Cost of Selling a property

Pre Selling Cost

• Valuation Cost: The very first cost that you should pay when you think about selling your property is to pay a licensed valuer to get valuation. Getting those “Free Market Appraisal” from real estate agent is not really good idea:
  1. First and foremost, their opinion could be of significantly different value from the bank/lender perspective. Imagine that your buyer will have usually a lender that will determine whether your property got that much value.
  2. Second, real estate agent tend to make it higher to get you to sign the selling agent appointment. For example: Agent A say they can sell your property for $500k, Agent B said they can sell it for $450k – by nature you will select agent A as your selling agent , right ? Your challenge to them (put it as contract term): if the property sell $1 lower than their appraisal, they will receive zip, zero commission – let see if they like it. The typical fee [1,All price is about right on early 2012] is just around $500 mark.
• Termite/Pest Certification: although this is not mandatory for all region, having the pest/termite inspector certify your property where you can put something like “Pest/Termite free certified” in your marketing will attract more buyer that potentially increase the selling price. The fee is around $300 mark.

Real Estate Agent Related

• Real Estate Agent commission: the typical percentage is around 3% mark. This usually your biggest cost outside capital gain tax.
• Advertising/Marketing Cost: this can vary from $1000 to $10,000 easy. Usually depending on the price of the property: the higher the price, you might want to push more marketing effort as you will need to reach more people.
• Auction cost (if you chose to sell your property by auction): this usually add to your cost something under $1000

Mortgage Related

This will apply if you have a mortgage on your property

• Government’s discharge feethe cost to prepare the paperwork of mortgage discharge from the lender
• Bank/Lender’s discharge fee: the cost to prepare the paperwork of mortgage discharge from the lender
• Settlement Fee: The fee to attend the settlement meeting, maybe around $200
• Exit Fee, Prepayment Fee, etc: this is all other possible cost that could be charge by your lender.

Other Cost

• Conveyancing/Solicitor Fee: do not save on this fee by ding it yourself unless you are one. There will be some trap and unnecessary surprise if you do not have your own conveyancer or solicitor/lawyer
• Minor Repair/Makeover: before you sell, to maximize selling price, especially on an auction, you need to do minor repair/makeover. Maybe as simple as repaint the wall, or replace the carpet, etc.
• Capital Gain Tax: This usually your biggest cost in selling. This is a tax of your profit. In Australia, investment more than 1 years will attract 50% discount. So, say if you make $200k profit, you will only taxed as if you only make $100k profit. Check your local law!
• Other cost: this might include pay off break fee of landlord insurance, utility (phone, gas, electricity, cable TV, internet, etc), maybe removalist cost, etc

Example

Let say you purchased a property 8 years ago (so you got 50% discount on Capital Gain Tax/CGT) for $300k and you sell it now for $500k.

Let see how much is the total cost and finally the actual amount of money goes into your pocket:

From the example above the actual cost compare to the actual selling price is around 14%. Of course, it will be different for each property, but I do hope you got the picture.

— Denis Kristanda

Basically there are 2 main strategy for your property investing:

1. Investing for Capital Growth:
   Basically you want the value of the property grow faster (maybe at least 5%- 7% per year) so you can make a profit when you sell, or simply so you be able to take the equity in the property for further investment. In this case usually the rent paid by the tenant is not enough to fully cover all the cost (Especially for the first 5-7 years). but you expect the property will double the value in 10-15 years.
   This is the most common type of property investing in Australia as the price of property is expensive.
2. Investing for Income or Cash Flow:
   In this strategy you will aim to have a property that produce income every single month. This is possible because the rent paid by tenant not only fully cover all the cost (mortgage, maintenance, and all the fee) but also produce extra income. This is what referred as “Positive Cash Flow Property”. So, the value of the property itself is not the main purpose, because whatever it is it already produce money to your pocket. So, you probably don’t want to sell it ever, right?
   This kind of investment is more and more difficult to get, but not impossible. Especially property in some rural area or outer town where the price is not that expensive, but the rent not too much difference.

So, with that in mind, the characteristic of a property is as follow:

• The value of the building itself is decreasing over time due to wear and tear. This is why you can claim the “depreciation” of the property for over 15 years or so (depend on local law).
• But the value of the land will usually always increasing as the population keep increasing and the total area of the land on earth will not be increasing.
  Yes, there are some special circumstances where land can be significantly reduced in value, such as: environmental contamination, natural disaster, social culture change in the area, re-zoning by government, etc. But those will not normally happen.
• If you buy a unit or apartment, you mainly buy a box of air space. Yes, you co-own the land with other unit’s owner but the land component of your ownership is very small.
  For example: There are 25 units/apartment in 1000m² block of land, so in average each owner of the unit will “own” only 1000/25 = 40m² each.
• So, as the land component is the one increase the most, you want as much land as possible in your property title.

Property With More Land for Capital Growth

Therefore, having a property with large land is really preferable if you really want to maximize the capital growth because there are more land component that drive the value higher.

As for the price, you will also ideally want as high as possible to give you more money. For example: say $500k house on 400m² land and $700k house on 600m² on the street will probably double in value for the next 15 years.  Meaning , after 15 years wait and you sell the property, you will get $1 million dollar if you buy the $500k one. But you will get $1.4 million if you choose the $700k. So, as general rule of thumb you do want your investment to be as high as possible of course according to your earning and cashflow situation.

— Denis Kristanda

(Whenever I refer to “house”, it actually can be broaden to all kind of real estate property such as: house, unit, apartment, town house, villa, condominium, flat, duplex, etc. So to avoid confusion, I will use term “home” instead to refer to it)

Asset vs Liability

Before we continue further, let us agree on the definition of asset and liability in investing world (The definition will be slightly different if you are talking about accounting). Simply put, asset is everything that can appreciate in value -or- produce income. Everything else is liability. To check whether something is an asset or not, do this 2 step test:

• Can it  give you regular income ? -or-
• Can it appreciates in value over time ?

If you cannot answer “yes” on any of the test above, it’s not an asset. For example: the car you just buy from the car yard. Unless you have a rent-a-car business, courier business or similar that uses car, your car is not asset.

What is Investment? Investment is an act of buy and/or selling asset to produce income and/or capital growth.

Make Money From Your Home

Your Home Is Your Biggest Liability

Your home might be your biggest liability if it meet one criteria: it has been mortgaged i.e: you have to take a home loan to acquire it. Why? Because essentially you took a debt to buy something for your consumption. It’s exactly the same with buying those plasma TV on your credit card. Here are the similarities:

• The goods are only for consumption (to be used only)
• The interest paid for taking this debt is not business cost, i.e: not tax deductible
• You cannot afford it, but you want it now, hence getting a debt to acquire it.
• You don’t use it for making money.

The only different between your home and that TV is that in long term your home can appreciate in value , i.e: you can sell it higher than when you buy it.  But “Long term” here is maybe 10 – 15 years as we don’t usually in the business of buying and selling your own resident. And within those years, the house will still be a burden.

Compare this with investment property where you will get rental income and all the expense is usually tax deductible (depends on the law of your country, though…)

Your Home Might Become Investment Asset

Now you can transform your home to meet the criteria as asset. The question is how to make your home an investment asset that will make you money.  Some of the way to make your own home become productive investment asset:

• Do home-based business from home.
• Rent out that unused extra bedroom for extra money
• Take the equity from the home to acquire other investment asset (i.e: to purchase share or purchase business)
• etc…

By doing those activities, your home is now involve directly with your money making activities and earn your home a status as investment asset.

So…

Your home might be the biggest purchase you ever made. To make the most of it, you need to transform it to become “investment asset”. In other words, since you use a lot of money to acquire it, it will be better if you can use it to make more money. Otherwise it only become your biggest liability ever that will not producing any money for you.

— Denis Kristanda

“For the last March quarter, the median price of house in this area has increase for 4% while the median price of unit has remained steady” or something like that…

The Terms

The term ‘median’ is statistic term. If we remember our school days, there are 3 important term in statistic: mean, median and mode. While ‘mode‘ is the numbers that occur most frequently and ‘mean‘ is nothing more than average, ‘median‘ is the term for the number exactly in the middle.

For example: let list down the price of 3-bedroom-houses in a street, say:
$330,000 $350,000 $350,000 $380,000 $400,000 $410,000 $750,000

In this example we can see the mode is $350,000 (appear twice, while other only once), the average is $424,286 (from (330k+350k+350k+380k+400k+410k+750k)/7) and the median is $380,000 (the one exactly in the middle).

To determine a median price, we need to sort the number from the lowest to the highest and get the one exactly in the middle. If the list is even number, we just average the one in the middle.

For example: if one more property is added to the list as below:
$330,000 $350,000 $350,000 $360,000 $380,000 $400,000 $410,000 $750,000
then the median price become $370,000 (from ($360k+$380k)/2), mode is $350,000 and mean or average price is $416,250.

The Meaning

So, looking at those prices above. If only 1 number is to represent the whole street, which price is more into the reality?

If we say the average price($416k), it’s probably not really picture the real condition as 5 of those 8 houses are priced under $400k. The average price is only get higher because of one property at the end (probably the luxurious one) has price much higher than the other.

If we use the mode, and tell people “the price of house on that street is $350,000″, then this is also not represent the real picture either, as most of the houses are priced more than $350,000.

Then we can see here that the median price are the best to represent the real condition. If people say the price on that street is about $370k… It’s more realistic, right? It’s exactly in the middle, some higher, some lower, but around that number.

We might say, it’s better to use the average price as the price can go higher and the bank will lend us more money as the valuation will go higher. That’s true… But, remember, the price average goes both ways… i.e: if one of the house got burned down and has no insurance and the value go down heavily, the average will be pull lower as well.

Beside that, there are times that we want the value of our surrounding as low as possible? When ? Say: during land tax valuation, when we are in the position of buying a property, when divorce attorney do the valuation, etc..etc

The point is, by using the median price, we eliminate this high or low bias due to our perception. Also, a change in small number of property will not affect the characteristic of the whole (the median price). In other word, median price is more stable and reliable compare to the other method (average/mean or mode).

Having said that, there are also some condition that give us a bit of disadvantage by using median price. For example: should there have been a lot of growth and sales on the upper part of the market (e.g: houses that has price more than median) but not much growth on the lower part, hence the median will be roughly the same. So, to change a median price , it will need an overall change of that particular area, cannot be just some part of it.

Also, if there are many brand new developments on the area, the median price is usually get pull higher creating some illusion that the area is having a good growth while the real situation is just simply there are some significant number or new property.

Some Tips

• If we want to buy a property, look at the median price of the suburb or are as the first criteria to judge the overall condition. But to see the real/actual growth, purchase the sales price history of that particular property (or next door if the property is brand new).
• Get to know the median price of our area/suburb for our property type. (There will be different median price for house and unit, or even 2-bedrooms-unit vs 3-bedrooms-unit) Then try to make our property above that median, hence we may say that the property is better than the crowd. (or ‘better than average’ although we know now that median is not average)
• Monitor the median price of our suburb at least yearly and you can approximate the value of our property without have to pay the valuer.

Conclusion

• Use median price when comparing property from one area to other area, or comparing property type (i.e: house vs apartment) to one another as this will give us the picture of that area or category as a whole.
• Median price is just the middle price, so there would be equal number of other prices on both side. I.e: if there are say 20 prices higher than the median, there will be 20 prices lower than the median.
• The individual change would not affect the median price much. Only overall change will have significant impact.

— Denis Kristanda

Without being too technical, we will discuss and calculate all the important numbers for both method. We also provide you with free tools to calculate the number based on your own situation. But the most important thing which method is the best? It will be revealed in an instant by the numbers. Let’s get started.

Negative Gearing

Negative Gearing simply means the income from the rent cannot cover all the cost (mortgage, repair, maintenance, strata/land tax, council rate, etc). Hence, the owner of the property need to come up with the money every month to hold the property.

For example:

We buy property for $330,000. Put 10% deposit ($30,000), and borrow the rest from the bank with 8% interest rate on interest only loan. The property is then rented for $350 per week. All other costs (strata/land tax, council rate, repair) , let say, is $2,000 per year, therefore:

• Loan: $300,000 at 8% interest the annual cost will be: $24,000 per year
• Rental income: $350 x 52 weeks = $18,200 per year
• Total cost: $24,000 (loan’s interest) + $2,000 (other cost) = $26,000
• Since total cost ($26,000) is larger than rental income ($18,200) then we have a negative gearing investment here.
• We need to ‘cover’ or ‘negatively geared’ the property at $7,800 per year or $150 out of pocket every week.

Negative gearing is very common, so we probably are pretty familiar with this scenario.

Positive Gearing

Positive Gearing simply means the income from the rent is larger than all the cost (mortgage, repair, maintenance, strata/land tax, council rate, etc).

For example: let’s use exactly the same property above, so we really do fair comparison. To make that property a positive gearing investment, the rental income need to be higher than the total cost, hence:

• Minimum rent per week = $26,000 / 52 weeks = $500 / week.
• So, if we rent the property for more than $500 per week, then we have a positive gearing investment because the rental income exceeding the total cost.

If the rental income only cover just about the cost, people also refer this as “neutral gearing” investment. Only if we have quite significant surplus, say $100 a week more – or $5200 per year surplus (means we need to rent it for $600 per week) – then we are enjoying a positive gearing investment the most.

By now probably we are puzzled already. How the heck we can rent $330,000 property for $600 per week ? There 2 simple answers for that:

1. In the low growth area: small city / rural / remote area.
   You might know that the price of a property is very cheap in area outside the city. Say your $330.000 property is probably priced only $110,000 there. But will the rent also 1/3 of the city ? The answer is most probably “no”.

   The rent is not really proportional with the price. Say in this case, that $110,000 2 bedrooms unit in this remote area probably rent for $180-$200 per week. Also, the rate will be cheaper. So if we do the same calculation like above, we will find that the property is an positive gearing investment.

   In reality, probably there is not many $330,000 property in small city/rural/remote which rented for $600. For this comparison, you may relate this situation with having 3 properties with price of $110,000 each and each of the property is rented at $200 per week. (A bit more realistic?)

2. Over Period of Time:
   After a period of time, say 5 – 10 years, the value of our property is not the only one growing, the rental income also grows. Let see on this example: we start with negative gearing condition and rent the property for $350 per week. After 2-3 years, for sure we will increase the rent as the market goes. Yes, the cost probably go up as well, but after several increase, we will reach a point where the rental income will cover all the cost.

The Drawbacks

Don’t be mistaken, Positive Gearing investment is our ultimate dream. Once our property is no longer a negative gearing, we received money every week to the bank while the value of the property is still growing. The bigger thing is, that we can tell the bank that we are ready for the next property since this positive gearing property is practically self funded. The bank will happily lend you money to buy another property.

But having said that, before you swarm all those properties outside the big city, there are 2 major important factors that become the drawbacks:

• The growth in small city/rural/remote area usually significantly less than the big city
• Tax benefit for negative gearing

Why this is important? When we are talking about investing, we need always talk about the Return of Investment (ROI). Since the price of the property (in dollar value) is very big compare to the rent, then small difference in growth of the property will significantly change our ROI. Let see.

In Australia, we can expect the property will be doubled in value in average of 10 – 15 years or 7% – 10% per year. But let us be more conservative, say in the big city where our property belong, the growth is only 5%-7%, but in the small city/remote/rural area the growth is only 1-2% (most likely less). Then our hypothetical $300,000 property will give us:

In our example above, assuming the rental is not changed for 3 years::

• Negative gearing, in the city with 5% growth , out of pocket= 3 years x -$7800 per year = -$23,400
• Positive gearing, in small city rural/remote are are with 2% growth, income = 3 years x +$5200 = $15,600

Here is when the tax benefit factor kicks in. On positive gearing scenario, that $15,600 is income, hence subject to tax. On the other hand, the negative gearing benefit makes the out of pocket money that we pay become a tax deduction. So in this case, depends on your tax rate, the tax payable and deduction are as follows:

Therefore,

The real ROI

Yes, it seems that the negative gearing produce almost twice the positive gearing. But, please do not jump into any conclusion yet.

Now that we have the dollar value of our ROI , then we need to see the real percentage of our investment. On positive gearing scheme, our only capital is the 10% deposit ($30,000). The additional cost and the interest are pretty much self funded (fully covered by the rental income). But on negative gearing scheme, we need to come up $7800 every single year to cover the cost and interest. So, here is the final figure:

Analysis

What we can derive from these numbers ?

1. Both positive and negative gearing produce similar result (around 100% ROI after 3 year)
2. If we have lower tax bracket, positive gearing investment is better
3. If we have higher income bracket, negative gearing investment is better
4. Negative gearing requires more capital

The Side by Side Comparison

Conclusion

Although we have proven that both scheme produce similar result, there is one other factor that makes positive gearing investment not really popular: it is significantly harder to find such property (need to find further and further from crowd) and also it’s harder to find and maintain the tenant (vacancy rate is higher). Also the more remote the site is, only few lender will give the money easily. Even if they do, usually the LVR (Loan to Value Ratio) will be lower than the city (you need more deposit money).

Having said that, if all risk has been taken into consideration and taken care of, if you can find a positive gearing property, by all means go ahead! You just found a gem.

The best alternative
If positive gearing investment is too difficult, then the best alternative for investing in property to get the maximum result:

1. Get property in high growth area, normally in the big city.
   It means, we need to use the negative gearing scenario at first.
2. Make that property become positive gearing as soon as possible.
   (See other articles about this)

Using this method, you will enjoy the maximum benefit of negative gearing, while at the same time reaping the value of high growth area.

Free Tools: All the simulation and calculation above can be customized based on your situation and your number at Property Gearing Simulator. So you can make better decision whether to invest in negative gearing or positive gearing.

Happy Property Investing !

Disclaimer:

• The article and tools presented are for general informational purposes only . It’s exclusively your decision whether or not to apply it to your investment. Before making any decision about the information provided, you must consider the appropriateness of the information in regard to your objectives, financial situation and needs. If in doubt, you should consult your adviser or investment professional.
• You might be eligible or liable for other deduction or cost. Please refer law / rules / regulation that applied to your situation and jurisdiction.

— Denis Kristanda