Your US property primer
By Nicole Navarro
November 3, 2010
Australian Property Investor
PORTFOLIO POINT: Yields can be strong, and cheap properties can be poised for capital growth, but buying in the US can hold traps for the unwary.
Depressed US property prices and a pumped-up Australian dollar are making many investors consider doing something they never have before: buying an overseas property.
But for every person brave enough to buy a property in the US, there are plenty more just that little bit hesitant to get involved in the very same market that kicked off one of the biggest financial crises in history.
Is now the right time to buy US property?
But as the dollar continues to hover around parity, we can only assume that the prospect of buying into one of the biggest property markets in the world is only going to grow as more and more investors return with tales of positive cash flow properties and capital growth plays.
Depending on who you listen to, the US property market is about to fall off a cliff thanks to the foreclosure scandal, or has reached rock bottom and is building a base for recovery.
It certainly doesn’t seem possible that the US Federal Reserve could cut the official interest rate further from its already close-to-zero rate. On top of that, job growth is weakening and property owners know just how dependent property prices are on the jobs market.
So what do you listen to and what do you ignore? Do you monitor the housing market indicators closely or do you just rely on your own research and due diligence in the market? And what does this doom and gloom mean for Australian investors who are considering entering this market?
“If the economy was good in the US then we wouldn’t be buying there,” says Eddie Borg, a property investor in Australia and the US.
The pursuit of yield
Those entering the market now are generally fearless investors picking up properties for $30,000 or less, shutting out thoughts of what may be below the surface and instead focusing on the pursuit of yields (which can be as high as 30%) and a potential recovery in prices.
“The opportunity is right now,” says Australian-based buyer advocate Andrew Allan, the chief executive of My USA Property. He adds, however, that “some are saying there’s a 12-month to two-year window for buying at these prices. Obviously if the Australian dollar drops down to US70¢ then the deal won’t be as attractive.”
With the Australian dollar almost back at parity with the greenback, the attraction of US property deteriorates with every cent we slide back. And with many economists divided over where exchange rates will be in 10 months, let alone 10 years, investors will have to consider the arguments and take a position.
Allan believes jobs growth in the US will eventually improve, at which point the housing market may begin to recover. But he admits that pinpointing when the recovery will come is anyone’s guess.
What he does reveal, though, is that while US property prices in some places are still dropping “the reality is the rental figures haven’t really dropped. The rental income many houses were getting pre-GFC is no different to now.”
Due to many home owners losing their houses in foreclosures, the rental demand is strong. This pursuit of yield is what is driving the decisions of many Australian investors.
“When the tide turns and people start buying in the US again, it means you’ll then be receiving even higher yields, with the capital gains as a bonus. I’m acquiring properties I can pay off within 10 years … but you need to have a five to 10-year holding strategy.”
Hidden traps
Two of the major risks faced by Australian investors who adopt the DIY approach are buying a property with a “lien” (an encumbrance or debt) against the title; and failing to find a good property manager and tenant.
“It’s common that some investors might see a $US10 property and think, ‘Wow, I’m getting a bargain’, but it’s later that they find out they’ve also inherited a tax lien of $US40,000 or more on the property,” Allan says.
He explains that unlike in Australia, where banks won’t transfer titles if there’s an encumbrance on that title, in the US the transfer will go ahead, particularly when investors are paying cash.
“People can buy property cheap then notice there’s a lien against the property to pay back,” says Property Women director Rachel Barnes, who recently experienced this first-hand on one of her properties in Columbus, Ohio. “It could mean just the rates due prior to settlement and it goes against the title.”
Allan adds there are independent title search companies in the US (like a conveyancer) that can tell you what lien might exist on a property. But he adds that it’s a good idea to additionally pay a small price for an insurance policy that covers you if a lien isn’t picked up in the initial search due to related paperwork still being processed by the government.
The risk of not finding a decent property manager and winding up with disastrous or even no tenants is “the biggest frustration”, he says.
Allan says that communication is the single most critical and challenging issue faced when dealing with property managers in the US. “Our expectations (of property managers) are high here … but over there, property investors generally buy near where they live and manage their own properties, so we have to educate the property managers there.”
Commonly experienced property management problems relate to the provision of statements, an absence of regular inspections and difficulty in finding quality tenants.
Property managers in the US generally charge commissions of 8–10%, he says. “While it sounds high, rents are generally lower in the US than in Australia, so you need to put it into perspective. On average, rents can be about $US500 a month.”
How to find the hotspots
Imagine asking an investor, ‘What are the hotspots for investment in Australia?’ and multiplying that by a 100 or more. That’s what it’s like when you ask about hotspots in America. The answer is endless because while the geographic size of the US is roughly the same as Australia, there are a hundreds more cities to navigate.
Also, unlike Australia, many parts of the US are oversupplied with housing. Allan says that because the oversupply of housing varies from area to area, the vacancy rate indicators don’t offer an accurate gauge of what’s happening.
Before entering the US market, investors need to understand one more important issue. Unlike in Australia where the closer to the CBD the better, the US is decentralised, meaning the infrastructure and amenities are often better further out into the suburbs. The same applies to employment.
He adds that US cities are often pocketed with ghettos.
So before flying into Los Angeles and scanning the destination list wondering where to head next, Allan suggests looking at areas where the migration rate is healthy and where future job growth is on the cards.
In an economic climate where jobs and house prices have plummeted across the country, there are some areas that have held up a little better than others.
Allan places areas into three categories:
1. Pure cash flow (about $US20,000–35,000). Cleveland, Ohio and Toledo, Ohio. Allan says these areas were hit significantly as these cities generally rely on heavy industry. “In certain areas there’s higher unemployment than in other areas but the infrastructure and amenities in suburbs outside both cities are good.”
2. Medium cash flow but greater potential for capital growth (about $US40,000–65,000). Kansas City, Kansas; St Louis, Missouri; Atlanta, Georgia; and Memphis, Tennessee. “These cities generally still have good fundamentals,” Allan says.
3. Higher capital growth potential and decent cash flow (about $US75,000 plus). Charlotte, North Carolina; San Antonio, Texas; Dallas, Texas. Allan says many of the Fortune 500 companies are based in these cities, along with three military bases in San Antonio.
He adds that in places like San Antonio, as the military force returns from Afghanistan over the next three years (or more), the areas close to the bases are worth watching as there’ll be a boost of income to the areas and demand for housing and amenities.
Other areas he considers to have potential are the Florida tourist hotspots of Orlando and Miami.
“However it still does come down to a street-by-street situation,” he says. “That’s why you need someone you can trust on the ground to tell you how it really is.”
As an example, you could be standing at the Chinese Kodak Theatre in Los Angeles where the rich parade with their Gucci handbags and Jimmy Choo stilettos, then walk 400 metres in one direction where you end up in a virtual ghetto.
Taking the plunge
Apart from seeing the market first-hand and getting a feel for the areas you might consider investing in, knowledge of the US tax system is the crucial first step, according to Michael Jones, a director of business advisors McHenry Partners.
“Many Australian investors have considered taking advantage of the post-GFC US housing market, but have felt the economic and legal differences between Australia and America confronting,” he says.
He says there are a number of safeguards to ensure that a venture into the US property market comes with both security and profitability. “Essentially there’s no restriction on property ownership in the US; you can acquire as a foreigner or what is referred to as an ‘alien’, but depending on the way you shape that investment, and how you deal with the variables involved, you could see a very different return.”
The variables Jones refers to include:
- Registration with Internal Revenue Service (IRS).
- Adherence to US federal tax conditions.
- Differing tax conditions between the 50 US states.
- Mitigation against potential liens.
- Asset protection.
- Insurance.
- The Australian
tax environment.
Depending on the individual’s circumstances, the proper navigation of these variables can be sorted out from Australia first for maximum tax flexibility, Jones says.
While various structures can be used for acquiring US property, the most common is a Limited Liability Company (LLC), he says – a US-based state entity that has similar characteristics to an Australian company.
Jones says that once the appropriate acquisition structure is identified, the accountant will facilitate the appropriate registrations at federal level with the IRS and then with the state in which the property is situated.
“If appropriate registrations aren’t carried out, the investors can incur taxes of 30% on gross rent received. That’s 30% of gross, not net rent received, on their properties.”
Due to America’s highly litigious environment, Jones encourages investors to safeguard their investment by obtaining public liability insurance and landlord insurance, and having their titles and contracts reviewed for the presence of liens, which could pass debts and taxes incurred by the previous title holders on to them.
“There are a number of differences between the American and Australian tax systems and it’s good to have some guidance when dealing with them,” he says.
“Lodging annual federal and state tax returns, adjusting the US tax year to correspond with Australia’s tax year, and utilising the US/Australia Tax Treaty are all important steps an investor should consider,” he says.
Investor Eddie Borg says that where his tax deductions are concerned, the following applies:
A property can only
- be depreciated for the first 40 years of its life.
- The interest paid on US finance and the Australian loan against the equity on the Australian property is tax-deductible.
- If the Australian portfolio is negatively geared, a cash flow positive property portfolio in the US will reduce the claimable amount on the negatively geared properties.
- Regular expenses like maintenance, rates, insurance and property management fees are tax-deductible each financial year.
- Purchase costs are tax-deductible against the capital gains tax when selling the property.
- Renovation (or “rehab” in American speak) expenses such as a new kitchen are depreciated.
- One trip to the US each year is tax-deductible, along with associated costs, such as car rental and hotel accommodation for that specific time period of looking at your property. Borg says you must have signed a contract prior to leaving Australia or already
own properties there.
Financing the property
Borg says there are three main options he considered for financing US properties:
Through a self-managed
- superannuation fund.
- Using equity from existing Australian properties.
- Borrowing from a US lender – a bank
or private lender.
Borg personally financed his first three properties in Florida using the first option, his self-managed super fund. “I just set up a self-managed super account though my own accountant and rolled over the balance into a cash management account,” he says.
He then set up an LLC to protect his assets, through an Australian-based accounting firm specialising in the US taxation system. Following this, he set up his US bank account remotely and flew over to inspect the properties emailed to him from an Australian-based buyers advocate service.
On selecting the properties, Borg would then transfer the relevant amount of money through a money exchange business to his US account where the cash would be made available.
He explains that the benefit of this is that he’s only taxed 15¢ in the US dollar on his net income, compared to 30¢ if he just bought it through a company, or up to 46.5¢ for individuals.
On his fourth investment, in Ohio, Borg used the equity from his one-bedroom apartment in St Kilda, a property he bought two years ago for $260,000 and now is valued at $410,000.
While you can borrow against the equity in your Australian property to buy a US property, you can’t easily borrow against the equity in your US property to buy an additional US property. “It is possible, but don’t expect to get low interest rates.”
However, because Australians (or “aliens”) are non-residents, lenders do consider them a higher risk so they’ll charge them higher interest rates and the minimum loan size is about $50,000.
Lenders won’t just lend on any property, he says – another good tip for the investor when deciding on a property type and location. The least risky property type is a single family home valued at $150,000 or more, but in some areas lenders are more cautious, such as Detroit in Michigan and Phoenix in Arizona.
Lets see if this is real..
