An important consideration as you expand your real estate portfolio for investment purposes is reducing the risk of losing assets in the case of insolvency due to bank securities.
How you structure your business and its financing will largely determine how safe you are from the possibility of losing the property and its accrued equity.
First we present a bit of background.
Banks and Gearing Rules
Simply put, gearing rules dictate financing structure. The general rule of thumb is that a 20% deposit is required to purchase residential property whilst 33% is preferred for commercial or larger properties. New Zealand also requires an interest cover rate of 2.5 to 3%, which is determined by the formula of rent + income / interest expense.
It is important to figure these percentages in the equation when considering the viability of a real estate purchase. Do you have the necessary cash flow to seal the deal?
Financing Strategy
One way to minimise risk of losing assets and equity is to finance with a split loan structure. This refers to using two lending institutions.
With the first bank, finance a property investment using the real estate and a personal guarantee as security. With the second bank, put down a deposit using family trust assets. As soon as it is viable, refinance the loan with the second bank based on revaluation of the property as the sole means to secure it. In this way you eliminate any guarantees that could result in loss of the real estate and other assets.
Of course, this type of financing relies on the set up of a family trust. Do this now, and also institute a gifting programme for allotment. In the above scenario, you will need to refrain from giving the second bank security over the trust.
Realise that this will probably be an automatic term of the loan, but it can be denied. Without a trust in place, the personal guarantee you give to the first bank in the above example places the property at risk.
In order to receive the most favourable terms at the bank, consider using a broker to do the negotiating for you. This allows you the strongest position from which you can stand firm and ensure that the security requirement does not eventually cause the loss of property. The trust must not be put at risk, nor should other assets.
It is a case of getting the right advice, at the right time to ensure the safety of your assets.
Author Resource:
Paul Easton is working with Gilligan Rowe & Associates are Chartered Accountants and are specialist Accountants and experts in property and family trusts.
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