Property Investing jargon exposed!
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In this episode we explain common property investing jargon, including:
- Negative gearing
- Positive gearing
- Section 32
- Capital Gains Tax
- Vendor Finance
- and more!
And in our quick tip:
- Where to find a good explanation of property terms
- How to keep track of tricky terms
- Get a property magazine and highlight terms that you don’t understand
- Make a point of finding out what those terms mean and recording them in your property notebook
Property Investing Jargon Exposed – Podcast Episode EPI 006
This is Everyday Property Investing episode 6. The show empowering everyday people to create wealth and financial freedom, so get on board! Anyone can be a property investor! It just takes a little knowledge, a little support and some action. So get started with us today!
Den: Hello and welcome I’m Den, and this is episode six of everyday property investing. In this episode, we’re going to cover property investment terms and definitions so that you can understand all of property investing jargon. We’ll be covering things like negative gearing, positive gearing, capital gains tax, depreciation and much more. And in this episode’s quick tip, we’ll tell you where you can easily find the answers to some of your property definition questions. I’m here with Kaz, and we’re here to help you develop your knowledge and ours, and to share our experiences within our everyday property investing community. How’s it going Kaz?
Kaz: Really good, thanks Den. I’m fantastic, how are you?
Den: Great, thanks. So Kaz what’s news with you?
Kaz: Oh, we’ve had some exciting news this week Den – I’ve been dying to tell you all about this.
Den: Tell us, tell us.
Kaz: You know how the last few episodes I’ve talked about how we had a property, and it looked as though we could potentially develop from the back of that property. We went ahead and got some plans from the council and sent them off to a drafting company. And the drafting company came back to us just this week actually and said, yes, yes you can fit something on the back of that so we’re now property developers.
Den: So you’re about to become a property developer?
Kaz: I’m very excited to say that yes I am about to become a property developer!
Den: Fantastic. So now you’ve got the approval, do you have any idea what the next step is?
Kaz: I do have a bit of an idea, funnily enough. Our first step that we want to do is to do feasibility study because the drafting company came back to us and said yes look you could fit a one bedroom unit on it or two bedroom unit with a bit of squashing, and I sort of thought well actually I’d like to fit a three bedroom two-storey on the same property if we can. And they said yeah that’s okay – you tell us what you want and we’ll make it. So it’s up to me now to try and work out what’s going to be financially viable. As in you know, is it worth the effort and the extra money involved to build a two-storey, three-bedroom town house, as opposed to, to building a two bedroom single-storey unit? So what are the pros and cons so we need to do a feasibility study!
Kaz: So yeah, that’s the first step. And it’s actually been interesting because it seems straightforward to say OK I’m just going to calculate the expenses and the cost of things but if you’ve not done something before sometimes it’s hard to estimate what those cost might be…
Den: Absolutely, I completely understand.
Kaz: I’ve been reading some books about it and I’ve got my spreadsheet ready. And I’m actually going to speak to a friend of mine who has done a lot of property investing – his full-time occupation is as a property developer. So he’s actually going to help me out with my feasibility study.
Kaz: What about you Den, what’s happening with you?
Den: Well, we had some probably not as good news as you had. One of our tenants has fallen behind in the rent, and they’ve fallen behind in the rent not by just one or two weeks, but they’re more than a month behind now. So I’ve been chasing up my property manager, who’s been chasing up the tenant. We’ve tried to put in place a payment plan for the tenant to get back on track. One of the things that I’m really big on is trying to work with the tenants to make sure everything’s ok. Now it’s, it’s something that I really hate when the tenant runs late and you find out because money doesn’t go into the account. I’d much rather attempt to get in touch and say we’re going to have a problem this month and we organize it. But if we can avoid going to tribunals or the court or to anything like that to sort it out, then we will. So right now the tenants agreed that they will go on a payment plan and hopefully things will get back on track. But as a property investor, it’s one of the things I think you have to be aware of – you’ve probably got to consider that maybe this won’t happen or maybe it won’t or work out and then we need to get into a different situation.
Kaz: Okay, so in our feature segment today, we going to talk about property investment terminology and definitions. We’re going to expose property jargon and help people including ourselves to understand better what these terms mean.
Den: Exactly, one of the things that I hate is when you start speaking to a professional, or someone who is really big in one field, and they use very clever words or whatever and you end up just feeling dumb and stupid as though you don’t belong in the same place as this person. And we want to make sure that anyone listening to this doesn’t have that experience if they’re speaking to a real estate agent, or to a tax accountant or to another property educator, or to whoever. So we’re going to really try and clear up about twelve or thirteen really common terms that are often used as jargon.
Kaz: Yeah and even just to help you in your own reading; if you sit down to read a property investment magazine and every second word you don’t understand that makes it really hard and excludes you from being able to learn. Just understanding these terms can help you in developing your own knowledge as well.
Den: Absolutely, so Kaz what’s our first term?
Kaz: Well our first term is one that is quite common and you may have heard of. It’s called negative gearing. Now negative gearing is a property investment strategy and what it basically means is that the amount of expenses or costs associated with owning a property exceed the income or the profits that are coming in for that property. So for an example, I’ve got some relatives of mine who actually have a house down near the beach and they rent that house out. Now that house costs them round about or $12,000 to $13,000 a year. Now that includes things like their rates and their water services and investment loan interest, but the income that comes in from that house is probably about $7,000 a year. Now quite clearly the costs associated with having that house exceed the income from that house. So that house is negatively geared.
Den: So they make a $6,000 lot from this house…
Kaz: Yes they do…
Den: Right about every year. And why would they didn’t bother with that? Why would they do that? What’s the advantage of negative gearing?
Kaz: Well it’s funny you should mention that Den because actually next week’s episode we’re going to go in there a lot more detail about negative gearing. But just to let you sort of understand the basics of it for today, it’s all about saving tax. Negative gearing the main sort of driver behind people wanting to negatively gear property is that they would save on income tax. But we will go into this in much more detail next week.
Den: Okay so what we’re saying negative gearing is where you lose money on a property and you do it to save tax.
Kaz: That’s right.
Den: Awesome. Now the next one I was going to talk about is positive gearing. Now positive gearing is then the opposite. Positive gearing is when you buy a property that you know is going to make you money straight away. So the reason you would positively gear is because the rent will come in, it will more than cover all of the expenses and you’ll make money straight away. So that’s positive gearing. Now remember though when you’re making money you’re paying more tax. But even after tax and when all those implications are given positive gearing is about making money.
Kaz: That sounds like a good strategy.
Den: I think that’s the best strategy! What’s the next one Kaz?
Kaz: Well the next one is actually what we call positive cash flow property. Now that’s a lot of people use that interchangeably with positive gearing but the way we’re going to differentiate those things are; positive gearing as you said the income exceeds the outgoings. Now with positive cash flow property you actually take into account the tax benefits that you get through depreciation of a property, and what that can actually end up doing is turning what might be a slightly negatively geared house into something that generates positive cash flow for you. So, for example, if you’ve got a house where the income and the outgoings are quite close to each other; I might be, say, $80 a month out of pocket on this particular house. I can depreciate items in that house (we’ll talk about depreciation in the second) – I can depreciate the building and the contents and, and fixtures and fittings and things of the house and what that does it gives me a tax benefit. Now that tax benefit reduces my taxable income and so I end up with more money in my pocket. And that more money might turn that $80 a month loss into $80 a month profit.
Den: Okay so, positive cash-flow is when a tax benefit turns negative gearing property into a money-maker for you.
Kaz: That’s right!
Den: So at the end of the week, you actually have a net positive amount of money in your pocket.
Den: Okay cool. So depreciation is when you have a claimable expense that’s judged by the tax department according to the amount that the buildings and the fittings in the buildings lose value over time. So you know how when you buy a new car, they always say when you get a car as soon as you drive it out it’s going to lose value. Well the tax department pretty much say the same thing – they say when you build a new house things get older and they going to lose value. When you’re an investor the tax department will allow you to claim this loss in value as an expense. Now with depreciation – there’s a whole show really in depreciation. What we can say is it’s proportional to the amount that the building’s cost and there are certain dates that are important because of different legislations. So what you can claim under depreciation can turn a property that’s losing money into a property that puts money in your pocket. That’s probably the most important thing with depreciation. Alright next one Kaz, let’s get legal, let’s talk about a Section 32.
Kaz: Yes, now funny it should get legal with me because I’m not a lawyer – I just wanted to say that upfront. But a Section 32; this is actually a Victorian term I think, Section 32, but the idea is what we wanted to talk about. A Section 32 in Victoria, is a collection of documents – documents which pertain to a particular property and do things like explain the services to that property; any building or land restrictions or details about the titles and things like that. They give you a lot of history about the block of land, when it was subdivided, and might have some plans of the house and things like that. So it’s a collection of things…
Den: And I think that also includes stuff like rights and outgoings and some of that stuff as well…
Kaz: Yeah exactly. And, and that document must be in place for a property to be sold.
Den: Yeah it actually has to be in place for someone to put an offer in on a property because -we’ve just have that issue, where we’ve needed to wait for a Section 32.
Kaz: Yeah very good! The idea is that a Section 32, if you’re a buyer, gives you a lot of information about the property and you need to get a hold of that. Now as you’ve said legally you must get a hold of that document, and there are equivalents in other states and even in other countries.
Kaz: So even though we’re talking about Section 32 here the, the point is there’s a bunch of information you need to get a hold of about your property and are legally entitled to.
Den: Yeah absolutely. Aright, so that’s the legal documents, the Section 32. The next thing we will going to talk about is Capital Gains Tax or some particularly jargon-friendly people call it. CGT. Now capital gains tax – when you sell an investment and you make a profit on it, that profit is subject to tax. Now there are all different rules about it and about how the tax works but ultimately you can expect that whatever your profit is, once all your costs have been taken out and everything that you’re going to be subject to tax on that. And it may have something to do with your income as well.
Kaz: And there are specific rules around that I mean obviously, as you said Den there’s lots of rules around that?
Kaz: And, and you really do need to consult an expert to find out about those rules…
Den: And I’m no accountant, but there are lots of rules about it…
Kaz: And though they’re different relating to whether a house is your principal place of residence, as opposed to whether a house was your investment and things like that…
Den: Yeah I’m pretty sure (look as I say I’m not an accountant) but I’m pretty sure that your principal place of residence is not subject to capital gains tax, and that an investment property is. So capital gains are all about your investment profits, okay. Next one, Kaz.
Kaz: Oh vendor finance is our next thing we wanted to touch on. Now vendor finance is a term you might come across when you’re reading property investing books and things like that. What it basically means is that a buyer and a seller actually engage in an agreement where the seller of the property actually provides finance to the buyer. Vendor finance can take place in a myriad of ways and how that actually works is an agreement for those two parties to come to. So as just an example, I might be purchasing a property with vendor finance terms, where the vendor is going to say okay well we’re happy to take a 10% deposit now but you can pay the rest of it off over, you know, a five-year period at a certain interest rate or something like that. So it’s basically two parties coming to an agreement where the person selling the property is going to finance in some way the buyer’s endeavor to purchase a house.
Den: And yeah that quite often happens if the buyer can’t get finance from a bank, that the buyer and the seller were getting to some arrangement. I don’t know how often it happens but I think that’s one of the driving forces…
Kaz: And interestingly, some people actually use vendor finance as a strategy to make money. So there are people out there who will purposefully seek out buyers, who want to buy a house but don’t have the money, and they will come to arrangements that are win-win for both properties. So some people actually use it as a strategy.
Den: Okay. Aright the next one we want to talk about is equity. Now the equity that you often hear; “use your equity” or “it’s equity mate”…. Equity is all about the value of your property that you actually own. So when you think about how much your property is worth, and whatever your loan is, the equity is the gap in the middle. So it’s a measure of how much you own. And there are certain circumstances in which you can use that proportion for further investments, or to put a deposit on, or to loan against or that sort of thing. So it’s about your net worth and it’s about what you own between your property and the loan, and it can be quite useful for investors.
Kaz: So a lot of people use equity to leverage into further properties, is that right?
Den: Exactly. Well there’s another jargon word, leverage, but equity is about this money that you’ve got which is tied up in your property because it’s not a liquid asset; the money that you’ve got that you can use and maybe loan against that to put a deposit down on another property and that happens quite often. Which ah brings us to the next one; let’s go to LVR Kaz, what’s an LVR?
Kaz: Wow LVR…it’s an acronym that means loan to valuation ratio. You might hear this term when you’re speaking to mortgage advisers or mortgage brokers or your bank about finance. That’s got to do with your loan, pretty much. It’s about how much of a property’s value you are going to loan so for example, if you’re looking to purchase a property and that property is $200,000 and you’re going to put in $40,000 of your own then the loan to valuation ratio there is 80%, so you’re loaning 80% of the value of that property. And so there’s rules around banks and how they want to give you finance and whether you’ll need additional insurance. So, for example, most banks will end up to 80% of the value of a property, but if you want to borrow more than that, they may or may not give it to you and if they choose to they will want you to take something called mortgage insurance…
Den: So insurance of some sort?
Den: So it’s almost like your LVR is the opposite of your equity?
Den: The equity talks about what proportion you own out of your property compared to your loan, and the LVR talks about the loan in relation to the value of the property.
Den: There you go, perfect. Aright the next one we going to talk about is yield. Yield talks about the amount of rent you get in on a property and compares it with the value of the property. So I’ll give you an example; one of our properties is worth about $200,000 (as I’ve said we’re not investing in diamonds and pearls, we invest in bricks and mortar. So we have a property that’s worth about $200,000). This property brings in about $10,000 a year. This $10,000 as a proportion of $200,000 is 5%. So for this property we’d say the yield is 5%. That’s talking in really simplistic terms and we’re not considering things like depreciation which we’ve talked about and certain other expenses. But if you consider that that’s the amount of money it gets and that’s the loan value then we could pretty safely say yield is around 5%.
Kaz: And so Den, what’s a good yield? Like, if I’m looking and someone says you know, (sometimes you see it on realestate.com or something like that and you’re looking at house and it says), “Wow! 6% yield!”
Den: “Great yield!”
Kaz: What does it mean?
Den: Look, how long is a piece of string? I think it depends on what your strategy is. But I would say if you’re looking at a 5% or 6% yield, that’s probably pretty good. If you’re looking at a 3% yield for a property than you’re looking to make money somewhere other than purely by getting rent in. So quite often if you think about what interest rates are, and if you say well if the yield is somewhere similar to interest rates, you probably going to be on a winner, as far as positive gearing or positive cashflow property goes. That’s probably what you would look for a yield.
Kaz: Nah that’s a good little quick tip!
Den: Aright? So there’s a bit of a tip, I suppose, look at what the interest rates are and see if you can get that as a yield. Okay, now Kaz what’s serviceability?
Kaz: Well serviceability is another one of those terms like LVR that you might hear when you’re speaking to a mortgage broker or a bank and you’re looking at loans. Serviceability is your capacity or ability to pay back the loan. So banks will assess how well you can service the loan before they’re happy to give it to you. Whereas LVR is looking at the proportion of the property that you want to actually borrow, the serviceability is saying well can you actually afford to make the repayments on that.
Den: Okay. So from what I understand when a bank approves a loan, they approve for two reasons: one is that you have enough deposit so that’s your loan to valuation ratio or LVR and the other one is that you can make a repayments, and that’s the serviceability.
Kaz: That’s right.
Den: Aright, there you go. Okay, so that’s a bit of a round-up of some of the most common real estate jargon. We hope we’d managed to clear a few things up for you? We’ve certainly cleared a few things up for ourselves probably as well.
Kaz: And I’m sure there’s lots more terms that people, people might be wondering about. We’re happy for you to email those into us and we will be pleased to put them on another show.
Den: Yeah remember, of course, the disclaimer – we’re not lawyers and we’re not accountants, we’re not bank managers either quite frankly, so we really look to try and put stuff into plain clear language and hopefully it helps you understand.
Kaz: In today’s quick tip, we just wanted to mention a great place to go and find out some more terminology and definitions if you’re looking for them. At the back of property investing magazines they’ll often have a glossary of terms and you can actually go and look up a lot of the terminology that you might be wondering about. So before when I was talking about how you read that magazine and you can’t understand every fourth word, well usually there’ll be a glossary in there somewhere so you can go and find out those things there. Another great idea is to keep a notebook, just like a little spiral bound notebook or something to do with your property investing, and you can just write the definitions of some of those key terms that you keep hearing in there because no doubt you read the magazine, you might read the glossary definition. Then a few weeks later you come across it again and think what was that again? If you’ve got it written down in your own explanation in your own book, in a way that made sense to you at the time then hopefully when you read it again it will make sense to you again.
Den: Absolutely, and we’ve also got some books on our website that we’ve reviewed and some of them have a great glossary or they go through the definitions really well so it’s worth having a look at them.
Den: Okay so the action we’re giving you this episode is to get a property magazine and read through the magazine. Grab yourself a highlighter and highlight the terms that you don’t understand and then make a point of finding out what they are. You can either go to one of the sources we mentioned in the quick tips or jump online to Google and find out what they mean. Now next episode we’ll be going through negative gearing as a property investment strategy. So that’s the first of our jargon terms for today. Negative gearing; we’ll make sure you understand what it means and we’ll look at the pros and cons of negative gearing.
Kaz: So I’m looking forward to that Den. And in the meantime you can email us with any comments or feedback or news or stories you want to share. Email us at firstname.lastname@example.org. And next week we’ll also have our usual segments including news and tips so get on over to iTunes and subscribe to the podcast, head on over to the website at www.everydaypropertyinvesting.com and sign up for our email tips and newsletter, until then!
You’ve been listening to Everyday Property Investing, the show empowering everyday people to create wealth and achieve financial freedom. Please note that this show provides general advice based on personal experiences and is for educational purposes only. We’re not qualified accountants or lawyers or licensed to provide professional financial advice for you. We strongly advise that you employ the services of qualified professionals and seek their advice that is specific to your own personal circumstances. You can visit us at www.everydaypropertyinvesting.com. See you next time!