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Client money mistakes: over-investing in property

Lessons from a Rising Star March 2017

Brent Story teaches clients that properties can be a real drain on cash flow, writes Alan Hartstein.

Brent Story, a co-founder of Brisbane-based firm Cornerstone Advice, says one of the biggest mistakes he sees clients making is over-leveraging with property.

This, he says, results from the typical assumption that property values always rise. There is a common belief that if you buy one property and its value rises you can then use the equity in that property to buy your next one, repeat the process as often as you like and it will automatically result in a positive financial outcome.

But such a simple approach does not calculate risk sufficiently.

“I’ve seen clients that have followed this approach, purchased several properties and found that none of the properties values have risen sufficiently to enable them move forward. It also needs to be remembered that where you negatively gear property for the tax advantages, the property is normally cash-flow negative. This means that rent doesn’t cover the expenses so you need to add money each year from your own pocket to maintain the investment. With property prices so high these days, properties can be a real drain on cash-flow,” he says. “You can potentially end up in a holding pattern whereby property values aren’t rising whilst cash-flow is limited meaning you cannot invest further. There is normally strong resistance to selling due to the high transaction costs involved.”

Story has seen clients get carried away with borrowing in general. Sometimes people fall into the trap of buying things on credit that they couldn’t otherwise afford. Rather than saving up to buy a new car or go on a holiday with cash, they simply add it to their credit card. A similar attitude also applies to purchasing property, he says.

Story, a finalist in the 2016 AFA Rising Star Award, likes to deliver straightforward and easy-to-understand advice, regardless of whether he’s talking about superannuation, property, or equities.

Story says it’s fantastic that most Australians want to own their first home early in life. It makes sense to use your monthly payments to repay a mortgage rather than going towards rent. However, it’s important to be realistic as to what you can afford and to be patient. First home buyers sometimes get carried away and decide to borrow as much as the banks will lend, they want to buy their dream home now. It then becomes very difficult to save any money, the higher mortgages payments drain your cash-flow.  

“I look at the previous generation. Whilst they often purchased a home early, they tended to buy a starter home and used second hand furniture. This meant that they could still save, they could repay their mortgage faster and they could then buy the dream home. Long-term, this approach gives you more choices as opposed to being a slave to your mortgage for 30 years,” he says.

Keep it simple

When it comes to building wealth, Story believes in simple, common sense strategies. This means not relying too heavily on debt, investing regularly and managing the risks. One simple rule is to save at least 10 per cent of your income which you use to build wealth.

Story also advises his clients to protect themselves against income loss with insurance and to build a reserve cash fund where possible. Whilst the majority of clients have a heavy preference for property investment, he prefers to strike a balance between investing in shares and property. Shares tend generate more income whilst property tends to be a more stable investment, they tend to work well together” he says.

Preventing clients from making mistakes

Knowing the reason why someone wants to build wealth is critical, Story says, and motivations do differ greatly. Once you understand ‘why’, you can establish a long-term strategy to ensure that they achieve their objectives, he says, adding that it is amazing to see how much wealth can be built where there is a commitment to invest consistently over a long period of time.

“Clients are often surprised that their lifestyle goals are achievable without taking too much risk as long as you are willing to stick to a plan. The financial planning process helps our clients to understand how they are tracking towards their objectives. This provides perspective as to the impact of their actions, which tends to mean they make smarter financial decisions.” 

Rectifying mistakes after they’ve been made

Story says that, unfortunately, it can be difficult to wind back the clock once someone has progressed into a difficult financial position. In such cases, he provides as much direction as possible, especially involving debt reduction, consolidation and budgeting. It may be necessary to make difficult decisions such as downsizing the home, renting out a spare room, reducing their level of discretionary spending, or delaying a family holiday. “Clients need our support during these times and they take comfort in knowing that we are there to help figure out the best way forward.”

Communicating with the right tools

Story meets face-to-face with clients at least once a year to evaluate how they are tracking towards their goals. Cornerstone Advice also hosts seminars and social functions that provides clients with extra opportunities to learn and engage with the team. Ideally, he says, clients develop the confidence in us so that they can ‘switch-off’ from the speculation around markets. They can focus on the long-term, comfortable in the knowledge that we are taking care of their investments. “They understand that we will contact them if anything occurs that they need to know about,” he adds.

Story uses a range of tools to educate clients in better managing their finances. He says the younger clients tend to benefit more from using budgeting and cash-flow management software such as Xero or Moneysoft. He also often directs clients to the moneysmart.gov.au website and in particular its budgeting information.