Moneyweb - Property scheme raises warning flags
Moneyweb insert: Louwrens Smith, CEO of Optimum Financial Services, an authorised financial services provider (FSP) with the number 8143 wishes it to be know that he has no connection to Peter van Wyk and Optimum Financial Services with FSP number 12145. The same names are merely a coincidence and the result of the Financial Services Board having no control over trading names.

A scheme doing the rounds promises to build up a passive income of R168 000 within one year. All that’s required is a monthly salary of R7 000 and a clean credit record.

“To qualify for this opportunity, all you need is a clear credit record and to be able to prove that you have a stable income of R7 000 per month or more,” reads an e-mail distributed by Optimum Financial Services, an entity authorised by the Financial Services Board (FSB) to sell financial products.

“It won't cost you a cent and you won't have to do anything. The formula is: Monthly Salary x 30 x 4 x 20% For example, if your salary is R7 000 per month, then R7 000 x 30 x 4 x 20% = R168 000. This is the amount that you'll receive tax free after one year, and every year after that – without ever paying a cent.”

It all sounds a bit too good to be true, which should raise warning flags among sensible investors.

Optimum’s scheme is nothing more than a buy-to-let residential property “partnership,” but with two significant twists. Optimum boss Peter van Wyk says he’ll help you form a trust for the partnership, source properties, obtain funding, find and manage tenants and invest surplus cash. In return, he takes 30% of any income the partnership derives.

Two warning flags

There are two aspects to the scheme which ought to trouble the sleep of risk managers of South Africa’s big four banks.

The first is a trick Optimum uses to maximise clients’ borrowing power. Van Wyk identifies four low-value properties he thinks are suitable for the purposes of the scheme. He then uses a mortgage originator to obtain quotes from each of the big four banks for each of the four properties.

He then accepts the quotes for the properties, but ensures that each is from a different bank. Each bank approves the loan, apparently unaware that three other banks are concurrently approving loans of similar value on four different properties. This allows Van Wyk’s clients to borrow four times more than banks would normally allow them to. Van Wyk says he understands that there are moves afoot by the banks to close this apparent loophole – in the meantime, however, he is making hay while the sun shines.

Asked if he thinks this is an abuse of the banks’ risk management systems, Van Wyk replies that this might be the case if his clients had to use their salaries to fund the bond. His scheme, he argues, requires no financial input from the client. This leads us to the second warning flag.

To cover the shortfall between rental income and bond repayments, Van Wyk has another trick up his sleeve. He cuts a deal with the sellers of the properties. The seller receives a higher price for the property than he or she would normally be happy with. In return, the seller makes a predetermined cash payment to the buyer after the transaction is concluded. This cash payment is used to fund the rental shortfall for a one-year period.

Naturally, Van Wyk ensures that the necessary legal framework is in place to prevent the seller from reneging on the deal.

The end result is that the banks provide finance for properties with an artificially high value. It will also distort their residential property price data.

Again, Van Wyk says he thinks that this practise is not an abuse of the system. After all, the banks are the property experts, he argues, and would not lend money for properties they deemed expensive.

How it works

What we know so far is that Optimum purchases four properties for each of its clients on their behalf. They also come up with a way of financing the bond for a one-year period. But what happens after that?

Van Wyk says that after a year, his clients apply to the banks for bond re-financing. Of course, this is subject to the properties increasing in value over the period, and therein one finds the greatest risk to Optimum’s scheme.

To his credit, Van Wyk is open with potential clients (Moneyweb posed as one) about the scheme’s risks. The major risks, he says, are that property prices don’t rise, interest rates go up, or a tenant defaults.

If property prices don’t rise and no refinancing is available, Van Wyk says there are two options available to clients: sell out, or cover the shortfall themselves.

So Van Wyk’s mind-boggling calculation above is based on the following premises: that each bank grants you a loan 30 times your monthly salary, that you get a loan from each of the big four banks, and that the prices of your properties increase by 20% more than the rental income shortfall each year.

Provided property prices keep rising at a pace greater than the rental income shortfall (which is hardly guaranteed), Van Wyk’s clients derive an income, of which 30% goes to Optimum. This income is tax-free, says Van Wyk, because the "income" is from a loan and must eventually be repaid.

Optimum does not participate in the ownership of clients’ houses, nor does it contribute to bond repayments. But this does not mean it is without potential liability: Van Wyk says that he signs surety for some of his less affluent clients to help them obtain loans.

Article from: Julius Cobbett -