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Module 2
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Student Declaration
I declare the following statement to be true:
I hereby acknowledge that this submission is my own work, based on my personal study and/or research. I have acknowledged sources and resources used in the preparation of my submission whether they are books, articles, reports, internet searches, or any other document.
I also certify that the assessment has not previously been submitted for assessment in any other subject, or at any other time in the same subject and that I have not copied in part or whole or otherwise plagiarised the work of other students and/or other persons.
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Instructions
In order to clearly identify your answers, please type inside the boxes. As you need more room the size of the boxes will automatically increase. Be sure to save your work regularly! When saving the file please do so in this format: Name-Module#. For example: Steve-McKnight-Module1.doc
Part One: Theory Training
Q1. What are some of the potential financial and non-financial downsides for ignorant investors?
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Q2. Referring to the diagram on Page 7–8, explain how an investor can use savings, capital appreciation, cash flow and quick cash investing strategies to create an independent income. What determines how large this independent income can be?
[Attach a separate page if more room is needed]
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Q3. Which Level of Investor best describes you at the moment? What are the likely future financial consequences of remaining at this level once you no longer earn a salary or wage?
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Q4. Explain these terms [within the context of the Wheel of Wealth]:
Earned income
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Quick growth
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Passive income
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Yield (as it applies to commercial property returns)
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Q5. Explain what types of real estate investing strategies would be appropriate for investors seeking quick cash returns.
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Q6. Explain what types of real estate investing strategies might be appropriate for investors seeking passive income.
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Q7. Using the headings below, explain the differences between commercial and residential property.
Who normally pays the outgoings
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Length of the lease
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Annual rent adjustments
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Cost of improvements
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Q8. Explain how the Wheel of Wealth model adds clarity and specificity as to the right type of property, and the right investment strategy, for an investor seeking to use real estate to create enough investment income to replace their salary or wage.
[Attach a separate page if more room is needed]
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Q9. Using the headings below, explain for whom Monopoly Theory is better suited as an investment system.
Investment horizon
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Approach to investing
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Career/income earning ability
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Q10. Identify three dangers associated with quitting full-time employment to become a full-time investor.
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Q11. Name three options that may be available to create more time for investing without suffering the full consequences you’ve identified in Q10.
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Q12. Identify five traits of properties that might make good investments under the Monopoly Theory system and explain why.
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Q13. Fred is a plastic surgeon who enjoys his job and is well paid for it. However, he is also a passionate property investor who ultimately wants to have enough investment income to live a lifestyle he has become accustomed to when he no longer wants to work as a surgeon. Which approach do you think Fred would be best suited to – Wheel of Wealth or Monopoly Theory? Explain your answer by illustrating the steps of your chosen model as Fred might apply them to earn before-tax investment income of $200,000 per annum.
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[Attach an additional page if more room is needed]
Q14. What is leverage?
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Q15. Samantha is interested in purchasing an investment property for $200,000 and is weighing up whether or not to take out a loan for 80% of the purchase price, or to simply use her considerable savings to pay for it outright. Calculate the leveraged and unleveraged return (profit/loss ÷ cash contributed) based on the following scenarios: [include your calculations if completing by hand, or else you may use a well labelled spreadsheet and attach it to your assessment submission].
The property increases in value by 20%
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The property decreases in value by 15%
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Q16. Explain the following terms:
Negative gearing
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Positive gearing
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Depreciation
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The property market
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Q17. Using the example of blocks of units built in the 1970s (that because of changes to the planning code could not be rebuilt today) explain how scarcity drives value.
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Q18. Provide a brief outline of the likely effect on the property market in the following situations. Demonstrate your answer by redrawing the relevant supply and/or demand curve to illustrate what is likely to happen to the property price (demand) and amount of property for sale (supply).
1. A new $20,000 government grant for first homebuyers
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2. The abolition of negative gearing
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3. The removal of the 50% capital gains tax discount
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Q19. Explain the tax incentive provided to investors who choose negative gearing. In your answer quantify the tax offset a taxpayer who pays an average 30% tax rate would receive on a $10,000 ‘income’ loss and explain how the remainder of the loss may have to be funded.
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Q20. It’s been said that positive gearing is a flawed investment strategy because it results in more income tax being paid (because there is a profit), rather than less (as is the case with negative gearing). If this is true, why would an investor favour positive gearing over negative gearing?
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Q21. Contrast the advantages and disadvantages of buying a new home as an investment property as opposed to buying an older property.
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Q22. Explain how each of the following variables are important considerations when deciding which property is ‘best’ for an investor.
Return
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Passivity
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Strategy
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Cash reserves/borrowing ability
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Price
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Location
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Housing profile
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Q23. What is a mixed-use commercial property? What emerging mixed-use property trend is unfolding in larger land-locked capital cities where populations are swelling? How is this an opportunity for forward-thinking investors?
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Q24. Calculate the required financial information for the following scenarios? [include your calculations if completing by hand, or else you may use a well labelled spreadsheet and attach it to your assessment submission]
1. The gross percentage return (yield) on a commercial property for sale at $500,000 that is currently renting for $1,000 per week
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2. The impact on the property’s value of a $50 per week rental increase (at the same yield as you calculated in Question 1)
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3. The impact on the property’s value if the dwelling was rezoned a higher density and the yield dropped to 5%
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Q25. Explain how an increase in value can lead to a decrease in yield, and a decrease in value can lead to an increase in yield.
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Q26. Explain the following terms:
Tenancy risk
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Vacancy risk
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Finance risk
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Q27. Using your own simple example, explain what capital gains are and how they can be eroded by the impact of inflation.
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Q28. Outline a brief strategy for how you might improve the ‘efficiency’ of an older 1950s house on a corner ½ acre block of land and in doing so manufacture a capital gains return.
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Q29. What is the ripple effect? How can it be used to potentially identify areas that may be able to experience above-average market appreciation?
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Q30. Using the illustration of depreciation, explain how ‘profit’ is different to ‘cash flow’.
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Q31. Identify and explain the three possible ‘income’ outcomes from a rental property.
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Q32. Explain the relationship between perceived value and actual cost, and how the relationship can lead to a profit or loss on a renovation project.
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Q33. Why is gathering accurate information about the existence and cost of any structural repairs of utmost importance in a renovation project?
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Q34. Using the 135% renovation formula (Page 15-8), calculate the following on a ‘renovation delight’ property, currently for sale for $250,000 [include your calculations if completing by hand, or else you may use a well labelled spreadsheet and attach it to your assessment submission].
1. The minimum sales price needed to achieve a profit
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2. The renovation budget that would need to be adhered to
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3. The allowance for ‘holding costs’ while the renovation was being completed
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Q35. Explain the following terms:
Subdivision
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Development
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Setback
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Covenant
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Crossover
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Q36. You have found a parcel of land that can be subdivided into two lots and are weighing up whether to simply split the title and sell the land, or to go ahead and subdivide and build a new dwelling on each site.
The forecast profit on the subdivision is $100,000. The additional potential profit if the dwellings are built is a further $75,000.
Explain why might it be better to sell the subdivided land (i.e. project profit of $100,000) rather than going ahead and building on it (i.e. project profit of $175,000), if going ahead and building is budgeted to provide a higher project profit (i.e an additional $75,000)?
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Q37. Building a property that is difficult to sell on completion is one of the larger risks associated with property developing. Drawing from the discussion of the ‘6 Ps of property’, explain how researching what the customer wants can reduce this risk.
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Q38. Which investment strategy ought to have the highest return: renovating, subdividing or property development? Give reasons for your answer.
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Q39. How is vendor finance different from a traditional cash sale?
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Q40. Explain these terms as they pertain to the profit an investor can make from a vendor finance sale:
Price margin
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Interest margin
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Q41. Using the example of a self-employed businessperson, explain how vendor finance may assist them to enter the property market, if they so choose.
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Q42. Explain these terms as they pertain to the lease option investment strategy:
Lease/right to occupy
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(Call) option
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Periodic rent
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Option fee
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Q43. How is vendor carry-back different to vendor finance?
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Q44. Name and briefly explain the four variables that need to be established when deciding the basis of a vendor-carry back loan.
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Q45. Create a simple financial model (include dates) that explains how a simultaneous settlement could result in a lump-sum profit for a creative investor [include your calculations if completing by hand, or else you may use a well labelled spreadsheet and attach it to your assessment submission].
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Q46. Since property prices in Australia have risen faster than rents (and yields have therefore fallen), finding positive cash flow properties (on a rental basis) is becoming harder and harder. While this is a challenge, explain how investors can acquire/increase their recurrent investment income (derived from their real estate investments) by adopting an active approach in each of the following strategies.
Rental (buy and hold)
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Renovating
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Subdividing
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Developing
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Vendor finance/lease option
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Vendor carry-back
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Part Two: Practical Training and Research Assignments
Research Assignment #1
Requirement
Not all real estate investment strategies are relevant to every potential property investment. In this research assignment, you are required to find five properties that are currently for sale in an area of your choice, and to match those properties to what you think is the most suitable investment strategy.
In forming your answer, you need to explain your thinking about why the property would make a good investment, and outline the variables (assumptions) that must exist in order for a profit to be achieved. A guideline for the length of each answer is between 200 and 400 words.
Your choice of five properties must include at least three from the following list:
a) A generic growth property
b) A generic income (positive cash flow) property
c) A renovation
d) A subdivision
e) A development
Documentation
You will need to submit a print-out of the advertisement or other document that features the property you are using as a case study, as well as your explanation for your reasoning. Also include other information that you feel is relevant.
The properties selected must be for sale at the time of choosing them.
Research Assignment #2
Requirement
> Step One: Visit a home that is currently for sale in an area of your choice (for example, attend an open for inspection or arrange for your own private walk through). As you do, pay particular attention and make a list of at least 10 items in the house that could be ‘renovated’.
> Step Two: Having identified the items, obtain ball-park quotes for renovating them. (You are NOT required to obtain actual quotes from builders.)
> Step Three: Make an assessment about which items you feel add more perceived value than actual cost, and which items add more cost than perceived value.
> Step Four: Assuming you pay the asking price on the property, use the 135% formula outlined on Page 15-9 to calculate budgets for:
a) Closing costs
b) Reno costs
c) Holding costs
d) Selling costs
e) Your expected profit
e) The sale price you would need to achieve to earn your profit.
> Step Five: Based on your findings above, form a conclusion about the potential validity of this property as an investment under the renovation strategy.
Documentation
As evidence of your research, submit the following information:
a) Information about the property you inspected (a web ad, brochure, etc.)
b) List of items that need renovating. Include photos if possible
c) Description of how you would renovate/improve those items
d) Cost estimation of the improvements
e) Calculations
f) Written conclusions including explanations for your reasoning.
Research Assignment #3
Background
Simon wants to sell his home for $400,000. Ben wants to buy it, but only has $20,000 for a deposit (plus enough cash to pay for the closing costs).
Requirement
> Part One: Based on the variables below, calculate the vendor carry-back instalments Simon would receive assuming he funds the shortfall between what Ben can pay (i.e. his deposit and traditional finance).
> Ben pays his maximum deposit
> Ben also pays the finance he qualifies for: 80% LVR from the XYZ Bank at 7% interest, with monthly repayments (in arrears) over 30 years
> Simon is willing to offer vendor carry-back but wants 10% interest and monthly payments of the balance over five years, with the first payment upfront.
In your answer, explain at least two forms of security that Simon could ask for as collateral for the vendor carry-back loan.
> Part Two: Based on the variables below, calculate the vendor finance instalments Simon would receive assuming:
> Ben pays his maximum deposit
> Simon is willing to offer vendor finance over five years, but the sales price needs to increase to $420,000. The interest would remain at 10% with monthly repayments in advance
> In calculating the instalments, Simon is willing to base the monthly repayments over 30 years, with a balloon payment at the end of five years
In your answer, explain how the Ben’s legal right of ownership differs depending on whether he uses vendor carry back or vendor finance.
> Part Three: Calculate the total amount of the instalments Ben would have paid at the end of five years under Part One and Part Two. Also calculate the amount still owing under both alternatives (i.e. at the end of five years).
Part Three: Personal Application Questions
Task #1
Using the items listed below (which were outlined in Session 18), and applying them to your circumstances, create a logical argument for what would be the most suitable investment strategy for your next property investment purchase [word length – 500 to 1,000 words]:
1. Personal variables
> Your access to time
> Your access to money
> Your passivity
> Your skill /expertise/desire
> Your risk profile
2. Desired profit outcome
> Growth
> Income
3. Profit type
> Generic (market driven)
> Manufactured
4. Financial variables
> How much profit/annual income you want the investment to make
> How much of your own money you want to use
> How much money you want to borrow
> When the profit is expected to be earned
5. Preferred strategy
> No investment strategy seems relevant
> Buy and hold (growth focus)
> Buy and hold (positive cash flow)
> Renovation
> Subdivision
> Development
> Simultaneous settlement
> Vendor finance
> Lease option
> Vendor carry-back
> Combination of the above
Task #2
Explain how completing task 1 has provided increased clarity and focus with your investing. What uncertainties has it helped to answer?
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