BY MARK ARMSTRONG
7 June, 2016
Trading property may sound exciting, but the entry and exit costs could eat away at your profit. It's a decision that needs experienced research and insight.
If you've thought of buying a residential investment property, renovating it, then selling it to make a profit you're not alone. It’s a common strategy, but unless you plan carefully, it may not bring the kind of return you were hoping for.
When you buy a residential property in Australia, the State Government asks you to pay stamp duty worth around 5% of the purchase price, it varies state to state.
If you’ve borrowed money to purchase the property and undertake the renovations, you'll be paying interest on your loan without receiving any rental income during the renovation period to offset the loan repayments. Make sure you're fully aware of the costs, and that you are confident you can manage to stay on top of them.
Don't forget that when you sell the property, you’ll lose 2 - 3% of the sale price in the commission you pay the real estate agent, plus approximately another 1% in advertising costs. Factor these costs into your calculations.
In short, not only are you paying interest on an investment loan out of your own pocket, but you are losing close to 10% of the property’s value merely by entering and leaving the market.
When you actively add value to a property, you're taking a gamble that the sale price will equal the price of the renovations plus your profit margin. Most property grows in value over time, but not all sectors of the market grow at the same rate.
If there isn’t sufficient demand for your style and location of property, you may not make enough money to cover the entry and exit costs, outstanding loan balance and renovation costs, let alone make a profit. If you're planning on trading property, be cautious about where you buy it, and how long you'll be holding on to it.
Research the local market and its past sales thoroughly to determine the property’s likely selling price. Look at other properties in the area that have been renovated to the same standards as yours and sold in the last three months.
If all goes as planned and you do make money on the transaction and you sell the property, you'll also be liable for capital gains tax.
It’s can feel like taking two steps forward and one back!
We’re not saying that buying to renovate and sell is a poor strategy in itself. It can be highly successful, but only if the capital growth outstrips the buying, holding and selling costs. Even in locations where capital growth is strongest, this may take several years. And capital growth compounds, so the longer you hold the asset, the greater the amount of growth. If you sell the property as soon as the renovations are complete, you may not have allowed enough time for capital growth to take full effect — substantially reducing your potential profit.
In other words, the substantial entry, exit and holding costs mean residential property should not be traded like shares, but held for the long term (at least 7 to 10 years) to ensure the capital growth justifies all the expenses you’ve incurred along the way.
"Make sure capital growth outstrips the buying, holding and selling costs."
If a real estate agent is advertising a property as 'perfect for adding value', ask yourself whose interests they are promoting — yours or theirs? Remember, they stand to make a commission on selling the property for the previous owner, followed quickly by another commission on selling the property for you after it has been renovated. It's an important factor to consider.
It’s also important to factor in the cost of your time. How much you would have earned from your normal job if you weren’t at the property supervising or undertaking the renovations? And what about your leisure time? How much time will you spend away from your family and friends?
For example, if the project is going to take up six months of your evenings and weekends when you would otherwise have spending time with loved ones, will the expected financial profit make that lost time worthwhile?
If the holding, transaction and time costs add up to more than the property’s likely sale price, you may need to reconsider whether it’s worthwhile undertaking the project.
Finally, once you've answered all those factors, if you still believe that buying to renovate and selling quickly is the right strategy for you, make sure you calculate all the likely holding and transaction costs.
"Make sure you calculate all the likely holding and transaction costs."
Trading property, or flipping property, as it's commonly known isn't something that will always end in financial gain, so be thorough in your research and consider the props and cons of each decision.
Here are five points to consider:
NB: All advice is general, and for guidance only. It is advised to seek professional financial advice, tailored to your personal situation before making any decisions.
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