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.
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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