Your cousin Mary approaches you about potentially investing in an already existing investment property jointly with her (50% each). The property is an apartment currently rented out at $750 a week and is for sale at $460,000. You each have 10% so that you can buy it with a 20% deposit. You have enough for the stamp duty and any fees to purchase the property in addition to the deposit but you’ll each have to borrow the rest and the current market rate is 2% per year (variable). The council rates and strata fees per year are a total of $5,000. Your cousin wants to buy it together because she won’t qualify for the loan on her own and she knows you have a Bachelor of Business Finance degree but she has a few questions.

1. Mary says the main reason she wants to buy it is for the tax savings because she has heard about something called negative gearing and she is wondering how much money she will save. Explain to her about negative gearing and estimate how much she will save under the current scenario. Assume her marginal tax rate is 32%.

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Mary has another property that she thinks is worth $300,000 and when she met a real estate agent the agent said he could sell her property for $350,000. It is a common tactic to over-promise a selling price to try to get a vendor to use an agent but Mary wants to properly incentivise the agent. The agent has proposed a 2.5% flat selling fee. She heard that one vendor gave a bonus $5,000 commission for each $25,000 above the target dollar amount so she was thinking about offering that with a target dollar amount of $350,000.

2. Explain to Mary the pros and cons of this type of incentive structure and how it relates to agency costs.

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Mary heard about a ‘lease to own’ contract that was offered for some properties in areas that have had significant foreclosures in the past. The contracts are similar to renting with the ownership transferring for $1 after a 25 year period but there is a small down payment required before the lease begins and the tenants are responsible for all maintenance and upkeep in the property. What is missing in these situations is there is no mortgage so a bank is not involved and therefore no appraisal or home inspection is required before the renters/future owners move in. Also, there is no credit check so people that previously who may have had problems with credit are able to rent and possibly own their home in the future.

3. What are the possible risks from a lessee’s perspective and from an owner/vendor’s perspective?