Know the rules, then break them.. 13/08/12

This week I think it’s time for a strategy to make some good money and secure a great deal.

A lot of the things I have written recently have been about understanding the limitations placed on buyers and sellers in the property market place. These limitations tend to guide us through what makes a good buy and what we should look to avoid. It’s what I would consider the rules of buying right. Things like, location, transport, size, fit out, and all those other wonderful bits and pieces that make up the essence of a property that isn’t only attractive to you, but attractive to a potential renter and in the future, to another buyer.

There are also rules about what banks and lenders will allow you to borrow money for. These are driven by size, location and in some cases rental management. So once we know what constitutes a good investment property, and what we can effectively borrow for, then we know what we are chasing and we go shopping. The only catch here is that what applies to you, applies to a heap of others as well, and that means competition.

So what about all those properties that don’t quite fit the bill for a good investment? The ones that are too small, not zoned right or classified as serviced apartments by their management style? Great examples of these are things like student accommodation units. These are units, normally studio or one/two bedroom, are generally in great locations and are in fairly good condition. The issues with them lie in the fact that they are generally zoned as not for owner occupation and are classified as “for use as student accommodation”. In the majority of cases they are zoned “business” as opposed to residential and for the most part are really quite small internally.   Not the sort of thing a bank thinks is a decent investment.

Rental wise, because they are in such a great location and are so close to the schools and infrastructure, they can average some pretty high rental yields based on their size. For the most part they are managed by companies that understand an international student is more willing to pay a higher rental rate to ensure they are in a new, safe property, walking distance to school, rather than save a few bucks to rent something a 30 minute tram ride away. With this in mind you can achieve the same sort of rent for a studio apartment in a student housing complex as you do for a two bedroom in the outer suburbs of Melbourne. The difference here is that a Student studio will only cost you $150,000- $180,000, and the two bedroom apartment is well into the $250,000 plus range if you are lucky.

I get asked all the time, why the banks think something that costs less yet returns more is a dangerous investment. The fact is there are a number of underlying factors that the banks know about which can make or break an investor. These include, but are not limited to, body corporate fees, other outgoings, rental control, pooled rental, management agreements and their binding nature and anything else that takes the control or revenue return away from the owner of the property. If these things are not correctly addressed and analysed before making a purchase in a controlled rental environment, it can lead to years of pain and in a lot of cases some pretty hefty financial loss. The banks and lenders have seen this happen before to a lot of their clients and as a result they throw a blanket ban over all apartments that even come close to this description.

This doesn’t mean they are all a bad and dangerous investment though. When you know how to analyse the management agreement and the other costs associated with the purchase, you can identify some of these properties that are really quite good. The problem is though, how do you buy them when you can’t get a loan from the bank? If only you had the money. Well, you do.

As a generalisation for those of you in your mid 30’s and above, have a quick look at what your superannuation policy has in terms of funds. That’s right, how much do you have in super. If it’s up around the $140,000 mark, then you are in business. Now, before we go any further, this is NOT investment advice for your super. I will not be telling you how to run out and register trusts and set up self managed funds. That’s for your accountant and Financial planner to do. What I will do is show you what happens if you have a self managed policy in place and about $140,000 in it.

Let’s assume you have found a student apartment that doesn’t have huge body corporate rates, or pooled rental and is managed on a single traditional lease basis, in other words one that ticks the boxes. These student apartments start back on the resale market at usually around their original asking price. So let’s say the last owner paid $220,000 for it. They list it and get no interest from the open market. No one can buy it because they can’t get a loan and the banks tell them it’s a bad deal.

Over a period of time this unit price drops lower and lower until eventually it comes to you at about $150,000. The owners really need to get out. Knowing you have $140,000 in your Super, you suggest to the agent that you may be the only real buyer out there that can purchase, and as you are looking to make a cash purchase, you put offers in at $100,000. The fact there is no one else that can afford the $150,000 asking price using bank leverage puts the owners under pressure. The agent can sense a sale is in the wings, so they work to get things done. A little to and fro and before you know it contracts are signed at $112,000. Add the stamps and legals and you still have a $10,000 buffer in the super and an unencumbered property. And what does this little place rent out for a month? Try $999.00. So it cost about $112,000 and makes about $12,000 gross per year. Don’t forget to add costs and outgoings for the real net figure, but you get the picture. It earns pretty well for the super.

The key things to remember here are as follows. Its zoned Business for now, so don’t expect a great deal of capital growth, however at some point in time in the future the zoning may change to residential and allow owner occupation. Can anyone say Ka-Ching? That’s when the property value will jump. Also, if you are looking to resell the property, expect that it will be tough based on its internal size. If you couldn’t get a loan on it then expect it will be tough for others to. You wouldn’t really care too much though as it sits unencumbered so you are never really pressured to sell it.

It’s not a bad scenario when you look at where the money comes from, how strong your bargaining position is because you are cashed up, what it rents out for and just how well you can do when the competition is limited and you have a plan. It all sounds really easy in theory too, and many of you will tell me that, like most property stuff, it sounds great until you try to put it into practice. It can’t be done. I mean really, who’s going to buy an apartment for $112,000?

When you know the rules and then know how to break them you would be surprised what you can achieve. The unit I’ve just used as an example is mine. I bought it early in 2012. I tend to practice before I preach. As always, negotiate hard, but fair. Have fun and buy well.

Garry McPherson

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