Economic slowdown ahead?

Question from Will updated on 16th January 2007:

Hello Experts! I'm currently in a job and earning between $1000-1500 a week after tax. I own my own home and I have one rental property setup in a LAQC with myself as the sole director/shareholder. It is my first financial year and my LAQC's mortgage is $500 a week. I currently get $300 a week in rental income to my company from the tenants in the property. I have a accountant who has setup the loss to be claimable off my personal paye tax. I have been considering purchasing a second property because I seem to have enough residual income to cover it with or without tenants, I don't really know anyone in the property investment game but every non-expert I do know keeps saying "wait wait" as if there is going to be some economic slowdown or something. What I am wondering is: 1. Is there any advantage in waiting, other than earning interest on my money? 2. Would I risk losing my tax rebate by purchasing another property which would add to the loss my LAQC is making now? 3. Is there any downside in purchasing now, other than not having as much lose cash? It's time for me to listen to the experts! Any help/advise would be greatly appreciated. Regards, Will.

Our expert responded:

Firstly, your rental property is negatively geared by $200 per week, taking into account only the mortgage as a cash cost and excluding all other cash costs such as insurance, property management fees, repairs and maintenance and rates. The age of the property will dictate how good your depreciation claim is, and from there, the size of your income tax refund. I would suggest that the refund is not going to be enough to cover the entire cash loss you are making on the property. From that point of view alone, before making any further property investments, you need to be sure that you can cover the cost of the mortgage if there are no tenants, and if there are tenants, that you can cover the shortfall ongoing.

I do believe there is going to be a downturn in the property market and the only question is how big a downturn. Right now, my crystal ball is not giving me the answer to that question. If there is a downturn in the market, then property investors will need to batten down the hatches, manage their cash flow closely and ensure they are not over committing themselves. Investors should also use this time to review their mortgage structures to make sure that their own home is not being used as security for their property investments. Banks will take the home as security when a mortgage will not stand on its own, such as a 95% mortgage on a rental property. For this reason, it is better to only borrow 80% of the purchase price and refinance at a later date, rather than give the bank both your home and the rental as security. Otherwise, if something goes wrong with the rental, your own home is put at stake.

So in answer to your question, is it a good time to buy? As Dolf de Roos says, the deal of the decade comes along once a week. In this market, the key is research and to remember that you make your money on day one. In other words, you only buy a property if it is under value, and really, it should be under value quite considerably right now. If there is a downturn and you buy now at the top of the market, it will not take long before the property is worth less than what you paid for it, so put some buffer into the equation by buying below value. Only buy now if you are really happy with the deal and not just because you can buy a property. Adding properties to your LAQC will not have any effect on your refund from IRD other than to make it bigger, and hopefully just be the size of your depreciation claim and not because you are not getting enough rent to cover all of the property cash costs.

Kenina Court is a director of Acorn Solutions Limited, an accounting firm dedicated to working with clients to help them create wealth. She is an avid property investor, entrepreneur and seminar presenter on asset protection and wealth strategies.


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