Podcast: Review: Proportional Property Ownership - An Unbiased Review on the Pros and Cons | Ep. 229

Posted by Ed McKnight on 29/04/20
Proportional Property Ownership the Pros and Cons 001
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Show Notes

What's Covered in the Show?

In this episode, we discuss a particular proportional property ownership model that is currently being promoted by a property investment company within New Zealand.

The model includes purchasing a residential property outright, without any debt – the investment divided into 12 equal shares and offered to investors. The benefit of this model is that an investor can get exposure to the property market for a lower entry price. The cons are that when a property is purchased without debt, there is no opportunity for leverage ... the key benefit of property.

We also mention that we are holding a webinar this evening at 7pm to teach you how to grow your property portfolio from 2 to 5 properties. Register for the webinar here.


Transcript of the Podcast

Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show we're talking about proportional property ownership and the pros and cons of it.

We're going to give an unbiased review of one particular model that we've seen cropping up. So, Andrew and I have been in lockdown, not together, unfortunately from his perspective, and, we've been doing a lot of reading. And one thing that came across our desks was this one offer of proportional property ownership, which is being promoted by one particular company in New Zealand, won't say who they are, and we're just going to give an unbiased view to talk about the pros, talk about the cons.

Now, Andrew, just for everybody at home who hasn't seen this, walk us through the structure that we're reviewing today. What's actually being promoted?

Andrew Nicol: Sure. So, this is an investment model where you bring a group of people, a group of investors together to purchase a share in an investment property. So, this model, they've suggested properties between 400 and $700,000, which have already met a certain standard of due diligence.

And so, the investment company's actually looked at the properties and said, yes, we think these make us suitable investment for our client base. And then the property is purchased by a individual company which was formed, and there are 12 shares issued no more than 12 shares, and each investor has got the opportunity to buy a share or you can buy multiple shares.

So, there's nothing that prohibits someone buying more than one share. Now, I ran some numbers, let's say this was a $500,000 property divided by 12 investors. Each share works out to be $41,666. So about 42 grand to buy one share of that property. And we'll just assume that 12 are investors here in this case and run some numbers. So, what's great about this is, it's something new and innovative.

But the challenge is that it does come with a few restrictions and that's what we wanted to talk about today.

Ed McKnight: Exactly. And within this model, there is no debt on the property. So you're buying in your share with either with cash or you could leverage it against your existing property, but you would just need to service that debt and, and pay those servicing costs based on any dividends you get out of this company.

Now the pros of this is it decreases the barrier to entry into the market. So you can buy a property or a share I should say of this property for $42,000 that's probably a bit less than if you were going to go out and purchase a property yourself, you know, using that same amount of money as a deposit.

So, you can get access and exposure to the property market with that lower entry price. So, I guess that's a positive. Any others from your side? Andrew, what are you seeing is the benefits of this?

Andrew Nicol: That's probably the main one for me Ed. I think that, yeah, the biggest thing is that this would give someone who maybe is brand new to investing and has a very limited deposit the opportunity to get into the property market sooner.

Ed McKnight: Exactly. Now, let's talk about the other side. Some of the cons, and I'll start this off. Just thinking about those first-time investors, the biggest benefit that property gives is not necessarily that property goes up in value, though that is a clear benefit, the main benefit of property is the fact that it is a leverage-able asset.

So if you put in a 20% deposit and the property goes up by 5% you're not getting 5% on your deposit, you're getting 5% on the whole asset, which means that your actual return in that first year is 25%, so the fact that you can invest using other people's money. Now in this case, if you're getting a share of a property that has no debt on it, then you're giving away one of the biggest benefits of property, which is leverage.

So, you could get a better return by putting that money into the share market, for instance, which would go up at a faster percentage rate than property. So, in this case, property may not actually be the best option for an investor, because you're giving away that leverage and for me that is the biggest flaw in this model.

And the biggest reason why I would say, well, will this be useful for most first-time investors, that perhaps has more limited usefulness.

Andrew Nicol: Yeah. And then I want to jump in there Ed. I think one of the other challenges that I have with this model is, when you co-investing, it's really hard when you're not all on the same page with differing goals in terms of when you're going to sell that property. And so, what you need to have as a really robust secondary market.

And so, what I mean by that is someone, a takeout position. So, say for example, an investor got in on this, and they wanted to double their money and at 5% growth, that's going to take 14 and a half years to do. So, they want to turn their 41,666 share into $84,000. Then they have to wait for 14 and a half years to do that at 5% growth.

Now what happens if in five years, half of the investors want to get out because it's not performing the way that they wanted. Now what you have to do then as one of the investors that wants to stay as you need to buy those people out, which might not be what you want to do, and of course if it was the other way around and you wanted to get rid of your shares is because the investment is not performing the way you wanted, who do you sell those shares to?

And that's where people potentially could come unstuck here. And then I also looked at, I ran some numbers on, say, a half million dollar property using our same normal costings that we would factor in.

So, I added in property management. I worked on $600 a week rent because my assumption is that these would be relatively high yielding properties. And then I worked on rates to three grand insurance of two grand, maintenance of 500 and accounting because you still going to have to do accounting of $1,000 for this particular property. In the return after all your costs is $379 a week. Divide that by 12 that means that you would be paid out. $31 and 58 cents and so then maybe if we look at $41,666 worth of a mortgage at say 3.25% divided by 52 that's $26 a week.

So, you're not really making a lot of money, especially if you've used the benefit of leverage by borrowing this money against your own house.

Ed McKnight: Yes, exactly. And so, the actual return you get is much smaller than what you could otherwise get through alternative means.

So let's look at what those alternatives might be because one of the things we talked about, Andrew, before we started hitting record is well, if you've got $42,000 that you can either leverage against your own property, or you've got an in cash, so you, you've got it to invest, what could you actually do with that money?

And I think probably you'd agree with me that the best thing to do is to wait a little bit to grow that by an extra $10,000 and once you've got say $52,000 worth of usable equity or in cash, you could actually go out and get a 10% deposit, use a 10% deposit loan, so 90% lending and go and purchase a property yourself for $500,000 and in which case you'd own the whole thing and have the benefit of leverage.

And with the current interest rates, it might cost you say $50 a week. So, it would be slightly down from a cash flow perspective because you've got the lending secured against the property, but you'd actually have a better return from capital growth over time because it's leveraged in that case.

Andrew, is that probably what you'd think most people would do in that situation? Pay down a bit of debt, get a bit more usable equity or save up a bit and then go out and use that?

Andrew Nicol: Ed yeah, absolutely. And because with new properties in particular, you can still borrow 90% with lenders. And actually, I just ran the numbers on that as well. If we changed everything and we added in a loan of even say 4%, that only cost you $8 a week because if we're working on that same rental income of $600 so if there is this investment which you could purchase in your own right, Oh, actually, sorry, I haven't even had it in the deposit here.

If I add on that deposit of 50,000 in cash, then it's positively geared by $30 you're actually making a better weekly return at a 4% interest rate, than you are by doing it collectively, and you've got the benefit of all of that capital growth being kept by you.

Ed McKnight: Exactly. Well, let's wrap it up there, but I guess the main thing that we're getting across with this is if you're looking at evaluating an investment like this, really think through the numbers and how they work.

Especially remember the number one thing that makes property different from other types of investments. The number one reason to use property is not necessarily it's stability. It's the fact that you can leverage the investment. So if you give up that leverage through the way you were structuring a property deal or the way you're entering the market, then you really are giving up one of the main reasons why you would get into property in the first place.

The fact that it is a leveraged investment, so that's our unbiased review on proportional property ownership, or I should say proportional property ownership in this setup. There may be other setups that work, and we didn't even touch on commercial property, and it's much more popular to have that sort of syndication within commercial property. That might have to be for another episode, but let's wrap it up there now.

Please don't forget to rate, review and subscribe to the podcast. It really does help us get the message out to more people and hey, if you want to learn more about property with Andrew and I we're holding a webinar this Tuesday at 7:00 PM I'm going to link that into the show notes and we're going to talk about how to get the bank to turn the lending tap back on if you're capped out, either on income or equity, so how to grow from two to five properties.

Thanks for listening to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and we're going to be back again tomorrow with even more daily strategies, tactics, and insights to help you get the most out of the New Zealand property market.

Until next time.