Why do it
There are a number of reasons why co-owning a property or number of properties with others is worth considering. Starting a property collective:
- Can make you money – as it allows you to get into the market quicker and means you can potentially build a bigger property portfolio than you could by yourself.
- Can save you money - as it reduces the amont of money you need to cover purchase, holding and other costs eg. for renovation.
- Saves you time – as you share the workload of investing and managing your portfolio with the others in your collective.
- Manages your risk – as you can build a more diversified property portfolio than you could on your own. While investing with others can reduce the effects of your own personal investment biases & allow you to leverage other’s skills and knowledge to your advantage.
- Makes you feel good – as you know that a sustainable proportion of your income is going towards building something for the future while allowing you to maintain your lifestyle at the same time.
These main benefits are explained in more detail below…
1. Can make you money
Get into the market quicker than you could on your own
How much is this worth to you?
Let’s work through a simple example…
- you want to purchase a $450,000 property
- that this property is in an area which you think will grow at 10% in the next year and 8% in the year after
- that on your own you would not be able to comfortably afford it for the next two years
- you decide to set up a property syndicate with 2 other friends and buy a property now
- at the end of Year 1 this property is worth $495,000 and at the end of Year 2 it would be $534,600.
As a group you have made a capital gain of $84,600.
Your collective has 3 members. So over this period you are each $28,200 better off than if you had done nothing and waited. Your decision to do something made you $1,175 per month in total.
Looking at it a different way, if you had decided to do nothing and wait, that decision would have cost you $1,175 per month.
And these calculations only consider capital growth. They don’t factor in either the cash flow benefit of having rental income to help pay your servicing costs or the tax benefits of investment property ownership.
What’s more, if you had waited two years, you would also have had to find extra money and income to service a larger loan as the value of your property increased from $450,000 to $534,600.
Build a larger property portfolio quicker than you could on your own
Is it better to have 100% of nothing, or 20%, 25%, 33% or 50% of something?
By increasing your financial muscle and pooling your resources with friends and/or family, you can get into the market immediately and purchase more properties than you otherwise might be able to in the short to medium term.
The more properties you have in your portfolio, the more assets you control. If you select your assets well, controlling more appreciating assets means you have more assets working for you over a longer period of time.
2. Can save you money
Reduces the amount of money you need to cover property purchase and holding costs
By pooling your resources you require less up-front capital to cover purchase costs, and less ongoing cash flow to cover your ongoing expenses.
Let’s use an example. Let’s assume:
- you want to purchase a $400,000 property with a 90% loan to value ratio (LVR),
- interest rates are 7% and
- the rental yield on the property is 4.5%.
What are your pre-tax costs over the first 12 months?
Well your upfront costs will be $65,000 to purchase the property:
- $40,000 in equity (the bank is lending you $360,000)
- around $20,000 to pay for stamp duty and conveyancing
- around $5,000 to cover LMI and other loan costs (however some banks may let you capitalise these costs into your loan). Let’s assume you don’t want to capitalise these costs.
Your ongoing costs (and here I’m talking pre-tax cash flow) for the first 12 months will be around $13,000:
- this would include close to $18,000 in rent minus $25,000 in interest (assuming an interest only loan) and
- rental expenses of $6000 (which would include property management fees, letting fees, rates, insurance but no body corporate).
So all up for the first 12 months you would be looking at cash flowing $78,000.
Now depending upon your income levels you would get some of your ongoing costs back post-tax, but the equation starts to look very different when you divide the $78,000 cost across two, three or more people…
Helps you be more disciplined with money
Many of us are better at spending money than saving money. This isn’t necessarily an issue unless the things that we spend our money on are productive assets. Setting up a property syndicate can act as effectively a de facto savings program.
It can be a passive investment strategy whereby you know that each month some of your income is going toward an investment for your future. For those of us who find budgeting a challenge, there is nothing quite like buying a property as a way to introduce some discipline into your spending patterns!
3. Saves you time
Share the workload with others
An important part of setting up your property collective is determining the roles and responsibilities of each person in your syndicate. Running your property collective can sometimes be a time consuming exercise. Due diligence, property selection, finance, tax, property maintenance, dealing with tenants, property improvements etc…
By allocating specific roles to you can leverage your friends’ natural strengths and interests. So not only can you leveraging each other’s money, but you can leverage the collective’s knowledge, experience and time.
4. Manages your risk
Build a more diversified property portfolio than you could on your own
The reality of property investing is that in making property selection decisions, you make the best decision you can make at a point in time based on all the information you have available to you.
Despite all the due diligence in the world, you actually don’t know how the property you select is going to perform over time. No one does. So building a diversified property portfolio makes sense as some of the properties you select may perform really well, however others may perform okay and others may perform poorly.
By controlling a number of properties you are more effectively managing your risk by spreading it across a number of investments rather than just one. By doing this you reduce the chances of picking a property that performs below average and increasing the chance of selecting a great investment.
Reduce the effects of your personal investment biases
Another benefit of sharing the risk with others is that when it comes to property selection and strategy decisions, you have a group of people with different knowledge and perspectives to draw on.
The field of behavioural finance brings insights from the sciences of psychology and sociology to correct some of the mental biases that we all have that can lead to poor investment decisions.
Overconfidence, confirmatory bias, loss aversion, framing (also called prospect theory ie. the idea that investors make different decisions based on the way the same piece of information is presented), anchoring (our tendency to grab hold of irrelevant and potentially subliminal information and then becoming biased towards that number when faced with uncertainty) and representativeness (our bias to make decisions based on how things appear rather than how statistically likely they are) are all natural personality traits that conspire against us when making investment decisions.
Bubbles are the most obvious demonstration that investor psychology plays a role in markets. George Soros, in his book “The Crash of 2008 and What it Means: The New Paradigm for Financial Markets” explores these themes through his theory of reflexivity.
The theory of reflexivity was adopted by Soros from philosopher Karl Popper. The theory suggests that the perceptions of investors have a reflexive relationship with reality – that these perceptions can inform and alter the fundamentals on which supposedly rational markets are based. In other words, financial trends start from rational causes but are often prolonged to a point where prices swing far into the irrational.
So having more minds with different perspectives focused on the same investment decisions can mean that as a group you end up making better investment decisions than you could by yourself.
Take advantage of a unique co-ownership structure that maximises flexibility and protection
Probably the most common models of co-ownership of residential property in Australia are tenants in common and joint tenancy.
i) Tenants in common
This is where two of more individuals hold property as tenants in common in any shares they choose. For example,
Will, Rachael & Wolfgang purchase a property for $400,000.
If Will contributes $200,000, Rachael $100,000 and Wolfgang $100,000, then the transfer is noted as “Will as to 2/4 share, Rachael as to 1/4 share and Wolfgang as to 1/4 share as tenants in common.” Each tenant in common has the right to deal with their share of the property separate from the others. So each individual can technically sell or mortgage their share of the property. Of course in practise, this is more difficult.
The most important advantage of a tenancy in common is that your shares are protected in the proportions you designate. This is best illustrated by the death of a tenant. When a tenant in common dies their share of the property passes in accordance with their instructions as set out in their will. So if you were to chose this option you would also need to have a valid and enforceable will, which specifies the entity which is to receive the benefit of your share of the property. This feature also means that tenants in common is the only model which allows you absolute control over who will receive your share upon death.
ii) Joint tenants
Joint tenants hold property in equal shares no matter how many joint tenants there are.
Upon the death of a joint tenant the share passes to the other joint tenant/s (in equal shares if more than one) automatically without reference to any intention of the deceased person, as may be set out in a will. The most common use of holding as joint tenants is a husband and wife situation where upon the death of the husband or wife their interest automatically passes to the surviving party.
Both tenants in common and joint tenancy apply where there are two of more owners of a property. But it is very important to note that not only will it apply to persons who own a property, but also to persons who take out a mortgage over a property.
And it is when it comes to the finance side of things that people need to think very carefully about what type of legal structure they want to move forward with.
It’s important to note that although being tenants in common or joint tenants on a mortgage can increase the amount of finance a lender will lend against a single property, what it also does is impinge on an individual’s future borrowing capacity. Parties are jointly and severally liable for the full debt in eyes of banks and so it can severely restrict individuals’ options in the future.
iii) The Property Collectives property syndicate model
The guiding principle in the design of the Property Collectives syndicate model was that the finance or money strategy needed to come first.
It needed to be flexible enough for all members of the collective to achieve their shared goals for the syndicate, but also allow members the freedom to achieve their personal goals outside of the syndicate.
This is because we recognised that forming a property syndicate is a long term venture. And who really knows what is going to happen in the future. Things change. Recognising this we wanted to build flexibility into the design of the property collective structure.
Everything in the Property Collectives syndicate model has been designed around the guiding principles of protection, financial leverage and flexibility.
5. Makes you feel good
Building something for the future…together
You’ve grown up together, played together, studied together, partied together, lived together. Typically the people who start a property collectives have had many shared experiences that have created a strong mutual bond. And because they intend to share many more experiences together they tend to have an open philosophy that the sharing need not to stop when it comes to making money. Particularly when they are in a position to help other each open up opportunities in the short term that will allow everyone to build something positive that can create more life choices in the medium to long term.
Frees up more of your own cash flow to support a more sustainable lifestyle
Investing in property with friends and/or family also makes it easier for yourself to maintain your current lifestyle, rather than having to curtail your enjoyment of life because of the strain of oppressive mortgage commitments.
Many of the people that elect to start a property collective have decided to continue to rent where they want to live and build their wealth via their investments rather than via the traditional path of buying their own home, paying it off and then investing.
For those of us who have not yet bought their own home, renting and buying investment properties can make a lot of financial sense. This issue is explored in more depth in an article “Is it Better to Rent or Own your own home?” by Ed Chan who is the principal of the Chan & Naylor accounting firm and author of “How to Legally Reduce your Tax”.
From a purely financial point of view its better to live in a small and affordable dwelling and have your money invested in assets that generate you both a capital gain and a rental income. If you own the home you live in, you receive the capital gain benefits of property ownership, but you forgo rental income and tax benefits of owning an investment property. These benefits over a lifetime can be quite substantial.
If you’d like to find out more about buying property in a syndicate, fill out the form below and we will send you a copy of our “Step by Step Guide to Starting a Property Syndicate”