Profit on Trading Property

There are a lot of people looking at going full time into property trading to make a living and gain wealth.
My first comment is be very careful about quitting your day job.

- This job brings you day to day cash flow, which enables you and your family to live.
- Banks love a steady, solid income. So without one, you might find lending difficult.

Secondly, do the figures really stack up?   In today’s market it is very difficult to buy well and easy to sell.  But the market can quickly change and it is easy to get caught with trading properties if the market turns. This can result in additional holding costs and also with a lower than expected selling price.

Third, how will you make a profit?  What is your formula to make a profit?

• Buy, subdivide and sell.  This can work well and the formula makes sense and can achieve a good profit.  Obviously still need to check numbers carefully
• Buy, add a bedroom and sell.  Again you can see how this can add value and could be profitable
• Buy, add value by doing up the bathroom and kitchen.  This depends on your abilities and what you are really doing.   This strategy is a lot harder and results less guaranteed.  Many people in the past has made great gains from this, BUT most of those gains are because the market went up, not because of the added value.

Here is an example of a Property Trade

Example

Purchased for $650, 000
Renovations cost $35,000
Could sell for $735,000
From a quick glance, a lot of people think “that’s not too bad” and it’s $50,000 profit.   But, unfortunately, that is not the case.   Below are the likely expenses and I always include commission as you may need an agent to help sell if the market turns.

So based on the expenses included, the Trade would make a tiny profit of $798.   If commission is excluded the profit would be $22,698 before tax, or around $15,000 after tax at average tax rates. 

This example shows how quickly a perceived profit can disappear.   If the property was held for longer, then it is likely to make a loss.

10% Rule

As a general guide, I would aim for a Net Profit before tax of around 10% of the purchase price for a simple trade.  So in the example above, aim for around $65,000 Net Profit.  You need to ensure your profit is large enough to make the risk worthwhile.

This level of profit gives the trader some room to move with either the selling price, or to hold the property for longer and to still make some kind of profit.
 
Overall

Property Trading is not easy and you need to ensure you have a market in which to sell your finished product.   With Trading you need to keep your properties moving, so the idea is to do them as quickly as possible and then move onto the next one.  Historically where I have seen Traders come undone is where they take too long or where they get too big too quick (i.e. have 2-3 or more on the go at once).

If you are thinking about trading properties, I suggest you organise a meeting with me to discuss the structures used, GST and the implications of tainting.  This can be booked at the bottom of this link, or alternatively a great starting point can be a free chat for 5-10 minutes

Property Accountants NZ - here to help you navigate the now tougher than ever property market / rental market in New Zealand.

Ross Barnett - Kiwi Property Accountant

Disclaimer: This article has been prepared for the purpose of providing general information, without taking into consideration any particular person's objectives, financial situation or needs. Any opinions contained in it are held by the author as at the report date and are subject to change without notice.