Property Traps
The real estate industry is not currently subject to the same laws and regulations as the finance sector so therefore it is open to some pretty unlawful activity by what are known as property spruikers. This page is designed to point out some of the common “tricks of the trade” and property scams that occur all too often. You should take care before signing any contracts relating to any of the following;
• Property Hot Spots
• Off the plan investments
• Vendor Finance/ wrapping
• Property Investment groups
• Guaranteed rent
• Free Flights to visit the property / two tier marketing
• Through complex trust structures
• House and Land Packages
Further detail below explains further;
We would like to point out a common easily misread and therefore misleading phrase” Hot Spot”. Almost all magazines and seminars that use the following statements which can be misleading;
- We tell you where the Property Hot Spots are
- Property Hot Spots
- The best places to buy
- Where to buy and get 20% growth
The reason for this is due to the fact that these statements are referring to past tense, these were the locations you should have bought into a year ago. They have already BOOMED and if you buy there now, you would have simply missed the boat.
A “True” Hot Spot is a location where the property is about to BOOM, and should you buy there, you will make the gains in property price… and you know when you have bought in the next Hot Spot because a year later that location will be all over the investing magazines, newspapers and shows like “A Current Affair” and “ Today Tonight” stating “ We tell you where the Property Hot Spots are”….
When investing with the wHere group, we love it when a year after we have been buying in a particular area, this Property Hot Spot is advertised all over the TV and magazines… why??? Because then you can be sure that hundreds of property investors will race out to buy in this location and put a final boost into our already gained property price.
The sad part for these investors is that approx 6 months later this location then flattens and they make no gains at all…
Purchasing “Off the Plan” simply means that you purchase a property that is not yet complete. You essentially look at some building plans or a "display home" and buy the property at a discounted price.
It is generally at a discounted price as the developer must get a few “Pre Sales” on the project to prove to the bank that this project will sell, this gives the bank a safer base of equity to work with before approving a loan to a developer.
Many companies offer these properties for sale and they can be good if purchased in the right location. The trick is ensuring that this is the case. Property companies can align themselves with developers and simply sell the products they have available. As payment for aligning themselves and selling you a property off the plan they receive a commission from the developer who simply adds this onto your purchase price. This commission can be as high as 6% of the purchase price. For this reason bank valuations may come in low on these investments.
This is not research based investing! This is simply selling properties where the developer builds.
The other major issue here is that when high rise developments are completed, there could be 100 investors all looking for a tenant at the same time and as time goes on the properties remain vacent and landlords then have drop their rent price per week just to fill the property and a spiralling effect starts. Some developers offer guaranteed rent for one or two years. This can be a trap, as this amount again is simply added into the purchase price. So you are really paying for your own rent!
Now this type of transaction is not illegal and can be quite profitable if you purchase correctly at a good discounted price. There can be a few sneaky tricks that occur and there are a few dangers to be aware of such as:
• The developer goes bust – we have all seen building companies go under in the last 2 years so do your homework on the builder prior to signing to make sure that they are in a sound financial position.
• Depending on what type of development it is, when it comes to finance, the banks could either do a valuation from the plans or wait until completion and do a valuation then. Either way the valuations often do not come in at the purchase price. This may prevent you from proceeding with the purchase and depending on the detail in your purchase contract; you may lose your deposit and you may also be liable for any losses incurred for the developer to resell this property.
• If you haven’t purchased this way before you must be wary of the inclusions and the quality of the inclusions. Also check the quality of the fittings and finishing’s. If this is a house and land package off the plan, check if your contract says “turn-key”, this means it includes driveways, carpets, landscaping, blinds etc, if not, you could be up for these as an additional cost later down the track.
• Developers may sell the first few units in a block to their employees at an inflated price. So when you come and buy they will show you that a few have already “Under Offer” and at higher prices. The developer may then release his employees from these contracts, penalty free, but you are then stuck. Ask to speak with other purchasers if you can.
• The Developer could sell and settle one property to a friend or family at an inflated price. This then sets a price precedence for valuation of future sales. A valuer may use this sale upon which to value other properties in the same development. At the end the Developer and friend can resell the property and even if they lose a little on one property they gain on all the others sold at the inflated price.
• The law states that a property must have 7 years builders warranty against any faulty workmanship. Now this all sounds good but we have all heard the hard luck stories of other owners trying to get a developer to come back after one year to rectify some work under warranty. Investigate the builder’s insurance policy and find out what it covers or excludes. You don’t want to end up in court and further out of pocket.
• Our advice is to always pay for an independent valuation yourself, before signing any contracts and have a chat to the valuer to get their honest opinion. They cost approx $250.
Vendor Finance, otherwise known as wrapping is simply taking advantage of the uneducated or experienced and ripping them off. It is usually only viable on cheaper properties which have high rents and is illegal in some states of Australia.
To explain further:
1. A property is purchased by an investor for $120,000 who funds the purchase with a loan from a bank at let’s say an interest rate of 5.04%p.a.;
2. The investor then offers the property for sale again immediately thru way of “Vendor Finance, no deposit required, even if you have bad credit” targeting people curious to find out how this works and wanting to get into their first home;
3. Once a suitable First Home Owner agrees to buy the property, it is then sold for $160,000 on a 100% loan by the vendor on a special contract drawn up by the vendor;
4. The inflated purchase price has covered any stamp duty costs the vendor had to pay when purchasing the property initially plus a tidy profit in a short time;
5. The vendor then offers the new purchasers an interest rate of around 2% higher than what they are paying the bank;
6. And often the contract stipulates that the purchaser must hand over the $7,000 or $14,000 First Home Owners Grant to the vendor;
7. In many instances, the new purchasers must pay up to several thousands of dollars deposit as well;
8. The vendor further covers his bank loan expenses of $504 (5.04% Interest Only on initial loan value) through the inflated loan repayments the purchaser has to make to the vendor. For example - the new purchasers make Principle and Interest repayments on $160,000 on an interest rate of 7.04% which equate to monthly repayments of $1,068;
9. Therefore the vendor is gaining $564 profit per month from the new purchasers;
10. Often the contract of sale stipulates that the title of the property remains in the vendors name until the loan has been repaid in full. If there are any defaults in payments then the vendor has full right to repossess the property back from the new purchasers, leaving them high and dry.
11. Because the new purchasers have been selected very carefully by the vendor, they bank on the purchaser defaulting so that the vendor gets to keep the deposit, plus the First Home Owners Grant and the property. Then they start all over again with another group of new purchasers.
12. Just a note - all bank loan contracts exclude this type of activity. However if the vendor does not disclose the intent to on sell the property under vendor finance – they may never find out - so it continues.
Be wary of property investment clubs selling volumes of properties in one area. Find out who owns the land and the building companies and if they are in any way linked to the investment club. Common practice amongst these companies is to buy a parcel of land, subdivide into many lots, sell these to investors and have their own building company build the houses. Again suburbs can be filled by investors and definitely no research into locations done here, they simply buy where the land is cheap and sub dividable.
Guaranteed Rent
Please let us make a clear distinction here. There is a difference between private investment firms that offer “rental guarantees” as part of their marketing package and Government Departments or Australian Defence Housing Projects that do the same. Government or Defence housing offers are funded by the government and therefore the rental returns are real.
What we want to draw your attention to are property seminars (often promoted on the radio or in property magazines) that invite you to attend their investment event and as part of their package offer guaranteed rent if you buy a property from them. These firms are usually flogging a property developer’s product or may be the property developer themselves.
The risk comes when the rents they quote are inflated and built into your purchase price. Again – lets us an example to highlight the issue here:
If a unit in a high rise building is being sold for $420,000 with a Guaranteed Rent of $400 per week for 2 years, part of your purchase price is to pay for your own Guaranteed Rent. It works in the following way; the developer knows that he can rent the unit very easily for $300 per week and have the unit filled for the entire 2 years. There is a shortfall of $100 per week over 2 years = $10,400. The developer is not in the business in giving away $10,400 on every unit in the block so this is added to your purchase price, meaning the unit is only worth $410,000 plus the extra $10,000 rent = $420,000
And as long as there are similar units in the area that have sold for $420,000, then the valuations by the banks will stack up.
The downside to this is that the rental returns stated at the time of purchase are usually inflated so after the 2 year period has ended, you are unable to gain the same rent per week. The other major issue is that there will be many other units in the block wanting tenants now as well, as their two year guaranteed rent has expired as well, therefore creating an oversupply in units available. And sure enough there will be a large reduction in rent to simply get them filled.
Free Flights to visit the property / two tier marketing
This is where property companies try to sell to interstate investors. Again there is no research as to why this area is better than any other; they simply sell where they have built the property.
You may recall media reports of this type of scam in the 1990’s out of Queensland. Unfortunately the same offers remain around today - to explain further;
• Advertisements seek and invite suitable investors that have plenty of equity in their home, usually couples in their mid forty’s to inviite them to investment seminar’s;
• During the seminar, the investors are presented with very compelling “data” showing them how they can buy property in other states that are “that are often better than their own homes and at a cheaper price” – e.g. new two story properties similar to their own but for $200k less. The key here is the leveraging of the new property against the investors perception of value for money in their home.
• The investors are pampered and flattered during the seminar and are sold on the idea of “We’ll even fly you to inspect the property for FREE!” The flights are arranged by the developer, and soon, 40 or so investors are jetting off to check out the prospective properties;
• Once the investors land they are escorted to a bus and driven strategically to the location. I say strategically because the bus will never pass a real estate agency along the way nor see any property advertisements on the side of the road;
• During the trip there the developers hype everyone up and conveniently say that there is, by chance, a mortgage broker on the bus whom you should all have a chat to as he can arrange your finance;
• Once the investors arrive, they are shown a select number of houses aimed to suitably impress with their value for money – often better quality and cheaper price than the investors own home. There also happens to be a solicitor on site as well, he/she can sign you up for your investment property today, with a finance clause of course;
• So the investors are encouraged to buy and sign that day as “this is the best deal ever and you simply can't miss a once in a lifetime opportunity…” Nor to they want to miss out as another investor on the bus may buy it first.
• The investors are fed, giving the opportunity to chat with the mortgage broker again and get the finance underway;
• They are then escorted back onto the bus and again strategically driven straight back to the airport and flown home;
• The problem is that if you were that investor, you would have just purchased a house for $400k – without independent valuation, in a different state that may only be worth $300,000! Your value perception of your own home, versus the investment property, would have misled you in making a decision that you were buying value for money!
Now because you have a lot of equity in your home, the banks will more than likely still give you the finance, even though the property only valued at $300,000, here's why;
- Your home is worth $600,000
- Your home loan is $250,000
- You buy the property for $400,000
- You borrow the entire amount (purchase price plus stamp duty) $420,000
- Total equity base is now $600,000 + $300,000 (real value) $900,000
- Total loans are $250,000 + $420,000 $670,000
- The loan to value ratio (LVR) is $670,000/$900,000 74%
- As this is below 80% the banks are happy to fund this transaction
- Conveniently the mortgage broker never tells you the real valuation figure for the property you just bought for $100,000 too much.
That is what ‘Two Tier Marketing’ is about and if you had been that investor, you would have just lost $100,000 and felt good about it until you find out years later when you try to refinance and find out the real valuation. This kind of activity is illegal.
This is common through solicitors, accountants and financial planning firms. They offer some "out of this world" revolutionary structure that no normal human being could understand and bamboozle clients into thinking this is the best way. Once clients buy into the elaborate structure, they could sell them property anywhere. This method also ensures the client now stays with them for life as no other accountant, financial planner or solictor would understand how they were structured. Set up costs here are extremely high and care should be taken when looking at the tax implications. A second opinion from your own accountant or an independent solicitor would be advised. Again there is no research into these property locations.
House and Land packages
This can be a great investment if purchased in the right location. As they are brand new they can have great tax depreciation benefits (especially when a depreciation schedule is provided or purchased) and rents are usually higher. The key with this type of purchase is to do the research first, not simply purchase the property because it’s new and the rent is high. The other big trap here is that if these properties are being sold by investment companies, then you could be assured that the entire suburb will be sold to investors. Keep in mind that the normal desired ratio in terms of property ownership in one area is home owners to investors is 3:1.
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