Why I gave up my Investment Property and moved into it as my own home

A few years ago I asked the question: 'Should move into my investment property?'.  It didn't make the greatest financial sense and in fact it didn't grant me the lifestyle I was looking for as a young, single bachelor.

Fast forward 3 years and all that has changed.  I'm now married and my wife and I we made the decision to move into my investment property...it was the right thing for us to do at this time.

So what changed?

When my wife and I sat down to work out where we wanted to live when we got married we actually decided to keep the investment property as an investment and to move into another rental as we saved for our own place.

This is not what my wife wanted.  Unlike my outlook on life her every decision is not dictated or influenced by financial considerations.  She wanted to live in her own home with a garden.  She didn't mind where it was either.

I was far more picky.  I couldn't be more that 45 minutes from the city, I wanted it to be in a decent area, close to public transport and to amenities. Unfortunately most of the houses which combined decent land size and good areas were well out of our price range...hence the decision to rent.

One concession I did have to make was that we would be in our own home by the time we were looking to have kids.  The property market is so hot in Australia at the moment and buying another property in this kind of environment is definitely not what I was looking to do! 

That being said I made that concession because my wife really doesn't push me all that much in terms of financial issues and this was one thing she was adamant about.

Fate intervened unexpectedly

You may remember that last year I had a mild panic attack when I raised my rent on my tenants and they never responded...had I just lost amazing tenants by being too greedy?  All was well though because on the date the rent increase came into effect they just started transferring the new rent amount.

This year I knew something was up when they didn't sign a new lease even though I offered them the ability to sign a one year lease at exactly the same rent they were on last year.  Sure enough a few weeks before my wedding they gave their notice of intention to vacate and their due date to move out was 4 days after my wedding.

Deciding whether to move in became purely a financial decision

My rental property is great and I've always been glad that I bought a suburban family home however it is not a 10 year house either for my wife or myself.  I'm not the biggest fan of the area and my wife wants more land to garden.

What it is though is a perfect interim place to live.  Somewhere we could live for 3 or 4 years while we save and look for our next place.

So the decision became...is it worth getting another tenant in and us find another place to rent for a shorter period of time or do we give up the rental income and tax deductions and move into our own place?

Pros of moving into the rental

1. I needed to do quite a bit of work on the property and doing this while tenants are in there is quite difficult
• Things like repainting and carpeting as well as replacing a fence have all been on the things to do list for years and being there myself will help me get this done
• 
  
2. Putting off buying another property for a few years
• Earlier I mentioned that I was incredibly wary about the current state of the Australian property market.  If we hadn't moved in the pressure to buy a place from my other half would have been intense!  I have managed to push this inevitability back 2 to 3 years
3. The rent I was receiving on the property was approximately $40 a week less than what we were looking to spend on a rental
• Normally the interest deductibility of your investment loan would needed to be counted in this valuation however my property was positively geared so I wasn't actually getting any benefit from this.

Cons of moving into the investment property

1. It was an area that I wasn't too keen on living in.  
• The area the investment property is in is great if you are raising a family but it is useless if you want things like convenience to the CBD, cafes etc.  However given my wife and I are looking to start a family soon the family aspect of it suddenly becomes far more compelling
2. It reduced the imperative to save hard for our own home.  
• I think people save for a variety of reasons.  My wife is brilliant at saving if she has something to save for.  My major concern was thay by living in our own home already thay she would not have the same motivation to save.  If I'm going to honest this is still a concern and I'm testing ways to keep us on track
3. All the repairs and expenses that are part of home ownership are no longer tax deductible.  
• This is a very real downside and it bit me in the backside almost as soon as I moved into the house
• I suddenly had to paint, fix fences and repair burst water pipes all without the benefit of being able to claim the expenses back on tax.  Some of the bigger jobs I will keep receipts for and add it to the capital value of the property (and depreciate it later when it goes back to being a rental) however smaller jobs I will no longer be able to deduct.

After weighing up all these pros and cons we decided to move into the property...so what swayed it for us?

So why did we decide to move into the Investment Property?

Although we came to the same conclusion my wife and I reached the decision to move into the investment property for quite different reasons:

• I saw it as a financially neutral decision which allowed me to put off buying into a hot property market for a few years.  The risk to this approach is that we take our foot off the wealth building accelerator because we are comfortable.
• My wife saw it as an ability to get into our own home ahead of children which provided stability.  The risk from her point of view is that we don't actually move after a few years and she doesn't get her garden.

I'm learning that relationship finances is as much about finding common ground even if they are for completely different reasons rather than always compromising what you you both want.

So what do you think about my decision to move into my investment property? Would you have done something different?

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Negatively Gearing the Stock Market

This is a guest contribution from Jeremy Kwong-Law

We have a national obsession with property investment in Australia. A key reason is because of the tax benefits of negative gearing. The idea of paying less tax is simply too appealing to most people (who can afford it).

Negative gearing only makes sense if the capital gains on the asset is more than the interest cost. Otherwise paying less tax is really because you are making less money, and losing wealth along the way.

Most people only think of investment property when they think about negative gearing. But there are actually other asset classes where negative gearing can be effective. The stock market is one of those.

Individual stocks are too risky to apply a long term negative gearing strategy. However, index based Exchange Traded Funds (ETFs) could be a suitable option. I previously wrote about why ETFs are a better way to achieve a diversified portfolio compared to direct stock holding (here).

With this concept in mind, I tested a $500K investment in the SPDR ASX 200 ETF (STW) using a negative gearing strategy. A $500K negatively geared investment property in Sydney was the comparison case. I selected the SPDR ETF because it is the oldest index ETF listed on the ASX, providing the most data points.

Over an investment time-frame from 1 Jan 2005 to 31 Dec 2014, the investment property offered better outcomes through negative gearing:

• Return on Equity on the property was 206% compared 104% from the ETF
• Total tax offset for the property was $214K compared to $116K from the ETF

 Despite this, the analysis shows that negatively gearing the Aussie stock market is a viable option. In fact, ETF offered a few benefits compared to property investment:

• Lower entry cost - A deposit for an investment property is likely to cost more than $100K, whilst you can start an ETF portfolio with a few $1,000s
• ETFs are much more liquid than property
• there is a lot less hassle compared to property investment. ie. no need to manage tenants / real estate agents
• lower transaction costs - buying an ETF is as cheap and simple as buying a stock with your online broker. Buying an investment property is difficult and expensive. You need to consider legal fees, stamp duty, and other costs

Funding

To fund the two investments, I assumed a loan at 65% LVR or $325K. This leaves a $175K equity / cash investment at the start. The mortgage's variable rate is based on the RBA’s published rate across the 10 year period. The Margin Loan for the ETF is assumed to be 2.85% p.a. more expensive than the mortgage. This difference is the spread between a CommSec Margin Loan and a CBA mortgage as at May 2015.

Both loans are repaid on a monthly basis, to the same dollar value. At the end of the 10 years, principal outstanding is $256K (79% of the initial loan amount).

Running costs & other tax offsets

The cost of the ETF is completely absorbed within the unit price so there are no other fees to pay - ever. For the investment property, there are a few costs:

• Real estate agent management fee of 6% of rental income;
• Depreciation on the property - I assumed 40% of initial investment is depreciated (some consultants suggest you can depreciate up to 60%!).

Income

The ETF pays a semi-annual dividend. Over the 10 years, it provided an average annual yield of 4.7%. I did not factor in franking credits.

The property starts off at 3.5% gross rental yield. Rent rise every year in December, at the rate of Sydney rental growth (ABS data). Over the period, average annual yield is 3.8%.

Asset Value

Property value in Sydney achieved big growth in the past decade, gaining 58%. The $500K property in Jan 2004 was worth $792K in Dec 2014. The Aussie stock market didn’t do as well over this period. The ETF share price increased from $40.79 to $50.25, a rise of 23%.

The higher asset value growth of property also translates to much higher equity value growth. Equity in the property grew from $175K to $536K, an impressive 206%. The ETF equity value grew from $175K to $357K, a 104% increase.

Tax offset vs cash flow

Obviously this whole strategy is about tax offsets - both investments achieved this. The property had tax offsets of $213K over the 10 years, whilst the ETF offered $117K of tax offsets.

Interestingly, the property offsets were achieved with lower impact on cash flow. Negative cash flow for the property investment was only $82K over the 10 years. The ETF had $117K of negative cash flow. This is mainly because property is able to claim non-cash tax deduction in the form of depreciation.

What does it all mean?

This is another example how why Aussies love investment property and negative gearing. You can achieve strong net wealth growth and tax offsets - a double whammy. This also shows that a negative gearing strategy can be applied to other asset classes.

Investing in ETFs is a way of achieving negatively geared investment in the share market. A core benefit of ETFs over individual stocks in this content is diversification - reducing risks. The risk of investing in a Sydney property and the SPDR ETF was similar in the 10 years. Sydney property prices had a standard deviation of $83K, whilst the SPDR ETF measured in at $84K.

On the face of it, investment property seems to be a more compelling investment class. They offer higher returns, more tax offsets and lower negative cash flow. However, I didn't account for a few things that are negative for property investments:

• stamp duty and other taxes;
• vacancy risk - if you can't rent out your property you get no income;
• significantly higher legal fees;
• higher transaction costs when you sell the asset, real estate fees of at least 1%.

The high cost of entry is also a critical issue for investment property. Currently, 1-in-3 Sydney suburbs have median home price of more than $1M. The initial cash deposit required is well north of $100K. For younger investors, this is a tough ask – an idea of reaching that deposit sooner is HERE.

Younger investors can explore the benefits of negative gearing through other asset classes. The asset must be able to achieve higher capital growth than the interest cost. One obvious option is the stock market, which usually delivers higher long term returns than all other asset classes. If negatively gearing the stock market is an interesting strategy, an investment in index based ETFs are a good option to start.

Do you negatively gear the stock market?  Share your thoughts in the comments below!

Jeremy Kwong-Law (@jeremykwonglaw) is Cofounder of www.BetterWealth.com.au. He is a former investment banker turned technology entrepreneur, a muru-D alumni (Telstra startup accelerator). Passionated about leveraging technology to provide better financial products & services to consumers. Coffee snob, business book reader, and fitness fan.

Why haven't I bought a second investment property?

When I first thought about buying an investment property I imagined that it would be the start of a property portfolio that would grow incrementally over time.  However almost 5 years after buying my first investment property I still only have one property.  Why haven't I bought more and why am I not some sort of young property baron?

My decision not to buy more properties was by design...

I actively decided not to buy more investment properties.  I could have done it several times and I definitely had the finances to do it.  My decision to stick to one investment property (for the moment) was by design and not through laziness or lack of opportunity.

I want to own a diversified portfolio of assets

My desire has never been to be a property baron.  Whilst I do want to be financially secure / well off and to reach my $90 million target I don't think that this needs to be within one investment class.  I want to own property, shares, bonds and alternative investments.

Owning an investment property puts a whole heap of your assets in one bucket.  Even if you can use a small deposit and use your cash to buy shares your actual exposure to the property market is still incredibly high.

If you want to own a physical property the fact is that you will be overweight that asset class for a very long period of time until everything else can actually catch up.  One of the reasons I haven't bought another investment property is that I was building up my other portfolio of assets during the last 5 years.

Your own home is an investment in the property market

When I was young I was very taken by Rich Dad Poor Dad.  I thought provided me with incredibly revelations that I had been completely missing before.  Once I did a bit more research and actually educated myself a bit more I realised that the book actually provided very little other than an idea of "you too can be rich".  

One of the core ideas that Robert Kiyosaki pushes in that book is that your home is not an asset because it takes money out of your pocket each month.  On face value this seems to be a true statement.  How many of us actually make money from our homes?  However the more I thought about the less I believed in this statement.

Your home is an asset.  You can spend too much for an asset, you can over-invest in an asset and you can over-capitalise an asset.  And most importantly not all assets put money in your pocket each month.  If you invest in physical assets (such as gold or oil or silver) they will typically take money out of your pocket each month due to storage costs and they certainly don't give you any cash until you actually sell the asset.  This is the same for your house.  Also owning your own home helps you avoid a cost - i.e. rent.

In fact your home is often one of the most tax advantageous investments you can own (in Australia).  You don't have to pay capital gains tax on your home and it is exempt from almost all forms of asset tests.

I don't own my own home (one that I live in) yet but it is definitely on the horizon. When I buy this home it will be an additional exposure that I have to the property market...and I will need to balance my other investment classes before I even think about buying property #3.

I can own additional property exposure through listed property funds and companies

I have written about buying listed property funds and companies before.  The major benefit of them is that you can buy them in small parcels and get exposure to sectors of the property market that I wouldn't normally be exposed to.  The major disadvantage of these types of investments is that you have much less control, the ability to leverage this investment is less and you have to pay fees on top of the natural costs.

I actually have a fair bit of exposure to the property market through listed funds although I have been reducing this lately.

The market doesn't look attractive to me at the moment

I'm a bit believer in value investing.  That is - putting my money to work where I believe there are fundamental traits which will make the investment more valuable in the future (even if these take a little while to realise).  At the moment I can't justify buying another property and increasing my exposure to the market.

If there was a crash or an amazing buying opportunity came my way I would not hesitate to go for it...but this does not seem likely in the current market and in the near term.

Over time I will probably buy more properties...but not right now

I don't have a problem with property investments in general.  In fact I think they are some of the easiest to understand and to own however like all investments you want to understand why your investing in something and have a thesis about how and when it will make you money.

Over time I will probably buy more properties and continue to hold onto them however this is not the right time for me.

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Refinancing your mortgage can save you THOUSANDS

Home loans are a funny thing.  They are probably the biggest liability that most of us have and we research them to death when we actually get them but once they are set in place most of us fall into the pattern of paying them off as fast as we can without thinking about whether we can get a better deal.

Sometimes the deal we are on is so good that we want to hold onto it for as long as possible.  However when competition heats up between banks in the home loan market (as is currently happening in the Australian market) you can often save a lot of money by renegotiating your home loan or moving to a different provider altogether.

How a great deal when refinancing your mortgage

Getting a great deal when refinancing your mortgage is basically being able to do 3 things:

1. Know exactly what you want and need from your mortgage;
2. Knowing everything you are currently paying for your mortgage and all the benefits you are getting; and
3. Leveraging the best offers in the market with the financial institution you want to deal with

Step 1: Know exactly what you want and need from a mortgage

This is the most important

What is a normal home loan interest rate?

When you look to buy a house, chances are the first question you will ask is "how much can I afford to pay" which is really asking the question "how much can I borrow?".  Once you know how much you can borrow, you can go out house hunting and buy that perfect home.

Unfortunately most people just Google one of those home loan calculators or go into a bank branch and ask them how much they can afford to pay and don't look at the biggest assumption that will determine the answer to the original question...the interest rate on the home loan.

The interest rate is the biggest unknown factor when it comes to taking out a loan

In Australia, most loans are variable rate.  If you are lucky you may be able to lock in a 5 year fixed interest period but for the majority of your loan you will be paying an unknown rate of interest.  Why is this a problem?

The problem is that most 'affordability' calculators assume the prevailing interest rates or they may have a small buffer in there if rates move.  In Australia the current rate of interest is ~5% on 30 year mortgages but will it stay like this forever...and will you be able to afford the interest bill if the interest rate moves?

The question we should be asking is: What is a 'normal' home loan interest rate?

The problem with this question is that there is no right answer.  Economists will argue until the cows come home what a steady state 'normal' interest rate will be but the fact is that it will all depend on the economic conditions and government policy in the future and there is too much uncertainty around that question.

So how do we deal with the uncertainty associated with unknown future interest rates?

The simple answer is to

Raising the rent on your investment property

Regular readers may have noticed that I have not written about investing in property for a while.  This is because once the initial work is done the amount of effort it takes to manage your property is largely a function of how involved you want to be.  I want as little involvement as possible and this is the way that it has panned out.

However, even if you are a low involvement landlord, one thing you will need to think about is when and if to raise the rent.

Keep on top of your contract renewals

In a previous post I wrote about how you should keep on top of your contract renewals.  One of the main reasons that you want to do this is that it provides an opportune moment to review what your tenants are paying and consider increasing the rent.

The process for setting the rent at this point should be pretty similar to when you first got the tenants into the property.  However make sure you take advice from your agent.  Your agent will often tell you whether you can increase your rent and if so by how much.  Sometimes, if the market is particularly soft, the agent may advise you against increasing your rent at all.

You shouldn't follow your agent's advice blindly

It is a reasonably tough rental market in Melbourne for landlords.  For the last few years, every time I've had a contract renewal come up the agent has advised me to keep my rent flat, and given the circumstances I have agreed.  Note that I haven't done this blindly - when I moved out of home I saw how easy it was to negotiate better rent with landlords or for repairs and work that they would not normally do.

However sometimes you have to back your own judgement.  I hadn't raised the rent on my investment property in 3 years.  In this time I have had the same tenants and I have largely agreed to all the maintenance (albeit minor) that they have requested.  I have also agreed to their request to have a pet.  I like them and they seem to maintain the property well.  It is a good relationship but it is not a charitable one.  After doing my own search on the internet I found that, although my property is not under-rented, it is certainly not far ahead of the market.

Agents often look at how many properties they have on their books versus how many people are coming to view those properties.  They are less nuanced about the

Optimising your First Home Saver Account

Recently I wrote about the benefits of the Australian government mandated First Home Saver Account.  If you did not read that piece I recommend having a look as there are quite a few strings attached to the account and the penalties if you do not meet the requirements are quite harsh (the amount you have saved gets rolled into your superannuation and you cannot access this until your retire).

That being said, if you do qualify for this account and you are thinking about buying a home in the near to medium term (at least 2.5 years away) then there are ways that you can maximise your investment in this account.

The superior returns from this account are due to a combination of a significant government co-contribution and concessional taxation

The beauty of this account is that the superior return comes in 2 separate forms:

• A 17c co-contribution (return) on the first $6,000 deposited each financial year
• An incredible return especially given it is risk free
• This return has the biggest impact in the first year on total returns and a diminishing impact as time goes on
• A 15% tax rate on any earnings within the account
• Members Equity has a First Home Saver Account which earns 3.25% p.a. which is a decent return but nothing amazing
• However if you think about the fact that this is taxed at only 15% you would need a significantly higher pre-tax return on any other account to get the same after tax return as this account.  For this different marginal tax rates (including the Medicare Levy)
• If your marginal tax rate is 19% (you're probably not paying the Medicare Levy) so you would need a 3.41% pre tax return to get the same after tax return
• 34% marginal tax rate (32.5%+1.5% levy) = 4.19% pre-tax return equivalent
• 38.5% marginal tax rate (37%+1.5% levy) = 4.49% pre-tax return equivalent
• 46.5% marginal tax rate (45% + 1.5% levy) = 5.16% pre-tax return equivalent

The next thing you need to look at is the alternative for your savings and investment dollars.  The first $6,000 each year is a no brainer - I can guarantee you that you will not get a better return of any other investment (other than paying off high interest credit card debt).  

The next thing you need to ask yourself

First Home Saver Account - Super Return but mind the strings attached

The First Home Saver Account is an initiative by the Australian government which allows people buying their first home (to live in) to get help from the government to save up for a deposit.  I remember being turned off by all the strings attached to the plan when I first looked at it a few years ago but if the timing works for you it can trump any other savings plan / investment in the market.

What is the First Home Savers Account?

The first home savers account is basically a savings account that you hold at your bank or credit union (note that most of the major Australian banks do not offer this any more but you can still get it from credit unions) which you use to save for your first home.

The benefit of this account is that:

• For every dollar you put into the account (up to $6000) in any financial year the government will co contribute $0.17 (i.e. up to $1020)...that's a 17% risk free rate of return on the $6,000 deposited 
• The account earns interest like a normal savings account.  Members Equity had the highest rate I could find at 3.25% p.a.
• The earnings in the account are only taxed at 15%

Trust me when I say there is nothing else out there which gives you a return anything like this.  In fact if it wasn't the government giving you the return I'd wonder if it was a scam.  But there are strings attached...make sure you don't trip over them.

What are the strings attached to the First Home Savers Account?

There are some pretty big strings attached to the account.  Look at the Australian Tax Office website for full details but in order to be eligible

1. You need to be an Australian citizen or Permanent Resident
2. You must not have owned a house in Australia as your primary residence (this is how I still qualify - I own an investment property but it was never my residence)
3. You must not have had a first home saver account before

Then there are the strings attached to being able to withdraw the cash itself:

Should I move into my investment property?

Recently I have been posting about buying a house for myself to move into.  This is not going to be a very short term thing - I was giving myself enough time to look and consider what I actually wanted and where I wanted to live.  What happened though was that I found out that property in Australia is much more expensive than I first imagined - in fact I found myself looking in the same area which my parents live (and I didn't grow up in a great area at all).

This didn't deter me though - I had a decent budget and I could get somewhere ok...certainly not where I thought I would be able to buy but I wasn't going to be buying in the middle of nowhere.  My girlfriend then asked me a question I hadn't really considered before: why don't you move into your investment property for a few years while you save up for a deposit on the place you actually want?

At first the idea of moving into my investment property didn't appeal to me

I think I was most opposed to the idea of taking something that was definitely an investment of mine and converting it into something which was not an investment - i.e. something which I was using for my own benefit.  In my mind I think I thought of that as reducing the amount I had 'invested'.

This was a really short term way of thinking about things and as I thought about it more I realised that perhaps it was not as bad a suggestion as I first imagined.  There are definite draw backs to such a move (which I will outline below) however there are a significant number of advantages (which I will also outline).

The benefits of moving into your investment property (while you save for another place)

When I outline the benefits of moving into your investment property please keep in mind that I am not comparing this to continuing to rent a place - renting is almost always going to be cheaper than buying a house (otherwise negative gearing wouldn't exist).  I am comparing this against buying a house that I can afford at the moment.

The benefits of moving into my investment property include

1. Being able to save for a place I really want
• I am currently priced out of those areas that I really want to live in.  Property in the areas that I want to buy are currently in the ~$1 million mark while I can only really afford around $700,000 mark
• Moving into my investment property will give me a few more years to save up and buy in the area that I want to live in
2. I already own the place I live in - no further sunk transaction costs
• Transaction costs (such as stamp duty) when you buy a property run into the tens of thousands of dollars
• I already own my investment property - I can invest those transaction costs which would have been sunk
3. My loan is currently at a very manageable stage
• My investment property loan is currently very manageable - I could pay it down very quickly and save for the place I actually wanted to buy
4. I can always convert the property back into an investment property
• When I eventually buy where I want to live I can convert my investment property back into an investment property, leverage against it (and so get a tax deductible loan) and use this to pay down my non tax deductible home loan

The cons of moving into your investment property

The cons of moving into an investment property instead of buying a new house are also very

Renewing your home insurance in 2013...don't forget the fire service levy

This post is for Victorians (in Australia) renewing their home insurance in 2013.  If you have already received your home insurance renewal you will have noticed something strange. Instead of the usual hikes in insurance which you then have to negotiate down your insurance may have been rather flat, or even dropped this year.

Before you go out and celebrate don't forget to adjust for the change in the fire service levy!

What is the change?

From 1 July 2013, the fire service levy (which you were already being charged) has changed from being part of your insurance cost to being part of your rates bill.

For once this is a political change that actually makes sense - it was recommended by the Victorian Bushfires Royal Commission and is fairer for a number of reasons including:

1. All property owners now have to contribute.  Previously if you didn't have insurance you didn't have to pay anything at all
2. People who insured their property for less used to pay less than people that fully insured their properties and so could game the system
3. It was previously at the insurers discretion how they recovered their costs so it was not always an equitable system
4. GST and stamp duty were charged 

That is some background to the why the system was changed but suffice to say that the change make sense and when I compare how much I used to pay and how much I pay now, the change was minimal so there is not that big a difference for me.

Why is it important to keep in mind when renewing your insurance?

If you do not take this into account you could get slugged with a large insurance premium increase and not even know it.  Typically we have some sort of idea what our insurance premium was last year and so if it does not change at all we are pretty happy about this.

However this is not the case this year.  Your insurance should be falling because you are no longer

Positive Dilemma: Is it an issue if your property becomes positively geared?

In Australia, one of the biggest benefits of investing in property, or borrowing significantly to invest in any investment class (including shares) is the presence of negative gearing.  That is, you can claim a portion of your losses (your effective tax rate) back against your other earned income.

Although a loss is always a loss negative gearing allows you to

• Supercharge your investment returns by investing less cash and using leverage to maximise the growth in your invested capital
• Have lower holding costs while you wait for capital growth to give you the returns mentioned above

How to investment properties become positively geared?

There are several ways that this can happen without you even noticing it:

1. You have been paying down a little bit of principal every month or have been contributing to an offset account and your interest bill becomes lower than the rent
• This is a really common way for investment properties to become positively geared
• You have managed to save so well and pay down your debt so aggressively that your investment property is now throwing off cash to you each month
2. Interest rates have fallen
• Typically we pay more attention when interest rates are rising because we know that we probably need to contribute a little bit more each month
• However when interest rates are falling most people do not tend to take as much notice
• It is entirely possible for interest rates to fall so much that your property goes from negatively geared to positively geared very quickly
3. The rent you charge goes up
• It is perfectly normal to increase the rent you charge ever year
• Because the incremental amount is so small (i.e. typically $5 - $10 a week) we tend not to notice it on a month to month basis 
• However over a few years it definitely narrows the gap between what you are paying in interest and what you receive from your tenants

Why does this cause a dilemma?

There are several investment books (which I don't like) which bemoan the fact that people are so focused on negative gearing and promote the idea that positively geared properties are ideal because 'they put money in your pocket each month instead of taking it out.  This is only right at a very simplistic level.

However it is not so simple if you think about your whole portfolio, instead if this investment in isolation.  What you should actually think about is: 

What the opportunity cost of having your funds invested in this property versus in another product?  

As I mentioned earlier what negative gearing allows

Investing in property: How much will you pay for non-interest expenses?

Recently a reader of this blog asked to me do a post on what the expenses associated with running an investment property were like.  This post will deal with that issue.

It will not, however deal with interest expenses.  Although this is the biggest expense associated with an investment property it is too hard to generalise about because it all depends on:

• How much you pay for the property
• What sort of gearing you use (i.e. a higher gearing will result in a higher interest cost)
• The interest rate you are charged on the loan
• How fast you pay the loan down

All of the above are not related to the property per se but rather with how you finance it and repay your loan.

While other charges will also typically be related to the individual property (e.g. the age of the property and the condition that it is in will determine what your maintenance expenses are) it is much easier to generalise about this and the costs associated with these.

When I discuss the costs below I will talk about them as a percentage of the rent I receive.  Note that this is only indicative and what I receive for my investment property and you should remember that every property will be slightly different.

Property management expenses (7% of gross rental)

This amount is a negotiated rate and includes GST.  I have posted before on how you can negotiate this rate with your agent down.  Note that this is the total amount that I paid to my agent - some people think they are paying a certain percentage but then end up getting stung on things like advertising, leasing and other miscellaneous fees.  

Paying between 5.5% and 8% is pretty standard for a property management fee.  If you are thinking about investing in property and are looking to add up all the expenses go down to your local real estate agent and find out what they charge.  It will always be a percentage of gross rent.

Maintenance expenses (~1%)

This will vary drastically from year to year. I have been pretty lucky, however and have had few issues.  This however was a function of the property I bought - I was willing to pay a little more for a property with few issues and then deal with all the relevant problems upfront before I leased it out.

In a previous post I recommend doing all the necessary maintenance up front and working out what can be left for later.  If you're thinking about how much maintenance expenses will cost you I would not assume something this low - I would choose a number more like 5% of gross income per annum. 

Rates and council fees (~9%)

As a landlord you will be paying the council rates as well as the water rates associated with the property (note that you do not pay for the water usage but rather the connection charges).  This will vary from property to property and from council to council.  My charges have been pretty steady at 9% so I feel confident using this number to forecast into the future.

If you are thinking about calculating this for yourself remember that your council fees are dependent on the value of your property.  If you are buying a high value, low yield property then this charge will be higher as a percentage of rent than if you bought a cheap, high yield property. 

Insurance (~4%)

Insurance costs me about 4% of my gross income.  The price you pay for this can vary greatly and it is always worth negotiating every time it comes up for renewal - I save hundreds of dollars by doing this every year.

I have done posts before on how to negotiate your home insurance and why it increases so much.  Modelling for 4% or 5% insurance costs is an appropriate number to use.

Total cash expenses (~21% of gross rent)

My total cash expenses for the last financial year came to 21% of my gross rent.  Note that this number is a 'run rate' type of percentage.  That is your expenses will typically be much higher in your first year of ownership because you are bringing the property up to scratch and have things like legal fees that increase your expenses

I should re-iterate that your interest cost will totally dominate your expense line.  However many people when thinking about property investment totally forget that there are a fair few expenses associated with running it and that you really only have 75% - 80% of your gross rent to help pay it.

Why didn't I include depreciation? 

You may have noticed that one of the big expense line items that I didn't include above was depreciation (which for me is ~20% of gross rent).  This is because it is a non cash expense - you do not pay anything when you claim it (however you receive the tax benefit of the deduction).  

The tax deduction component of depreciation could almost be considered in the income line because you do receive this money back from the government however I have been conservative and not included it.

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What is NAV (Net Asset Value)?

NAV, or Net Asset Value is typically a term used in investment funds (both listed and unlisted).  It is the assessed value of the funds assets, normally by the management of the company and approved by independent valuers (though not always).

NAV is also sometimes referred to as NTA, or net tangible assets however I think this term is incorrectly used as NTA is used for all types of companies and does not necessarily refer to this independent valuation of assets process

What types of entities disclose NAV?

NAV is typically disclosed where it is hard for investors to see or discern the value of the assets.  This is often used for investments where the exact composition of the portfolio is unknown or where the assets are inherently illiquid and so assessing an actual value from regular valuation methods becomes difficult for investors.

There are many types of entities that disclose NAV however some of the most common ones are:

• Property trusts (both listed and unlisted)
• Property of all types is inherently illiquid.  As investors we know that the value of properties are changing however without the full information about all the properties held in the trust it is pretty hard to know how the valuation of these trusts are moving year to year
• Property trusts normally revalue their assets on an annual (or sometimes semi annual basis) so that investors know what the theoretical value of the assets within the trust are worth
  
• Equity funds
• Equity funds normally disclose their NAV on a daily basis.  It is very easy for them to calculate however very hard for outside investors to work out because they do not know the exact composition of the portfolio
• For equity funds the NAV represents the valuation of all the shares within the fund (and you divide this by the number of units to get the per unit NAV
  
• Infrastructure funds
• Infrastructure funds also typically disclose a NAV for the same reasons as property trusts
• They typically hold more than one asset and investors find it hard to value these assets from an external perspective.
  
• Companies with minority stakes in several unlisted assets
• Where a company does not have a controlling shareholding in several assets they often disclose NAV because it is almost impossible from regulatory filings and presentations to work out what these assets are worth
  
• Externally managed vehicles
• I have written before on the corporate governance related to externally managed vehicles
• External managers are often compensated based on the value of the assets under management. In order for investors to understand the fees being paid to external managers they often provide a valuation of the company and it's assets to justify the fees.

Why do companies trade at a discount or premium to NAV?

For listed funds and companies you will notice that they very rarely trade at NAV (the exception to this is listed equity funds which never really deviate far from NAV).  This seems counter intuitive - if you know the value of the assets then why would you see for less than they are worth and conversely why would you buy for more than they are worth?

The answer is quite simple - the NAV is always

Yellow Brick Road's 1.15% discount is good...but not a game changer

There as a splash recently in both the financial and regular press about a 'fifth pillar' entering the Australian banking system.  The press lauded the entry of this competitor as great for consumers and finally providing some competition to the big four Australian banks.

Who is this new competitor?

The new competitor was Yellow Brick Road, a financial services company with 130 retail stores across Australia, which had recently struck a deal with Macquarie, an Australian based investment bank to use it's balance sheet to provide funding for Australians looking for home loans.  Their headline rate seems staggering - they are offering a 1.15% discount to the standard variable rate which is a discount rate almost unheard of in the Australian banking environment.

Yellow Brick Road is a company founded by Mark Bouris, the host of Australian's version of The Apprentice.  He was also the founder of Wizard Home Loans, a mortgage provider he later sold to GE Money for A$500 million.  With Macquarie's balance sheet backing him this venture is unlikely to be a 'here today, gone tomorrow' type operation so it should be something that those looking for a loan should consider.

However there are risks of a new competitor like this which you need to consider BEFORE you refinance you loan with them

Although the deal seems great, there are actually several draw backs and 'false' comparisons which many hyping this product have failed to point out.  These include

• The 1.15% discount is for the first year only.  This then reverts to a 0.86% discount.
• Generally promotional or 'sweet heart' rates are targeted at those who only look at the first year and do not consider what rate they are likely to be paying later on.  Given that home loans last for 20 to 30 years, it is the 'normalised' rate that you should be considering - not the sweetheart rate
• To be fair to Yellow Brick Road - they do provide what the rate will be over the life of the loan on their comparison table
  
• The comparison table is flawed - ALL banks offer significant discounts if you ask for it
• The standard discount on a loan of more than $250,000 is 0.70%.  This table does not take into account this discount
• For example they have the NAB rate at 6.08% however I am only paying 5.91% on my loan (which is not very different to the 5.79% offered by YBR)
  
• Although you get a discount to the Standard Variable Rate (SVR), you do not know whether YBR will reprice their SVR to a rate higher than the other major banks
• There is no 'standard SVR' - banks can make this whatever they like
• Over time you can see that the major banks track their SVR's relatively close to each other however there is no such proof for a new competitor.  If they want to increase their profits they can increase this SVR to a point where they are actually charging you more than the major banks even if your discount is larger
  
• There are no ongoing fees BUT this is a very basic product so you do not get many of the bells and whistles that are standard on other banking products
• Banks often charge a 'package fee' for the loan that they provide.  Mine is $120 p.a. and for that I get an offset account linked to me loan, fee-free credit cards and discounts on significant other products
• The YBR does not charge the fee but you have NO option to have an offset account, they do not offer fee free credit cards or any of the other benefits that come with having a 'package deal'
• For me, the offset account is one of the most critical tools that I have in managing my finances so personally this is what killed the idea for me straight away
  
• As this is a basic product you should compare apples with apples
• As mentioned above YBR's comparison table compares it against the major banks and their standard home loans.  
• However this is a

Real Estate Investment Trusts: An alternative to direct property investment

Over the past few months I have gone through the pros and cons of investing in real estate and how to go about buying your own investment property and then all the things you need to know about to effectively own an investment property.

In this post I will outline an alternative to direct investment property - the Real Estate Investment Trust (commonly referred to as a REIT).    I will not cover every aspect to REITs in this post however I hope o cover some of the salient features with a few to providing more detail in future posts.

What is a REIT?

Broadly speaking, a REIT is a vehicle where several investors pool funds to invest in property.  It is essentially a managed fund which invests exclusively in real estate.

Below are some of the points which commonly define REITs (although they are not necessary for something to be classified as a REIT):

1. There are several investors (large, or listed REITS can have thousands of investors)
2. There is usually more than one property in the REIT
3. They are usually structured around specific types of property (e.g. office, industrial, residential, retail etc)
4. There is a manager who takes a management fee

Beyond these general characteristics, REITs can take on so many different forms that you can basically search for and invest in exactly the type of product you are looking for - there are listed and unlisted REITs, some of which are open ended and some of which are closed.  There are also REITs focused on growth and those focused on income and heaps of other features as well.

If you are thinking about investing in a REIT - make sure you understand exactly what you are investing in because it is not as standardised as many other financial products.

Benefits of investing in a REIT

There are several benefits associated with investing in a REIT (relative to direct property investment).  These include

• The entry costs are much lower
• Investing in direct property costs a lot of money up front.  This includes the amount for a deposit, taxes and a certain amount to cover the interest until the property is rented out
• REITs do not have these costs - you generally invest a minimum amount (which can be as low as $1,000) and you get the same proportionate return as everyone else
• Your risk is spread over several assets
• Single asset investing is inherently risky - all your eggs are essentially tied up in one basket
• Investing in a REIT gives you exposure to the property sector but spreads your risk among several properties - see my post on diversification
• It requires very little effort
• Once you decide to invest, other than keeping track of the performance of the manager and whether they are doing anything particularly dumb - you do not need to do anything

Downsides to investing in a REIT

Investing in a REIT is not the golden solution to property investing (although during times when the property market is on an upswing people assume it is).  There are several risks and downsides to investing in a REIT including

• You have to pay a management fee
• This fee can vary quite a lot but generally you are paying 1% - 2% of the totally amount you have invested each year for the manager to manage the portfolio - this can really add up over the long run
• You have no control over the asset or what assets are invested in
• When you invest in property directly you have a lot of control to make sure that the property is being looked after the way you want and that you get the property you want
• If you let someone else do this you are hoping that they will do it right
• You do not take as great an interest in the fundamentals of the investment as you would if you were managing the asset
• When you have an investment property you know absolutely everything there is to know about that property - the tenants, the upcoming expenditure requirements - everything
• Although you should keep track of your REIT investments the fact is that most people trust the manager to do it right and only look at it once a year (if at all)
• It is quite hard to know if and when things are going wrong until it is too late

Overall

I think that REITs have a place in every investor's portfolio.  They offer access to investments that would be out of the reach for normal investors (e.g. office buildings) and at various points in the cycles can be great value.

I hold both direct property and REITs.  I use REITs to hold those property forms that I am not comfortable investing on my own - that is development properties, commercial properties and retail investments.

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Things to consider when investing outside your home state

To date my series of posts on investing in real estate have been centred on the assumption that when you buy your first investment property you will be buying close to home.  This is because you tend to know the areas better, know the demographics and have a sense for the rules and regulations. 

When investors start thinking about their next investment property, or one further down the track they often start thinking about investing outside their home state.  There are several reasons that you may want to consider doing this but be aware that it comes with significant draw backs and you cannot assume that because you have an effective, functioning relationship in your current property / properties that this will translate to another state.

Pros of investing outside your home state

There are several pros to investing outside your home state and most of these centre around the benefits that come from having a diversified portfolio.  I have outlined some of the benefits below:

1. If your state is relatively expensive for property at the moment you can sometimes buy in 'slower' states which you think will recover
• Property markets are not homogeneous and while some are growing very fast, others are slowing down or are often in slumps
• If you are looking to buy a property you may not find value in your own state but there may be many great deals in other states
2. It allows you to diversify state specific downturns / high rental vacancies
• If you have multiple investment properties in one state the fact is that all of them will be affected by the same factors at the same time
• Having properties across multiple states allows you to diversify some of this risk away, especially when the other states are driven by different sort of impacts than your own home state

Cons of investing outside your home state

There are some very clear downsides to investing outside your home state and you should think about these very carefully before investing.  Only if you are totally comfortable should you go ahead and take the plunge.  Some of the downsides and risks include:

1. You have to start from scratch and do all your research again
• Although the asset class is the same, fundamental things like rules, regulations, rights and obligations are often very different between states
• Do not go into an investment in another state thinking the same rules apply!
2.  You do not have the insights that you do in your own state
• We all have significant insights into our own state that we don't have in other states
• We know which areas are better and worse and which ones are desired or have the potential to be desired in the future
• Although you can do your research in another state you just do not have that same level of inherent knowledge
3. Searching is a time intensive process - there is a risk that you make a hasty choice because you have limited time when you travel
• As you would know from your

Should I allow pets in my Investment Property

This will be a very brief post on whether a landlord should allow pets in their investment property.  Unlike things like age, gender and children, you are allowed to discriminate between tenants on the basis of pets and some day you will face the issue about whether you should allow pets in your investment property.  This post will cover the things you need to think about when deciding whether to allow pets in your investment property.

I have briefly touched on this topic before in my post on how to choose the right tenants.  You may want to have a read of that post here.

Is your property suited to pet ownership?

The first question to ask yourself is whether you are allowed to have pets on your property.  If you own the land this will never be an issue as you are the king of your castle - however if your investment property is in an apartment complex there are often rules about pets and whether they are allowed or not - do not advertise your property as allowing pets if they are not allowed.

Assuming it is allowed then it comes down to an issue of suitability.  Cats are generally easier in this sense than dogs because they take up less room and honestly are less of a mess.  Dogs require space, an enclosed area so they cannot escape and probably a bit of grass as well for all those other things. 

Check with their previous landlord about any pet damage caused

The fact is that some animals are more destructive than others and some owners are more conscientious than others when it comes to caring for your property - especially in relation to pets.  Your best bet is to call up the previous landlords when screening your tenants to find out what they were like in their previous property

Make sure you allow for and account for the pet in your lease

If you are allowing a pet on the property your lease needs several provisions

• An extra bond specifically for pet related damage on top of the bond they are already putting in place.  There is normally strict legislation on what sort of bonds you can take from your tenant so make sure you stick to the rules
• Provisions for cleaning when the tenants leave.  This is especially important for cats whose smell tends to linger for long after they have gone.  Put a provision in the lease that says that when they leave the property they will have it steam cleaned etc.

When you do your annual inspection CHECK for damage caused by the pet

It is better to catch issues earlier rather than later and your pet bond (described above) is more likely to cover the damage if you catch it before it gets too bad.  This comes down to being interested and involved in your property.

Finally - make sure you are comfortable with a pet being in your property

I can tell you, and other landlords can tell you, that it is not a problem having pets in your property as long as you take the right steps however if you are just not comfortable with it then they are not worth having.  If you are constantly worried about the damage that your tenants dog is going to do then you are probably going to ruin your relationship with your tenant or worry yourself unnecessarily. 

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Property manager changes: A natural part of the industry

If you have a real estate investment there is a fair chance that you manage your property through a property management company (normally through a real estate agency).  I have posted before on the decision to use a property manager versus self management, how you should choose a manager, the expectations you should set and how much you should pay.

You will eventually get to a point where all things are running smoothly and you really do not have a great deal to do at all.  This is the perfect place to be as your investment is running according to plan and not taking too much of your personal time. 

Invariably though, whether it be after 6 months, or 2 years, you will get a letter in the mail telling you that your property manager has changed.  This post will deal with the question of why and whether this is a big deal.

Why do property managers change so often

The first few times it happened I was honestly surprised how quickly my property manager was changing.  In the first 3 years of owning my property I had 3 different property managers.  1 got promoted to running the full property management team at the estate agency I was contracted with and the second took maternity leave.

I looked into it and it turns out that I was not alone.  Turnover is very high in the property management industry for several reasons including

• Property managers are often overworked. The fees associated with each property are relatively low, so to pay a decent wage and still provide profit for the company each property manager typically gets a lot of files to deal with
• Unreasonable tenants / owners.  The property manager is often the one caught in the crossfire between tenants and landlords.  This requires a certain type of personality and the pay is often not enough to compensate for being the punching bag for both sides
• The job is often seen as an 'interim' one: I read on a forum once that property management jobs are seen as a good way to 'get your feet wet' in the real estate market.  Your wage is not dependent on the number of sales you make but you learn to deal with people in the property market

The real answer is probably a combination of the above factors and others as well.  However the fact is that if you rent out your property through an agency then you are going to have some turnover in your property manager over the years.

Should I worry if my property manager changes?

The change of a property manager is particularly disconcerting if you have had a good relationship with your old manager and were happy with the way things were going.  In a word you should not worry if your property manager changes. 

However you should be especially vigilant for mistakes in the first few months of a new property manager.  If the company you are with has good systems in place then you probably will not have an issue but it is probably a good thing to keep a close eye on things just in case.  This is one of the benefits of going with a large established firm with a good reputation over someone that is operating on their own or starting a new firm.  The probability that a small firm gets a good replacement for you is lower than a large firm. 

If the new property manager is not up to scratch then there are several things you should do:

1. First talk to the new property manager and make sure that your expectations are understood.  They are probably getting used to a hundred different landlords and it could be that they just briefly dropped the ball - give them a chance to get up to scratch
2. If this doesn't work then speak to the management of the firm: They will either get that manager in line or allocate you to a new one who does know what they are doing
3. If this doesn't work then move to a new manager:  In your property management contract you should not have a break fee or notice period - the property management firm will always try and include these in the contract - make sure you take it out.  Before you give notice to your old management company make sure you have a new manager all lined up!

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.

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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