11/12/2013

Question: When do you cut your losses? I purchased a PPOR house about four years ago with a clean building and pest report, but we have since found out this is not accurate. Do we spend the money on repairs and structural issues, or cut our losses now? Our concern is, if we spent, say, $10,000–20,000, we would not be able to get this back in the sale. The other option is, do we spend the money and turn it into a rental as it would be cash flow neutral? The area would be considered a low socio-economic area, and this concerns us to ensure we are not wasting money.

Answer: My initial reaction is to investigate the work undertaken by the building and pest inspection company. They should have a complaints process or, alternatively, a disputes handling process.

If they are negligent in their duty of care, then one would believe you could seek reimbursement for works to be carried out because they failed to detect a problem when they inspected the property.

If this fails, the three options to consider are:

  • Repair and live in the house as your owner-occupierproperty;
  • Sell up and cut your losses; or
  • Turn it into an investment property as you stated above.

All three are valid considerations, and your answer lies in understanding more about what your goals are. Let’s look at doing the repairs and staying put.

When I talk to clients about owner-occupier properties, I ask them: are we talking about a lifestyle purchase or a stepping-stone purchase? If it’s a lifestyle purchase, then the value growth of the property is not important, since you are choosing to live in that property and that location because it offers you something you often can’t get or don’t want to get in another location.

Usually this has a lot to do with being close to family and friends and being very familiar with the area itself, so you have chosen to live there for your good reasons.

When you think about the property in this context and compare selling up and buying again in the same area, the costs might be greater than improving the existing property, which must have had some appeal to you when you initially purchased it, otherwise you wouldn’t have bought it.

If this theory rings true to you, it might be worth staying put, and if you are going to stay put it might be for 10 to 20 years, so the works you are going to perform are not going to be significant enough to overcapitalise when you annualise what the works will do to the structural and general soundness of the property over this period of time.

If, however, you bought the property as one that you believed would be a stepping-stone property that you could improve cosmetically and then look to sell in a few years from now, using the gains you have made to upsize to a property that was more your end game, then it’s important that you consider your options carefully.

Most might just do as you say and cut their losses and sell up, especially if, as you also said, you are concerned that the money you put into the property to repair it may not be guaranteed to be returned to you in a higher sale price. I wouldn’t advise you to spend any money you were not confident about getting back.

If you did sell, it would be better to offer the property as an ‘opportunity’ to someone who sees its potential in its current state so that you can recoup your initial outlay and put it down to a learning experience, as opposed to throwing good money at a bad outcome, if you think it will turn out this way.

Or, as you noted finally in your question, what if you became the landlord and offered the property for rent? Often lower socio-demographic areas do achieve very good rental yields. If the property will be close to cash flow neutral, this may present a real opportunity for you.

As my default position as a property investment adviser, I’m always cautious about jumping into selling property if you are going to need to repurchase, because the costs of both selling and re-buying are quite high, so it can often take a long time before you are in front again, and this will depend on what you buy next and how it performs.

In your case, you need to assess what is the absolutely essential amount you need to spend to make the property safe and sound and, if you then rent out the property, whether it is going to deliver you a regular income. Also, if you decide to make the improvements, you should be able to attract depreciation benefits, which could further assist from a cash flow perspective. I think this is definitely something I would want you to consider, as opposed to selling up.

So don’t think you don’t have options; you could very well come out of this OK. Best of luck with considering these options presented.

Ben Kingsley is the founding director and CEO of Empower Wealth. He is a qualified property investment adviser (QPIA) and property analyst and the chair of Property Investment Professionals of Australia. He holds a Cert IV in mortgage finance and is a licensed estate agent.

Disclaimer: The views provided are of a general nature and should be considered as general information only. This is not financial advice and it is not to be acted upon without advice from a qualified professional who understands your personal circumstances.