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“Success comes from doing things differently”– Steve McKnight

Steve McKnight

Steve McKnight

Steve McKnight is a full time property investor, award-winning author and ex-Chartered Accountant who bought his first property for $44,000 in Ballarat back in 1999. Since then, Steve McKnight has founded propertyinvesting.com, a successful website and forum which has taught thousands of ordinary Australians about property investment. His book, From 0 – 130 properties in 3.5 years is Australia’s most successful real estate book ever. Steve McKnight - 0_130_properties_3.5_years

One of the key tenets which Steve McKnight advocates in property investing is to do things differently, that is, to try not to follow what the general investing public is doing or adopting a “herd mentality”. Many investors think that buying real estate is about getting in at the right price, find a good tenant and wait for capital growth to propel the investment forward.

However, savvy property investments are much more than find a good property to buy. It involves a detailed understanding what drives our property markets, its players, effective tax and ownership structures, financing options, how to “manufacture” equity and getting the investment dollar to work at its optimum rate. Steve McKnight’s techniques are about risk and return, using cashflow positive properties to continually drive towards a self-sustainable portfolio, minimising negative gearing and to sell when the time is right.

Many investors are against cashflow positive investments due to its location and perceived poor capital growth rates and even more are in favour of negative gearing as a form of tax minimisation. Still, some investors hold the adage that you should always buy and never ever sell due to its transaction costs, capital gains tax and so forth. Steve McKnight’s answer is there is no one single solution for every investors because investing depends on individual needs, risk profile and desired outcomes and he has proven that by doing things differently, we open ourselves to greater opportunities, albeit sometimes at a higher but calculated risk and have a detailed plan in ensuring that contingencies and other unforeseen have been taken into account.

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Top pros and cons of selling your investment property

I have met many property investors who steadfastly hold the principle that one should always buy and never sell investment property. A discussion of whether to sell can be fairly controversial and depends on many factors which can differ from one investor to another. Before getting into the pros and cons of selling, it may be useful to look at how an investment property might perform over time.

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Property Life Cycle

Over time, investment properties experience different phases where, when new, they tend to generate higher returns. As capital growth generally increases faster than rent, the property will go through a cycle of growth and maturity where returns will start to slow and eventually decline. Newer properties in the market with modern facilities will generally command higher returns than properties where fixtures and fittings are older and dated.

Just as there  is a right time to buy, there is also a right time to sell. And I have learnt from Steve McKnight that your chances of achieving financial independence are almost non-existent if you dismiss selling as a possible option over your investment lifetime. The right time to sell is when you can earn a higher return from your investment elsewhere.

Cons of selling

Investors who believe that selling is a ‘bad’ idea will invariably have the following arguments against selling:

  • Paying Capital Gains Tax, selling costs etc – Selling an investment property requires effort, let alone time and money. Costs involved may include hefty CGT, agent’s fees, legal costs let alone stamp duty and other acquisition costs during purchase. The emotional factor may also loom large when sentiments are attached to the property and when it has made decent returns over many years.
  • Refinance the capital gains – This is a convenient option to access equity without having to incur CGT and other costs.
  • Forgo future capital growth – Selling will involve “missing out” on any future capital gains the property may yield.
  • Cost of buying back in – Buying another property upon selling may seem futile as there will be additional costs such as stamp duty, legal fees notwithstanding the costs of selling. There can also be no guarantee the next investment property will perform better than the existing one.

Pros of selling

There are obvious drawbacks about selling as discussed above. However, there are also key advantages:

  • Crystallising your profits – A capital gain is only worth its paper value unless it is realised and converted into cash through a sale. Many investors, especially those in the US would have seen their capital gains vanished overnight when property values nose-dived in the wake of the global financial crisis.
  • Investment focus as a key criteria – The aim of sustainable property investments should be to constantly achieve the highest possible returns rather than to save tax.
  • Refinancing and its setbacks – Refinancing is a popular way to access the equity or capital gains achieved. However, the most important thing is to ensure the refinanced funds will be utilised in such a way as to achieve a higher return than the additional interest charges from the refinance.

a) Finding a suitable lender – Refinancing involves borrowing from the same lender and if that is not possible, refinancing the entire loan can be costly.

b) Increased credit risk – A larger loan exposure means higher risk from adverse movements in interest rates and exchange rates for investors who own off-shore investment properties.

c) Valuation and LVR – Refinancing is subject to the bank’s valuation and limits on amounts that can be borrowed.

  • Paying down debt – The proceeds from the sale can be used to reduce debt and interest charges and hence, improve cashflow or be used as a equity for a property with better returns. It can also demonstrate to your financiers that you are in control understand how and when to realise a gain on your investment.
  • Tax deferral – By deciding not to sell, you are deferring tax liability to a later date when and if you do eventually decide to sell. You will need to take into account inflation although this may (or may not) be compensated by higher capital growth.
  • Fund your path towards financial independence – you need to be able to fund financial independence from positive cash flow properties. By not selling and refinancing equity to take on more debt, your interest bill will be increased and it should be remembered that in funds used for lifestyle expenses is not tax deductible.

2-4-4 property development rule

Property development

Property development can be a risky business, especially if one is not familiar with issues such as subdivision, the process of liaising with council, utilities and relevant authorities to obtain building approval, managing builders, architects, applying for finance / development loans, obtaining accurate cost estimates, timing the market, building the right products for the right location and the list goes on.

Some investors take to property development because they feel that it may be “cheaper” than buying a property by paying retail price. Through small renovations, extensions and building new dwellings, they can “manufacture” new equity through the profit margins of the new development and hence, pay wholesale price. This thinking is logical provided the entire spectrum of property development principles are successfully carried out to minimise the risk involved.

Ron Forlee

Book by Ron Forlee

One simple rule that I follow is the 2-4-4 property development rule. I withered down extensive research on articles and books about successful property development, attending seminars by respected property investors such as among others, Michael Yardney, Steve McKnight and Ian Hosking Richards who have had decades of personal experience and have built up multi-million dollar property portfolios and successful property related businesses. One particular book that I would recommend is An Intelligent Guide to Australian Residential Property Development by Ron Forlee.

Importantly, I have also spoken and had in depth discussions with architects, builders, surveyors and project managers who are experienced in the specific location that I choose to develop and also have relevant contacts with planning officers in those local councils. By educating myself and getting into the details whilst maintaining a sense of the big picture, that is the end result of the successful development, I am able to minimise and alleviate substantial risks involved by applying this simple 2-4-4 property development rule.

My simple 2-4-4 property development rule says that in order to be successful, I must always keep strict control of the 3 largest elements of a project – profit margin, site / land cost and building cost in the proportion of 20%, 40% and 40% respectively. This rule always ensures that I should walk away from a potential development if it is not met.

A profit margin of 20% allows me some buffer for unforseen circumstances such as a sudden change in market conditions, new rulings or factors which are purely beyond my control. In such situations, this 20% margin still allows a fair return and minimise the risk of losing money. Depending on the location, the cost of the development site should be no more than 40% of the project’s completed sale value. Therefore, if the completed sale value of your project is $1 million, then the cost of the development site must not exceed $400,000, and likewise with the building cost.

Reed Construction Data has an excellent building cost calculator which can be used to calculate an approximate per square metre building costs.

This 2-4-4 property development rule is simple but can prove difficult to follow and implement. If implemented successfully, then risks are substantially minimised and margins better assured.

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Things I learnt from Steve McKnight

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Steve McKnight and Albert Wong at the relaunch of McKnight award-winning book

Steve McKnight bought his first property in May 1999, a $44,000 house in West Wendouree, which is a suburb of Ballarat, a regional Victorian town about 1 hour’s drive west of Melbourne. From humble beginnings, the ex-Chartered Accountant has become one of Australia’s most successful property investors and award-winning author on property investment. I met McKnight in November 2009 at the re-launch of his book in Sydney  – From 0 – 130 properties in 3.5 years by Steve McKnight which happens to be Australia’s most successful real estate book ever.

Steve McKnight - 0_130_properties_3.5_years

Some of McKnight’s property investing principles which he shares include the following:

1. Buy an “ugly” house.  Buying the “worse” house in the best street of a good suburb is cliche advice. What McKnight really means is to look for property which is almost close to land value in itself in suburbs with high rental demand and growth potential. “Ugly” or “old” houses generally have a relatively higher land to asset ratio, that is, the land on which the house was built has a much higher value than the house itself.

For example, if you bought an old house for $400,000 and the value of the land was say $350,000, the cost of the old house would be $50,000. Therefore, the land to asset ratio would be $350,000 / $50,000 = 7. As land appreciates and houses depreciate, the value of the investment would increase more significantly if it has a high land to asset ratio. On the other hand, new land and house packages on the market have relatively lower land to asset ratin because the cost of building a new house is much higher and comprise a significantly larger portion of the total packages.  It is not unusual for the land value to comprise of only $200,000 for a land and house package which cost $400,000.  In this case, the land to asset ration is $200,000 / $200,000 = 1. Moreover, a new land and house package will also have significant depreciation charges and if an investor is not in a position to be able to negative gear or offset these charges against taxable income, the investment will incur tax losses.

As rental from an “ugly” house can cover the mortgage to a large extent, it is then up to the investor to “manufacture” new equity through renovation, redevelopment or subdivision. He advocates “buying problems and selling solutions” as one of his successful property investment strategies.

2. Negative gearing a flawed strategy for seeking financial independence. Negative gearing is a strategy created to make a certain loss today and hope for a profit sometime in the future. Most investors are attracted to this notion because it helps to reduce their tax bill. However, this method means you are investing a lost-making property and unless you have a high annual income with no leverage, investing in a loss making proposition is hardly wise at all. According to figures from the Australian Tax Office, 1.2 million Australians declared negatively geared property investments in 2008 – 2009, claiming total losses of more than $12.75 billion. On average, they claimed losses of more than $10,000 each. This loss strategy also requires the property to gain good capital growth in the future in order for you to make a capital gain or profit when you decide to sell. In addition, this strategy also requires you to stay in your job to generate an income to offset the tax losses. Therefore, this  is hardly a strategy for financial independence.

3. Sell when you can make a better return elsewhere. There are many investors who steadfastly hold on to the adage that one should always buy and never sell their properties. Being an accountant like McKnight, I believe that if you hold on to a loss making venture and are either too proud or stubborn to cut losses, the course of action may cost you even more in the future, let alone the opportunity costs of missing out on more profitable ventures in the meantime. My adage would be to always buy and seldom sell, but do sell when your money can generate better returns on investment elsewhere. Sure, there may be exit costs but these costs should also be taken into account during the acquisition stage, where if one buys the right property, then money is made when it is bought as opposed to when it is sold.

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