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Chapter 2: Tips For Beginners
Avoid Common Ways To Lose Your Shirt

As I mentioned in Chapter One, you should look for cash flow positive properties, in other words, investments that put money in your pocket.

Most property investors don't do this. Most settle for an investment which breaks even or may even lose money. Why would someone willingly buy an investment that's advertised to lose money? I don't know and can't think of one good reason why it happens.

Perhaps if people were more educated they'd make better decisions. Read the warnings below and hopefully you won't lose your shirt.

Warning #1: Investing On The Basis Of Future Capital Gains

Selling agents often mention how the house you're interested in just happens to be a smart buy because it's positioned in a corridor of fantastic growth potential (all the time reminding you it's all about location, location, location). In most cases, the future may indeed look good.

However, the simple fact is that the future is unknown, and any speculation about what might happen, is just that - speculation. The investment must be viable on the assumption of zero capital growth. The ongoing passive income you derive from your property investment is the meat and potatoes of the deal - any capital growth is merely the gravy on top. (and a very tasty gravy it is too!)

Warning #2: Factoring In Depreciation Allowances And Tax Write-Offs

Some properties are sold with the major benefit of the deal being the depreciation allowances and/or tax write-offs associated with buying a newly constructed dwelling. The "benefit" is the related income tax deduction which reduces the tax associated with your investment. This seems reasonable doesn't it?

No. Your investment decision should be independent of any possible depreciation allowances and tax write-offs.

Why? The simple answer is that these deductions are only maximised when you have earned salary income. Unless you are planning to earn a salary forever, don?t include tax benefits you may not be entitled to once you no longer work.

Also, “depreciation” is not a cash flow item, but an accounting term used to make an allowance against the future replacement of the asset. If you don?t plan to replace the asset, then it's likely you will have to add back the depreciation you have claimed once you sell the property. Factoring in a depreciation allowance is incorrectly including a non-cash item in a cash equation. Further, if you are already in an income "loss" situation, all the depreciation deductions in the world are not going to help you recover.

One reason I avoid buying investment properties from developers is because they usually include the tax benefits in their "passive" income calculations - and even then they are just at break even or a small loss. With property, work on the KISS principle - Keep It Simple Stupid! Seek only those properties that make you money, without including complex tax implications.

Warning #3: Property Selling Agents Keep Alive By Selling Property

When dealing with real estate agents (or realtors), remember that they are paid to sell you property. They have excellent skills in finding out information you don?t usually want to give away and later using it to “qualify” you. Many books have been written about the tricks selling agents play – such as how agents show you through numerous ?dud? properties until they finally take you to the last property (which is the one they really want to sell you) which, by this stage, seems like the oasis in the desert.

Be wary about asking agents whether the property is a good purchase. Do your own research and compare many agents' opinions before making a decision.

Warning #4: Stick To Your Niche

Often you will be making great progress in your investment strategy when along comes "an incredible opportunity" which is a little out of your area of expertise. Buoyed by your successes, you feel you have the Midas touch and proceed regardless - only to find a whole new set of problems which you are not familiar with solving.

The most common trap is the "rehap" or "fixer-upper" opportunity where you can make a quick $20,000 with very little effort. Unless you know a thing or two about redecorating and have a love of power tools, be warned - spending your weekends peeling wallpaper isn?t much fun.

Another common trap is the "no brainer" moneymaker in a town you have very little knowledge about. If it's too good to be true, it may well be because the locals know it's a lemon.

Find something you like doing, in a location you'd like to invest in and then go for it. Avoid stepping outside your established area of property investment expertise.

Warning #5: Don?t Get Into Negative Cash Flow / Negative Gearing

Negative gearing is a combination of Warnings #1, and #2 above.

This is where your tax deduction for interest and maintenance costs of owning property exceeds the income you receive from it. You use that "negative" to offset other income you may have, thus "saving" tax. The capital gain you receive in the long run should more than cover the "negative". Sounds great? I'm not convinced for the following reasons:

First. Negative geared properties will 99% of the time be negative cash flow and the other 1% of the time will break even. How many negatively geared properties can you afford to own if they lose you $100 per week?

Second.The gain you are supposed to make on the sale is based on a theoretical property price increase. Ever since the beginning of time, the property market is cyclical, with values both rising and falling.

Finally, if interest rates rise and you have a variable interest rate mortgage, how much more "negative" can you afford before you need to sell the property or work longer hours for more pay to cover the increased interest expense?

Summary Of Chapter 2.

Watch out for the pitfalls in property investing. Trust your instincts and always ask "where's the money in the deal". Stick to what you know best and stay away from negative cash flow or negative geared investments.

 




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