By Lacey Filipich, BEng(Hons), MAICD
This month my husband and I sold a property. We don’t do that often. In fact, it’s only the second time I’ve sold and the first for hubby. The last time was a golden handshake from my employer: they paid me the average of two valuations on the home and I signed it over to them. I didn’t have to engage an agent, I didn’t have to clean my house for home opens, I didn’t even have to think about it really. That’s a far cry from this recent sale, which can reasonably be termed ‘a learning experience’. With all this learning fresh in my mind I am writing this post so that you, dear reader, may profit from it if you ever decide to sell a property.
A bit of background
We settled on this particular property on 4 May 2011. It was a rental and remained so until December 2012 when we decided to update it to get a better yield. Soon after, we decided to move in to take advantage of the excellent location. Within a matter of months, we realised this home would be too small for our future needs so we knew we needed to move again. Our preference was to buy. This left us with a decision: keep the current property as a rental, or sell and use the cash towards the next home?
We opted to sell. There were a number of reasons which I will elaborate on in this post. Not the least of these was that we wanted the equity to put against our next home, which we knew would have to be considerably more expensive to meet our needs while remaining in the area. We signed up to sell in late January 2014. After three months on the market with no success, we decided to rent it out instead. Our tenants moved in on 4 June… and moved out again in early October when they purchased a home around the corner. They gave us four weeks notice as per our agreement, so we decided to sell again within that window – if it didn’t sell, we’d just rent it out again. This time, we got an offer and signed within two weeks of listing. Settlement was 4 November 2014.
The purchase price for this property, which is a four-bedroom, two-bathroom villa in Bicton, WA on 350 square metres, was $540k. We sold it for $568k exactly three and a half years later. On the surface, we made a ‘gross profit’ as it would be termed by RP Data, the popular Australian real estate data source. Using their calculation method – sale price minus purchase price – our profit would have been $28k (5.2%). We would have fit neatly into the ‘0 – 10% gain’ category of their recent Pain and Gain report which summarises the overall profit and loss proportions of sales for the June quarter of 2014.
This is misleading. In fact, we took a loss on this property. I hazard a guess that many of those in the same band as us did. So what’s wrong with the gross profit measure?
1. Buying and selling are costly
When you buy property in Australia, you can expect to pay the following over and above the purchase price on the contract you signed:
- Stamp duty
- Conveyancing for settlement
- Title search fees
- Fee to establish your mortgage (if you have one)
- Fee to attend settlement from your bank
- Building and pest inspections – if you elect to do them (which you should)
Of these, stamp duty is the killer: we paid nearly $20k for the purchase in 2011. With all the other fees included, our purchase cost was nearly $562k.
You can breathe a sigh of relief that you’re not paying stamp duty when you sell. But be prepared to gasp again: you’ll still get slogged at that end too, this time by the agent’s commission. Again you pay for conveyancing, title searches, and fees to attend settlement. Our net sale amount after these costs was $547k.
Taking all buying and selling costs into account, it’s a loss of $15k (2.8% loss) compared to a 5.2% gain on the gross profit method.
And that’s not all…
2. Inflation reduces your gains
‘When I was a little girl, a ticket to the movies and an ice-cream cost sixpence’. We’ve all heard the octogenarians lament the ridiculous expense of living today, and they’re not exactly wrong. You probably won’t get change from $20 for the same today. But is it actually more expensive? Not really.
Prices go up over time and the end result is that the $20 in your pocket today will be worth $19.42 in 365 days. In 70 years, that $20 will buy for you then what would today cost $2.50 – perhaps a chocolate bar. You will be aghast when this happens and lament to your grandchildren: ‘In my day, $20 got you a movie ticket and an ice-cream!’ while they roll their eyes and think ‘But a chocolate bar costs $20 Grandma, so just shut up about it you doddering fool…’ all the while nodding and smiling at you. Inflation, the cause of these price changes, is a fact of life so best get used to it. Comparing nominal dollars (those in the currency of the day) is not useful. You must compare real dollars (those adjusted for inflation).
Now get ready for some of my favourite TLA’s (Three Letter Acronyms)…
Inflation is represented by the Consumer Price Index (CPI) in Australia. According to the Reserve Bank of Australia (RBA), our economy can be considered ‘healthy’ when CPI is between 2.5 and 3.5%. The RBA will actively pursue this range through monetary policy, i.e. adjusting interest rates. Using data from the Australian Bureau of Statistics (ABS), specifically data series 6401.0, I calculated the inflation between the purchase and sale of the Bicton property:
To compare the purchase and sale in real (inflation-adjusted) terms, the calculation becomes:
- $547k minus 7.55% to convert to June 2011 = $506k
- $506k minus $562k = -$56k
In real dollars, we lost $56k (10.4% loss) at sale, not just $15k.
Depressing, right? Wait, it gets worse…
3. It was negatively geared
We lived in the property for around three quarters of the last financial year (FY14). Before we moved in in mid 2013, it was rented for $400 to $420 a week via an agent. After we vacated, the repairs and improvements we’d done increased the rent to $525 a week privately. The post-repair rent is more typical of Perth yields today. Even so, we made a loss on that property every month it was rented. The losses on my tax returns were:
- FY11: $247
- FY12: $6,718
- FY13: $8,993
- FY14: $613
And this is just my half because we owned the property 50/50. Between both of us, in nominal dollars, our loss was around $32k. Adjusting for inflation each year brings that down by around $1k. So we actually lost $87k (16.2% loss).
This is the problem with negative gearing. By its very definition, you are losing money on any property that is negatively geared. The theory is that the capital growth of the asset offsets this loss. This may be true in some cases but it certainly wasn’t in this instance.
I won’t bother tallying the capital improvement costs that we will now never recoup in entirety – carpets, air conditioners and the like. Or the costs of the money we borrowed, though these are somewhat offset by tax returns on rentals. Suffice to say that a $87k loss is conservative – it may be worse than that.
What did we do wrong?
As I mentioned, this isn’t my first turn on the property merry-go-round. When we bought this property, it had been nearly a decade since I’d bought my first property. I understood the process, the risks and the potential rewards. So what the heck went wrong here? I’ve wracked my brain and mentally flagellated myself over this. Here’s what I surmise:
1. Skimped on due diligence
We were in a rush when we bought. We first saw the house on 2 March, knowing we’d be off to America to live for at least six months on 1 April. It ticked so many boxes we have for investments:
- Street front stand alone property on its own parcel of land.
- Amazing location – 800m to river, close to transport, shops and good schools.
- Solid construction – not easily damaged by tenants.
- In shabby condition that could be easily corrected with cosmetics.
- Reliable tenants in place for extended period of time.
We did the right thing on our contract by including building, pest and finance clauses, all of which were fulfilled within the allotted time with no issues.
What we didn’t do was scope out the neighbours.
The selling agent has a duty not to be discriminatory, so he was not allowed to point out that the flats next door were owned by the Department of Housing unless we asked. We didn’t. Given our tenants had been in there for nearly two years with two small children, we had assumed it must be a reasonable neighbourhood and didn’t worry about checking for ourselves as we thought we were too busy packing our belongings into storage. I’d like a time machine so I can go back and slap myself for THAT particular thought. It was only two years later when I was trying to get the dividing fence fixed that I found out.
Soon after, we moved in and learned for ourselves that of the ten apartments, two were occupied by some real pieces of work. Over the next several months we made dozens of complaints for disruptive behaviour of all descriptions: yelling, swearing, damage to property, fights, death threats… all within the apartment block. At one point after three consecutive nights of complaining due to the loud music and excessive swearing coming from a third unit, Housing finally worked out it was being occupied by squatters who happened to be friends of one of the problem tenants. The squatters were turned out but their friends remained. It all came to a head in late February 2014 when one group received an eviction notice and started lashing out at the neighbours. A metal chair landed on my shed roof at 9pm, not three metres from where I sat with my one-year-old daughter. I left with my daughter that night and never slept there again. We moved into a rental within the week.
In the book ‘Rich Dad, Poor Dad’ Robert Kiyosaki advises a thorough scoping of any property. Knock on the doors of neighbours to see if they’re helpful. Walk through the area at all times of day and night. Pay attention to who is coming and going. Fifty visits might be considered enough. Had we taken the time to do that, perhaps we would have spotted the undesirable neighbours and made the decision not to buy.
2. Sold too soon
It is generally recognised that it is unwise to sell a property within seven to ten years of purchase. Why? Aside from the masking effect of inflation making you think you’ve made a buck, here are a few excellent reasons:
- The costs of getting in and out, as I’ve explained above, are huge compared to other investments. You don’t want to be paying stamp duty and agent’s commissions every few years.
- If you follow the recommended repayments on a mortgage of 25- or 30-year terms, you will barely make a dent in the principal in the first five years. So you’ll be making repayments, but the interest you’re being charged will almost cancel this out. When you sell, you’ll basically kiss goodbye the original value of the mortgage, which means your equity (if there is any) is entirely reliant on growth.
- Property goes through cycles in Australia, just like our economy as a whole. There are ups and downs. It’s not just a steady increase year on year. So if you sell inside a cycle, the chance is greater that you’ll pick the wrong part of the swing and end up making a loss. Crossing multiple cycles means these ups and downs even out somewhat. The average cycle is seven to eight years, so buying and selling inside that can be problematic.
So, we broke that rule outright by selling in less than four years. Silly us. Sure we had excellent reasons, but if we could have held on for a few more years, there’s a good chance we’d have made a more significant gross profit. I can’t vouch for the real profit after costs and inflation though.
3. Got emotional
It’s pretty hard not to take it personally when someone throws a heavy object in your direction. Every complaint made to the Department of Housing was an emotional drain. I dreaded the follow-up interviews and the letters. It got so I hated thinking about the property, even when we’d moved out. If I’d been thinking with my financial brain, I would have handed the property to a rental agent as soon as our tenants gave notice and instructed them to take care of everything. The property would have been close to neutrally geared, meaning it wouldn’t have cost us much to own. We could have waited out that last group of problem tenants. They’ll get evicted eventually and then the neighbours wouldn’t be such a turn-off for potential buyers.
Our financial brains were overridden by our emotions. We took a low offer because we just wanted to be rid of the place. We allowed ourselves to get stressed about it and it clouded our decision-making. We probably could have got an offer closer to $600k if we’d been willing to wait a bit longer, but even that wouldn’t have been enough to get us in the black. Do I think we could have made a real profit on the property eventually? It had all the makings of a great investment so perhaps it would.
I’ve always had the philosophy that no matter what you do with money, you have to be able to sleep at night. I was losing sleep on this one, so perhaps a $87k loss is a small price to pay for not worrying anymore. Can you put a price on your mental health? I suspect not. I’d still prefer to make a profit if I can.
For a few weeks after we signed the contract, I doubted myself. How dare I have the audacity to write educational materials about money when I have failed? How could I consider myself a credible investor if I could make a mistake of this magnitude?
I now realise this makes me even more qualified to talk about money.
I’ve learned the hard way – and I’ve REALLY learned. I won’t be making this mistake again. We’ve bought our dream home now and I reckon I spent more than twenty hours ‘casing the joint’. I took my daughter to the local playgrounds, asking unassuming parents about the kinds of people living nearby whenever I could. I knocked on doors. I wandered the streets every chance I got, even in the wee hours of the morning. I did that as well as all the other due diligence we did last time. This time our neighbours are fabulous.
Perhaps more importantly, an $87k loss is just a blip for us. It’s a bit less cash in our offset account, so it’s a bit more interest we’ll be charged on our home loan. We had plenty of equity owed to paying down the mortgage quickly, so we still walked away with a wad of cash. We’re not on the verge of bankruptcy. We don’t have to sell any of our other properties or shares to survive. Our portfolio is constructed such that a loss on one item is not going to have a substantial long-term impact. Because mistakes happen – sometimes we stuff up, sometimes things outside our control can derail the most promising of investments. No one is perfect. Act accordingly.
Where to from here?
This property is my worst investment yet. It was my fifth property purchase after four successful and (so far) profitable ones, and is therefore excellent proof that experience does not make you infallible. So even if you’re an experienced investor, please take heed from my example:
- Do your due diligence. All of it. Read ‘Rich Dad, Poor Dad’ for some great pointers. Do not skimp.
- Plan to buy and hold. As much as possible, invest in property with the long term in mind. Especially with established homes you’re planning to rent – development is perhaps the only proven short-term moneymaker in the property game.
- Distance yourself emotionally. At all stages from research to selling, do not make investment decisions based on emotion. Use your logic and trust the numbers. If you find yourself too involved, get some separation by hiring someone to take care of it for you for a while. Don’t let emotions override good sense – unless you’re losing sleep.
- Calculate your real pain/gain. The gross profit method is useless for anything but mass statistics. Be honest with yourself: have you really made money? Take your costs, losses and inflation into account whenever you work out how your property performed. You may be pleasantly surprised or unpleasantly shocked, but at least you’ll be able to better analyse where you can do better next time. Here’s how to do that calculation again:
- Add all your buying costs (stamp duty, title searches etc) to your purchase price.
- Take all your selling costs (agent’s commission etc) away from your sale price.
- Find out the inflation between your purchase and sale from the ABS (series 6401.0) and either prorate up your purchase or prorate down your sale so you’re comparing apples with apples.
- Work your your yearly profit or loss, including the cost of borrowing and any capital improvements. Tax returns are an excellent resource if you’re analysing an investment property. Use inflation results to convert these to the same basis as you used for the dot point above. Include this in your calculation.
Have you got a property investing story you’d like to share? We’d love to hear about it – please leave a comment below.
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Lacey Filipich is the co-founder and director of Money School. She helps parents raise financially savvy kids and helps adults get on top of their finances. Connect with her on LinkedIn and follow Money School Facebook to learn more.