Be careful about what you post in investment forums: lawsuits bite!

Most of us who are interested in finance and investing find ourselves in discussions about investing with our friends family and colleagues.  Naturally part of this discussion centres around venting when things do not go our way or when we feel we have been cheated or when corporate executives or directors of companies we have invested in undertake actions that we feel are not in our best interests.

Given the important of the internet in modern communications, more and more of these communications are happening online through investment forums (such as HotCopper) or through people expressing views on their own blogs (such as I do on this one) or by commenting on other people's blogs. As readers of this blog would know I have frequently criticised companies - both listed (such as FKP over their rights issue) and small er companies(though less so the small companies - only when I think they are real scams).

However...keep in mind that speech is not free and that you can be sued for defamation

When you post something on the internet it never goes away - we all know that.  It's the reason we are all so careful about our Facebook and other privacy settings.  However we seem to forget this when we are on investment forums talking to other 'hard done by' investors.  What you always need to keep in mind, however, is that you can be sued for these comments.

Although the story seems to have died down somewhat now, this issue got a fair bit of publicity when Susanne Deveraux, a retired nurse from Queensland, was sued by Empire Oil and Gas for defamation in

Does it matter if my broker holds the title to my shares?

In my previous post on Interactive Brokers, I mentioned the fact that they act as custodian over my shares and that I would do a post on the upsides and downsides of holding the shares in the name of interactive brokers instead of your own.

What is the difference between holding the title to shares yourself and the broker holding title

There are several practical and legal differences in the way that shares are held.  I shall outline only a few below.  It is probably worth researching further and seeing how different brokers operate before making the decision about whether you are comfortable with it.

Practical differences in the way title is held

• When title is held in your name the company knows that you are an investor.  When it is held through a custodian all they know is that a custodian has customers with x number of shares.  Thus all communications are with you instead of with the custodian.  You will notice that when you go through a custodian that you never receive any correspondence yourself and dividends are paid to your custodian not to your bank account.
  
• The rights to participate in things such as DRP's and corporate actions are at the discretion of the custodian if they are held in their name.  This is why Interactive Brokers does not allow DRP's however it does have a system for corporate actions.  The same applies for voting.

Legal implications regarding the way shares are held

• Custodians should hold your shares in a trust outside the business structure.  They do not own your shares and only hold them for you on trust.  However there have been examples, most recently in the GFC, of customers losing their money due to dodgy practices - see the example below
  
• If your custodian is based in the US you may not be able to participate in some corporate actions.  Due to how strict the SEC is on filing requirements, a lot of companies specifically exclude US investors from participating in equity raisings and corporate actions.  You need to make sure that you are not affected by this.  Interactive Brokers tends to set up entities in various regions so it has not been a problem for me to date.

What can go wrong - A Prime Example

The collapse of many independent brokers during the GFC really brought to light the issues that can occur when you do not hold the title to your shares in your own name.  In Australia the primary example was Opes Prime, an Australian share broker which held the shares in the companies name rather than the individual investor.

When Opes collapsed in 2008 the customers expected (rightly) that their shares could simply be transferred to another broker. Instead Opes had, illegally, borrowed against these shares for their securities lending business and the lender to this business called in that collateral, sold the shares at a significant loss and the customers of the business only got back a fraction of what was rightfully theirs.

Let us be very clear from the start - what Opes did was illegal.  There should have been a trust outside the main Opes entity to hold the shares of customers as the company had no right to treat these shares as their own assets.  The customers could sue the company afterwards, however if the company is bankrupt there is little point in suing them.

What should you do IF your broker holds your shares in their name (like Interactive Brokers)

If you acknowledge the risks of investing through a broker which does not hold the shares in your name and still decide to go ahead with it (because of their low costs of trades or access to more international markets etc.) then you need to put in place risk mitigators.

You need to keep a constant look out for signs of financial stress at your broker.  You owe them no loyalty.  At the first sign that they might be in trouble it is time to abandon ship and transfer your shares to another broker (I suggest having another brokerage account) where shares are held in your name.

Set up news alerts and ALWAYS read their disclosure statements (even though it may be particularly boring).  It is not worth losing all your investment portfolio (which presumably you worked your whole life for) because you have been lazy.

You May Also Be Interested In:
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Interactive Brokers - The negatives start to pile up
Corporate Actions on Interactive Brokers
Interactive Brokers - No DRP

Understand your rights and obligations as a landlord

After you have purchased your property and have rented it to suitable tenants you need to make sure that you understand your rights and obligations as a landlord.  This is one of the core things that you probably will not know intuitively and so need to go out and seek the information.

There are several general things that you need to be aware of when it comes to landlords rights and obligations including

1. Rights and obligations vary across jurisdictions
• Make sure you understand your rights and obligations in each jurisdiction. 
• Understanding your position in your jurisdiction is not helpful if you invest in a property in another state or country
2. Not knowing the law is no excuse for not conforming with the law
• Another common way of saying this is 'ignorance of the law is no defence to a breach of law'. 
• If you do not know a rule exists and inadvertently do something you can still be liable for penalties even if you did not mean to breach the rules
3. Things always go wrong eventually
• There are some things that you can control for but others that you have absolutely no control over
• Things will always go wrong so make sure you understand what your rights and obligations are in each situation

What are the types of rules and regulations you need to understand

To list all of the rules and regulations would be a bit pointless as not all rules and regulations exist in each jurisdiction and more importantly I would not want to miss important ones that you may need.  The list below, therefore is an indication only of things you need to understand when renting an investment property

• Tenancy agreements - what they must contain and what they govern
• Rent in advance, deposits, charges, bonds
• Paying rent
• Water expenses
• Obligations on the tenant on the way in which the property must be kept
• Inspections and rights of entry
• Sub letting the property
• Rent increases
• Rights around end of tenancy and when either party can end the lease and on what notice
• Evictions
• Rights and obligations and avenues for appeal relating to tenancies

Where can I get the relevant information

Most jurisdictions have large tracts of legislation that cover these issues and as time goes by you should probably spend some time getting to know this area of law (after all you have hundreds of thousands of dollars invested - you probably understand your day job much better and have less money invested there!)

However, if you have read legislation at all in the past you know that it is often written in a way that is hard to read and often seems relatively ambiguous. 

The best source of information is typically on consumer affairs type websites and are typically written for tenants.

• This isn't a problem though as a tenants right is your obligation and their obligation is your right so you are reading it in reverse
• This is the best place to start as it is often written very very simply and will give you a feel for what you need to do in any given situation
• I suggest googling "landlord's rights and obligations for [xxxxx state]" and seeing what comes up
• You should get something like this site which covers the law for Victoria in Australia and gives a breakdown of everything you could possibly want to know

Laws change so make sure you keep on top of the information

Laws are changing all the time.  Make sure you keep on top of any changes to the renting laws in your state or jurisdiction so that you are not caught unawares when something goes wrong.

This area seems like a lot to learn when you are first starting out but it isn't that bad actually.  It is very rare for something to go wrong in the first couple of months so that gives you a fair amount of time to learn your basic rights and obligations.  As time goes on you can get into the nitty gritty so that you are aware of everything you need to know.

You May Also Be Interested In:
Investing in real estate - All topics
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Investing in real estate: Essential record keeping
Investing in real estate: What insurance should you have?

The Australian Energy Regulator's insurance dilemma with respect to SP Ausnet

In the last week we have seen a fair amount of controversy raised in Australia (and Victoria in particular) over the Australian Energy Regulator's (AER) proposal that SP Ausnet be able to recover funds that they have to pay out (above their insurance cover) to the Black Saturday bushfire victims through higher charges no the Victorian electricity network.

This is the way SP Ausnet (an ASX listed company 51% owned by Singapore Power) described the proposal by the AER:

This further draft decision deals with the insurance pass-through event, which had not been finally determined. Under the draft decision, there may be circumstances in which liability which exceeds insurance may be recovered by SP AusNet as regulated revenue. The AER’s consultation on this draft decision closes on 12 September 2012.

I admit when I read this I could not believe it - on first read it seemed like a private operator was getting immunity for harm that they cause and the burden would need to be borne by rate payers.  The media's response was particularly ferocious.  This article by Michael West of Fairfax Media is just one of a host of articles ridiculing the proposal.

The Victorian government has announced that they will also be opposing this proposal and will lodge a statement with the AER.  However I think this was only in response to community misunderstanding and the flames whipped up by the media.

However I do not think that the issue is as simple as the media makes it out to be

In fact I think that the media does not understand what this proposal is truly saying.  This is pretty ironic because they have, probably without knowing it, been beating the drum on both sides of this debate.

If you go back through the articles written by Michael West of Fairfax Media (the same author as above) you will find this article which expresses outrage at the high price that consumers have to pay for electricity because of the gold plating (over spending) on the networks which consumers then have to reimburse.  To be fair to the author - this was an excellent article which raised very valid considerations.  He does not seem to link this to the article that he wrote opposing the AER's decision though.

Victorian transmission networks have not been gold plated unlike other states and there has been limited overspend compared with states such as New South Wales and Queensland.  This is largely a function of the privatised nature of the Victorian distribution network.  When you 'over-spend' or 'gold plate' a network it means that you spending to get that last (expensive) 1% of network reliability.  To get this last 1% it is very expensive and as outlined in the article above, probably not worth it.

However this 1% also adds to things like safety of the network.  When you spend these excessive amounts of money the probability of an event like Black Saturday happening also decreases.  Regulators, governments and in the end consumers need to work out what is the appropriate balance and what risk (there is always risk) is acceptable.

To mitigate the consequences of this risk the regulator requires (and provides an allowance for) insurance to cover these events

In the regulatory determinations (you need to read a fair few to get the hang on them) the AER allows operators a certain amount to take out insurance to cover the risk of an event happening.  This is because, in an efficient system you can never have 100% reliability.

What the regulator is proposing in this case, which the media does not seem to grasp is that, if the operator (in this case SP Ausnet) has spent this insurance money efficiently and appropriately and this is still not enough (i.e. implicitly the regulator did not give them enough in the first place) then they should be reimbursed

This actually makes a lot of sense in the regulatory context.

Investing in Real Estate: Don't forget to renew the lease

As outlined in my previous post, once you have bought your property and leased it out to your tenants there is nothing much you need to do other than keep track of your finances, the required maintenance and your lease.

This post will cover the last of those points.  Typically properties are leased for either 6 or 12 month periods.  Towards the end of this period you need to renew your lease.  Many landlords and indeed property managers are quite lazy about this and leave it quite a long time.  I confess the first time my lease renewal came up I got onto it straight away but the second time I totally forgot about it (my fault not the property managers).

However it is in your interest to keep on top of this and renew the lease in good time

There are several reasons why keeping on top of this is important for your financial well being.  These include

1. When you renew the lease you typically are able to raise the rent.
• This is typically all the lease renewals come back to
• It is always a balancing process - raise the rent too far and you risk good tenants seeking accommodation elsewhere (and getting no income for a period of time).  Do not raise the rent at all and you are possibly renting your property too cheap and doing a financial disservice to yourself
• The process is the same as when you were setting the rent - have a look at what the rents are like on similar places around you
• If rents have gone up a lot then you are probably OK to increase your rent to get it close to the market
• If landlords are advertising very low rents to try and get people in the door, you probably don't want to be increasing your rent and losing your tenants
2. A lease locks the tenant in for a specified period of time
• If they exit the lease early then there are financial penalties for them
• If you do not renew the lease it typically goes onto a month to month lease basis and they only need to give very short notice to you to move out
• Having a 6 or 12 month lease is good for the investor because it provides certainty around cash flows
• Advertising and re-letting a property to new tenants if the old ones move out suddenly because you don't have a lease costs a fair bit of money (especially in terms of lost rent and fees paid to your property manager)
3. Insurance is typically based on having a lease agreement with your tenant

Investing in Real Estate with family members or friends

Investing in real estate in some countries (such as Australia) are seen as the 'easiest' way to make money and so everyone clamours to get into the real estate market.  However saving for a deposit is one of the hardest parts about entering the property market and so people who are looking to get on this supposed gravy train look to go with other people to get into the market quicker.

Although there are some positives to investing with others, especially with family, in my opinion these are largely outweighed by the negative factors.  I have listed both the pros and the cons of investing with family or friends and things you should consider before you invest.

Benefits of investing in property with family members or others

There are a few clear benefits to investing with others.  These include

• As mentioned above it is easier to enter the property market if you are not saving on your own for a deposit.  Banks are also more willing to lend you money as they have two incomes as security
• It reduces your exposure in any given investment
• One of the biggest downsides of property investment is that because of the prices of houses it is hard to spread your risk because the capital requirement for each property is so high
• When you invest with others your effective risk and capital contribution is much lower
• Provides a fall back in the event one of you get sick or lose your job
• If you get sick or lose your job, your mortgage still has to be paid and your property still generates expenses. 
• Having more than one person means that in the event one of you get sick the other can still take over the responsibilities

Cons of investing in property with family members or others

I think the cons far outweigh the benefits when it comes to investing with others.  While I have outlined almost all of the benefits of investing with others above below are just a few of the cons of investing with family members or others

• You are completely liable for any liabilities at the property
• This means that if the person you are investing in is unable to pay their share or refuses to for any reason you are liable for the full amount
• People always say 'this can't happen to me' and you often have a high degree of trust between yourself and family members or close friends but sometimes their inability to pay is not their fault - they may lose their job or have an accident.  The bank does not care about this and they will come after you.
• You may not have the same investment philosophy or time horizon
• When you own a property on your own you control everything including when maintenance gets done, when you sell, if and when you refinance.
• It is very rare that two people are in exactly the same financial situation at all times and so there can be conflict over what is to be done with the property (i.e. they want to sell at any price and you want to hold on to the property because you think the price will increase)
• There are serious legal implications for buying properties with others
• In common law countries (Australia / UK / Canada), properties are general bought under one of two types of title - tenants in common or joint tenancy
• Under joint tenancy if one person dies their interest in the property automatically goes to the other owner
• Under tenants in common the person that dies can will their share away to someone else
• How do you split the profits / benefits if one person has contributed more than the other?
• This can be a very touchy subject especially if one person has contributed more OR if one person was contributing while the other was out of a job and vice versa
• What happens if you have an argument?

Investing in Real Estate - Doing the Due Diligence

This is my ninth post in my Investing in Real Estate series and covers things you should check when buying a property.  This is one of the most important steps in the process however is the one which is also the hardest to carry out. 

You have found the perfect investment property, have your finance in place and have gone through the  stress of negotiation with the other party saying yes.  If you have gotten to this stage well done!  However the most important part of the process is the due diligence.  It allows you to carry out the terms you and the vendor agreed to in your contract before there is formal settlement of the property.  It is the hardest stage because by this stage you cannot help but be emotionally involved.  However you need to try and detach yourself because if there are real problems with the property (e.g. structural problems) then you need to back out pretty quickly or you will have some serious problems in the future.

The due diligence that you do is totally dependant on what you put in the contract.  At the very minimum you should include a building and pest inspection clause.  Do not use the pro forma wording that the real estate agents suggest.  Use wording that is as unambiguous as possible for this.  I suggest googling around for appropriate wording - I am not a lawyer and do not want you using a broad suggestion that I put on this website in a contract. 

The building and pest inspection
For your building and pest inspection use a reputable building inspector.  You want a person to tell you the truth, not what you want to hear (i.e. that it is perfect).  In Australia a lot of investors and home buyers use Archicentre.  I have never used them though I have heard from friends who have that they are not as detailed as they could be.  They do not tend to get right into the property to find any potential flaws.  I used a person recommended to me by a real estate agent friend.  He said that this person was hated by real estate agents because he found every single little problem and caused people to back out of contracts.  Make sure you tell the inspector that you want to hear about everything.

At the same time do not run away at the first sign of a problem.  All houses develop their own little problems over time and some are not very serious.  When I got my report back from the building inspector I almost had a heart attack with the amount of problems there appeared to be.  I then asked the following questions which I think are essential

1. I asked him if he could take me through the whole report slowly and explain it to me in simple terms as I do not have any building experience
2. I asked him what was necessary to fix right away, what could wait and for how long
3. Finally I asked in his estimation how much all of it would cost me.  This was important because I discovered that actually many of the 'problems' were super cheap to fix and not really an issue at all

A lot of inspectors are reluctant to give you that information because they fear you will sue them if they get their estimates wrong etc.  If you make clear that you are just trying to put things in perspective I have found that they are normally very good.

Property and title searches
This is a bit of legal due diligence that you should never skip over.  Ensuring that the vendor has the right to sell you the property before you hand over the cash is essential.  This is often done by a lawyer or a paralegal.  People often argue about whether it is better to use a lawyer who tend to be more expensive however have a better understanding of the law if anything goes wrong or a paralegal who do this as their bread and butter work every day, are cheaper though will not be able to help you as well in a bind.

My personal strategy was to use a paralegal (Moira Ryan - I highly recommend her if you are buying a property in Victoria, Australia) who came very highly recommended but to have a lawyer in the back of my mind (I didnt retain them) just in case things went a bit pear shaped.  I found this worked perfectly for me as most times there are no real issues.

Check any and all representations that the real estate agent has made before signing the contract
Contractually representations made before signing the contract but that are not in the contract do not count for anything.  For example if the real estate agent has told you that this land is prime development land, you do not check and it turns out the council refuses to develop any land, if it is not in your contract then you cannot get out of the contract for this reason.

There are some things which you can put in a contract though.   One of the easiest things to check in diligence (and which they should have no objection to) is seeing the rental agreement with any existing tenants.  You should always check this just to make sure that the real estate agent has not inflated the amount that the property is being rented for.  Specifically check the term of the agreement to make sure that the agent has not rented the property at an inflated rate for a few weeks / a month to get a good sale (I actually did see this once and never dealt with that agent again)

Conclusion
There are an unlimited number of things which you can put in your contract for the diligence phase which can give you an out for things you are worried about.  However keep in mind that more conditions are likely to make a vendor nervous about the certainty of the sale.  The conditions above should never be left out so consider them an absolute minimum for your contract.

Most importantly after they are in your contract make sure that you follow up on them in the appropriate amount of time and exit the agreement if necessary.  Not exiting when you know something is wrong or too costly to fix is the biggest mistake you make.  You wont catch everything but if you ignore information that you have been told then it is your own fault.