REAL ESTATE AGENTS UPDATE OCTOBER 2012
HOW TO AVOID PITFALLS WHEN BUYING INVESTMENT PROPERTIES
For most people, buying a home will be by far their largest financial commitment. It is important that they take all reasonable steps to avoid the inevitable pitfalls. If the property is intended as an investment it is even more important that care be taken.
Planning before Purchasing
The saying “to fail to plan is to plan to fail” still rings true. Most people do not plan to fail, but many fail to plan. And statistically, those who do not plan are worse off than those who do plan.
Whether purchasing your first home, or an investment property, real estate is a major commitment, and requires as much planning and care as any major business investment.
Don’t buy the wrong type of property
It is easy to make emotional and impulsive decisions when buying property. Before even starting to look for a property, consider the question – what type of property is best for you? Are you buying an investment property, a home to live in long-term, a house for just a few years, an apartment for the children, or do you want a home-and-income?
If you are buying an investment, what are your goals – are you looking for long-term capital gain, cash-flow, or tax benefits. Or do you require a balance of all three?
Are you ready for commercial property, or do you wish to stick to residential property? What is your price range?
Do you want to be an active landlord, or to have someone else manage the property for you? Do you wish to purchase a property in your immediate area, so that you can keep an eye on it, or are you comfortable with a property located out of town?
Having made these decisions, you should then look for a property that meets your criteria.
Avoid the wrong property
The big one. Theoretically you may have chosen the right property, but in practice it doesn’t work out. So what went wrong?
Most likely the buyer had not carried out proper due diligence before and after signing the contract. It was either the wrong specific property, the ownership structure or loan structure was set up inappropriately, or the timing was wrong.
Before considering putting an offer on a property, you should consider all of the matters which should be checked. Some can only be checked after signing a contract, often by your lawyer, accountant or valuer. Some you can check yourself beforehand.
Those you can check include: likely maintenance costs, cash returns and capital gains. Is the property likely to be high maintenance; are rentals likely to be good; is it in an area – or at a price – which should generate capital gain over time?
Remember to consider all on-going costs such as rates, insurance, maintenance, garden care, and management fees. If it is a unit title, do not overlook body corporate levies. You should also make allowance for lost income when the property is untenanted, unless it is to be subject to a long-term guaranteed lease.
Your lawyer will be able to check whether there are there any legal issues with the title.
You should familiarise yourself with the different types of land ownership – i.e., freehold, leasehold, cross-lease and unit titles. Don’t leave this to your lawyer.
If it is a cross-leased title, is there an exclusive use area, and does the house as it stands correspond with the survey plan? Problems can arise when owners build garages, decks or carports on the land without their neighbour’s consent and without completing a new “flats plan”. What is shown on the flats plan attached to the certificate of title is all that should be on the land. If a garage, carport or conservatory has been added, this addition should be – technically must be – added on the flats plan. If it is not, then the title is deemed to be defective. Many owners acquiesce in this. But what happens when they want to sell and a buyer – or their lawyer – is more fussy? Older cross leases do not always include exclusive-use areas, so all of the owners of the freehold title can technically use any area outside the flat – and that can cause friction between owners.
If it is a unit title, is there a robust body corporate budget, including a sinking fund for maintenance. A buyer does not want to be faced with a huge bill for re-roofing or re-painting shortly after buying. Similar to a cross-lease, you cannot alter the external dimensions of the unit without completing a re-development plan. This plan is subject to the same survey, local authority and other legal requirements as the original plan. All owners and their mortgagees must consent.
A shared driveway may cause problems for owners, whether a freehold, cross-lease or unit title property. If there is a shared drive, are there any provisions for maintenance?
Beware of leasehold property which has a rent review at a later date. Ground rent may increase dramatically.
Are there any easements, e.g.; rights of way, which affect the property, or which may be required for the proper use and enjoyment of the land?
Planning compliance. Is the property compliant with Resource Management Act 1991 and the Building Act 2004? Does the house have a building permit or a Code Compliance Certificate? Are there any Council requisitions affecting the property?
If there is a swimming pool, does the fencing comply with Council requirements and the Fencing of Swimming Pools Act?
Is it potentially a leaky building?
Is there a Master Build Guarantee? What warranties are available? Are warrantees available from the contractors and suppliers of whiteware and other chattels?
Ensure you have the correct ownership arrangement
You should decide before entering into a contract whether it will be in your personal name, a partnership, trust or company (LTC or otherwise), or some other structure. You could even buy through a property syndicate.
This decision is crucial. Depending on your choice you can incur significant costs, lose major tax benefits – or have to pay more tax than you should have to pay. You might even have to pay a future capital gains tax unnecessarily if you make the wrong decision now.
Due to the “associated persons” rules under the Income Tax Acts, the sale of your own home can be treated as taxable activity if you are deemed to be a property developer or trader. If you are planning to purchase more than one investment property, or to sell one or more property within a short period, or are buying with the intention to on-sell, you must consider how to (a) avoid either being deemed to be a developer, or (b) if that is not possible, how to quarantine your own home.
Use the most appropriate financing and loan structure
You should receive advice from your accountant and bank manager, as well as lawyer, prior to determining what ownership structure is right for you. We recommend initial discussions with these experts prior to entering into a contact to purchase.
Remember that the more debt you have, the less the bank will lend you. You may be tempted to buy an investment property before you buy your own home. Cash flow would be greater, and the purchase tax favourable. But if you do not reduce the mortgage balance – and you may chose not to so in order to maximise your tax losses – you may find that when you wish to buy you own home the bank says no. It may be better to own your own home first, and reduce the mortgage prior to buying an investment property using the equity in your home, and borrowing the full purchase price of the investment.
What to look for before signing any contract
Always remember, an agreement for sale and purchase is a binding contract. Do not sign it without prior legal advice – and read the contract before signing it!
Although the contract is binding, you are not committed to settle the purchase until all of the conditions in the contract are satisfied or waived. Conditions may be inserted for the benefit of either the vendor or the purchaser, or both. The agreement comes to end if they are not satisfied. The purchaser is obliged to take genuine steps to try to satisfy the conditions.
Remember, if you change your mind after signing the contract, it is most probably too late. You cannot cancel a contract just because you have changed your mind about a property.
Matters to consider before signing include:
(a) Is it the right type of property for you?
(b) Is this the right specific property?
(c) Is the contract either in the name of the purchaser you have chosen, or you and/or nominee, to give you flexibility?
(d) Is the price right? You cannot easily renegotiate the price after signing. If you are uncertain, the contract should be subject to a satisfactory valuation.
(e) Is there a finance clause that gives you sufficient time to arrange finance? For an investment property this may be longer than for a home-buyer. Do not underestimate the time that may be required to arrange finance, particularly if it involves restructuring your existing property.
(f) Is the deposit at a level you are comfortable with? Particularly if you are to borrow this money. Is the deposit payable to a trust account?
(g) Are there any further conditions which need to be inserted, for instance, in relation to the sale of an existing house, or for the receipt of a satisfactory LIM report from the Council?
(h) For most residential properties it is usual to make the contract subject to the Purchaser obtaining a satisfactory Land Information Memorandum (Property Report) from the Council.
(i) A building report condition may be appropriate for an existing house. Particularly if it has monolithic cladding, or was built between 1999 and 2006.
(j) Does it allow you the opportunity to conduct any due diligence that has not already been done, and the chance to cancel the contract if you are not satisfied with the due diligence process?
(k) The “due diligence” process can call for input from several disciplines, including local government, legal, financial, valuation, management, surveying and engineering. We recommend carrying out as much of this as possible prior to signing the contract.
(l) The Agreement should list the chattels to be transferred to the purchaser’s ownership. Check if there are any other chattels which should remain in the property. You should check with the vendor whether any of these are subject to any guarantees or warranties.
(m) Check the arrangements for settlement. Will you have sufficient time to organise your finances, and the other matters to be taken care of prior to settlement?
(n) Remember that once the contract is unconditional, you are required to settle unless the house is destroyed or substantially damaged. Ensure that you have your own insurance policy in place. For rental properties, the insurance should be landlord’s policy, not homeowners or a simple fire policy. You may want rental replacement cover, particularly for a commercial property.
(o) You should also consider life insurance, and possibly mortgage insurance.
(p) Buying at auction requires particular care. You will most probably be purchasing unconditionally. Your due diligence process must be completed before the auction, and you must generally be ready to settle the purchase within one month.
(q) It is important to consult a lawyer so that he or she may act for you before you enter into any contractual arrangements for the purchase of a property. The lawyer can advise you on the terms and conditions which should be included in any agreement by the documentation required. The lawyer can also assist in raising finance and given advice on all aspects of any purchase or investment.
Conclusion
The purchase of real estate is a major commitment, and requires commensurate care and due diligence.
Please feel free to discuss any of the above matters directly with John Cox.