Real Estate

Real estate is physical land and property on that land (including its resources). It is a popular investment vehicle in markets where land and building prices increase over time.

Arguments for and against real estate investing:

• You can borrow to finance the asset, meaning you can leverage a huge amount. It’s not possible to leverage to the same extent for other investments like shares.
• Transactions costs are huge, ‘forcing’ you to buy and hold for several years (7+). Any capital gains may be nullified by the transactions costs. Expect a total transaction cost of around 10% the purchase price of the property (stamp duty, real estate agent commissions, etc.)
• Illiquid. You can’t pull money out of your investments like for shares. This is sometimes argued as a strength because it keeps investors committed to buying and holding.
• You have finer control over the investment compared to shares. With shares, you cannot determine how businesses operate. With real estate, you can make improvements (sweat equity) and negotiate for below-market prices.
• Quality investments usually require far greater starting sums. You’d need several thousands of dollars to get started in real estate investing, which definitely isn’t the case for shares.
• Requires far more of your time and energy compared to passively investing in shares. Some time sinks include:
  • Finding professionals to work with.
  • Being a landlord.
  • Researching suburbs and zoning.
• You will be living with day-to-day emotional challenges and toil of being a investment property owner. You should be interested in real estate. If you have too many work/family obligations or want to channel your time/energy into starting a business, reconsider real estate as an investment. Some headaches include:
  • Tenants causing problems.
  • Building maintenance.
  • Frustration dealing with real estate agents.
• Tax incentives for investors:
  • Negative gearing. Unlike other countries, Australia’s tax system lets you make unlimited deductions for income losses on investment properties.
    • If, according to the accounting, your property lost $20000forthisyear,andyourincomewas$100000, then you’re only taxed on $80000.
  • Property expenses are tax deductible:
    • Interest on mortgage.
    • Building depreciation.
  • Capital gains tax reductions.
    • 50% discount on CGT when you’ve held the property for over a year (which makes the vast majority of real estate investors eligible).

Investing Strategy

Note: your home (principal place of residence) is not an investment property. Despite this, home equity is considered a source of security for banks when they’re approving further loans.

As a new investor:

• Diversification wisdom applies equally to real estate investing. Don’t concentration your investments on one geographical location. For new investors, buy away from an area where you live, such as a different suburb.
• Prefer freestanding houses over other dwelling types. It’s harder to achieve positive cash flow, but the expected returns is higher because of the land you hold.
• Consider buying an investment property, but living with your parents.

Some strategies:

• Serial home selling is a strategy where you acquire one house, move into it immediately, renovate it, sell it for no CGT, then repeat.
• Buying in the path of progress is a (speculative) strategy where you buy undeveloped land in a place where development progress is likely. It depends on you being able to identify places with expected rapid population and job growth.
• Buy-and-flip is a strategy where you buy a house at a bargain, optionally fix it up, then sell it at market value very soon after. It’s said that opportunities for this have largely disappeared after the GFC.

Interest Rate

A higher interest rate decreases the purchasing power of buyers, reducing demand and therefore also bringing down house prices.

• Generally, a higher interest rate makes it harder for both home buyers and sellers. Overall, there will be fewer property transactions.
• Buyers can no longer qualify for bigger mortgages unless their wages increase.
• A higher interest rate can sometimes improve rental yield since fewer people can qualify for mortgages.

You can be prompted to buy a new home by either lower interest rates, or lower housing prices (or both).

Gearing

Positive gearing is where you take a loan to invest, but the income from the investment exceeds your loan’s repayments, ie. you’re getting a positive net income despite the loan repayments.

• For positively geared investments, you have to pay tax on your rental income.

Negative gearing is when you take a loan to invest, but the income from that investment is still lower than the loan repayment.

• For negatively geared investments, you can claim a tax deduction on the loss, which is better enjoyed by high income earners. This is a favourable tax policy for investors that also exists in some other countries such as Japan and New Zealand.

Dwelling Categories

Dwelling definitions matter legally and will differ between different states/countries.

• Freestanding House — single, detached dwellings which may also have a granny flat on the lot.
  • Most expensive type of dwelling (in terms of purchase and ongoing fees like maintenance and land tax).
  • Land value might constitute a huge share of the property’s value (e.g. 70%).
• Apartment/Flat — Land value constitutes a small share of the property’s value (e.g. 10%).
  • Buying an apartment only makes you an owner of the “airspace” and “interior surfaces” of the unit. The commons areas belong to the body corporate.
• Studio —
• Terrace —
• Townhouse — , considered an in-between of apartments and freestanding houses.
• Condominium —
• Semi —
• Duplex —
• Bungalows —
• Mansion —
• Villas —

Detached dwellings such as freestanding houses tend to perform better than attached dwellings like apartments in the long term.

• Most people prefer detached dwellings for privacy and more land.
• Detached dwellings are easier to build and therefore oversupply.
• Greater land means higher expected capital growth.

Detached dwellings tend to have lower rental yields than attached dwellings, however.

Expenses

The main expenses to consider are:

• Property maintenance.
• Strata fee.
• Land tax (which exists mainly for investment properties).
  • The value of the land itself is taxed, not including the property’s value.

Tax

Ownership Structure

Make sure to get property ownership structure right before signing the contract of sale. Claiming the property under your name may lead to more taxes being paid than claiming the property under a different ownership structure (e.g. jointly).

• Sole ownership: cheapest and simplest. You, and you alone, can decide what to do with the property.
  • Making the spouse that does not work the sole owner of a positively geared property is probably better.
  • Making the higher earning spouse the sole owner of a negatively geared property is probably better due to larger tax deductions.
    • If you own multiple IPs, keep in mind that the stacking of tax deductions may push you below your spouse’s tax bracket, at which point it’d be better to exploit their higher tax bracket for deductions.
• Joint tenancy: held by more than 1 individual, split evenly. The share of ownership due to death of any individual will be distributed to the remaining individuals.
  • This tends to be best for similarly-earning couples.
• Tenants-in-common: held by more than 1 individual, split according to defined proportions (unlike joint tenancy).
  • Allows people to pool together money to afford expensive homes.
  • You’re vulnerable to the mistakes of other owners. E.g. if one goes bankrupt, then you could be forced to have the property sold.
• Partnerships: held by more than 1 individual indirectly through a partnership.
  • Partners usually have unlimited liability, meaning you can be screwed by the decisions of another partner.
• Company: held by a company.
  • Has limited liability, meaning you don’t get financially destroyed if the company dies.
  • This is expensive due to fees necessary to ensure compliance to regulation.

PPoR and IPs

PPoRs and IPs have very different tax treatments.

• PPoRs are completely free of CGT.
  • TODO: you can’t carelessly exploit this because you must actually live in the PPoR for a while. The ATO does not specify how long precisely, but you must be able to prove that you lived there by receiving utility bills in your name, and having it be where mail is directed.
• Costs in maintenance, improvement, mortgage interest, etc. are tax-deductible for IPs, not PPoRs. For investors with a high marginal tax rate (e.g. 45%), the tax deductions are amazing.
• TODO: you can hold a property as a PPoR for up to 6 years before you incur CGT, even if that property is tenanted. This works, provided you don’t claim another home as a PPoR.

Converting a PPoR to an IP:

• You’ll pay CGT on any capital gains from the date of conversion onwards.
• You may be able to claim tax deductions on improvements you made, while it was a PPoR. Things that weren’t tax-deductible or depreciable may now be otherwise.
  • This is why you should keep records in the event you convert your PPoR into an IP.

Gearing

• Depreciation of wear-and-tearable things like the carpet, oven, blinds, etc. count as expenses and should be claimed to reduce your tax. Many of these things can’t be claimed as a one-off tax deduction. These items have different lifespans (which may be entirely inaccurate but we must follow the ATO’s guidelines):
  • Carpets depreciate to $0 over 10 years.
  • Buildings depreciate to $0 over 40 years.
    • Depreciation affects the costs basis and therefore has tax impacts you should know about. If you depreciate a building’s cost, which costs $100kle{t}^{\prime }ssay,for1year(forexample),andthensellthepropertyat$200k, your capital gain would actually be $102.5k,not$100k.
  • Capital works (such as driveways) depreciate at the same rate as buildings.
  • … and so on. These lifespans are subject to change by the ATO.
• Negative gearing is suited for a higher marginal tax rate individuals. Positive gearing is suited for lower marginal tax rate individuals.
• Currently, there are no limits to how far you can negatively gear. You can even negatively gear to the point of having a negative taxable income (at which point, you owe no taxes and clearly don’t benefit from deductions anymore).

Zoning

The value of land is heavily dependent upon what you can develop on it. Never purchase land without thoroughly understanding its zoning status and what you can and can’t build on it.

Private Treaty vs. Auction

There are mainly 2 ways a residential property is sold:

1. Private treaty: multiple anonymous offers are collected. The best one wins.
   • Anonymity is legally protected.
   • These ‘final’ offers are still conditional (if negotiated) on the house passing building and pest inspection and formal approval from the bank.
2. Auction: multiple people compete and announce their offers. The best one wins.
   • Hiring a buyer’s advocate is recommended to keep you in check.
   • If there are too few or no bidders, then the auction reverts to a private treaty.
   • Auctions can sometime produce inflated prices when two emotional bidders participate in the auction.
   • Agents may still try to get bids post-auction from the people who gave up during the actual auction, and push the winner’s offer up even further.
   • Auctions have an associated reserve price, which is the lowest possible price the seller is willing to sell for. If the auction winner’s offer doesn’t clear the reservation price set by the seller, it’s not sold. The winner is invited to further negotiation with the seller.
   • Unlike private treaties where you can lay out all the terms, auctions require you to do all your due diligence before an offer (securing financing, building inspections, etc.)

Property Development

Developing property carries a number of serious financial risks:

1. Long end-to-end time involved in finding, buying, developing and selling the property. The time under development generates no income for you.
2. Subdividing and rezone rules have changed since you bought the property.
3. Pissed off locals who will protest against your developments and local councils who will take their side to win their favour, politically.
4. Builders going broke halfway.
5. Unprecedented macroeconomic effects might kill you.

Given these risks, the expected return should be very high to compensate you for taking them.

Professional Contacts

• It’s generally true that “you get what you pay for.”
• Having your real estate team established early can help you can complete a transaction more quickly than other buyers, which the seller will favour.
• Interview your professional contacts if you can, check their credentials, and call their references. This is pretty important if you hire property managers as poor management can lead to reduced profits and more property damage.
• Where appropriate, the people you hire should have professional indemnity insurance.

The key people to have in your real estate team are:

1. Solicitor/conveyancer.
   • This is essential. Buying a property without legal advice is heavily discouraged. It’s possible to buy a book and learn DIY conveyancing.
   • This is the person you send documents to for them to review for caveats.
   • Think of a solicitor as a superset of a conveyancer. They can do everything required for conveyance, plus more. A solicitor is generally recommended, at a slightly higher expense, since they are full-fledged lawyers who are qualified to provide legal advice.
2. Lender or mortgage broker.
3. Accountant (i.e. tax experts).
   • A competent accountant can provide useful feedback on your investing strategy (although they’re not legally allowed to give financial advice).
4. Building inspector.
   • It’s advised to never cheap out on a building inspection.
5. Buyer’s advocate.
6. Valuers.
   • They access to more data than you do. If they stop you from overpaying for a property, then their fee was very worth it.
7. Property manager.
   • Unless you have several IPs, it may be better to hire a property manager due to their economies of scale.
8. Tradespeople.
   • Plumber
   • Electrician
   • Gardener
   • Carpenter
   • Painter

Insurance

Get insurance as soon as possible (usually before settlement). Treat insurance as a last (but necessary) resort and do everything you can to minimise risks yourself.

• House and contents insurance
  • Rebuilding costs following natural disasters.
• Landlord’s insurance
  • Loss of rental income.
  • Damage by tenants.
• Public liability insurance
  • Legal costs defending personal injury lawsuits.

Also consider income and wealth preservation insurances like for life, TPD, trauma, etc. When your income is taken away temporarily or permanently, you may be forced to abandon your long-term investment plan and destroy your financial security.

Negotiation

• Never reveal your upper limit (or just reveal as little about yourself as possible). The correct response to queries of how much you can pay is: “it depends on the property”.
• Always get an answer to “why is the vendor selling?” from the agent. Some vendors may just be testing the market.
• Set an expiry time on your offer.
• Seek to be the most knowledgeable about the property and be able to fully back up your offer with data (repair costs, other sold prices of similar properties, etc.)
• Supposing the seller is hell-bent on a certain price, try to negotiate for chattels or repairs to identified problems in the building inspection.
• Get quotes on repair work that’s necessary, factoring in an additional amount for your time and energy for getting those repairs done. Use these to argue for deductions on the price.

Property Versus Shares

Sources:

• https://www.choosi.com.au/life-insurance/articles/investing-property-or-shares
• https://moneysmart.gov.au/property-investment
• https://www.aussiefirebug.com/property-vs-shares/
• https://curvo.eu/article/i-want-to-invest-in-property-how-does-it-compare-to-passive-investing

TODO: tidy this section up.

Investing in properties is more subject to micro events such as changes in taxes. This is especially true in a country like Belgium that is known for its fiscal uncertainties.

Rental income can cover most or all of the mortgage, however you cannot rely on it because there may be times where your property is vacant.

Real estate investment mostly does not require special domain knowledge.

• Property is illiquid.

• Costs associated with buying, holding and selling a property:

  • Stamp duty — a one-off tax payment associated with your purchase of a property. It’s a function of location, property type and property value.
    • Concessions/Exemptions may exist as incentives for first home buyers.
    • It’s also called transfer duty in states other than NSW.
    • You must pay the stamp duty shortly after the property’s purchase.
  • Conveyancing fees
  • Legal fees
  • Real estate agent fees
  • Search fees
  • Pest and building reports
  • Insurance
  • Landlord insurance
  • Body corporate —
  • Land tax
  • Repairs and maintenance
  • TODO: strata?
  • Capital gains tax, if the property has increased in value

• Settlement periods can span weeks or months.

• You can borrow huge amounts of money to acquire a property and therefore can take advantage of higher leverage, which is an investment strategy involving borrowing money to increase potential returns. It’s sometimes ‘unfair’ to compare % capital growth between shares and property if you don’t account for the ‘cheap’ leverage you can get through acquiring a property through a mortgage.

  • You can also borrow money to invest in shares, just not as much. Doing this is called ‘investing on margin’, and you are subject to margin calls where the lender can request back their money if the value of the securities you invest in fall below a threshold.

• You must have a secure enough income stream to meet mortgage repayments.

• You must be able to respond to increases in mortgage repayments from interest rate hikes.

Picking an investment property:

• Find areas of high growth, high rental yield, low vacancy rates.
• What are proposed developments in the suburb?
• Consider:
  • Distance to reputable schools.
  • Distance to shopping centres and transport.
  • Garage.
  • Bathrooms.

Your property is exempt from capital gains tax if you’re an Australian resident and you’ve lived in the home for the whole period of owning it and has not been used for business activity.

House buying process:

1. Contact a bank or mortgage broker to acquire a pre-approval. How much you can borrow is a function of your income, job history, credit rating, etc.
2. Inspect the home for damage, broken things, pests, etc. Consider paying for a thorough pest and building inspection.
3. Get a conveyancer to review the contract.

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“Job, walk or drive a certain area once a month for 10 minutes. I have found some of my best real estate investments doing this. I will jog a certain neighbourhood for a year and look for change.” — Robert Kiyosaki, Rich Dad Poor Dad