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HELP Please Capitalising LOC

Discussion in 'Finance & Banking' started by gotta, 3rd Aug, 2006.

  1. gotta

    gotta Member

    3rd Aug, 2006
    Hi There; This is my first post so I'm hoping somebody can help me here.

    I work but my wife dosent. We recently got a LOC on our home and lent it to a property development deal maker at 20%.The interest is capitalising.

    The investment is in my wifes name as I thought it would be better not to just add the return to my income. Thought it may take me into the next tax backet (at that time but with new tax rates it may not matter)

    I thought the interest would be deductable in my wifes name is that correct?

    Has this been a smart move or a dumb move?

    Going to make the same investment soon so I would love to know if it's the right way make the investment or should I put the investment in both our names?

    Thanks for any help you can give me.
  2. Nigel Ward

    Nigel Ward Team InvestEd

    10th Jun, 2005
    Hi Gotta and welcome to InvestEd

    Some observations. These are intended to help you, so please take them on board or not as you like. They are intended to be instructive rather than as criticism.

    1) time for some tough love. Why are you borrowing against your home (the roof over your heads and a relatively low risk asset) to lend to a developer (presumably unsecured) for a development (high risk activity) and you're not even getting paid any interest until presumably the project is finalised? Sounds like a high risk proposition to me.

    2) I'm not saying there isn't a place for mezzanine finance, but in my opinion you would only ever consider lending to someone for a development if it was money you could lose without it causing you major financial harm.

    3) Hypothetically let's say the property development is a dud and nobody wants to buy the properties, or they can only be sold at a much reduced price. Guess who gets paid first - the Developer's bank. Guess who gets paid second - any secured mezzanine lenders (maybe). Guess who is supposed to get paid last - the developer. Guess who ACTUALLY gets paid last or not at all - the unsecured creditors, such as you.

    4) On the tax side of things if the LOC is in joint names then I suspect that you'll get half the deduction and your wife the other half (which may not be of much use if she doesn't have income against which to offset that deduction).

    5) You will have to pay the interest on your loan from the bank without receiving the interest from the developer - I assume you've factored in that you can meet the cashflow shortfall.

    6) There is a direct correlation between risk and return. A 20% return is high. Therefore the risk is high (see points 1 & 3 above).

    7) From your post I'm not sure if you have actually lent the money or if you're just about to. Assuming you haven't, my question to you and your wife is this:

    "Are we prepared to lose our home if this investment fails?"

    Ask yourselves that several times and make sure you can BOTH honestly say "Yes". Don't just say, "Oh she'll be right mate. It won't go bad. The developer is really good and he's a mate...".

    8) Where are we at the moment in the property cycle? The answer may well be different in different states. One view may be that a development now late in the property cycle is more risky than one at the beginning of the cycle.

    9) What due diligence (i.e. enquiries, investigations, research) have you done in relation to:
    a) this developer?
    b) this development?
    Does the developer have a strong track record of similar developments? Are they financially sound. If you're not getting any security, why not? Have they had any failed projects? What returns have previous investors received? Can you speak to some previous investors (not just patsies from the developer)? Have you actually seen any of the developer's other developments? Is this project TOO BIG for this developer's experience and resources?

    What about this development? Is it in a good location? What's the design like? Will these properties be in demand when completed? What's the marketing and sales plan? Are there any impediments from council to getting it built as planned? What's the timeframe? Will labour shortages delay the development? Can you keep paying the interest on your $100k LOC drawdown if the project takes 2-3 years to finish?

    10) Have you taken legal and financial advice before entering into this transaction. I STRONGLY suggest you do given you're putting your home on the line.

    Just some food for thought.

    I hope this is useful to you. Perhaps you've already thought of all the above.

    Best of luck

  3. TryHard

    TryHard Well-Known Member

    17th Aug, 2005
    Wow ! Great post Nigel ... there's so much 'noise' out there (if I get another 'rah-rah' email from the 'usual suspects' I might just implode) ... and so little concrete cautious and realistic advice, its refreshing to be bought back to Earth.
  4. gotta

    gotta Member

    3rd Aug, 2006
    LOC for investment

    Thanks for that Nigal;

    The situation here is that while house price may be begining to settle, there is still a big demand for blocks. This new development will be alongside the new Mandurach railway so the block are certain to sell. another developer has blcks for a highprice nearby.

    yes; it's a risk but in order to make some money one has to take some risks. We know the person concerned.

    Would a straight loan be better than a LOC? we currently have both available to use.

    Both the LOC and Loan facility is in joint names but the last investment with the developer was in my wifes name alone. Is this a good way to go or should it be in joint names?

    I have been reading about Westpoint and it's very chilling considering the ASIC advised those ripped off not join a class action but to take their claim to some tribunal where each individual has to argue their own case at their own cost and if the cases are paid out the tribunal would run out of funds to any more anyway. one can only wonder why the goverment appointed a new chief whose appointment was critised by consumer groups.

    Thanks for your feed back and it would be nice to know if it's perhaps better to use a loan rather than a LOC on our home.

    thanks - gotta
  5. APerry

    APerry Active Member

    7th Jul, 2006
    Hi Gotta,

    I also have some money leant out at high rates (the same rate as you actually). There is definately risk involed, but this can be managed by choosing your clients carefully, make sure that you know their situation intimately, and structure the loan contract so that it is strongly in their interests not to default.

    I don't have a great amount of money to lend, so I restrict my activities to people I know well and I have never had any trouble. I also know some others who private lend on a larger scale, every one of them restricts their activities to areas they know well eg one is a builder and lends large amounts to developers on the proviso that they use his company to build. If they default he happily takes over the development.