Help!!! With figures on subdivision trade!!

[moovet]

Hi all,

I have an opportunity I wanted to run past a few of you because I am having difficulty with the figures. I have found a property in one of the best areas of town with a "potentially" subdividable section. I want to buy the property subdivide and sell the rear section and use the profit to make the front house cashflow positive. I have spoke to 3 different agents about the value of a section that size in that area and 2 said $160000 and one said 100-120K. He then offered to buy the section after the subdivision hence I do not trust his price and he also was very keen for the address so i think I need to act quickly.

So numbers as I see them are:

Buy $260K
GST claimed on buying 32.5K
Subdivision including services 25K
Holding costs - 12 months @ 8.05% 21K
Solicitor/valuer - 3K
Renovations to existing house - 20K
Section sale price 140K
GST paid on section sale 17.5K
House rental while developing 13K

Remaining Debt =260 -32.5+25+21+3+20-140+17.5-13
= 161K
New Rent of finished house $320 = 10% Yield in best area.

I have been conservative on the sections worth and holding costs and renovations to the existing house.

My difficulty is in whether I get charged tax on the profit when I keep the front house so haven't really made a profit yet to be taxed. (If that makes sense??)
Does that profit only get taxed when and if I sell that house?

Because the house is owned by a GST reg company, is the rent exempt from GST?

Do I have to buy this property in my trading entity or could I do it in my LAQC and still subdivide and say I was going to put a minor dwelling on but changed my mind.

Any ideas would be great as always. I have to nip out for a few hours but will check replies when I get back. I need to decide what I am going to do by tomorrow AM. THe vendors have had a reg Val done and are not letting on. My last offer was 247K and I still got no counter. The agent said she hasn't seen the valuation but thinks $260K will buy it

Cheers in advance,


Geoff

[moovet]

That last offer of mine was a cash offer too

[MJU]

So many issues

This looks like it could be a good deal, but you appear to have a few issues:

You will be subject to capital gains tax (so to speak) if you are subdividing. The trigger for this is the act of selling.

The "cashflow positive front section" will be tainted also, so Michael Cullen or his successor will be a silent, non-risk taking partner with a share of eventual profit based on your marginal tax rate at the time.

If the company is GST registered, Michael Cullen and his successors will also have a ninth equity share that comes of the top before their share based on your marginal tax.

If you get the right professional advice you may be able to mitigate "some" of this.

If a non-GST registered entity was subdividing to build a further property to rent out that might not put you in the capital profits category.

Go get the expensive advice!

[Dean@Massiveaction]

Hi Moovet. You buy it into a trading trust and sell the house to an LAQC or rental trust after the development is complete. There are absolutely no tainting issues if you do it this way. You will have to selll the house at fair market value so there will be some tax and GST to pay but you can then start depreciating the property from scratch at the new fair market value. If you get everything done quickly enough you won't depreciate inside the trading trust so no problem there.
My only issue with the deal is whether 25K is enough for the subdivision. In Auckland it's 90K if nothing weird is encountered. You need to be certain that your development costs are realistic. Everything else looks great.

[Mark_B]

So numbers as I see them are:

Buy $260K
Renovations to existing house - 20K

Remaining Debt = 161K

New Rent of finished [renovated] house $320 = 10% Yield in best area.

Yield is determined by purchase price + other costs. In this case it is $260k + $20k = $280k.

So your yield would be 5.94% (not the 10% you have claimed)

M

[moovet]

The yield figure I calculated was a final yield after I had sold the section and used the profit from that to pay off some of the debt on the house

[Mark_B]

The yield figure I calculated was a final yield after I had sold the section and used the profit from that to pay off some of the debt on the house

Yes I realise that.

But if you throw enough money at any property to lower its LVR and the yield will increase accordingly (until such time as you have an infinite yield as you have a zero LVR)

I know it sounds nice ("10% yield in [the] best area"), but it is a meaningless analysis and one which provides no basis for comparison with other properties.

It is also misleading. If you say to people that you have a property worth $280k that yields 10% then they will rightly assume that that it brings in $28,000 pa in rent (or $540 pw) - which of course it doesn't do. You've changed the common and accepted meaning of the term "yield" to suit your own means.

Mark

[SuperDad]

Mark,

I have to disagree. You wrote:

If you say to people that you have a property worth $280k that yields 10% then they will rightly assume that that it brings in $28,000 pa in rent (or $540 pw) - which of course it doesn't do

The only people that will "rightly assume" that the property brings in $28K on the basis that the value is $280K and it is yielding 10% are...complete idiots.

Yield is never calculated against the value of a property. Gross yield is usually calulated in one of two ways:
1. Against the purchase price, assuming 100% finance, or
2. Against the actual cash outlay for the property, where this is usually less than 100% of the purchase price. (It can be more, as in the case where renos need to be done in order to get the property fit to rent.)

Why isn't gross yield calculated against the value of the property? Because gross yield is a rough calculation for the return on an investment. The investment in this sense is the cash (total borrowings, not deposit) that has been put into the property.

With respect, it seems that you are the one who has:

...changed the common and accepted meaning of the term "yield" to suit your own means.

If you want to continue calculating yields against values, feel free. But that is not the way "yield" is either commonly, or correctly, used. To quote but one definition (From Lisa Dudson and Andrew King's The Complete Guide to Residential Property Investment in New Zealand):

An equation for comparing rental returns is the gross rental yield. This is calculated by dividing the annual rental return by the price of the property and multiplying that sum by 100.

I have emphasised the important point. You also wrote:

But if you throw enough money at any property to lower its LVR and the yield will increase accordingly (until such time as you have an infinite yield as you have a zero LVR)

Yes, that is how it works. You buy a property with an 80% LVR, and it is yielding 10%. You pay down half the mortgage, and then it is yielding 20% on the money you still owe on the property. Finally, you pay off the loan, and you are getting money for nothing. (Call it an infinite yield if you like. If you don't like the concept of an infinite yield, either leave $1 owing on the property, or take a course in the philosophical foundations of number theory.)

Paul.

[Mark_B]

The only people that will "rightly assume" that the property brings in $28K on the basis that the value is $280K and it is yielding 10% are...complete idiots.

I'm glad you implied I am an idiot.

It makes showing you the error of your ways so much sweeter.

Yield is never calculated against the value of a property. Gross yield is usually calulated in one of two ways:
1. Against the purchase price, assuming 100% finance, or
2. Against the actual cash outlay for the property, where this is usually less than 100% of the purchase price. (It can be more, as in the case where renos need to be done in order to get the property fit to rent.)

WTF??!!

Who told you that crap? (it is complete crap)

Yields are always calculated against either:

- the purchase price
- the actual outlay (eg. purchase price + renovation costs) (As with my $280k example)

There is also a very good argument that yields can be calculated against current market value (if you wish to check historical yields with current market yields).

Interestingly the quote you've chosen supports my point of view not yours. The quote makes no mention of the amount of cash the investor has put into the deal yet you've quite deliberately and misguidedly interpreted it as such.

I don't know who has fed you that b/s about yields calculated against your actual cash outlay. It simply isn't right.

Btw, Actual cash outlays are used to determine an investors ROI (Return on Investment).



Mark

[SuperDad]

Mark,

Yes, you have used "yield on cost". However, I would argue (as I'm sure moovet would) that you have employed the wrong cost in your yield calculation. The true cost of the property that Moovet will be letting for $320/week is $161K, not $280K.

Moovet has clearly pointed out that the new rent of the finished house will be $320. How much did the finished house cost? It wasn't $280K, because half of the land is missing.

By the way, it wasn't a lesson in mathematics. It was a lesson in meaning - in this case, the meaning of the term "yield". You demonstrated (when you calculated that yield is calculated against the "worth" of a house) that you didn't understand what the term means This was further compounded when you talked of lowering the LVR. Yield has nothing to do with value. Your math was fine - its your concept of yield that I thought was a bit suspect.

Paul.

[Dean@Massiveaction]

You are both right actually. Yield is calculated against purchase price typically becaus that is your only accurate cashflow forecast.
However lost opportunity cost yield is calculated on current value as you may be able to sell the asset and put that cash into something that gives a higher yield.

[moovet]

Thanx Dean,

Selling to the LAQC makes perfect sense. Should've worked that out myself. Still cant get any movement from the vendors or agent. It is an estate too so was hoping motivation was high. Could turn the existing house into a 4 bedroom as well. Other option would be to do up house and sell it too.

[moovet]

It is also misleading. If you say to people that you have a property worth $280k that yields 10% then they will rightly assume that that it brings in $28,000 pa in rent (or $540 pw) - Mark

Mark,

Thank you for your thoughts and advice. However I also disagree with the above statement. I have a rental property I paid 100K for 4 years ago. The mortgage is still 100K and it rents for 220/wk soon to be $260/wk. The property has appreciated and is valued at $240K. To me the yield is on what I paid for the property which now is 11.4% not 4.7% based on the current value. If I were to sell it then sure the yield would be less for the purchaser. The difference is in what you paid for it, not what it is now worth.

The income statement for the trade I am looking at doing after selling the section leaves a net figure of 160K in borrowing. If that leaves a property rented at $320/wk that is positive cashflow. Plus I will have the benefit of extra equity in the property that is left because it will be worth more than 160K.

[SuperDad]

Mark,

I wrote:

The only people that will "rightly assume" that the property brings in $28K on the basis that the value is $280K and it is yielding 10% are...complete idiots.

You replied by writing:

I'm glad you implied I am an idiot.

I'm sorry, I didn't mean to imply that you are an idiot, although this is the clear implication of what I wrote. I will be more careful in future. What I meant to say was that I think it is wrong to calculate (gross) yield against the value of a property. Pooomba has pointed out that there is a kind of yield that can be calculated against value - I've learnt something new.

Again, I'm sorry for implying that you are an idiot - clearly you are not. I just wanted to express my vigourous disagreement with your contention that the yield on moovet's property is 5.94%.

Paul.

[Monid]

Basically what calculation you use depends on what you are doing, whether you are looking at buying, whether you are looking at some way of modifying the deal (Like Moovet is) or whether you are looking at an existing asset and deciding whether you would be better to keep it or to sell it to either purchase another now better yielding asset in the same class or to switch to a (currently) higher yielding asset class. The absolutely most efficient way to make money is to switch your investment classes in line with the various yield cycles... The difficulty is predicting these cycles Personally I'm happy with good enough rather than the most efficient system so I'm going to stick to holding on to my properties...

David