s passive income approach was just what I was
looking for.
Today I’m on the road to financial freedom — I know my goal and I’m working hard to achieve it.
Aside from my investing (my property portfolio is worth $1.2 million), I have started an internet
marketing business to bring in the dollars I need to continue to buy real estate.
The reason I’m investing is because I want total control over my time. If I have to work then it
restricts what I’m able to do, and I want to be free to pursue my dreams without having to front up to
work every Monday or beg for four lousy weeks of annual leave each year.
I believe I have something special to offer the world as I get a kick out of supporting and helping
others. I’d like to travel overseas and help people in third-world countries. Whether it’s building a
school, providing micro loans or just digging a well to create clean water — having the time and
money to help underprivileged communities is my idea of ultimate success.
I still have some way before I reach my financial goals, but when I look back on what I’ve achieved
I feel excited about what else is possible.
MATT’S DEAL
The property I’ve chosen to write about is a classic starter deal that made $45 000 profit in nine
months.
The deal came to my attention after setting up an online alert at <www.realestate.com.au> to be
automatically informed when any house sites of 1000 m2 or more were listed.
One popped up that seemed promising, but when I rang the agent I was informed it was under
contract. All was not lost though as I found out the real estate agent was about to get the sales listing
for the property next door.
Keen to sign up the deal, I drove to the property, waited outside the house while the sales agent
signed up the listing, and then followed her back to her office where I negotiated and submitted my
offer there and then. The deal was done 45 minutes after it was listed. The property is shown in figure
25.1.
Figure 25.1: the two-bedroom investment property
The property was a 1012 m2 block with a two-bedroom house that was built in the 1960s. I was told
that it was the old worker’s cottage for the main farmhouse next door. It was a little run down, but a
cosmetic reno would bring it up to scratch.
The plan was to buy, subdivide and sell the rear, while renovating, retaining and renting the front
property. This was our first subdivision, so my business partner (who was my cousin) and I were
learning on the go.
We negotiated early access with a long settlement (70 days) so we could get the renovation and
subdivision under way without paying interest. We set to work and completed the reno and had
tenanted the property within four weeks of settling.
The subdivision was relatively smooth, but two mistakes we made were:
Miscalculating the council contributions. I had allowed $18 000 but the final number was
$39 000. Luckily the budgeted profit was high enough to absorb this cost overrun.
The surveyors put the access easement on the wrong side of the property. I just assumed they
knew what they were doing, but have since learned to closely check everyone’s work. It cost
$3000 to fix, plus an extra six weeks in interest as the council re-evaluated the correct plans.
Ouch!
There was already a huge three-bay shed on the back block, so we didn’t have a problem selling the
lot to someone who wanted the extra storage plus enough room to build a new house.
Table 25.1 shows the profit we expected to earn.
Table 25.1: expected profit
Sales price: block
$260 000
+ Value reno house
+ $330 000
− Sales costs
− $20 000
− Purchase price
− $405 000
− Closing costs
− $20 000
− Reno and subdivision costs − $70 000
− Holding costs
− $13 000
= Expected profit/equity
= $62 000
As the project went on we decided to sell both the house and the land to release as much money as
possible for future projects. Table 25.2 shows the actual outcome of the investment.
Table 25.2: actual investment outcome
Sales price: block
$266 000
+ Value reno house
+ $322 000
− Sales costs
− $17 000
− Purchase price
− $405 000
− Closing costs
− $15 000
− Reno costs
− $11 000
− Subdivision costs
− $75 000
− Holding costs
− $20 000
= Expected profit/equity = $45 000
In hindsight we probably should have built at the back to create a bigger profit rather than just
selling the land. However, we wanted the cash back as soon as possible so we could invest in the next
project without delay.
Midway through the renovations the house next door came up for sale, and had we been on our game
we could have acquired that too and applied the same strategy. Sadly, we missed the opportunity
because we could not organise finance quick enough. I was too ‘on the tools’ to capitalise on what was
happening right beside us.
Another lesson came during the selling process of the back block. The market was peaking and we
managed to negotiate with a builder to buy the block for $280 000, $20 000 more than we budgeted
for.
The buyer wanted my assistance to help speed up the approval process with the council by signing
paperwork agreeing that he could start building as soon as possible. I thought the agent was managing
this and I waited for him to call me, and started to get nervous when I didn’t hear anything. Then, a
few days before the contract was to become unconditional, the buyer pulled out because he thought we
were not assisting him with the approvals. At the same time the market came off the boil and we
ended up suffering a few months in additional holding costs and a sales price of $14 000 less. The
lesson is to assume nothing and make sure you manage everything and everyone.
Something I’ve realised is that you can’t be successful without being personally developed; they
have to go hand in hand. So property investing is like one big personal development course that keeps
me constantly challenged and out of my comfort zone.
THE FUTURE
The past four years have been my property apprenticeship and, although there is still much to learn,
I’m confident and ready to take my investing to the next level.
The next 12 months are really exciting! Aside from adjusting to family life and moving to the
Sunshine Coast, I will continue helping investors via the property networking group I’ve established.
Of course, I’ll be doing my own property deals too.
26
Scotty from Sydney
Hi. My name’s Karen but my friend’s call me Scotty.
I’m an extremely happily married woman with a beautiful nine year old son and wonderful,
supportive, hard-working husband. We live in Sydney. With time marching on (I’ve hit 50) I’m
looking forward to the day when we are able to choose how we spend our time rather than slogging
away at work.
My husband, Brett, runs his own mobile mechanic business. He’s really good at it, but each day the
physical work is taking an increasing toll.
Property investing has been a huge help because it has provided the flexibility for me to work from
home and be there when our son returns home after school. We are working towards building a
portfolio of positively geared property that provides enough passive income so Brett can stop working
without compromising our lifestyle. We are active in our local church and are looking forward to
having more money, and more time, to give towards helping and blessing others.
Over the past six years we’ve bought and sold 11 properties. At the moment our portfolio consists of
two deals worth $250 000 and $430 000. I am also involved in a joint venture project.
CARAVAN LIVING
Let’s pick up my story in 1998. I was teaching at a school in Albury (a town on the New South Wales–
Victorian border) and had just married Brett, who was working as a part-time mechanic for a car
dealership in a small farming village just north of Albury. He was also a part-time pastor. We lived in
a small house I’d bought a few years earlier.
Things were going well, but we decided to make a lifestyle change in 2000 and moved to Sydney to
study at a Bible college. We rented our home to a family member for a very nominal rent, and because
we couldn’t afford the rent of even a very small Sydney bedsitter, we bought a cheap caravan and paid
$100 a week to park it on the front lawn of a lady’s house. Oh, and to make life more complicated
there was a baby on the way.
Not long after we’d set up, the family member renting our house in Albury decided to move to
Sydney too. Horrified at the thought of renting our house to a stranger, which sounded way too risky
given all the terrible tenant stories you see on TV, we decided to sell.
At that time, I was rather distressed at being a house-bound new mum who couldn’t contribute
financially towards the upkeep of our family. I wanted to find a way that I could earn money while
still being a stay-at-home mum. We had the proceeds of the sale of our house coming and the question
arose: what do we do with this money?
Coincidentally, friends of ours at the time lent us Robert Kiyosaki’s book Rich Dad, Poor Dad, and
as we read it, it was like someone switched a light on inside our heads. With a new way of viewing
money our investment journey was ready to begin.
BECOMING AN INVESTOR
With limited money, the natural place to begin was by attending free seminars. That was a good
beginning, but many of them were really sales presentations with the aim of selling you
something — usually property or a more expensive course. As the funds allowed I would purchase
books or attend seminars that seemed more like genuine learning opportunities.
After a short and costly dabble in the highly leveraged futures market, I decided I didn’t like the
speed at which money could come and go (and, to be honest, it mostly went). Brett and I decided to
focus on property investing as it seemed a better fit for our risk profile since it was less turbulent and
more predictable than the stock market.
So it was then that in early 2003 we began to look for positive cashflow property. We wanted to buy
in an area we knew, and because we couldn’t find anything in Sydney, we looked in the Albury region.
On our next visit to the rellies, we found and bought a small three-bedroom brick house in Wodonga
(Albury’s sister city on the Victorian side of the border). It was positive cashflow and after all costs
we made about $40 per week.
After a year, general market growth had increased the value of the property from $160 000 to
$230 000. Who said you can’t get positive cashflow and capital gains?
Anyway, our $70 000 of equity gave us the funds to buy another property, but given we would be
borrowing 100 per cent of the purchase price (80 per cent with a mortgage and 20 per cent by
refinancing our equity), the return needed to be quite high if we were going to get another positive
cashflow outcome.
One of the resources I’d bought along the way was the first edition of this book, and what really
caught my attention was Steve’s 11 Second Solution. With prices rising faster than rents, I asked
myself, ‘Where would properties that pass this rule exist?’ My search led me to mining towns.
Some people think mining towns are risky because they boom and bust on the highs and lows of
commodity prices. The truth is that it is only risky if you don’t know what you are doing, in which
case you are gambling rather than investing. The four questions I ask myself are:
How much will it cost?
How much will I make?
How long will it take to make it?
What could go wrong (what’s the worst-case scenario) and can I live with the consequences?
My research took me to Mt Isa in Queensland and before long we’d bought two investment
properties. One we on-sold using vendor’s finance and made $22 000 in two days; the other was a
simple buy-and-hold that returned 12 per cent and was sold a year later for twice its purchase price.
The nice thing about these deals is that we didn’t use any of our own cash because we could use our
equity to pay for the deposits and other costs.
Compared to the hard slog of working 40+ hours a week, making money from property investing
was far easier. I was hooked!
A MAJOR MISTAKE
After a couple of years we thought the potential of mining towns might be starting to ‘top out’. We
didn’t research anything to see if this was true — just listened to (unqualified) opinions. Well, we
didn’t want to be stuck with a ‘dead’ property and lose profit, so we quickly sold.
It was time to try something different. From attending seminars, talking with other investors and
reading books I became aware of more sophisticated techniques — such as renovations, subdivisions
and property development — that didn’t rely on the whim of the market to provide growth returns. I
was keen to try, but only if it was close to where we lived so I could micro-manage things if they went
wrong.
By early 2005 the Sydney property market had changed dramatically. Although prices were still
high, the boom had ended and values had stopped rising. This meant that it was difficult to find a deal
where the numbers worked, especially as with development deals there is often little or no income
between buying and selling, so you need to access cash or equity to pay the interest and other costs.
After many weeks of looking, I still couldn’t find a deal we were comfortable with and the pressure
was starting to make me feel increasingly desperate. I made a mistake by compromising my selection
criteria by looking at deals with smaller profit margins. Before long I’d stumbled across a mortgagee
sale on a block of land that we bought and built a four-bedroom, two-bathroom, double-garage spec
home on.
Let me cut a long story short. The deal was a disaster. Yes, we bought at a reasonable price, and yes,
we sold at the projected price (well, nearly) and yes, we built for the budgeted cost. So what went
wrong?
Although we came out of the deal with a small gain, the unexpected additional interest from the
property taking seven months longer to sell than expected reduced our budgeted $22 000 profit to just
$9000. We would have been better off leaving our money in the bank.
To make matters worse, we watched the prices (and rents) in our beloved mining towns go through
the roof! Although our bank balance went up slightly that year, had we kept our mining property we
could have made 200 per cent rather than 2 per cent.
To summarise, the lessons learned from this experience include:
Don’t make investment decisions based on hearsay. Do some proper and thorough research.
If a strategy is working for you, stick to it. (Why fix something that isn’t broken?)
Don’t let emotion (in my case desperation) dictate your investment decisions.
Don’t compromise on your investment strategy or criteria.
I was guilty of all of the above, and we paid the price for it.
SCOTTY’S DEAL: GARNHAM DVE
The moment the house settled I went straight back to looking for deals in mining towns. After
refocusing my selection criteria, I began looking for property that provided a positive cashflow return
and also offered value-add potential in towns where there were good capital growth drivers.
As I researched different areas, one particular location — Dysart in Queensland — seemed to tick
all the right boxes. Dysart had been purpose-built in the 1970s to house workers for the nearby coal
mines. At the time of being established, the township was only expected to have a projected life of 15
years, but with mine upgrades and expansions, the town has not only survived but has grown.
With the commodities boom came increased mine activity, and this meant more workers were
needed. A problem arose because the increased demands on housing meant the property sales and
rental market were red hot. For example, most properties sold on the day they were listed, sometimes
for well in excess of the asking price.
I decided to fly up to see what was happening first hand, as one of my rules is to visit a town before
buying property there. Despite knowing that finding accommodation would be difficult, I flew up and
started working with local agents to try to find a property that met my requirements. On more than one
occasion I struggled to find a place to sleep, and one night I ended up sleeping under a bridge in a tent
I’d bought earlier that day (no joke!).
I wasn’t having much luck finding the right property with the local agents, but as I was driving back
to the airport to fly home I noticed a small, scrawly handwritten sign draped across a letterbox that
read ‘For sale by owner’. As soon as I saw that sign I thought, ‘You beauty’. I pulled over and knocked
on the door.
The door was opened by a middle-aged woman, and when I mentioned the sign on the letterbox she
invited me inside and showed me around. In the course of our discussion it came up that she and her
husband were moving out of town and wanted to sell privately to avoid paying sales commission.
The property was a highset hardiplank and timber three- bedroom, one-bathroom home on 881 m2 of
land (shown in figure 26.1).
Figure 26.1: Garnham Dve property
I agreed to buy it for $375 000, which was a good price because three months later it was
independently valued by a bank at $425 000. The rent was $1200 per week, which after all expenses,
except tax, provided $685 per week in positive cashflow. The figures are shown in table 26.1.
Table 26.1: investment figures
Annual rent
$62 400
− Finance costs
− $21 600
− Other annual costs − $5 200
= Net rent
= $35 600
Aside from the impressive rent, the property comes with many ways to increase its growth and
income, including:
renovating the downstairs area to create extra room
the interior is original 1970s, meaning a cosmetic reno would increase the rent as well as add
capital value by adding to the appeal for a potential buyer
there is sufficient room in the backyard to subdivide and build another four-bedroom, twobathroom home.
Table 26.2 illustrates the development potential.
Table 26.2: development potential
Additional costs
Build extra room under
$6 000
+ Strata subdivision
+ $15 000
+ Construction new house
+ $270 000
+ Additional finance costs
+ $15 000
= Total costs
= $306 000
Additional value
Existing house
$460 000
+ New house
+ $475 000
= Total value
= $935 000
Additional profit
Total value
$935 000
− Purchase price (inc. costs) − $390 083
− Total additional costs
− $306 000
= Total potential profit
= $238 917
Since buying this property, commodity prices have fallen and mining activity has come off the boil.
The lease has just been renewed for another 12 months at the lower rent of $750 per week. Even at this
reduced rent, the property is well and truly positively geared and continues to put money in our pocket
each week.
It would not be prudent to start building the extra dwelling until the coal mines start employing
more people again. Given the world’s insatiable appetite for coal, this is a matter of when, not if.
Up until now, we have been reinvesting our returns to build a larger asset base. If all goes to plan,
we will have enough cashflow from our investments to start replacing our current income early next
year. When this happens we will be financially free to spend our time with people we love, as well as
assisting those who need a helping hand.
27
Jenny from Western Australia
Hi. My name is Jenny Smith. I live in Western Australia and am married with two teenage children.
I began investing in 2003 after stumbling across a small classified ad in the local paper that
mentioned a free evening property seminar. I went along, and for the first time understood how
property could be used as a vehicle to create wealth.
Over the past six years I’ve worked hard and managed to acquire a portfolio with 15 properties in it.
Today that portfolio is worth more than $11 million, and assuming I sold everything, after repaying
debt I’d walk away with more than $5 million cash. I’m not telling you this to boast, but rather to
point out that financial freedom isn’t an impossible dream.
Investing has given me the freedom to follow my own path at my own pace and allowed me the
flexibility to work from home and be around for my family! I am happier, as is my family, and I have
a much clearer idea of who I am and what my purpose in life is.
I’m now the director of several investment companies as well as being a coach/speaker/educator for
health, wealth and lifestyle, with a special interest in keeping our brains and bodies functioning at
their best as we get older.
JENNY’S DEAL
When I started investing my goal was to buy a portfolio of properties with development potential that
could be rented in the meantime. That sounded great in theory, but the Perth property market was hot,
and although I found a couple of suitable sites, they were quickly snapped up by others.
Finally it seemed my turn. A local agent who I had got to know from making enquiries and attending
open for inspections rang to say he’d just listed a three-unit site and asked if I’d like to look at it
before news of the deal was released to the wider public. Did I ever!
As I turned up to do the inspection I remember thinking how feral the house looked. Although it was
a classic knock-down job, the block was large (728 m2) and the location was good; a quiet street that
benefitted from being close to shopping and walking distance to the train station, and the pub!
Despite its shoddy condition, the property was tenanted and, while not always up to date, the
occupier did eventually pay the rent. However, a curious thing happened once he found out that the
property had been sold. It seemed the property turned into an unwanted car yard as four wrecks
appeared on the front lawn. If that wasn’t bad enough, there were regular public barbeques as the
tenant and his mates huddled in mismatched chairs around an open fire, again on the front lawn.
Being issued with an ‘Untidy Notice’ from the local council — a bluntly worded document that said
clean up or else we’ll prosecute — was the incentive needed to encourage the tenant to move on.
It took several skip loads of rubbish to clean up, and to his credit the car wrecks disappeared too. He
even left a going away present in the form of an enormous hookah (smoking pipe) over a metre tall.
The strategy was to:
demolish the house
subdivide into three lots
build three new townhouses
sell all three townhouses.
Table 27.1 shows the outcome assuming all three properties sold.
Table 27.1: outcome assuming all three properties sold
Sales price
$2 040 000
− Sales costs
− $61 200
− Purchase price
− $680 000
− Closing costs
− $34 000
− Building costs
− $860 000
− Finance costs
− $102 200
− Finishing costs
− $100 000
= Expected profit = $202 600
My only previous development experience was as a joint venture partner. Nonetheless, I was eager
to learn on the job.
As we were building fewer than four dwellings, our lender was happy to provide a residential loan
(rather than a commercial loan) of up to 100 per cent of the expected sales price without any pre-sales
on the basis that we also contributed other property as collateral.
Although Steve had been saying for some months to prepare for the end of the Perth property boom,
I was surprised how quickly the market turned. I had expected 12 months of additional growth, but
was soon left needing to come up with alternative plans in case the properties didn’t sell.
In conjunction with Simon, my RESULTS mentor, I came up with the following plans:
Plan A was still to sell all three townhouses.
Plan B was to sell two and rent one.
Plan C was to sell one and rent two.
Plan D was rent all three.
After an unsuccessful sales campaign, we have opted for plan D and have rented all three to create a
cashflow neutral position. The outcome is shown in table 27.2. The finished development is shown in
figure 27.1. Our plan is to sell once the market improves.
Table 27.2: rental outcome
Annual rent
$93 600
− Finance costs
− $87 500
− Other annual costs − $6 150
= Net rent
= −$50
Figure 27.1: the completed development
It’s humbling, but I deliberately chose to demonstrate this deal in the hope you can learn from my
mistakes.
If you’re just starting out, I recommend that you:
Talk to others who are already investing in order to understand what works and what doesn’t.
Don’t be afraid to ask questions. It’s better to risk looking silly than risk losing money!
Join a networking group to become more educated. Education provides knowledge, and increased
knowledge will help you make better investing decisions.
Jump on the internet to read and participate in online investing forums.
Join a mentoring program which offers one-on-one mentoring.
Don’t lose sight of what you are trying to achieve. How many houses you own isn’t very
important, rather the critical question is, how does owning those properties advance your pursuit
of financial freedom?
THE FUTURE
I’ve recently sold two other properties in our portfolio and have two more earmarked for sale under a
plan to turn over the poorer performers to reduce debt to less than 50 per cent of the current market
value of our portfolio. By doing this we are positioning ourselves to be able to purchase short-term
cash-producing projects (such as subdivisions or strata titling units) to build sufficient equity. We are
following Steve’s suggested model of building our investing capital to buy debt-free commercial
property to create an independent income.
One of the great benefits from our property experience is that my husband and I are united in our
vision for our financial future and are working together as a team. Our secret to staying motivated is
having fun.
Financial freedom is more than money to us. We know how much income we need to be able to
enjoy our lives without worrying about money, as well as provide for our children and give back to the
community. Better yet, we have a realistic plan to achieve it.
28
Dean and Elise from Victoria
Hi! We’re Dean and Elise Parker from Victoria — a happily married couple in our early 30s.
Since buying our first property in 2003, we’ve transitioned from being full-time employees to fulltime investors. Today we control a real estate portfolio valued at just under $5 million.
We started buying property because we were sick of driving three hours a day to and from work. If
the long commute wasn’t enough motivation, the fact that our incomes were not large enough to
provide our dream lifestyle meant something had to change because we certainly didn’t want to work
as IT professionals for 40 years!
Our fate was sealed when Dean, along with half his work-mates, was retrenched in a corporate
reshuffle. So much for job security!
After reading the first edition of this book, we decided to focus on positive cashflow properties. In
June 2004 we attended one of Steve’s seminars, and this was helpful as it opened our eyes to many
new investing possibilities. We liked the open and honest teaching style and felt equipped and
empowered to try investing more seriously.
An aspect of investing that’s rarely discussed is just how hard it is to tackle and overcome your fears
and doubts. In our case we had to overcome our nerves relating to:
Losing money — which we overcame by starting with small projects, taking the time to be
thorough with our financial analysis and seeking input from experts in areas where we lacked
knowledge (like how much it cost to renovate or build, and end sales prices).
Not having enough knowledge — which we overcame by investing in our education, seeking help
and advice from mentors, and by asking lots of questions — even if we looked silly. Based on our
mistakes and learning experiences, we created a series of very helpful checklists that have
enabled us to invest using a system, and it’s this system that allows us to run multiple projects
easily and without increased risk.
Stepping out of our comfort zone — which we finally mastered at special training Steve and Dave
offered in New Zealand where they put Dean on the spot and forced him to make a decision about
buying a property rather than sitting on the fence. It was lucky they did because it helped us make
an extra $70 000!
DEAN AND ELISE’S DEAL
The property we’ve chosen to write about is a perfect starter deal for investors who want to combine a
reasonably simple renovation with a subdivision.
As you can see in figure 28.1, this property — a group of three 1970s one-bedroom apartments on
1000 m2 land — was not going to feature in Home Beautiful magazine. However, for investors who
know how to turn ugly properties into cash, this really was a gem waiting to be polished.
Figure 28.1: property before
Working closely with agents is a great way to find deals. In fact, our close working relationship with a
local agent is how we came to know about this property as he phoned us soon after he had inspected
the site as a potential listing.
Because we’d just helped Steve with an almost identical project just around the corner, we were
confident that we could make a profit from this investment, yet we still wanted time to properly
evaluate the deal. To prevent another investor from stealing it from under our noses, we submitted an
offer at full asking price, but also added in a 14-day due diligence clause that allowed us the time to
complete further research and pull out if any problems arose.
The offer was accepted and we quickly got to work using our powerful checklists to properly cost
the renovation and calculate the likely profit, and to seek further advice about what the properties
would sell for once they’d been renovated and subdivided into single titles. Table 28.1 shows our
budgeted numbers.
Table 28.1: budgeted numbers
Expected sales prices
$385 000
− Purchase price
− $240 000
− Closing costs
− $12 560
− Reno and subdivision costs − $65 000
− Holding costs
− $6 800
− Selling costs
− $15 400
= Potential profit
= $45 240
Budgeted time
3 months
When all was said and done there was an estimated profit of $45 240, which was a reasonable return
given we had allowed three months to complete the project, so we went unconditional and became the
proud new owners.
We financed 80 per cent of the purchase price through a normal first mortgage and borrowed the
remainder from private investors. Although we could have used our own money, we find that using
private financiers helps us to undertake more projects.
We’d arranged for vacant possession and for all our trades to be ready to move in the moment we
settled. Our cosmetic renovation included:
new kitchens
new bathrooms
polishing the floorboards
French doors to the private courtyard in each unit
new painting and interior design
new fencing to create privacy
general site clean up to make the property look more inviting, including topping the driveway and
painting.
One funny anecdote was that while we thought we’d have to replace some of the external facade
material because it looked so dated, the interior designer disagreed, saying it was so old it had actually
come back into fashion! While surprised, we took her advice and were happy to save some extra
money.
Our timing was good, because when the properties were ready to sell the prices for one-bedroom
units had risen substantially in response to the increased federal and state government grants for first
home buyers.
We had been thinking about keeping the site as positive cashflow rentals, but given the market was
red hot, we sold to maximise our profit. Table 28.2 shows the investment outcome.
Table 28.2: actual numbers
Total sales prices
$421 000
− Purchase price
− $240 000
− Closing costs
− $12 171
− Reno and subdivision costs − $67 651
− Holding costs
− $5 562
− Selling costs
− $19 094
= Actual profit
= $76 522
Actual time
3 months
Figure 28.2 shows the street view of the finished project, while figures 28.3 and 28.4 show the
before and after renovation pictures of the kitchen and lounge room (overleaf).
Figure 28.2: property after
Figure 28.3: kitchen before and after
Figure 28.4: lounge room before and after
Good home staging is critical to create a wow factor for potential purchasers, which is why you see
furniture and other props in the photos.
Although renovating is a proven and fantastic way to make lump-sum cash profits, it’s easy to spend
more money than you think and end up with a lower profit. For example, we often see people who are
emotional about the potential when buying come back to earth with a thud when the true cost of
renovating is known. That’s why our checklists are so important, because they allow us to accurately
cost the project at the start as well as controlling expenses along the way.
THE FUTURE
It may seem ambitious, but in addition to renovating 18 properties, in the next 12 months we also plan
to build a further 23 new homes. We don’t physically do the work, but we certainly actively manage
the projects. However, using our checklists and systems we are able to do all this and only work a few
hours a day.
Just as we’ve been strongly influenced and assisted by our mentors, we also hope to help investors
who would like to renovate properties to make attractive lump-sum gains. That’s why we’ve created
and published a resource that combines our proven systems with real life case studies so you can
learn, step by step, exactly what to do to make the most money possible.
After only a few years, investing has given us a lifestyle few achieve and the freedom to enjoy it.
We’re confident that once you have the knowledge, you can do it too.
----------
Highly recommended resource
Imagine how much easier and more profitable your investing could be using Dean and Elise’s 17
step-by-step checklists (over 70 pages). They’re included in their excellent product ‘The Complete Renovation System’,
along with:
a written manual containing 214 pages of professional training
six case studies that explain how to apply the knowledge in real life
six DVDs
five audio CDs
a data CD that contains every checklist.
Dean and Elise have generously offered readers a fabulous discount. Full details will be emailed to you once you’ve
registered your book at <www.PropertyInvesting.com>.
----------
29
What’s your next move?
Central heating units use a thermostat — a small control box or panel — to measure temperature and
to turn on or off the airflow as needed. The machine can’t read your mind though; you have to
program how warm you’d like the room to be.
Whether or not you know it, you also have a thermostat for the way you live your life. And just like
the central heating unit, how you set the temperature determines how your life is regulated.
CRISIS
A ‘crisis’ setting signifies a low life temperature, and people who consciously or otherwise choose
this setting lurch from one calamity to another. Worse still, they tend to drag other people down to
their own low setting by including them in their day-to-day dramas. Another word for crisis is
survival, and when you are trying to survive it is a fight to maintain the basics of life let alone think
about a more positive financial future. Does this sound like someone you know? If so, write their first
name in the box below.
----------
People I know who are in ‘crisis’
----------
COMFORTABLE
Think of an article of comfortable clothing that you own. It could be a pair of jeans, a sweater, perhaps
even the dreaded daggy tracky pants. Now, would you wear that piece of clothing out to a party? Why
not? Because it’s not special, and if the truth was told, you’d want to be seen in something more
glamorous.
Another word for comfortable is average, and I have just one question for you — do you want an
average life? I don’t.
A friend of mine, Brendan Nichols, once told me something which has been forever burned into my
brain: the enemy of a great life is a good life.
Steve’s investing tip
Good is not great.
People who are financially comfortable are doing okay, but they often live with unfulfilled dreams
which can turn into regrets. While they may have nice things, such as a nice house, a nice car, a nice
garden and a nice dog, the niceness numbs the motivation to dig deeper and be great.
Comfortable is the equivalent of 60 per cent on a test. It’s a safe pass, but compared with what you
could achieve, 40 per cent of untapped potential remains.
Who do you know who is living a comfortable life with nice things, but at the same time is living
with untapped potential?
----------
People I know who are ‘comfortable’
----------
CHAMPION
Champion represents the ‘hot’ end of life’s thermostat. It’s a setting few dare to choose because it
requires a lot of energy and output to get there and maintain.
Yet champions get the best results. They overachieve. They win.
Unlike others who talk about what they wish they could do, or what they hope to do one day when
they have more money, financial champions acquire the resources to achieve their dreams, and more
besides.
Champions pick a passionate cause and then fight to defend it. Who do you know who lives life like
a champion?
----------
People I know who are ‘champions’
----------
SELECT YOUR SETTING
It’s time to make a choice. Do you want to live your life in a crisis, do you desire to be comfortable, or
are you bold and courageous enough to want to be a champion? Remember, you choose the setting.
How to be a champion
The three things you need to become a champion are looked at below.
Vision
Vision refers to your ability to see or perceive a life that’s different and better than what you have
now.
Steve’s investing tip
Nothing happens without vision.
Vision relates to creating a plan to improve the lives of yourself, your family and your community.
It’s about choosing what you will do, and what you won’t do. It requires that you make a stand and not
be counted among the lowest common denominator of knockers and mockers.
Intelligence
Intelligence refers to your ability to know how to achieve your vision.
Every week around the world hundreds of millions of people invest in lotto tickets and dream of a
better future. Yet achieving their destiny relies on luck or chance, and for every winner there are
millions of losers.
The world is full of dreamers who hope and wish but fail to take control.
I’m a huge fan of a concept I call upwards intelligence, which means being open and teachable to
learn from others with more intelligence in areas you want to learn about. It’s about surrounding
yourself with people who are smarter and then being humble enough to listen and apply what you
learn.
Are you the smartest person you know? Who do you associate with who has more expertise in areas
you want to learn about?
Purpose
Having vision (the ability to see) and intelligence (the ability to know) is not enough. You also need
the ability to do, and this speaks to your life’s purpose. Unless you have a strong enough purpose,
when times get tough you will give up or fall away.
Is achieving your financial goals a must or a maybe? If it’s a must then you’d do absolutely
everything in your power to make it happen. Nothing would be too much trouble. Every sacrifice is
worth it.
Steve’s investing tip
Having a strong purpose is the glue that holds your financial dreams together.
If achieving your financial goals is only a maybe then you might get there, but you might not as
well. This lukewarm approach means that you will only work hard when, and if, it suits you. Such an
attitude won’t result in greatness, just a comfortable life.
When you say something is a must, does the way you approach the task indicate you really thought
it was a maybe? For example, when you say you’ll meet someone at a certain time, do you really mean
plus or minus five minutes?
The morning of writing this chapter I had arranged to meet a colleague for breakfast at 8 am. I
waited 15 minutes, and when he failed to turn up I went to eat by myself. He finally arrived at 8:35
am, apologising because he slept in.
Apology accepted, but the lesson here is that when this person makes a commitment, it’s a maybe,
not a must. What are the musts in your life? What are the maybes? What are the musts that are really
maybes?
Everything you choose to do, or not do, has a consequence. For example, where you are today
emotionally, physically and financially is not a fluke. It didn’t just happen. It’s the consequence of
years of operating below your peak performance! If you won’t accept this for a moment longer then
make a stand and do something about it!
Steve’s investing tip
If you want something different then reset your sights and aim higher.
Choosing to be a champion requires three things: having the vision for a better outcome, obtaining
the knowledge to achieve that vision, and having a strong enough purpose so you will soldier on
despite the difficulties. If you don’t care enough about your life to make it better, who does?
YOUR CHOICE
As I see it, today, right now, this very instant you have a choice.
On the one hand you can continue to do what you’re doing. Stop for a minute now and think 10 years
ahead. Imagine what your life would be like. If you work in a career, pause and look up the corporate
ladder. Is the top rung a destination where you want to end up? Look around your workplace. Do the
people with more seniority have the sort of lifestyle that you feel is appealing? Would you like to
work as hard as they do?
On the other hand, is there another possibility that you feel is more attractive? One where you can
gradually gain the freedom of your time?
All that’s required is that you make a choice and decide to take action towards an outcome that you
feel your heart is calling you to. Take the test opposite.
Multiple choice (circle your answer)
Today’s date:
Question: What do I want?
a) More of what I’m doing.
b) Something different.
If you work in a job and answered a), then I wish you the best of success with your career. In fact,
I’m a little envious because I never experienced the job satisfaction that you must enjoy from your
work. The advice I leave you with is to always maintain control over your finances and only invest in
things that make money.
If you answered b), then I urge you to spend a few moments now thinking about the physical steps
you need to take to harness your momentum.
Steve’s investing tip
The only way to transform do into done is to take action.
Make a list (do it now) of action steps you can complete over the next 30 days that will get your life
in order and allow you to begin or expand your property empire.
My action steps:
1 ____________
2 ____________
3 ____________
4 ____________
5 ____________
6 ____________
7 ____________
8 ____________
9 ____________
10 ____________
THE WORST-CASE SCENARIO
A friend’s father once asked him what he’d do if all his investing plans amounted to nothing. Can you
imagine how he responded? He said, ‘Dad, a 1 per cent chance of achieving success is better than a
100 per cent chance of failure, which is what I will have if I never try at all. I can always go back to
my job’.
Is the same also true for you? If you tried to make a go of property investing but failed, could you
always just go back to what you are doing now? Sure, you might need to take a slightly lower initial
salary at a new employer, but so what?
It took a lot for me to abandon my career as a chartered accountant in public practice. However, I
can still remember the day I finally came to terms with the fact that I really had nothing to lose, as I
was already living my worst-case scenario — having to work hard for a considerably long time.
Because I could always go back to doing the books for clients, I owed it to myself to at least try
something different, for I knew that in order for things to change, first things had to change.
THE ANSWER
It’s a tough ask, but if I had to summarise the secrets to my success in just one paragraph, it would
read like this:
Instead of living a comfortable lifestyle, I chose to delay my gratification and allocate my savings
and reinvested profits to acquiring cash and cashflow positive properties. I’ve also looked to
maximise my investment returns by solving the housing needs of everyday people within the context
of creating win–win outcomes.
Keep the following two questions in mind:
Question 1: How can I turn my theory into practice?
Question 2: Do I have what it takes to be successful?
If you haven’t already worked out your own answers, I’m happy to share my thoughts.
Question 1 can only be achieved by taking action. It’s hard to move out of a comfort zone, but you
can do it with an expectation of success provided you have a purpose and a plan, and on the
assumption that you only invest in assets that make money.
As for Question 2…you have what it takes to be successful if your mind can believe that your
dreams are achievable — for what the mind can realistically see, the body can achieve.
YOUR JOURNEY
I think I’ve said enough. It’s time for us to shake hands and part ways, for although we may share
financial independence as a common destination, the road your journey must take will be different
from mine. Thank you for allowing me to share my story and experiences with you. Good luck, and
God bless.
What to do next . . .
The benefits of owning this book are only just beginning!
Your next step is to register your copy of the book online at <www.PropertyInvesting.com>. It will
only take a few moments and you’ll gain access to many valuable resources, including:
Gain full member privileges at <www.PropertyInvesting.com>.
Latest commentary on what’s happening in the property market.
Video tutorials by Steve McKnight.
Audio interviews with guest experts.
Many useful investor templates to download and use.
More real life case studies.
Substantial discounts off products and seminars.
The ability to contact those who contributed to this book.
And much more!
Registration is free, so join today to maximise your profi t potential.
CHAPTER 29 INSIGHTS
Insight #1
Are you living life in crisis, are you comfortable or are you a champion? You control the temperature setting on your
life’s thermostat, and so it’s up to you to determine how ‘hot’ you’d like to be.
Insight #2
Everything you choose to do — or not do — has a consequence. For example, where you are today emotionally,
physically and financially is not a fluke. It didn’t just happen. It’s the consequence of years of operating below your
peak performance! If you won’t accept this for a moment longer then make a stand and do something about it!
Insight #3
Are you living in your own worst-case scenario? What’s really at stake if you were to try something different?
You don’t need to do anything too radical — perhaps just invest a few days into looking for property deals that make
money straight away. You could start with residential property — or move straight into commercial, if that’s your
preference.
The worst thing you can do is nothing at all. For in the absence of change, things will always stay the same. That’s also
called relaxing into a comfort zone — and I can tell you that no-one ever became financially independent by staying in
his or her comfort zone.
Insight #4
Don’t be fooled into a false sense of security. Becoming a real estate baron (or baroness) is a lot of hard work and
there’s always the chance that you’ll lose money. My advice is that money can always be replaced, but time can’t.
Insight #5
While financial independence is a nice outcome, the real adventure is the journey. I can’t promise you that every day
will be a good day, but I can tell you that creating win–win outcomes through property investing beats the living
daylights out of doing tax returns.
Insight #6
Success comes from doing things differently.
Index
1 Per Cent Rule
6 Ps of property developing
11 Second Solution
advertising
aged pension
artist’s impressions
assets
— identification of
— loans and
— protecting
— replacing
— types of
Asset Zoo
Australian Bureau of Statistics
Ayles, Martin
balancing charges
banking ‘radar’
banks
— competition and
Barton, Tony
borrowing
— capacity
— maximising
— size of loan
— tax and
— to fund lifestyle
boutique lenders
Bradley, Dave
Bradley McKnight Foundation
builder’s report
business bankers
buy and hold (rentals)
— types of properties
buying demand
calculating returns
capital gains
— asset identification and
— cashflow vs
— indexation of
— manufacturing
— over time
— reinvesting
— reliability of
capital gains tax (CGT)
— 50 per cent discount
— investment time frame and
— negative gearing and
— simultaneous settlements and
capital purchases
capital works deductions
car parking
cash
cashflow positive see positive cashflow
cashflow returns
— capital gains vs
cash-on-cash return
cash properties
cash returns
charity
commercial property
company structure
comparative sales
Complete Renovation System
compounding returns
construction finance
Consumer Credit Code
Consumer Price Index (CPI)
corporate veil
cost base adjustments
country areas
covenants
credit cards
credit checks
credit history
crossovers
deal diary
Dean and Elise from Victoria
debt
— ability to repay
— eliminating
— recycling
— reducing
debt-to-income ratio
— calculating
delaying gratification
demographics
deposits
— size of
depreciation
— cashflow and
— eligibility for
— methods of
deregulation
developing
— cashflow and
— finding land
— number crunching and
— position and
— pre-sales and
— presentation for sale
— price and
— product and
— project management and
— promotion and
— restrictions on
— target market for
— tips for
diversification
driveways see crossovers
due diligence
earning capacity
easements
economic cycle
employment
— history of
equity
family home
family trusts
financial assets
financial freedom
— achieving
— phases to
financiers
— loan assessments and
— networking and
financing
Finishing Touch
First Home Owner Grant
flipping see simultaneous settlements
future income
— borrowing against
get-out clause
getting started
global financial crisis
goal setting
— time frames and
goods and services tax (GST)
government incentives
government monetary policy
growth phases
happiness
home staging
HomeStarter program
honeymoon rates
income
— importance of
— proof of
— spending habits and
inflation
— negative gearing and
infrastructure
inspection templates
interest
— margin
— rates
interest-only loans
internet
investing purpose
investing structure
investment groups and seminars
investment models
investment strategies
— evolving
investment time frame
Jenny from Western Australia
joint venture partners
landlording
land size
lease options
— call option component
— in today’s market
— potential clients for
— prequalifying leads
— residential lease component
— right properties for
— sandwich options
— success factors for
— vendor’s finance vs
lending industry
leverage
lifestyle
— funding
lifestyle assets
loan application checklist
loan repayments
loans
— applying for
— disclosure and
— fees and
— going outside the system
— guaranteeing
— obtaining approval for
— personal information and
— pre-approval for
— property information and
— security for
loan-to-valuation ratio (LVR)
— 80 per cent finance
— 100 per cent finance
— calculating
— maximum
local councils
location
long settlements
low-cost housing
low-documentation (low-doc) loans
lump-sum cash profits
Maes, Katrina
making an offer
— price and terms
matching principle
Matt from Queensland
median house prices
Medicare levy
mining towns
money partners
money problems
mortgage brokers
mortgage insurance
mortgage protection insurance
mortgage stress
multiplication by division
multi-property portfolio
— creating
— negative gearing and
multi-step investment
multi-unit complexes
National Rental Affordability Scheme
negative gearing
— capital gains tax and
— falling tax rates and
— inflation and
— popularity of
— promoters of
negative gearing spiral
networking
New Zealand
non-investment income
non-investment-related expenses
non-traditional finance sources
nothing-down deals
number of properties owned
ongoing funding
overlays
partnerships
passive income
path of least resistance
personal appearance
personal debt
personal financial statement
Peter and Jackie from Tassie
planning
planning applications
plateau effect
poor credit history
population
positive cashflow
— asset identification and
positive gearing
positive gearing spiral
pre-sales
prescribed private funds
price margins
principal and interest loans
print media
privacy laws
private lenders
profitability
property
— condition of
— costs and
— current market
— demand for
— finding
— for other people
— how to buy
— inspecting
— knowing the area
— laws relating to
— loan applications and
— losses and
— making improvements to
— making money in
— market booms
— market phases and
— options on
— performance over time
— position of
— presentation for sale
— prices
— reasons for investing in
— rentals
— returns from
— what to buy
Property Lifecycle, The
property surveys
purchaser’s settlement statement
qualifications
quick-cash techniques
rate recovery auction
real estate agents
— tricks of
Real Estate Institute of Australia
redrawing
refinancing
registered valuers
reinvestment
renovations
— costs of
— formula for success
— labour and
— managing
— number crunching and
— perceived value and
— property presentation and
rent
— incentives and
rental properties see buy and hold
(rentals)
rent assistance
renting by the room
residential rental properties
RESULTS mentoring program
retail banking
retirement
return on investment (ROI)
risk
rural areas
sandwich lease options
saving
savings
scalable investing
Scotty from Sydney
second mortgages
selling
— reasons for and against
selling deals
serviceability check
setbacks
settlement statement
shares
shopping centres
simultaneous settlements
— affordability and
— finding buyers
— long settlements and
— profitability and
— success factors for
six-step process to buying
sourcing deals
spending habits
stamp duty
— simultaneous settlements and
street appeal
subdivisions
— local councils and
— process of
— property surveys and
— timing of sale
— tips and tricks for
sub-prime lending collapse
Sue from South Australia
superannuation
surveyors
sustainable investing
tax
— deductions
— deferral of
— effect on salary
— fixtures and fittings and
— minimising
— profitability and
— rates of
— saving
tax returns
tenancy laws
tenants
— finding
— incentives for
trust deed
trustees
trusts
— beneficiaries of
— tax benefits of
undervalued properties
units
unrealised equity
useful life
vendor’s finance
— arguments for and against
— human aspect of
— in today’s market
— lease options vs
— legal aspects of
— phases of
— sale terms
— success factors for
wealth creation
win–win outcomes
<www.PropertyInvesting.com>
<www.PropertyInvestingFinance.com>
zoning