The Bank of Mum and Dad - Part Two Mitigating risk via Asset Selection and Establishing Timelines

​In part one of the Bank of Mum and Dad we discussed the mechanics of using equity in the family home to assist your children in gaining a mortgage and entering the property market. If you missed Part one please review our blog posts “The bank of Mum and Dad” found on the MCS Buyers website. 

Part one concluded with the suggestion, “The purpose of the Bank of Mum and Dad is a leg up, not a forever financial commitment”. Our reason for this being the financial risk and potential disruption to parents financial plans over a lengthy time frame using cross collateralisation (The guaranteeing of funds or use of equity in a primary property as financial security to facilitate a mortgage on a secondary property or asset), could create a disruptive or in a worse scenario, costly impact at some point in the future.

In part two we will examine the different property categories and their risk profiles while sharing a number of ways to manage risk and ensure a timely exit from cross collateralisation.

Understanding growth in the property market forms the basis for this plan and the first thing we must dispel is that the property market will always grow quickly allowing the child to refinance or sell the property with a healthy capital gain. Assumptions are no basis for establishing a timeline and this strategy is fundamentally flawed for a variety of reasons.

1. I am a licenced Buyers Agent and would never put myself in a position of giving assurances of short term market growth especially if we are talking in vague terms of the market in general. Longer term, sure we can look at the underlying trends, but keep in mind The Bank of Mum and Dad is best used to facilitate a short term loan (I would suggest 1-3 years) not a 10/20/30 year financial investment.
2. The property market in general rises like a tide, raising all values across a city although strategy and asset selection will see some areas perform better than others. The property market also works the other way dropping across the broad market often as a result of either a local or international event (Example, the Global Financial crisis).
3. The intent of sharing equity to enable your children to buy a home is to see them enter the property market quicker and benefit from capital growth. 
   ​What it may not do is escalate the child’s progress up the property ladder. Sure you’ve helped get your child into the market but they may become stuck on the first rung of the property ladder if the property they buy offers little additional growth other than moving with the market tide.

Asset Selection

As a Strategic Buyers Agency our focus is always on buying quality assets. What makes one asset of better quality than another are the features or benefits they have that most don’t. I like to call this the law of scarcity, finite versus infinite. Location, Aspect, Construction, Flow, Amenity, Connection and Views are some examples.

The rule applies equally to a first home/apartment as it does the dream home. Apply the rule and you’ll purchase property that offer an edge over the rest and this edge acts as a value safeguard should you find yourself selling in an unfavourable market. It simply increases your chances of achieving a sale compared to other listings.

The second part to buying well is buying property with the scope to add value. This simply means improving a property to create a better property at sale, resulting in capital gain above market. The level of potential value add is often offset by the risk of over investment, so you do need to be measured and careful. Renovations to update the layout, flow, main utility rooms and outdoor areas are by far the easiest value adds that most people are capable of project managing. These aesthetic improvement done well, should deliver a 3 fold return on the renovation budget. This alone can be the key to releasing the financial cross collateralisation guarantee in a timely manner.

Asset selection and cosmetic improvement are the key ingredients in mitigating risk should life events deliver a forced or untimely sale. Primarily though these measures are the ingredients aimed to achieve a profitable property flip beyond broad market growth, (buy-renovate-resell for profit).

Now let’s connect the dots. The purpose of the Bank of Mum and Dad is to fast track a child’s entry into the property market. This comes with financial risk and potentially lengthy time-lines of cross collateralisation. The combined benefit of strategic asset selection and a value add program for asset improvement can facilitate the release of the guarantor equity assistance in a timely manner via re-valuation or asset sale for profit, while fast tracking your child on their journey, climbing the property ladder.

A note of caution, improving a property requires effort and some sacrifice. The property industry like to use the term sweat equity to describe the effort versus reward of home renovation. I personally believe every young person is in the best moment of their life to focus spare time on building financial wealth, but if you or your child just want a turnkey solution to market entry then maybe consider other versions of the Bank of Mum and Dad. A non-repayable financial gift or cash loan from future inheritance are options available to those who have the spare funds.  Just beware that capital growth on a fully maximised property will only be driven by the broad market growth and of course the initial asset selection.

If you are looking to use the loan guarantee version of the Bank of Mum and Dad to assist your child into the property market then it’s important to understand which property types offer the best scope to achieve capital growth and which offer limited growth beyond market movement.

The value add property segment

Older 50’s/60’s/70’s/80’s Houses, Apartments, Villas, Townhouses, Duplexes.

This type of property offers the best foundation for aesthetic value add.

Avoid fully maximised properties with no scope to add value

New Homes, New Apartments, Fully Renovated Older Properties.

These properties are at their full potential at time of purchase which will have been reflected in the purchase price paid, they offer little to no value add beyond broad market growth and are more suited toward a self-leveraged buyer with a longer ownership timeline.

The Do’s of value add

Minor internal layout and flow improvements, new kitchen and bathrooms, flooring, lighting, paint and finishes. Garden and outdoor space improvement. Zero to very minor structural changes – for example the removal of a wall between kitchen and living area. (A licenced engineer and approvals will be required as this may involve a key structural supporting wall of the property.)

The Don’ts of value add for a cross collateralised first home

Upstairs additions or extension to the house floor plan, knock down re-build, extravagant and deeply personalised interior design or colour choice. Old properties that require rewiring, new plumbing, roof replacement or waterproofing.

All of the issues outlined above involve potential lengthy timelines and certainly potential budget blow outs and over capitalisation. They are not suited to the novice and should never be considered using cross collateralisation of parents funds – the risks of over capitalisation and time line blowout are just too high.

This now brings us to the number one and most important element in achieving capital growth on property, The Initial Asset Selection.

Every Mum and Dad has the best interests of their children at heart, I see this at auctions every week. The question I pose, do you have the experience as a buyer to fully understand the market drivers and assist your child into the best possible asset choice ensuring they buy well? Most families in Sydney live in the same home for 20 plus years, this is a long time to be out of the buying market.

The full services of a Buyer’s Agent will cost you around 1% of the purchase price and bring 24/7 market engagement, honed and refined property choices, understanding of asset advantages, timely market data, accurate valuations (not farcical Real Estate Agent price guides) and the ability to negotiate against the best in the Real Estate sales game. So why wouldn’t you have a Buyer’s Agent on your team

I have a theory, and I don’t think it’s the cost. Every parent wants to guide their child toward success as a matter of pride, buying a home is no different. What’s missing here is a potential misunderstanding of the process in using a Buyer’s Agent.

Of course I can only speak on Behalf of MCS Buyers, where our approach is both property professional and mentor. Our process is inclusive and our service is efficiency, knowledge, experience and expertise. Parent and child are the central part of the journey as we guide you down the path as consultant. You maintain your central role as a parent but surround yourself with the best guidance and advice. There is nothing more satisfying than sharing a drink at the end of the journey and receiving the appreciation from a parent knowing they have given their child the best guidance in getting their foot on the property ladder.

To conclude this series looking at “The Bank of Mum and Dad”. Assisting your children to enter the property market sooner via a financial guarantee, gift or personal loan is a noble gesture that can see real financial benefit. Recognising the risks and understanding the steps you can take to ensure the acquisition of a quality asset and the opportunity to add value will help manage your financial exposure and reduce the timeline in which you are financially exposed. Seek the best advice and guidance to ensure you buy well and be prepared to help your next child following your first success.

If you live in Sydney and are in the process of helping your children into their first home, please reach out to us at MCS Buyers, the Strategic Sydney Buyers Agency. Let’s just start with a coffee and share how we can guide you to a successful purchase.

Important Note: The above article is not intended as financial advice and serves as an example of a strategy practiced by clients we work for in securing quality property in the Sydney Real Estate market. It is strongly advised that anyone looking to buy property should first seek professional financial advice from a licensed accountant, financial planner, and mortgage broker to review their individual financial circumstances and abilities.