2 Loans for 1 property......

[alexlee]

Hi Alex,

I bought my first investment property this year and am buying a second one now (Gladstone QLD - also 105% financed). Wasn't around in the bust in the '90s (if that is what you are referring to).

Be interested in your views on what I'm doing, as you're obviously been in the game a lot longer than I have

I've only been in this game for about 7 years. So I've been in it longer than you but certainly not long enough to have seen the last bust (90s). I have enough experience to know that downturns can and do happen.

All I'm saying is that going 105% right from the start is a risky strategy. Great if the market is booming. Not so good if the market stagnates. Your research may tell you the mining towns you have chosen have great fundamentals, but even mining supercycles have temporary crashes. The mining boom has been happening for a couple of years now. How confident are you that it'll continue without a hiccup? We're talking about factors such as US demand for Chinese imports and, in turn, Chinese demand for our resources.

I have no comment on your strategy investing in mining towns as I don't do it, don't plan to do it and have no research. I just do NOT think going 105% on a first property is wise. Nor do I think investing for less than 12 months is enough to conclude that a strategy of buying with 105% LVR is sound, because it has never been tested. Is it a presumptious of me to think that you don't have a big cash / equity buffer, and that is why you're using 105% LVR?
Alex

 

[Omega Investmen]

Saving for a deposit sacrifices capital growth

Hi Alex,

I think 105% financing is suitable for your first property given the below. We probably have very different risk profiles and I'd be keen to hear your thoughts on each of the below points

1) You'll be unlikely to do it after your third property
You'll be using loc doc lending at 80% and accessing the other 25% (including closing costs) through the equity in your property. You can only use 105% when you have a high disposable income (eg, not negatively geared on another two or three properties)

2) Returns are higher the less deposit you put in
Putting in no deposit and only the net interest (eg interest - rent) payments, means that your returns on any capital gain will be in the 100s of percent.

For instance, over two years I might make $20k in interest payments on a $300k property and have a capital gain of $60k. That equates to a cash-on-cash return of 200% on my money. If I put in a 10% deposit plus 5% closing costs (eg, $45k) and made say $10k in interest payments, my cash-on-cash return is 9% (ie, ($60k - $55k)/$55k).

200% cash-on-cash return vs 9%?

3) I can use my deposit as a safety buffer
If I keep my $30k deposit on a $300k purchase and 105% finance it, I can keep that $30k in the bank as a buffer in case I ever get 'cash crunched'. In reality, you would not keep all $30k or you might as well put it in as a deposit for the loan. Say, I keep $10k as a buffer. This equates to $415 extra for repayments a month for two years - more than enough protection for my leveraged position

4) Saving for a deposit carries a huge opportunity loss
Say I save for two years and build up a $30k deposit. In those two years, if property prices went up 5% I would have lost $30k in capital gains on a $300k property held for two years. In fact, my $30k now only buys me a property that would have been worth $272k if I had bought it two years earlier.

Does it make sense to save for a deposit? Wages only go up by 4% (for most people) a year - how much property prices? 5%, 10%? 15% in the last quarter in some places in Melbourne...... Better to buy now as prices will rise faster than you can save - particularly if you are looking for an owner occupier.... it'll be the housing commission only for you if you wait to save...

5) You may not have a big deposit (I didn't)
It's probably easy for you to make sweeping statement about not using 105% financing. I assume you have at least three properties, maybe more now you have been investing for the last seven years - including some of the best years for capital growth in the last 50 years....

However, not everyone has equity like you do. I didn't have a large deposit - it would be impossible to save enough and buy within a year. 105% was the way to go.

Also, my property in Roxby Downs that I bought in September (signed contract July) has gone up $40k - hear that... $40k. Probably not a lot to you but a lot when you only had a $10k deposit! I've tripled my money (factoring in the closing costs of the capital gain) in three months. If I had been saving, maybe I would have a deposit of $15k now. What is the better position?

Now, I have a 105% loan and $10k in the bank to act as my buffer. And I have a 12 month rental contract to mitigate risk. I do agree with you regarding a mining town - maybe China invades Taiwan tomorrow and there are global trade sanctions on China and the mining industry tanks. That would devastate Roxby, just like S11 devastated areas linked to tourism. However, if you worried about those macro risks too much you'd never get out of bed.

5) Take risks when you're young!
I'm 30, so what better time to take a risk that now? I can afford to take a big hit - I've no dependants, just me, and plenty of working life to get myself back on track, if things hit the wall.

Thanks!

Flynn

 

[Simon]

Hi Alex,

I bought my first investment property this year and am buying a second one now (Gladstone QLD - also 105% financed). Wasn't around in the bust in the '90s (if that is what you are referring to).

Be interested in your views on what I'm doing, as you're obviously been in the game a lot longer than I have

Thanks, Flynn

You have bought one investment property and you are posting here, purporting to be an expert, advising people to take on high risk investments?

You need a Surgeon Generals warning attached to each of your posts I think.

 

[alexlee]

1) You'll be unlikely to do it after your third property
You'll be using loc doc lending at 80% and accessing the other 25% (including closing costs) through the equity in your property. You can only use 105% when you have a high disposable income (eg, not negatively geared on another two or three properties)

I make no distinction between using equity to finance 25% and getting 80% LVR on a new property. I would consider that 105%. I bought my first couple with 10-20% cash deposits, and then used 105% effective LVR for remaining properties. I have been negatively geared throughout, and still am.

2) Returns are higher the less deposit you put in
Putting in no deposit and only the net interest (eg interest - rent) payments, means that your returns on any capital gain will be in the 100s of percent.

For instance, over two years I might make $20k in interest payments on a $300k property and have a capital gain of $60k. That equates to a cash-on-cash return of 200% on my money. If I put in a 10% deposit plus 5% closing costs (eg, $45k) and made say $10k in interest payments, my cash-on-cash return is 9% (ie, ($60k - $55k)/$55k).
200% cash-on-cash return vs 9%?

Lower deposit results in higher returns. That's true WHEN THE MARKET GOES UP. When the market stagnates or goes down, you magnify your losses too. You haven't been doing this long enough to have experienced a downturn. what's your cash on cash return when the property falls 5%?

4) Saving for a deposit carries a huge opportunity loss
Say I save for two years and build up a $30k deposit. In those two years, if property prices went up 5% I would have lost $30k in capital gains on a $300k property held for two years. In fact, my $30k now only buys me a property that would have been worth $272k if I had bought it two years earlier.

Does it make sense to save for a deposit? Wages only go up by 4% (for most people) a year - how much property prices? 5%, 10%? 15% in the last quarter in some places in Melbourne...... Better to buy now as prices will rise faster than you can save - particularly if you are looking for an owner occupier.... it'll be the housing commission only for you if you wait to save...

Personally, my own income has gone up by significantly more than 4%. And I saved around 40-50% of my after tax income. And again, I note you haven't been doing this long enough to have seen anything other than a hot market, and in a regional centre wholly dependent on mining. What was happening to those mining towns BEFORE this mining boom?

5) You may not have a big deposit (I didn't)
It's probably easy for you to make sweeping statement about not using 105% financing. I assume you have at least three properties, maybe more now you have been investing for the last seven years - including some of the best years for capital growth in the last 50 years....

However, not everyone has equity like you do. I didn't have a large deposit - it would be impossible to save enough and buy within a year. 105% was the way to go.

5) Take risks when you're young!
I'm 30, so what better time to take a risk that now? I can afford to take a big hit - I've no dependants, just me, and plenty of working life to get myself back on track, if things hit the wall.

We're the same age. I'm also 30, and I started 7 years ago. I got deposits by saving 40-50% of my income and increasing my income by going overseas. Now I have a dependent spouse. Unless you have had truly personal reasons like an illness or had to take care of someone, ask yourself why you haven't managed to save a deposit by age 30, and whether you might need to re-look at your savings habits?

Also, my property in Roxby Downs that I bought in September (signed contract July) has gone up $40k - hear that... $40k. Probably not a lot to you but a lot when you only had a $10k deposit! I've tripled my money (factoring in the closing costs of the capital gain) in three months. If I had been saving, maybe I would have a deposit of $15k now. What is the better position?

You timed it right, and that's great. You haven't actually tripled your money because 1) you can't access it all and 2) if you sold there would be significant costs. I just question what happens if/when the market turns. Also, are you basing this price increase on agents telling you it's gone up or actual contract prices? How do you assume that it's sustainable? Markets can and do go down: go to Western sydney and see what can happen, and we still have full employment.

Personally, I'm investing for the long term. Short term pops are bonuses but my first priority is that I have enough buffer to hold for the long term no matter what happens. I'd also ask, why didn't you start buying in these mining towns 5 years ago when they weren't that hot (yet)? I got lucky with a Perth buy in 2004. I only expected 7% gains a year and the thing doubled in 3 years. I also did 105% effective LVR (25% from an existing property, 80% from the new one) so the return is infinite, I suppose

However, that was lucky. I'm not expecting to constantly find those sorts of properties. Humility is a great asset for an investor.

Now, I have a 105% loan and $10k in the bank to act as my buffer. And I have a 12 month rental contract to mitigate risk. I do agree with you regarding a mining town - maybe China invades Taiwan tomorrow and there are global trade sanctions on China and the mining industry tanks. That would devastate Roxby, just like S11 devastated areas linked to tourism. However, if you worried about those macro risks too much you'd never get out of bed.

I don't think you need war for that. I think a US recession is coming. I'm not selling all my properties for that, though I AM being more careful.

Basically, Flynn, I think it's great you've started investing, and you've done well by buying in Roxby and catching a hot market. I do note, though, that this is your first 2 only, you've only been doing it for a year, and you have never hit any sort of downturn / recession / job loss. To advise other people to follow your strategy is irresponsible because you haven't got enough experience to be able to say it works.

Have I missed out on a lot of opportunities because I have been conservative on my LVRs and use cash for deposits? Yes. I think I've done ok, though, because I've powered up the savings to above normal levels and time to compensate.

Am I confident that I will ride out a 3% immediate increase in interest rate, 6 month vacancy, 6 month job loss, general market mayhem, which is in fact my stress test? Also yes. Don't think that won't happen. We've had a 16 year stretch without a recession.

We all have our definition of sleep at night factor, of course. Many people do well at the edge of the risk curve, as you say. Just remember that it's more likely you'll get killed in a downturn when you sit closer to the edge.

I sometimes wonder whether it's better for first time investors to start when the market is hot or when the market is cold. When the market is hot, of course, you get more equity from appreciation immediately so you can refinance more quickly. Unfortunately one might also be tempted to think it's personal skill that created those returns instead of just the market. Buying in a cold or down market means you are buying on fundamentals, because the broader market isn't going up. You will be more careful and more appreciative of the 'rising tide lifts all boats' theory.

Humility, I stress, is a great trait for an investor. (Donald Trump notwithstanding).
Alex

 

[Mofra]

Hi Oemga,

Just a couple of follow up questions (not picking, just workign through contingencies):

1) You'll be unlikely to do it after your third property
You'll be using loc doc lending at 80% and accessing the other 25% (including closing costs) through the equity in your property. You can only use 105% when you have a high disposable income (eg, not negatively geared on another two or three properties)

That in itself is a fair assumption - with a credit squeeze, and a strategy based on yield plays, capital growth targets based on recent market performance are unlikely be met.

2) Returns are higher the less deposit you put in
Putting in no deposit and only the net interest (eg interest - rent) payments, means that your returns on any capital gain will be in the 100s of percent.

The basic rule of leverage is that it magnifies gains and losses. On a $0 money down strategy, an extended period of stagnation is technically a loss of 100% in holding costs alone.

Interesting to know why you went for a Fundcorp caveat loan rather than a cheaper unsecured personal loan in any case - not only for the interest rate difference, but in you downside planning you will not be able to refinance or dispose of the property quickly, as lenders require a caveat-free title before securing it (without prior exception).

For instance, over two years I might make $20k in interest payments on a $300k property and have a capital gain of $60k. That equates to a cash-on-cash return of 200% on my money. If I put in a 10% deposit plus 5% closing costs (eg, $45k) and made say $10k in interest payments, my cash-on-cash return is 9% (ie, ($60k - $55k)/$55k).

200% cash-on-cash return vs 9%?

You need to factor in aquisition costs as well, in addition to subtracting the initial extra 5% purchase lend from the first scenario.

3) I can use my deposit as a safety buffer
If I keep my $30k deposit on a $300k purchase and 105% finance it, I can keep that $30k in the bank as a buffer in case I ever get 'cash crunched'. In reality, you would not keep all $30k or you might as well put it in as a deposit for the loan. Say, I keep $10k as a buffer. This equates to $415 extra for repayments a month for two years - more than enough protection for my leveraged position

But with a higher interest debt to service, you increase the chances of cash-flow issues to begin with.

Good luck with your strategy, hopefully it pays off but there does seem to be little/no hedge against a downside that is of greater chance of occurring now than in the recent market conditions.

 

[grantc]

Hi Flynn,

Wouldnt it have just been quicker & cheaper to finance it with this loan??

http://www.propertyinvesting.com/forums/getting-technical/finance/4322008


Cheers
Grant

 

[Omega Investmen]

Thanks to all the experienced replies

Hi Alex, Simon and Mofra,

Thank you for all your replies and for expressing your views and concerns. I think I should have prefaced my first reply with the statement that I am suggesting a higher risk strategy that increase your chances of being wiped out in a market turned down and that you need to undertake detailed research before committing to the strategy.

(Hi Grant, thanks for the suggestion with First Permanent. Looked at it - they will not do the post code in Roxby Downs. In fact, the two mortgage insurers (GE and PMI) declined to provide mortgage insurance. I was approved by Homeloans Ltd @ 85% (with LMI from the third smaller Australian LMI provider) and Carrington National (aka - lender of last resort for prime mortgages) @ 90% but the LMI provider also refused, however the CEO of Carrington intervened on my case and waived the $4k LMI. I went with Carrington because of the higher LVR and no LMI (not saying the LMI waive can be repeated - haven't heard of it occurring before))

Your key feedback is:

1. You are not in a position to express an opinion on the subject
Given I am not an experienced investor; it is fair to say I can not represent myself as an expert. I'll flag the fact that I am starting out in future posts.

2. Higher LVR magnifies your losses
It magnifies your % losses but not your $ losses. While I make the point about greater % upside returns the lower your deposit, it is not a real comparison doing it the other way.

If we both have a $300k property and they fall in value 10%, what is the result? Well if you put in a $30k deposit, you've lost 100%. If I put in $3k, I've lost 1000%.

The above is true. But it is also true we have both 'lost' $30k. Neither of us are in a worst financial situation as we've both suffered the same financial $ loss.

However, if I don't have a $30k deposit and therefore do not get into the market and the market rises 10% what happens? Well you make 100% on your money and I make nothing because I never got in. If I waited to be 'safer' and saved my deposit and the market rose 10%, I still missed out.

So my strategy works in a rising market only. In a falling market, I'd say we both get hit the same way?

3. What about a downward /stress market situation
Alex, you made the comment that your stress test is:

3% immediate increase in interest rate, 6 month vacancy, 6 month job loss, general market mayhem

That's a pretty dire situation. Even assuming you mean separate and not cumulative events.

My contingency plan is save the deposit and use it as a buffer. If you have a 10% deposit, don't you think this will cover the above situations to some extent?

It sounds like you had both a 10-20% deposit for your first property plus another 10% buffer to cover yourself for six months job loss, which would be the biggest risk in your stress case. I didn't have 30% in savings and had to go with a 10% buffer to my 'riskier' strategy.

4. You can not pick 'hot spots'
I disagree. You can if you do the research. Specifically, I have

- flown and met with real agents in Roxby Downs (SA), Zeehan (Tas), Gladstone (QLD) and Penola (SA), inspecting an average of 8-10 properties.

-through www.factiva.com done a 'press search' on all the press articles on these towns for the last year. To give you an idea, I have a 55-page press search on Roxby Downs, 16-pages on Zeehan, 81-pages on Gladstone, and 20-pages on Penola.

- charted the demand and supply forecasts for Uranium, Aluminum and Coal for the next 10-20 years, and the price trends for Zinc, Nickel and Copper. All point to demand exceeding supply over the medium term.

- looked through and read the presentations on the web sites of BHPBilliton, Rio Tinto, Zinifex, Santos, Protavia (pulp mill constructor for Penola), Arrow Energy (LNG plant at Gladstone), Gladstone Pacific, QLD Residential Tenancy Authority (for data on rising yields), Allegiance Mining, Zeehan Zinc, Metal X, Tasmanian Mines Council, Natural Resources and Mines (QLD Gov - "QLD's World-Class Coals: Mine Production and Developments"), Australian Coal Association Research Program ("Assessing the Social and Economic Impacts of Coal Mining on Communities in the Bowen Basin"), Duaringa Shire Council QLD ("Report on the Blackwater Housing Forum (04)"), Gladstone Economic and Industry Development Board, Real Estate Institute of QLD, REISA, REIT

- charted the population's age and income demographics for the towns based on Australian Bureau of Statistics for 2001 and then two months ago for 2006, which indicated high household incomes (eg, c50% with $100k+ annual incomes) in Roxby (and other areas like Blackwater, Port Hedland and Dysart) and high incomes in Gladstone

- secured 12 month lease contracts with 5-6% yields on the two properties I have bought (signing Gladstone one next week)

However, I need to do more research and am continuing to do it.

The research I have done to date includes data available up to two years ago. This all points to the same conclusion, I should have invested two years ago. I only did the research 7 months ago but had I done it 24 months ago the result would have been the same.

You can find 'hot spots' if you do the research. Alternatively, you can just pay a buyers advocate to do it for you.

5. I'm using expensive funding that exposes me to a credit crunch
It was expensive. I used Carrington National (8.7%) and Fundcorp (13.5%) because I wanted to invest in a mining boom town and they would be the only ones to come to the party (with Homeloans Ltd but @ 85% LVR) in a regional town.

I chose Fundcorp over a cheaper unsecured loan because I had already taken a $15k unsecured loan with a major bank and it didn't look like I'd get another to use as a deposit and I didn't want a series of CRA hits on my credit file. Fundcorp was happy to give me $45k as the deposit, secured by caveat and not 2nd mortgage (so Carrington was happy).

I have a $10k cash buffer to help with any cash crunch

6. Why haven't you saved a deposit?
Fair question but not really relevant. Even if I had a deposit, I would still have financed 105% and used the 20% deposit to let me buy even more properties.

However, to satisfy your curiosity I have worked for a US investment bank and management consultancy and have a relatively large disposable income. I've enjoyed spending that, knowing my skill set will always be in demand (relative to other professions), but have now decided - enough is enough - buy property, leverage up and cut all my disposable income so I don't waste it.

7. Have humility
I am admittedly very enthusiastic about what I am doing - working a demanding job and researching to 1am every morning for months on potential investment areas requires a little enthusiasm.

I'm also a little optimistic and this can come across as not being humble, so my apologies.


Haven't answered all the comments you've made, such as some of the calculations but I don't want to write too long a post.

Love your responses - they are valuable to my learning - this is a great forum!

Flynn

 

[alexlee]

2. Higher LVR magnifies your losses
It magnifies your % losses but not your $ losses. While I make the point about greater % upside returns the lower your deposit, it is not a real comparison doing it the other way.

If we both have a $300k property and they fall in value 10%, what is the result? Well if you put in a $30k deposit, you've lost 100%. If I put in $3k, I've lost 1000%.

The above is true. But it is also true we have both 'lost' $30k. Neither of us are in a worst financial situation as we've both suffered the same financial $ loss.

True, but for someone who has no equity buffer, a $30k is a LOT more than $30k to someone who has a $500k buffer.

[However, if I don't have a $30k deposit and therefore do not get into the market and the market rises 10% what happens? Well you make 100% on your money and I make nothing because I never got in. If I waited to be 'safer' and saved my deposit and the market rose 10%, I still missed out.

So my strategy works in a rising market only. In a falling market, I'd say we both get hit the same way?

No, in a rising market the person who leverages more wins bigger (same dollar growth, higher return on cash contribution). In a downturn the person who leverages more gets hit bigger too (same dollar loss, higher loss on cash contribution). A $30k loss to someone who has no equity buffer has a much bigger impact than someone who has an equity/cash buffer.

In a downturn the name of the game is survival, and the more buffer you have, the better your chances. You both get hit for the same dollar amount, but the ability to withstand that hit is very different.

3. What about a downward /stress market situation
Alex, you made the comment that your stress test is:

3% immediate increase in interest rate, 6 month vacancy, 6 month job loss, general market mayhem

That's a pretty dire situation. Even assuming you mean separate and not cumulative events.

My contingency plan is save the deposit and use it as a buffer. If you have a 10% deposit, don't you think this will cover the above situations to some extent?

Yes, it is dire. And I think that may well happen in a downturn. Am I overly pessimistic? Maybe. And maybe the investment banks should have included the possibility of a subprime pop affecting commercial bill markets.

A 10% deposit is one buffer. Is it enough? Depends a lot on other income sources. The bigger your portfolio, the less % hit you can stand in terms of cashflow. Getting, say, a 5% hit on your cashflow as a result of vacancies and rising rates wouldn’t be a big deal if your portfolio is only $200k and you make $100k+ salary. That’s only a 10k hit and relatively small compared to your salary. If your portfolio is $2m, that 5% becomes a lot kickier.

It sounds like you had both a 10-20% deposit for your first property plus another 10% buffer to cover yourself for six months job loss, which would be the biggest risk in your stress case. I didn't have 30% in savings and had to go with a 10% buffer to my 'riskier' strategy.

That’s fine, but you have to recognize that by going 105% LVR you’re taking a lot more risk than someone who puts down a 10% cash deposit. Not just from an equity point of view but cashflow.

5. I'm using expensive funding that exposes me to a credit crunch
It was expensive. I used Carrington National (8.7%) and Fundcorp (13.5%) because I wanted to invest in a mining boom town and they would be the only ones to come to the party (with Homeloans Ltd but @ 85% LVR) in a regional town.

I chose Fundcorp over a cheaper unsecured loan because I had already taken a $15k unsecured loan with a major bank and it didn't look like I'd get another to use as a deposit and I didn't want a series of CRA hits on my credit file. Fundcorp was happy to give me $45k as the deposit, secured by caveat and not 2nd mortgage (so Carrington was happy).

I have a $10k cash buffer to help with any cash crunch

With a yield of 6% and something like 10%, you’re losing a LOT of cash. My own experience tell me assuming costs and tax effects even out, you’re losing 4% cashflow a year. On a $300k place that would be around $12k. How much spare income do you have when you keep buying with numbers like that? Or are you depending on refinancing to capitalise costs?

A 10k buffer would disappear in an instant if rates went up, you have vacancies and you need some repairs done on your property. It is more risk than I would personally go for, especially as your portfolio grows. While it’s only a couple hundred k and you have a high salary, you might be ok, though.

6. Why haven't you saved a deposit?
Fair question but not really relevant. Even if I had a deposit, I would still have financed 105% and used the 20% deposit to let me buy even more properties.

However, to satisfy your curiosity I have worked for a US investment bank and management consultancy and have a relatively large disposable income. I've enjoyed spending that, knowing my skill set will always be in demand (relative to other professions), but have now decided - enough is enough - buy property, leverage up and cut all my disposable income so I don't waste it.

Large disposable income means nothing for investment purposes if you don’t save it. That’s my point. My own strategy is dependent on an ability to save to cover emergencies. If the doodoo hits the fan, can you shift your lifestyle so that you start saving? Why do you think you can do it if you haven’t so far? You haven’t mentioned anything about saving: or are you counting the money you are putting into the property to cover the –ve cashflow? To me, buying properties with high -ve cashflow and forcing yourself to save from the salary is NOT as good as simply saving more and putting it in an offset.

7. Have humility
I am admittedly very enthusiastic about what I am doing - working a demanding job and researching to 1am every morning for months on potential investment areas requires a little enthusiasm.

I'm also a little optimistic and this can come across as not being humble, so my apologies.

Enthusiasm and optimism are great. Borrowing 105% LVR to buy into mining towns when the mining boom started 5 years ago and assuming the boom will continue without any short term hitches even with economic storm clouds in the US and China……. Is that too much optimism? For me humility is understanding that sh*t does happen, despite all of our research and confidence, and to be prepared for that. Timing and property selection become much more important if you go for 100%+ LVR, and really, if the experts don't always get their predictions right........ my own humility, in this case, is knowing that I probably won't forecast any better than the experts, so I don't try. Instead I aim for 7% appreciation per annum over the long term, and plan for busts.
Alex

 

[ermen]

However, to satisfy your curiosity I have worked for a US investment bank and management consultancy and have a relatively large disposable income. I've enjoyed spending that, knowing my skill set will always be in demand (relative to other professions), but have now decided - enough is enough - buy property, leverage up and cut all my disposable income so I don't waste it.

7. Have humility
I am admittedly very enthusiastic about what I am doing - working a demanding job and researching to 1am every morning for months on potential investment areas requires a little enthusiasm.

I'm also a little optimistic and this can come across as not being humble, so my apologies.


Flynn

I think investment bankers (if you are/were one) normally have a more sophisticated outlook towards leverage and risk than the average punter on the street. Your 105% strategy is great, I like it a lot - but u probably have to recognise it won't suit all risk profiles or it would be too hard to explain it to everyone...

On humility, I have observed throughout Somersoft there are other seasoned and not so seasonsed investors who don't have much humility. I guess it's just part of the investing world...

 

[Omega Investmen]

There's a reason why you can now 105% LVR...

I think investment bankers (if you are/were one) normally have a more sophisticated outlook towards leverage and risk than the average punter on the street. Your 105% strategy is great, I like it a lot - but u probably have to recognise it won't suit all risk profiles or it would be too hard to explain it to everyone...

On humility, I have observed throughout Somersoft there are other seasoned and not so seasonsed investors who don't have much humility. I guess it's just part of the investing world...

Thanks ermen,

You make a sound point that probably differentiates me and Alex - we have different risk tolerances and attitudes to risk. He is conservative and, on his own admission, has probably missed out on some opportunities. Myself, I'm willing to take a higher risk and in doing so get myself into the market.

Alex has two valid issues with my strategy.

1. 105% lending is risky (it's not risky, if the cashflow is the same)
Firstly, he makes the point that lending at 105% is risky. Of course he is right. You couldn't easily lend at 105% five years ago. It has only been recently that these products have come on the market (eg, First Permanent's 105% loan and Fundcorp's $45k caveat secured personal loan).

They are risky because of higher interest rates and higher total debt costs due to capitalisation of LMI or mortgage risk fees into the loan. These all increase your repayments relative to a loan with a deposit.

However, if you can service a $400k loan then what is wrong with servicing a 105% loan of say $360k that will have roughly the same repayments as a $400k loan with a 20% deposit? Same cashflow position however one required an $80k deposit and the other was 'no-money-down' and in the game.

This said, you need to know what you can 'really repay' each month. If you haven't saved a deposit then maybe you can't find the money to make the payments on a 105% loan. Solution to this is borrow 105% but buy a cheaper property to make sure you can make the repayments and keep any deposit as a buffer.

2. It is better to save a deposit (the property window is closing)
It is true that having a deposit creates a safety barrier. If a market tanks and your property falls 20% then you just lose your equity. If you are geared 105% then you probably have to declare bankruptcy because you probably don't have any assets. Fair point - you lose the same amount of cash but don't have a 'real' buffer if you are geared 105% (though, if you keep your deposit as a buffer for cashflow reasons this can mitigate your situation).

However, these 105% products have come on the market because house prices have gone up astronomically. In Alex's day - 7 years ago - house prices were 50% less or probably even 75% less than they are now. Back then, it was feasible to save a 20% deposit for 'most' people.

However, what about now? The June 2007 median house price in metro Melbourne is $420k (up 10% in the quarter!). In Sydney it is $559k. In Brisbane it is $405k (up 9.5% in the quarter!). Indeed, according to RP Data, the median Australian house price is $459,402 (www.news.com.au/business/story/0,23636,22353393-37037,00.html).

Can you see where things are going? Do you know what the prices are like in London, in Tokyo, in New York? What happens is that eventually the 'average' person gets priced out. There forms a permanent 'renter-for-life' group of people... those that didn't get in and now can never get in.

In London, there are entire suburbs of blue collar baby boomers whose properties have tripled or more in value but can not sell because there is no where to go - they can't afford to move because they still have blue collar wages. They also can afford to draw down on their equity, as they can't service an increased loan. Same with many white collar suburbs. Those who are not in the market have to rent and rent for life (or until their parents die).

Now it is not that bad (yet) in Australia. But ask yourself; were prices 'crazy' five years ago? Seven years ago. What will they be like in another seven?

105% allows you to get in and get in now. I believe now is the time to get in - a strong economy, full employment. What better time to take a higher risk strategy

If you spend the next two years saving for a $40k deposit, the house you were looking at will have gone up $30-80k...maybe $100k... Of course it may not (especially in outer suburbs with room to expand or depressed areas like West Sydney) but look what has happened in the last seven years. I don't see the Australian economy slowing - the US can go into recession but China is still buying and will insulate our economy. Remember Australia has already had the Asian Crisis, SARS, Sep 11, Iraq war and oil prices.


There is nothing wrong with Alex's strategy and comments on my strategy. He has obvious done well with his conservative strategy. Mine in part is by necessity more aggressive - I have sat one property boom out, I don't want to sit another. 105% financing gets me in now - I don't want to wait.

I deliberately bought a cheaper (albeit $360k) property in Roxby Downs to make sure I didn't over commitment myself. The market has continued to boom - BHP announced an expansion of the reserves of Olympic Dam, all is well on the mining front, house prices are up 20%+ in the last year - so I'm now confident to move to the next property in Gladstone.

Anyone wanting to adopt my strategy needs to work out their cashflow capacity and simply not borrow more than that. If you can only afford $1000 a month in repayments (net of rent) then that's it. I don't think it matters too much whether you borrow 105% or 80% LVR - just don't go over $1000 a month and keep a buffer in case things get tight.


One final thing - while I'm investing in regional boom towns and 'do' expect 10%+ capital growth, I agree with Alex that 7% or so is more realistic long term. My main point is, 'get in now' not later when prices are much higher. Also, I'm jumping on the 'real' (versus 'hype') bubble of the commodities (versus 'tech') boom and using this to my advantage in my investing.

Hope Alex and I have provided you all with food for thought

Flynn

 

[alexlee]

2. It is better to save a deposit (the property window is closing)
It is true that having a deposit creates a safety barrier. If a market tanks and your property falls 20% then you just lose your equity. If you are geared 105% then you probably have to declare bankruptcy because you probably don't have any assets. Fair point - you lose the same amount of cash but don't have a 'real' buffer if you are geared 105% (though, if you keep your deposit as a buffer for cashflow reasons this can mitigate your situation).

That's NOT what I said at all. Going into negative equity does NOT mean you have to declare bankruptcy. However, going into negative equity basically kills your ability to refinance. Since at 105% LVR you're already in a worse cashflow position than if you had a lower LVR (since you assume rent is the same %) then you're more vulnerable to rate increases, etc.

However, these 105% products have come on the market because house prices have gone up astronomically. In Alex's day - 7 years ago - house prices were 50% less or probably even 75% less than they are now. Back then, it was feasible to save a 20% deposit for 'most' people.

Uh, we're not talking about about 30 years ago, Flynn. It was only 7 years ago, and you and I are the same age. I bought my first place for $170k when I was on a salary of $35k. How feasible is it for people to save a deposit on that salary? Feasible, certainly, but not common. If you try you can do it. I would also assume you are on MUCH more than the average salary now.

Can you see where things are going? Do you know what the prices are like in London, in Tokyo, in New York? What happens is that eventually the 'average' person gets priced out. There forms a permanent 'renter-for-life' group of people... those that didn't get in and now can never get in.

In London, there are entire suburbs of blue collar baby boomers whose properties have tripled or more in value but can not sell because there is no where to go - they can't afford to move because they still have blue collar wages. They also can afford to draw down on their equity, as they can't service an increased loan. Same with many white collar suburbs. Those who are not in the market have to rent and rent for life (or until their parents die).

Now it is not that bad (yet) in Australia. But ask yourself; were prices 'crazy' five years ago? Seven years ago. What will they be like in another seven?

I do know what London is like, having lived there. I agree that long term prices can get a lot higher than we think is 'affordable'. That does NOT mean prices go up in a straight line. You can't assume that the market will go up in the next 7 years at the same rate as the last 7. The 90s show that property CAN stagnate for years.

105% allows you to get in and get in now. I believe now is the time to get in - a strong economy, full employment. What better time to take a higher risk strategy

Actually, I think the best time to take a higher risk strategy would be when the market is crap, the economy is down and unemployment is relatively high. The 90s, basically. Why? Because in such an economy the prices are probably trailing long term growth rates.

I don't see the Australian economy slowing - the US can go into recession but China is still buying and will insulate our economy. Remember Australia has already had the Asian Crisis, SARS, Sep 11, Iraq war and oil prices.

There is nothing wrong with Alex's strategy and comments on my strategy. He has obvious done well with his conservative strategy. Mine in part is by necessity more aggressive - I have sat one property boom out, I don't want to sit another. 105% financing gets me in now - I don't want to wait.

Here you and I disagree. I believe a US recession will drag China right down with it. You've sat one boom out, but I don't believe a second boom follows right behind. I believe we'll have a few years of stagnant growth until the next one comes along. If China stumbles (and inflation pressures combined with decreasing exports from the US recession may well trigger that) the mining boom gets hits first.

Obviously, in the end, we all choose our own strategies. Flynn may well have enough income / job security to survive a downturn. Or I may be wrong and we keep growing for the next 7 years like we have for the last 7. My own bet is that prices will be stable or even fall for the next couple of years. I may be wrong, but either way I'll survive until the next one.

For those who have fewer resources than Flynn, think carefully before trying 105% LVR especially for a large loan amount.
Alex

 

[alexlee]

I think investment bankers (if you are/were one) normally have a more sophisticated outlook towards leverage and risk than the average punter on the street. Your 105% strategy is great, I like it a lot - but u probably have to recognise it won't suit all risk profiles or it would be too hard to explain it to everyone...

On humility, I have observed throughout Somersoft there are other seasoned and not so seasonsed investors who don't have much humility. I guess it's just part of the investing world...

Don't get too enamoured of investment bankers. They generally go have a more sophisticated outlook on leverage and risk, but that also drives them to take much more risk that the ordinary person won't. I'm not a banker or trader but I've worked with them enough to know that they're much more human than people think. Don't be too impressed by 'black box' type theories because they come from someone who you think should be more sophisticated when it comes to risk. i.e. just because you don't understand it doesn't automatically mean it's 'too sophisticated'. Question the fundamentals. Property is fundamentally a very simple investment. We're not talking CDOs here.

Hedge funds are run by sophisticated finance people. They still blow up, because they take far more risk than usual. Just because someone is sophisticated doesn't mean they can manage any risk.
Alex

 

[sue78]

I don't really get what you are trying to achieve...sorry haven't read it all yet.

However, I borrow 2 loans for one property all the time. One loan for the land and one loan for the construction...which is secured by security all over the place.