It seems everywhere you turn these days there is dire news about Australia’s property markets.

Late last year, property analytics firm CoreLogic revealed house prices in Sydney had suffered their biggest monthly fall in 14 years. Conservative analysts suggest the overall Australian market will fall 15-20 per cent with no rises for another two years, while others are predicting even more bleak scenarios. There’s no doubt that many of Australia’s property markets are now softening and that conditions are radically different in the east coast capitals to 15 months ago. But if you’re a property developer or investor, it would be a mistake to throw your hands up, walk away, and wait for the market to head north again. As the esteemed American investor Warren Buffet so eloquently puts it, smart investors are “fearful when others are greedy and greedy when others are fearful”. With the right strategies, property speculators can survive and thrive the current market, but how? Here are six smart strategies.

  1. JOINT VENTURES WITH PROPERTY OWNERS

One of the big challenges facing developers and investors is the drying up of credit. Under instructions from APRA, banks have previously capped investor loans and are now significantly reeling in the number of interest-only loans they issue. While restrictions have been lifted, it’s harder to get money to invest. If you’re a developer, one solution may be to consider forming a joint venture with the vendor of the property you’d like to develop. Essentially, you enter into a partnership where they supply the property and you supply expertise and potentially meet the construction costs. In return, they share the profits you reap. This significantly lowers your need for cash upfront. With vendors now achieving significantly lower sale prices and looking for ways to add value, a falling market is the perfect time for such agreements. Just be sure to involve lawyers so that each party’s obligations and benefits are clearly spelled out. As with any development, there is a possibility of getting it wrong which may result in the property being unprofitable. The owner has the property, so they keep it and don’t lose anything, but you are out of pocket for all the experts and have to abandon the project with nothing to show for the amount of time, money and effort put in.

  1. RENT TO OWN (LEASE AGREEMENT)

While not so common in Australia just yet, this approach is used in the US and elsewhere in the world. Rent-to-own schemes (also known as rent-to-buy schemes) are leasing agreements giving renters the right to buy a home at the end of an agreed rental period, at an agreed price. A vendor who is having trouble selling a property enters into an agreement with a buyer who might be struggling to get a loan. The vendor agrees to lease the property to the buyer over a period of, say, three years, with the buyer given the option to buy the property at the end of the period. The lease payments count towards the final price paid. Property investors can make a profit by acting as intermediaries, connecting potential vendors with potential buyers. Again, with property prices on the wane, more vendors will be keen to explore this kind of agreement. The risk with this option is that the market may fall but you are locked in at a higher purchase price, meaning you could have made a bad bet. The same applies with any property purchase, but if you are in it for the long-term, then this unlikely to be a problem.

  1. SECOND MORTGAGE CARRY BACK

This is another useful tactic for situations where you may not be able to borrow enough money to carry out the development you have in mind. Essentially the vendor steps in and lends you the shortfall. Seller carryback financing is when a seller acts as a lender and carries a second mortgage on the subject property, which the buyer pays down each month along with their first mortgage. So, for example, if you want a property worth $1 million and the banks will only agree to lend you $700,000. You reach an agreement where the vendor signs a second mortgage on the property for the remaining $300,000. You now have the money needed for the project to proceed and the vendor has $700,000 plus regular income provided by the interest payments on the $300,000. This works particularly well where an empty nester is looking to downsize to a smaller home. A risk with this method is that the market falls below the value of the two mortgages registered on the title, resulting in negative equity (the debt owed is greater than the value of the property).

  1. OVERAGE AGREEMENT

An overage agreement is where a vendor receives a bonus if your planned development proves to be as profitable is planned. They might agree to sell you a property at below its market value (e.g. $900,000 instead of $1 million) with a legal proviso in the contract that if you achieve a certain profit they receive an extra payment (perhaps $200,000). This reduces your upfront investment and means the vendor takes on additional risk (and potential profit). As with any contingent liability, there is uncertainty and a potential debt. However the contingency is subject to profit levels, so if you keep the contingent liability factored into all feasibility studies (i.e. not let it out of sight or mind and get a shock when the seller puts their hand out for more money after the fact), sometimes there is a risk that you may have allocated profits three times over. Once the numbers have been run, again when receiving a contract for sale and the third time when actually being paid – at this point there is not enough to go around.

  1. OPTION AGREEMENTS

Acquiring a property before you know whether you will obtain a DA (development approval) and be able to develop it profitably is a risky business. An option agreement allows you to effectively take a property you are interested in off the market and then buy it at a time that suits you. You enter into an agreement where the vendor receives a small sum of money (typically one percent of the agreed purchase price) and agrees to sell to you at the end of one or two years if you choose to take up the option. However, if the market falls, you have locked in a higher purchase price and lose your option fee. The mitigation against this risk is to make sure it is only a call option whereby you can elect to walk away and not exercise the option (as opposed to a put and call option where the seller can compel you to go through with the purchase of the property at a higher price). You want to option but not the obligation to buy the property.

  1. INCREASE YOUR TAX EFFECTIVENESS (2% HOME LOANS)

If you are paying off a home mortgage and have property investments, there are ATO-approved tax solutions that can reduce the interest rate you pay on your home loan by multiple whole percentage points. Essentially, these solutions allow people who own a home and one or more investment properties to restructure the interest rates in a more tax-effective way. So, for example, rather than paying 5.6 per cent on your home mortgage, you might pay two per cent. This can potentially improve your overall economic position, giving you greater scope to invest in the market. The product – “The Loan Controller” is offered by an Australian lender who has obtained an ATO ruling that is valid until 2020 (at time of writing). It enables you to pay off your home sooner (by providing a low-interest rate on PPR debt) and allocates higher interest to an investment property, meaning that all of that interest is then tax-deductible. The risk is if you don’t refinance before 2020 then the ruling expires. The ATO may grant a further period and renew the ruling but if not, this may not be available after 2020. For those who refinance in time, the ruling will apply for the term of that loan. So, don’t write off the property market. Instead of seeing the downside, look for the upside and potential opportunities.

 

ABOUT THE AUTHOR

Dominique Grubisa BA (Hons) LLB, LLM is the CEO and founder of the DG Institute, a wealth management education service specialising in making property investment possible for all Australians.

 

This article was first published in the ANZPJ May 2019 edition. Visit the ANZPJ library to read past publications.