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28 REAL ESTATE RICHES FOUR MAGIC QUESTIONS 13

other investment vehicle where you can easily and consis- I think you will agree that your options are limited.
tently have the government give you money even when you
make a profit—rather than take it away in taxation.)
To understand why the government would boost your prof- When you buy your $1.5 million property for a
its rather than tax you, you need to understand the concept of contract price of $1 million using your $100,000 cash
depreciation. In the normal course of events, assets used in and a mortgage of $900,000, what can you personally
business go down in value over time as they wear out, or as do to increase the value of your property?
they are made obsolete through new technology. Governments Wow! Where do we start?
want you to stay competitive and efficient, so they want to en- You could paint the property. If you do not believe that it is
courage you to upgrade your assets often. One incentive they possible to buy a property for $60,000, have it painted, and
give you is to allow you to depreciate your assets. As the assets then sell it for $80,000, then you are missing out on spectacular
go down in value, you can claim the decrease in value, or de- opportunities.
preciation, against your income. Wait a minute, you say, let’s slow up a bit! Why would any-
For instance, let’s assume that you purchase a computer one be willing to pay $80,000 for a painted house, but not
worth $10,000. We all know that computers go down in value $60,000 for one in dire need of a $400 paint job?
quickly. In some countries you can claim 40 percent deprecia- The answer lies in the way we have been conditioned to
tion per year. This means that in the first year, you can claim expect instant results. We want, expect, and can generally get
$4,000 against your income as a write-off. instant soup, instant coffee, instant passport photos, instant
Now it hasn’t really cost you $4,000 in cash during the year credit card application approvals, instant messaging, Jiffy
(you paid for the computer when you bought it) but the depre- Lubes, and Curry in a Hurry. So when the masses go looking
ciation allowance is fair in the sense that in all probability the at properties, and they see an old house with bare wood ex-
computer has indeed gone down in value. posed on the siding, they tend to dismiss it as being a rotten
Let’s say that at the end of the year you want to sell the com- old property that will require a lot of work and effort (it prob-
puter. Remember that you have claimed $4,000 in depreciation, ably has many things wrong with it besides the condition of
so that the computer now has a “written-down book value” of the paint)—definitely no instant gratification! Most people
only $6,000. If you only manage to get $5,000 for it ($1,000 less would rather rot in front of the television set than pick up a
than the book value), then for tax purposes you can claim an- paintbrush and paint a $20,000 profit for themselves in a
other $1,000 as a tax-deductible expense. Conversely, if you couple of days (or better yet, pay someone to paint it for
manage to sell it for $7,000, then you have to pay “depreciation them for a modest $10, $20, or, who cares, even $50 an hour
recapture tax” (also known as depreciation recovered tax) on while they spend the time saved looking for the next $20,000
the $1,000 surplus of sale price over book value. profit).
If you think it is fair to allow businesses to depreciate as- Magically, when that same house is painted, the masses
sets used to generate income, then the depreciation rules on a will see it as a cute cottage in excellent condition that they
computer will seem sensible. In a similar manner, govern- could move into instantly, that would be a delight to live in,
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14 REAL ESTATE RICHES

and that they could (instantly!) show off to their friends. Per-
ception is reality!
Well, so much for our first idea on how you could increase Chapter 3
the value of your investment in property. There are many other
ideas . . . You may increase the value of your property by re-
placing the rusted gutters and downspouts on the front, by
putting in a new heating/cooling system, by changing the cur-
tains or drapes, by modernizing the bathroom, by putting in a
A TAXING ISSUE
new kitchen, by painting the roof, by erecting or replacing a
fence, by installing an alarm system, by fitting new doorknobs
throughout, by changing the window shades, by adding a

T
swimming pool, by removing an old shed, by cleaning the car- he tax laws as they relate to property are so incredibly di-
pets, or by paving the driveway. verse from one part of the world to the next, and so com-
On commercial properties you can increase the value by plex within each country, that it would really go beyond
finding a tenant for a vacant space, by splitting a large area that the scope of this book to attempt to give the reader spe-
may be worth only $5 per square foot and for which you have cific tax advice as it relates to property investments in specific
no tenants into two smaller areas worth $7 per square foot and geographic locations. However, there are almost universally
for which you can easily get tenants, by (again) painting it, by applied tax principles throughout the Western world that make
agreeing to a longer lease length, by attracting a better tenant, investing in property even more lucrative than the previous
or by replacing the carpets. chapters would suggest on their own.
There are literally 101 things you can do to massively in- For example, consider a property that has positive cash
crease the value of your property without spending much flow before tax. This means that before taxation is taken into
money. In fact, to prove it, I have written a book detailing just account, your income exceeds your expenses, so that there is
that (see Appendix). We will explore some of these ideas in money left over. In the normal course of business, you would
more detail later in this book. expect this profit to be taxed.
But for now, let’s get back to the point. Whereas with most Imagine if I told you that, under certain circumstances, the
other investments there is little you can do to increase the tax man considers you to be running this property at a loss,
value of the investment, with property you are only limited by and therefore lets you claim this “loss” against other income
your imagination. (even though you have positive cash flow!). The net effect of
This brings us to our fourth and final question for this course is to increase your profits even more. Despite the fact
section . . . that you are already making a profit before tax, the government
Part of the reason why we invest is in the anticipation boosts this profit so that after tax you are making even more.
that things will go up in value. So, let’s assume that all in- It sounds too good to be true, right? And yet this is exactly
what happens with property. (Once again I do not know of any

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FOUR MAGIC QUESTIONS 15

vested assets have doubled in value. (I am not specifying a

time frame here—it may happen in a year or over a period of
many years.) That means that the $100,000 stock portfolio
has doubled to $200,000, and that the $1.5 million property
has doubled to $3 million.

Question Four
You bought $100,000 worth of stock with $100,000 cash
that was worth $100,000 the moment you bought it. It
has doubled in value to $200,000. What must you do to
enjoy some of the increased value?
Well, for most investors, the simple answer is: “Sell!” You
could sell the entire portfolio, and thereby get your original
$100,000 investment back plus $100,000 profit, or you could
sell a portion of it. Either way, depending on the tax jurisdic-
tion you are in, you will be up for capital gains tax, which will
take some of the wind out of your windfall. What’s more, by
selling part of the portfolio, you are reducing the amount that
is left that can earn further profits for you. Something sounds
counterproductive!

You bought $1.5 million worth of property for a

contract price of $1 million using $100,000 cash
and a mortgage of $900,000. It has doubled in
value to $3 million. What must you do to enjoy
some of the profit?
By now you have probably learned to expect something other
than the pat answer: “Sell it!” And you’d be right. Selling the
property would be the dumbest thing you could do! Why sell
it? After all, you own an asset, the value of which is indexed for
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16 REAL ESTATE RICHES CONSPIRACY THEORY 25

inflation. It is generating a passive rental income that is simi- you have had on your investment, you will not only need to
larly indexed for inflation. As time goes on, both the value of know all the cash flows into and out of the property (such as
the property and the income it generates will continue to rent, maintenance, mortgage interest, and tax benefits), but
creep up. What’s more, if you were silly enough to sell, you you will also need to know how much the property will have
may have to pay capital gains tax on the profit. changed in value during the year.
But, I can hear some of you say, if you don’t sell, how will You may have noticed a subtle issue with the two situations
you ever access the increase in value? above. When comparing the increases in asset values, the USA
The answer is simply to refinance. You get a new appraisal Today article compared the average rise in property values
(this time for $3 million) and go back to the bank and ask for a with the average returns from CDs and other cash investments.
new mortgage. At the 90 percent loan-value ratio, you would Other charts compare the cash flow yields of equity invest-
get $2.7 million in your hands. After paying off the original ments with the cash flow yields of properties. Apart from
$900,000 mortgage, you would still have $1.8 million left over stocks, most financial instruments only enjoy either an in-
of surplus new cash in your hands. come, or a capital growth, whereas property enjoys both.
And ask yourself this question: Is the $1.8 million tax- Clearly, working out the true return on a property invest-
able? Of course not! Why would it be taxable? It is not in- ment is much more complex than simply declaring the yield
come, so there would be no income tax due. Similarly, you on a bank deposit. Later on I will explain how you can quickly
have not sold the property, so there can be no talk of a capi- and easily work out the true return on a property, and I
tal gains tax. promise you, this will be a real eye-opener, one that will make
You could use this $1.8 million as a 10 percent deposit on a you say something like: “Why did no one ever explain it this
further $18 million worth of property, which, combined with way to me before?”
the $3 million you already own, makes your total portfolio By buying into the notion that it is fair to directly compare
worth $21 million. property yields with the yields on other assets, or increases in
At this stage, if property values were to go up a mere 1 property values with the increases in value of other assets, you
percent, you would have made $210,000 (1 percent of $21 may be missing out on some of the most lucrative investment
million). And the surplus passive rental income cash flow propositions out there. Always compare apples with apples!
would be very handsome. If the property were to go up by 10
percent (perhaps in one year, or perhaps over a period of,
say, five years), then you would have made a further $2.1 mil-
lion (10 percent of $21 million). At this stage you could again
refinance, pull some more money out, and invest in more
property, or you could buy anything else such as an airplane
(tax-deductible if you use it to fly around inspecting your ex-
panding empire).
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24 REAL ESTATE RICHES FOUR MAGIC QUESTIONS 17

Whereas the $100,000 deposit in the bank required This airplane raises an interesting point. . . . As a broad
$100,000 in cash, the $100,000 property could be bought, using generalization, the poor typically earn their money, pay their
our 90 percent loan-to-value ratio, using only $10,000 cash. So tax on it, and then spend what’s left on the things they want.
the rental return of $6,000 should be considered relative to the On the other hand, the rich earn money, spend it on the things
cash input, not the arbitrary purchase price. they want, and then pay tax on what is left. Well, the property
Of course, if we do that, then we have to take the interest investor has an added benefit: When he refinances a property,
payments into account. If the interest rate is, say, 5 percent, first he receives money for which he has expended no effort (as
then we would be paying $4,500 in interest, and we would be in exchanging time for money); then, there are no tax obliga-
left with $1,500 per annum ($6,000 in rent collected minus the tions attached. Next, he gets to use this tax-free money to buy
$4,500 mortgage interest payments). Done that way, the return the things he wants (in this example an airplane). Further-
would be 15 percent ($1,500 divided by the $10,000 cash input). more, he gets a tax benefit from the interest payment on the
As the owner of the property you also have property taxes, money that he didn’t even have to earn but simply got from the
insurance, maintenance, pest control, management fees, and a bank. Finally, he can depreciate the asset to give a further tax
variety of other expenses that have to be taken into account. benefit. All aboard, please!
Then again, on the plus side, for taxation purposes, you can But I am getting ahead of myself.
depreciate the building, usually at around 2.5 percent to 4 per- My aim in writing this chapter is to share with you why I
cent depending on where you live. Furthermore, the contents think property is not just as good as other investments, not just
of the house—the chattels, or fixtures, or fittings, whatever you a little bit better than other investments, and not even just
want to collectively call the lamp shades, curtains, drapes, ver- much better than other investments, but tens and even hun-
tical blinds, extractor fan, dishwasher, stove, fridge, washing dreds of times better than other investments.
machine, dryer, floor coverings, irrigation system, wiring, My belief is that whereas most other investments do not of-
plumbing, and so on—can usually be depreciated at a much fer significant leverage, property offers tremendous leverage
higher rate, typically around 20 percent to 30 percent. Note through the generous application of mortgage financing. What’s
that depreciation means you can reduce your income for taxa- more, unlike with other investments, you can often buy proper-
tion purposes without it costing you even one cent out of your ties at prices significantly below their true value, you can do
pocket of the amount depreciated. things to them to further increase their value way beyond the
Finally, when you deposit $100,000 in the bank for a year, cost of the improvement, and you do not need to sell to reap
then all you expect to get out of it is the interest. If you know huge benefits from the increase in value.
what the interest rate is going to be, then you also know what Taken one at a time, the advantages just mentioned make
the return on your investment will have been: It is only the real estate a phenomenally powerful investment vehicle. How-
$6,000 of interest earned, divided by the amount of the invest- ever, when considered in unison, when these advantages work
ment. This is really stating the obvious! together, the effects compound each other, and, as we have
Conversely, when you buy a $100,000 property, at the end seen, an investment of a mere $100,000 may give you access to
of the year its value may have changed. To know what return
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18 REAL ESTATE RICHES CONSPIRACY THEORY 23

$18 million without much effort at all. Even if it were only half A typical scenario is as follows. It is boldly claimed that
as good, the resulting $9 million would still be phenomenal! while yields on properties averaged, say, 6 percent in a given
Even if it were only one tenth as good, the $1.8 million would year, the average yields on stocks averaged, say, 19 percent, so
still be spectacular! Even if it were only one hundredth as good why would you be bothered with all the hassles of real estate
($180,000), that is still, in my biased view, wildly better than the investing when you can get a better return from something
results of investing the same original starting capital of that requires much less involvement?
$100,000 in something that does not offer the advantages dis- On the face of it this seems like a sensible argument, and I
cussed in this chapter. know from the countless people who have told me so in per-
Now I have no illusions: For every argument and example I son, by phone, fax, e-mail, or letter, that such advice was an
present in this book, there will be scores of detractors who will ongoing reason why they did not get into the real estate game
cry foul. They will seize specific clauses, phrases, sentences, at a much earlier stage.
and passages, and quote them in such a way to try to convince To understand why such a comparison is nonsense, we
themselves or their audience that what I am saying cannot be have to, once again, compare apples with apples.
right. They will say things like: “Where I come from you cer- When you invest $100,000 cash in the bank, and you receive
tainly cannot get 90 percent mortgages!” or “You cannot make $6,000 per annum in interest, then the yield is simply 6 percent.
$20,000 profit by spending $400 on paint and throwing in a (The true yield will vary somewhat depending on whether the
weekend of labor in my town! Deals like that don’t exist here.” interest is paid monthly, quarterly, annually, or even weekly,
If you choose to agree with them, that is fine by me! I will daily, or continuously, and whether it is paid in arrears or in ad-
address the doom-and-gloom merchants, naysayers, disbe- vance. However, in all cases it will be close to 6 percent, so let us
lievers, and detractors later in this book. For now, please ac- just generalize and agree that the yield is 6 percent.)
cept that what I have described here is my reality. Similarly, when you buy a property for $100,000 and you re-
My contention is that most detractors of property do not ceive $6,000 per annum in rent, then the yield is, by definition,
fairly compare property with other investments. Consciously 6 percent. (Again, technically there will be a difference depend-
or subconsciously, they distort the truth, and then end up be- ing on whether the rent is paid weekly, biweekly, monthly, quar-
lieving this distorted perception themselves. So, it is time to ex- terly, or annually, but let’s again generalize and agree that the
plore the benchmark used to compare most investments. You yield is 6 percent.)
can then decide for yourself what is accurate and what is not. On the basis of yield alone, it would be fair to say that both
investments returned the same amount.
Many advisors who are property-averse are quick to quote
the relatively low yields of real estate, and go on to steer their
clients into other investment arenas.
However, is that where the comparisons should end? By
now you should be jumping out of your skin saying, “What
about leverage?”
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22 REAL ESTATE RICHES

That is exactly what happens to stocks and shares traded

on markets around the world. In other words, a stock market
may have an increase of, say, 5 percent in a year, but that really Chapter 2
represents the average of many wildly disparate stock gyra-
tions, with some going up phenomenally, others going under,
and everything in between. Whether your collection of stocks
does well or not is, it seems to me, a bit of a gamble.
On the other hand, it is much easier to see which proper-
CONSPIRACY THEORY
ties will go up in value: Trends are slower, less volatile, and with
fewer deviations from the average. Thus, the city with the high-
est growth in any nation in a particular year is very likely to be

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at or near the top again the following year. In other words it is here are two fundamental ways that the mass media, in
stupendously easy to beat the national average! (That’s proba- my humble opinion, misrepresent how good real estate is.
bly what investors of technology stocks thought when they The first relates to how the media compare increases in
were popular, to their eternal regret.) We will explore this con- house prices with increases in the values of other assets.
cept of beating the averages later in this book.
There is one more aspect that the newspaper failed to men- Increases in Asset Values
tion. Not only did the value of the property rise by more than
the other asset classes, but the home also provided accommo- On Wednesday, December 27, 2000, a headline in USA Today
dation for the family. If they didn’t own that home, then they read, “Housing Market Beats Stocks in 2000.”
would have had to pay rent somewhere else. And rent on your The first paragraph read: “When the numbers are in, 2000
own home is not tax-deductible, whereas mortgage interest in will go down as one of those rare years in which Americans
most countries is. Yet the table at the beginning of this chapter count their houses, not stocks, as their best-performing assets.”
fails to take any of these factors into account. A table in the article, reproduced here, details how the
value of various assets changed during the year.

Homes Beat Stocks in Value

Yields The average value of a home increased
The second way in which the performance of property is often more this year than many investments.
misrepresented is when reference is made to the relative yields Home 7%
of various investments. 1-year CD 4.97%
Just to clarify, the yield is, by definition, the ratio of the an- Money market fund 5.5%
nual income generated by the investment, divided by the dol- Dow Jones Industrials –6.9%
lar amount of the investment. Nasdaq composite –39.6%

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20 REAL ESTATE RICHES CONSPIRACY THEORY 21

These results are appalling! Not because the statistics show increase of $70,000 on our $1 million property, which is an in-
that housing outperformed most other forms of investment, crease of 70 percent on our original $100,000 investment in
but the notion that in other years property trailed behind! A real estate.
rare year? Get out of here! Once again we have come up against leverage, or gearing.
The media’s inability to grasp what I consider to be a fun- The same would apply to leverage in other forms of invest-
damental advantage of investing in real estate is, I am sure, one ment, but like it or not, banks and financial institutions love
of the prime reasons why potential investors, goaded on by fi- lending money secured against property, and shy away from
nancial advisors who have not yet figured out a way to profit lending money secured against nearly all other assets. In other
from advising clients into property, stay away from property. words, gearing is readily available to property investors, and
In any comparison, it is important to compare the prover- rarely available to investors in other asset classes.
bial apples with apples. Thus, in comparing the investment So, if we can show that statistically most property investors
performance of your money invested in various sectors, it is are geared, while most money market and stock investors are
important to always consider how the asset performed in rela- not geared, then I believe it would be perfectly fair to compare
tion to the capital put in. When you buy a CD—certificate of the performance of property relative to other investments by
deposit—you have to put up the face value of the CD. As we taking this phenomenal power of leverage into account.
have already seen, when you invest in the stock market (or Calculated this way, even if the stock market goes up by
money market funds), nearly all investors have to put up all of 15 percent, and real estate goes up by only 5 percent, then
the cash representing the investment. any property investors with a modest mortgage of 70 percent
On the other hand, when you buy a property, you may would still have done better than their property-averse
choose to pay the full price in cash, but you can also (very eas- counterparts.
ily!) get a mortgage for 20 percent, 50 percent, or 70 percent, of Since the average level of gearing on property in most
the value. There are mortgages available for 90 percent and Western nations fluctuates around 50 percent, is it not more
more of the purchase price. In other words, it is not comparing accurate to show the percentage increases in house prices rela-
apples with apples to compare the performance of a $100,000 tive to invested capital, rather than property value? That would
investment in CDs, money market funds, or the stock market immediately double the returns for real estate!
with a $100,000 property. And yet this is what most market Of course leverage also works in the other direction: If the
commentators will do, and certainly what a lot of financial ad- market goes down, then the downside is amplified just as
visors do to convince their clients that property really is not surely as the upside. But that brings me to a very interesting
that great. observation. . . .
What we should do is compare the performance of a Consider all the properties you have ever owned. And
$100,000 investment in CDs, money market funds, or the stock then consider all the properties your relatives and friends
market with $100,000 invested in property. Thus, if this $100,000 have ever owned. Have you ever known one to plummet in
was used as a 10 percent deposit on a $1 million property, then value by 60 percent, 90 percent, or even disappear off your
a 7 percent increase in property values would translate to an balance sheet entirely?