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My first real estate deal

I bought my first investment property aged 24. It wasn't all smooth sailing. Read how thorough analysis and research rescued me after a bumpy start.

Beginnings of a Real Estate mogul?

I bought my first investment property aged 24.

My first real estate deal.

At the time there was a lot of propaganda about an “investment strategy” called negative gearing. The sales pitch typically went something like “the tenant pays for half your property, the tax man pays for the other half”.

Sound too good to be true? It usually was.

the tenant pays for half your property, the tax man pays for the other half

Letting tax considerations choose your investments is a terrible idea

How the approach worked can be summarised as follows:
  • A person earning a decent wage would be paying lots of income tax.
  • The person purchases a rental property, adding any rent earned to their pre-tax income.
  • Any expenses, including financing costs, reasonably incurred while earning that rental income are deducted from total pre-tax income.
  • A further deduction was potentially available for the non-financial depreciation expense of capital equipment (the house, fixtures, fittings, but not the cost of the land).
For negative gearing to be successful the investor needed to first find a cash flow positive property, one that earned more than it cost to hold.

Depreciation is a figment of an accountant’s imagination, in that the owner doesn’t actually part with any cash as a result of assets becoming depreciated. Roughly speaking it is the periodic reduction in value of an asset over its useful life.

Once the investor applied the depreciation deduction, their cash flow positive property produced a negative taxable income. This "loss" was offset against the investor's other income, reducing the size of their overall tax bill.

Unfortunately many investors heard the “reduce your taxes by applying property losses” message, but missed the part about the property first needing to be cash flow positive.

Asset costs more to hold than it earned.
Asset costs more to hold than it earned.
Think about that for a second.

Loss making businesses aren't the route to riches

Many landlords were running a loss making business, in order to minimise their income tax. They were subsidising their tenant’s housing costs in doing so, spending $1 to avoid paying less than $0.50 to the tax man.

this meant many landlords were actually subsidising their tenant’s housing costs
The owners argued any short term holding costs would be more than offset by anticipated long term capital gains resulting from a rising property market. Their goal was to minimise holding costs while waiting to be rescued by rising house prices.

I was quite proud of myself for seeing through this potential trap for young players.

I built a fancy spreadsheet that allowed me to analyse cash flow and taxable property returns.

I researched employment trends, rental yields, capital growth forecasts, city planning proposals, development applications, infrastructure improvements, and zoning regulations.

I identified a target area, inspected a few properties, made a couple of cheeky offers, and purchased one.

Yay for me! I was now a property owner.

Within a couple months the property was tenanted and the cash started to flow.

I did the victory dance.

Then the wheels came off

Then interest rates rose.

And rose again.

And again.

But rents didn’t.

The cash stopped flowing. Argh! I'd undercooked my tolerance for rising borrowing costs.

Argh! I'd undercooked my tolerance for rising borrowing costs. 
For the next 6 years I too was one of those idiot landlords subsidising their tenant’s housing costs.

So what?

This adventure into property investment taught me some valuable lessons. In time all that research paid off. A major shopping centre was built nearby. Several new schools and leisure facilities opened.

The value of the property more than doubled during this period, with the accumulated equity securing the purchase of several more investment properties.

2 comments :

Miss Mazuma said...

Wow - what a ride! Glad it all turned around eventually but you took a huge risk. I was about the same age when I bought my first place. I had no idea how important location was until I found myself at 25 living in a working class community of various languages...none of them spoke 25 year old single girl. ;) Within a year I sold and moved to the city where I belonged. After that my real estate addiction went off the rails causing me to learn a few lessons of my own. I only wish mine turned around as good as yours!

Slow Dad said...

Thanks Miss Mazuma. It is fantastic that you ended up finding where "home" was, even if the investing didn't always work out how you'd have liked.

My father used to say the difference between a bad haircut and a good haircut was about two weeks. I think this is likely true of real estate also... unless a person really has the area they buy in wrong, if they wait long enough it'll end up looking like a successful investment... the old "everyone looks like a genius in a rising market" cliché very much applies.

Of course what they gloss over is the potentially huge opportunity costs associated with tying up their capital during that wait. My six years is a good example of that. While everything worked out in the end, a more prudently chosen property initially would likely have seen me reach Financial Independence several years earlier than I actually did.

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