I have been running a real estate agency for 15 years now. During this time I have sold hundreds of properties, many of them being investment properties. You might have
heard that property prices rise over time, and a common belief in Australia is
that property doubles in value every 7-10 years. Some of these investors sell
their investment property at some stage in their life for a profit; let’s name
them category ‘A’. There is another group f the investors that never sell in
their lifetime, let’s call them category ‘B’. There is a third group who, for
financial or other reasons, cannot hold on to their investment during a
property downturn cycle and have to sell at a loss, say category ‘C’.
I would like to share a real life example of a category ‘A’
client, the happy one. Whist the example is real, the name is fictitious. You may
know of many names that can be filled in the blanks, just with different dates
and figures.
Mr. Kumar Khan Singh since immigrating to Australia five years, worked and saved hard as most of the migrants do. He had savings of $100,000 in his
bank when he visited his accountant to file his annual income tax return for
2015. Accountant asked Mr Singh, “You are wasting your funds by keeping
them idle in the bank? Why don’t you buy an investment property and get it work
for you? property will give you huge returns one day”.
He referred Mr Singh to one his finance broker ‘friend’.
Broker arranged a $400,000 loan and adding $100,000 of his own, Mr Singh bought
a property of my real estate, a standard 3 bedroom house in Ingleburn with a
purchase price tag of $500,000. He did some basic repairs and renovations,
spending about $20,000. I then managed the rental property for him for the next
two years. Rental return was little less than the ‘interest only’ mortgage
payments but for the sake of simplicity, let us assumes that the rental income
covered all the outgoing expenses.
To Mr Singh’s delight, the market did boom in 2015-16 and he
started getting marketing flyers from real estate agents, telling him that his property
is now worth around $700,000. Why don’t you sell and make a decent profit? It sounded
like a good idea to hardworking Mr Singh. After all it was more than his last
two years’ salary, with all the overtime and shift work factored in. So he
decided to sell. House fetched $640,000 in 2017, which was $60,000 less that
what agent quoted (that is a story for another day). Still Mr Singh was happy
to make $140,000 profit, just by signing two documents in two years. One being a
purchase contract and other a contract of sale.
Everything sounded good to him and normal to me until one
day he rang my office and told that he has bought another property for
investment and is planning to buy one every year thereafter. He was boasting to
discover this 'secret' winning formula. Buy and sell every second year, make $150-200K
profit and live a happy life. He was so confident that he started contemplating
giving up his full time job in the near future.
This rang a bell in my mind; I didn’t
know for sure but had a feeling that something is not right in the
equation. There must be something that I missed for all those years. That evening I sat down with
pen and paper. Started writing some numbers that I knew, trying to understand
the ‘winning formula’. Here they are;
Own funds (equity) = $100,000
Bank loan= $400,000
Purchase price =
$500,000
Stamp Duty= $18,000
Solicitor/inspections= $2,000
Renovations= $20,000
Total purchase cost= $540,000
Sale Price= $640,000
Less selling fee = $16,000
Gross profit= $640,000
-$540,000 -$16,000 = $84,000
Capital Gains Tax (with 50% exemption after first year) =
$13,000
Net profit $71,000.
So good so far. Few months later, Mr Singh visits his
accountant again, with $171,000 in the bank now. Property market was still booming. Average 3
bedroom house now sells around $700,000.
Mr Singh, being a good negotiator, got a good deal and
bought his next property for $675,000. Very similar to the one he sold few
months ago.
Stamp duty = $26,000
Solicitor = $2,000
Total Purchase cost = $703,000
His equity = $171,000
Bank loan= $532,000.
(This is when bell stopped ringing in my brain)
Mr Singh owned a property with $400,000 debt, now he owns a
similar property (fetching the same rent) with $532,000 debt. Yet he thought
and I believed (at that time) that he has made a profit from the first sale.
Remember category ‘A’, happy seller, rising market. If this
is their story, what would be it like for category ‘C’, when they sell for a loss.
