Spreading the Risk, Capital Gain & Returns

Once again when we enter the field of financial investing we emphasis to seek professional advise from your Accountant/Financial Advisor, Solicitor and Financial Institution, the following example is NOT to be taken as advise. It has been posted as a request from a party that wished to share educational examples.

The following example came to light when I was asked by a friend of mine who was considering investing into residential property. I will not disclose parties names or addresses to protect the relevant parties. They approached me as friends do and asked me for my opinion in relation to this particular property. The subject property presented well and the asking price was reasonable. Once they disclosed their financial position to me I asked them several questions, such as why they wanted to buy this particular home, was this a long term plan and if they had ever considered moving into the property at a later date.

After discussing these matters with them over a period of time it became apparent that this was a wealth plan for their Superannuation Fund. Once they disclosed that they had intentions of buying this property for their Superannuation Fund it also became apparent to me that they needed to discuss this further with their accountant, if they have not already done so. I advised them that it was extremely important that they have their entity in which they had intentions of buying the property with to be in place prior to executing a purchase. They then went on to tell me that they had all legal entities in place with their Self Managed Superannuation fund (SMSF).

Well now these people also disclosed to me that they had a large amount of equity to contribute towards the property and this is when we provided them with a simple option, to keep it simple, don’t put all your eggs in one basket, in other words spread the risk. These people then asked for an example on what we meant by that, and it was a very good question.

At the time they had considered buying, Capital Gains was running quite high, running at about 8% per annum. They had approximately $220,000 in their bank account, and the homes in the suburb they looked at had asking prices ranging from $250,000 – $280,000.

We advised them to consider buying two homes as this was permissible within the Regulators scope of SMSF financial loans.

This example was quite simple and we had no intentions of making it difficult for people to understand, we adjusted the figures to be simple and conservative, you will notice that the rental has not increased over the years and we have allowed lower than average growth figures,

1st Proposal: 1 Home $250,000
Annual rent            Gross return           Capital Gains     Total annual return
$12,5000                5%                           7%                        12%
2nd Proposal: 2 Homes $500,000
Annual rent            Gross return            Capital Gains    Total annual return
$25,000                   5%                           7%                       12%
If they had considered keeping the properties for 2 years
1st Proposal 1 Home would return a rental total of $25,000 and a realistic possible sale price of $267,500,  total return $292,500, a gain of $42,500, 21.25% over 2 years
2nd Proposal 2 Homes would return a rental total of $50,000 and a realistic possible sale price of $535,000, total return $585,000, a gain of $85,000, 42.5% over 2 years
The above figures are based on returns before loan repayments and taxes.
Our friends are happier with this method because not only did they spread their risk but they also increased the potential of their Capital Gain and gross returns.
Once again, if you are considering investing into real estate seek professional advise from your Accountant / Financial Advisor before proceeding with signing of any documentations.
George Serghis
Property Consultant

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