A few novice questions

[avura]

Hi All

I discovered this forum only a couple of days ago and have literally been stuck to my monitor absorbing the wealth of information here. Prior to finding a reference to the forum in Michael Yardney's book, I had a number of investment property questions. Reading his book and browsing these forums has taught me a lot, but in terms of satisfying my previous curiosities, I am more confused than ever. If anyone could shed some light, I would be very grateful.

As a bit of a backgrounder, I am in my mid 20s and have been working on developing the family's property portfolio over the past three years (I know, not the best time). My parents have a PPOR, but everything else has been acquired in the past three years by me (often with their financial help). Like most uninformed novices, I focussed immediately on CF properties. I had previously heard opinions similar to Yardney's about CG, but I could never internally justify them. After reading this forum, I have seen numerous posts with similar sentiment.

So, my main issue is with the distinction of CF and CG properties. Yardney shows a number of calculations and tables, but looking at the market, it doesn't seem so clear cut (of course). I just don't seem to be able to accept the idea in Yardney's book that CF properties simply have a higher portion of their return in CF. In an example, he proposes a CG property of 14% may have a CG of 10% and CF of 4%, then the inverse for a CF property. That would mean the CF property would grow to the point that the CF would be huge. Imagine finding an IP now for $300k that had a $2k per week CF?

Where I have the most trouble with this, is in practical situations. Right now I can buy an inner city property with two dwellings which provide a combined high CF. Is that classified a CF property to the majority of people? Do CG people think that will have a lower CG than the one next door with a single dwelling (obviously cheaper and lower CF)? I realise these are just terms and theories, but I think it would help me digest these theories if I knew what a CF and CG property were. If I had minimal equity, I would probably lean more towards these CF properties with a good CG potential. But with a bit of equity now, I'm torn between focussing solely on CG or a combination of CG and CF.

Lastly, I understand the more seasoned investors would recommend devising my own theories, but I think I'm stuck in that void where I can disagree with others, but don't have enough experience to back my theories up!

Many thanks

 

[alexlee]

I haven’t seen Michael’s figures, but I agree with the general idea that yield + cg = a constant. Yes, CF looks crazy if you project the numbers, but remember that at some point the property becomes old, has to be torn down, etc. so the use changes. A new yield / cg combination then restarts.

There's also the argument that rent goes up with inflation while CG goes up at higher than inflation. So in time the yield drops to almost nil. Obviously that can't happen: what happens in reality is that the house (for example) gets old and decrepit, and will be torn down and rebuilt. A more 'normal' yield then applies to the new properties. Or, the property becomes so valuable that it enters the luxury market, where there are so many owner-occupiers that yield becomes irrelevant. (Think beachside mansions).

As for the 2 dwellings (I’m assuming a duplex) v a free-standing house on similar sized blocks: just because a property has good cashflow doesn’t mean it won’t have cg. You may just have a really good property that does both! Just in general, though, the free-standing house would be worth less (I’m assuming it’s older, as opposed to the duplex which would be newer) than the 2 dwellings. i.e. because more of the value is in the land it’s worth it to tear down the house and rebuild, generating more cg, as opposed to tearing down the duplex.

In the end, concentrating on CF or CG depends on your objectives. Personally, I’m 29 and have a 10+ year horizon, so I’m concentrating more on CG. If you need more income now go for CF. If you find CF properties with good CG potential, buy it! There’s no rule that says it’s either or, just that most properties tend to be either CG or CF.
Alex

 

[arriety]

There is nothing wrong with starting your property portfolio with CF properties.

The main problem as I see it for you Avura is that you've started your investment portfolio at the end of a boom. Canberra, (is that were you are investing?) is only just starting to recover so it is difficult as this stage in the market to predict how long it will be flat, how long before pick up and climb happens. For CG portfolio at your tender age you need quick growth,so you can get your equity out of the property and keep investing. If you have cash flow on your IPs now this will increase as rents rise, however those properties may only increase in value by 3% in next couple of years, making it difficult to fund more IPs. However if you get some good financial advice re your income v. investment you should be able to build up the equity in the existing properties and be in a good position to buy up just before the market starts its upward swing again.

 

[avura]

Thanks Alex

I completely neglected to consider the cycle restarting due to dwellings becoming too old, although there are many 40+ year old house still renting strong around here. But it does provide the missing link, thanks!

My situation is similar to yours, I'm a bit younger but with a slightly different outlook. While my own is 10+ years like yours, I have to consider my parents who are five years from theoretical retirement. They have little superannuation from running their own business and I would like to get them sorted. Much of what I have achieved I owe to their equity, so I owe it to them to consider their outlook (plus they're my parents). They said they'd be happy on 100k a year during retirement and that seems easily achievable.

Moving on from my previous concern, I guess the next one is whether ~40 years of historical data is enough to predict the future with any certainty. If the old cliche about good property doubling every 7-10 years is true, then this is going to be relatively easy. Although you say CG grows above inflation, I have seen stats showing that it has stayed with inflation if you look much further back. But in reality, I personally think our history (especially pre-WWII) is too crazy to use as reliable data (I wasn't alive back then, so what would I know ).

One of the other points from Yardney's book is that property isn't such an outstanding investment when considering the returns of other investments. He says the difference is in the leverage available and that makes it the best (subjectively) investment. But I can leverage just as much (80%), more easily, with much fewer costs (not as much stamp duty, land tax, etc) with shares. So there's always that question too. I personally think good property is more secure and psychologically safer (is that even valid?), but would be interested to hear the views of others.

 

[avura]

Thanks Arriety

I guess that's exactly what I did, start with CF properties. It's only now that I am considering theories other than my own (I'm sure this has nothing to do with my 'tender age' as you put it, hehe). I only have my PPOR in Canberra, the rest in in NSW and QLD, but I want to concentrate on Canberra now since I have been here for a while (5 years) and know the area better.

I always thought I was buying at the end of the boom, but now I'm starting to think it's the end of the end of the boom . That is, possibly the flat period, which optimistically is the period before the start of the upturn. Nonetheless, if the cycle continues as it has in the past, I figure I can just keep buying and buying (good properties) and it will all catch up eventually. But as I mentioned in a previous post, I have my parents' situation to consider, which really throws a spanner into the works.

Your opinion on needing quick growth, which at this stage will be more likely in rents, is one I had considered but never heard anyone else put forward. That was always my case to other 'CG-lovers': "how can I invest if I simply don't have the money!?" I guess the answer to the CF vs CG debate isn't so clear cut.

Thanks again for the reply.

 

[Les]

G'day Avura,
Welcome aboard - and thanks for your searching post. You've obviously given this some serious thought.

I guess the answer to the CF vs CG debate isn't so clear cut.

You said a mouthful right there!!! Most people understand "cash in the hand" but can overlook PROJECTED cash (i.e. they understand CF but can't quite "get with" CG). Thus, they stick with the familiar (can't say I blame them in most cases as they've never been exposed to alternatives)

Avura, you said this:-

In an example, he proposes a CG property of 14% may have a CG of 10% and CF of 4%, then the inverse for a CF property. That would mean the CF property would grow to the point that the CF would be huge.

Ahh, probably not - as CG hits, yields drop - so, a $200k property returning (say) $200pw has a return of around 5%. But, if the property doubles in value in 7 years (10% growth) but the rents "don't keep up" (3% growth) you will end up with figures like this:-
7 years out:- Value $400k Rents $246pw Yield is now only 3.1% instead of 5% But, of course, this is a yield of 3.1% of a MUCH higher figure.


The inverse is the CF+ property - where growth is lower, but cashflow is better. Starting with the same $200pw scenario, here's what you'll see:-
$100k IP, $200 pw rent 10% yield (or 2 x $50k IP's at $100 pw each)
7 years out:- Value $132k Rents $246pw Yield is now 9.3% (assuming the same 3% rental growth...)

Imagine finding an IP now for $300k that had a $2k per week CF?

I seriously doubt that this would be a MY quote, so I guess it's your own Avura? Not sure how you arrived at this one - but happy to discuss it further if you wish..... Unless you are thinking of a CF+ IP in the year 2050... but you're presenting a 30%+ yield - that's HELLUVA Cashflow !!! How does one get THAT?

Don't forget - yield DROPS as CG increases - so, even though you might start with a "10% yield", this is relative to the current value of the IP.

Percentages can be confusing - a favourite example of mine occurs whenever the RBA decides to lift Interest rates. Today, we tend to hover around 6.75% - then tomorrow (I hope not!!) the RBA lifts rates by 0.25%.
Now, 0.25% doesn't sound a lot, does it? But wait, there's more !!

Based on the CURRENT rate of 6.75%, 0.25% is a 3.75% increase !!

See what I mean about percentages? Stick to REAL NUMBERS if you want to understand the truth. Use percentages by all means, just as long as you really understand what they are telling you.

Regards,

 

[simonjulie]

Where I have the most trouble with this, is in practical situations. Right now I can buy an inner city property with two dwellings which provide a combined high CF. Is that classified a CF property to the majority of people? Do CG people think that will have a lower CG than the one next door with a single dwelling (obviously cheaper and lower CF)?

Hi avura
This is the way I see it.
The main player is the land that the dwelling is on. That is what really goes up in value. The type of dwelling/improvements situated on that land only governs the income or yeild. The better the yield the easier it is to hold the land while the land grows in value over time.
The bottom line is "buy well located desirable land with potenial for increasing the yield". This can be done by purchasing a tired old place with potential,add value to increase both overall property value and yield. Michael Yardney would probably add redevelop to the equation.
Simon

 

[arriety]

Excellent Post Les

 

[avura]

I seriously doubt that this would be a MY quote, so I guess it's your own Avura?

Many thanks Les.

Is MY an abbreviation for something I should know? Those numbers weren't anything I calculated, just me trying to make a point about an increasing rate of return. But based on the posts here, I understand the reality now.

Thanks to everyone else too. Much appreciated.

 

[lizzie]

i would hazzard a guess that MY is michael yardney

 

[Les]

Sorry Avura,

I guess we're so used to using abbreviations that I didn't stop to think. Lizzie said it:-

i would hazzard a guess that MY is michael yardney

You'd quoted Michael earlier in your post. My take on the numbers was that they weren't likely to be numbers that he would've presented in a brochure - thus I figured they were your take on things.

But if you ever DO find ANYTHING giving 30% return, don't think twice - BUY IT !!!! Even if it has problems, they aren't likely to be THAT severe (unless it's shares in the Titanic of course)

Regards,

 

[handyandy]

One of the other points from Yardney's book is that property isn't such an outstanding investment when considering the returns of other investments. He says the difference is in the leverage available and that makes it the best (subjectively) investment. But I can leverage just as much (80%), more easily, with much fewer costs (not as much stamp duty, land tax, etc) with shares. So there's always that question too. I personally think good property is more secure and psychologically safer (is that even valid?), but would be interested to hear the views of others.

The other difference is that with property there is no ongoing revaluations happening as against with margin facilities which are recalculated at least monthly with any shortfall having to be made up immediately or the shares sold.

Cheers

 

[alexlee]

I completely neglected to consider the cycle restarting due to dwellings becoming too old, although there are many 40+ year old house still renting strong around here. But it does provide the missing link, thanks!

My own example is my parents house. North Shore Sydney. Bought for $250k or so 20 years ago, now worth at least $1m. Currently yielding (if rented out) maybe 3%. All around the area are new houses (more expensive but yielding a LITTLE more than 3%), some medium density but mainly it's almost all owner occupier so yields don't matter.

My situation is similar to yours, I'm a bit younger but with a slightly different outlook. While my own is 10+ years like yours, I have to consider my parents who are five years from theoretical retirement. They have little superannuation from running their own business and I would like to get them sorted. Much of what I have achieved I owe to their equity, so I owe it to them to consider their outlook (plus they're my parents). They said they'd be happy on 100k a year during retirement and that seems easily achievable.

$100k a year implies around $2m in net assets, with low debt because if you assume returns on assets < your mortgage rate, the higher the debt the lower your returns. I did some projections on my own portfolio, and I found that even when I have net assets of $5m+, I might still have zero cashflow because of my LVR. But you can run the numbers yourself. Just be very careful to include ALL costs when projecting into the future.

Moving on from my previous concern, I guess the next one is whether ~40 years of historical data is enough to predict the future with any certainty. If the old cliche about good property doubling every 7-10 years is true, then this is going to be relatively easy. Although you say CG grows above inflation, I have seen stats showing that it has stayed with inflation if you look much further back. But in reality, I personally think our history (especially pre-WWII) is too crazy to use as reliable data (I wasn't alive back then, so what would I know ).

Personally, I think the doubling in 7-10 year thing still works. And it's because the city GROWS, and the land use changes (houses to medium density to higher density). The suburbs get pushed further and further out. a property's CG will grow above inflation (i.e. above wages and therefore above the growth in real purchasing power) because the population grows and total demand grows. Demand for a house increases, and therefore can grow faster than wages.

One of the other points from Yardney's book is that property isn't such an outstanding investment when considering the returns of other investments. He says the difference is in the leverage available and that makes it the best (subjectively) investment. But I can leverage just as much (80%), more easily, with much fewer costs (not as much stamp duty, land tax, etc) with shares. So there's always that question too. I personally think good property is more secure and psychologically safer (is that even valid?), but would be interested to hear the views of others.

That's a point every property investor hears: Shares return more than property. And yes, it's leverage that makes property such a good investment. Yes, you can leverage 80% on shares, but remember shares are much more volatile and have margin calls. Also you can't add value to your shares the way you can do a reno to your property. Personally, I hold both for diversification.

Some members use LOCs to invest in shares, which is the same as gearing into shares but without the margin call risk. It's funny but I personally feel gearing into shares is very risky (I buy shares with cash) but I'll happily borrow hundreds of k for property.
Alex

 

[avura]

But if you ever DO find ANYTHING giving 30% return, don't think twice - BUY IT !!!! Even if it has problems, they aren't likely to be THAT severe (unless it's shares in the Titanic of course)
Regards,

Funnily enough, I did see a property south of Sydney promising a 30% return. It was on leasehold land and had a motel/hotel on it. I'm sure there was more to it, but I didn't bother looking any further. I could probably find the link for those interested.

Back on topic though, if I am to look toward CG property now, what role does the unimproved value play? I know what it is, but how much weight should I give it? Should I simply find a decent property with a price closest or even below the unimproved value? I have one in mind that I believe I could secure for below UV. Properties in the recommended suburbs of professionals (e.g. Residex) seem all to have a UV less than 70% of the price. I'm sure it's not this simple, but is it a good start to consider UV for long term growth? How reliable are these UV figures?

 

[avura]

$100k a year implies around $2m in net assets, with low debt because if you assume returns on assets < your mortgage rate, the higher the debt the lower your returns. I did some projections on my own portfolio, and I found that even when I have net assets of $5m+, I might still have zero cashflow because of my LVR. But you can run the numbers yourself. Just be very careful to include ALL costs when projecting into the future.

Good point, my figures have a habit of looking much better when not thought-out and written down on paper.

Every reply here gets me thinking about something new. In reference to your post Alex, now I'm wondering at what stage one would allow their equity to increase in order to improve CF; opposed to consistently purchasing to 80% LVR. Just as you mentioned, at $5m you could still be at zero CF. What would your plan be (if you don't mind me asking) to enjoy the fruits of your labour?

I'm going to get a bill for consulting fees from this forum soon.

 

[Les]

G'day Avura,

Funnily enough, I did see a property south of Sydney promising a 30% return. It was on leasehold land

Shucks - I never even THINK of leasehold (I don't live/buy in Canberra) - so I should qualify my statement. In short, if you can find a 30%+ return on any freehold property, BUY IT!!!

Can't think of any problems that would swamp such a return (but then, I missed "leasehold" - so treat my comments with the ignore they deserve )

Regards,

 

[alexlee]

Good point, my figures have a habit of looking much better when not thought-out and written down on paper.

Every reply here gets me thinking about something new. In reference to your post Alex, now I'm wondering at what stage one would allow their equity to increase in order to improve CF; opposed to consistently purchasing to 80% LVR. Just as you mentioned, at $5m you could still be at zero CF. What would your plan be (if you don't mind me asking) to enjoy the fruits of your labour?

I'm going to get a bill for consulting fees from this forum soon.

That's the great thing about Somersoft. You get advice from people more experienced in property than most financial planners and accountants, and it's all FREE!

I have a couple of options that I'm considering. Commercial / industrial property (rent > residential mortgage rate), shares and LPTs (divs / distributions > residential mortgage rate), small developments, fixed income, all supported by a 'core' of residential property generating CG. Based on my projections, just buying CG-type IPs isn't enough. I'd be building up lots of equity but little cashflow.
Alex

 

[Les]

G'day Avura,

Re your UCV question, check this out -
http://www.somersoft.com/forums/showpost.php?p=197189&postcount=10
For the life of me, I can't see much correlation between UCV and reality (as you'll note when you click the link). But maybe just as well, as all Rates and Land Tax are based on UCV - so I wouldn't WANT them to be triple what they are today...

But I'd be real interested if any members have made substantial moves in understanding UCV..... It has never seemed to make much sense to me,

Regards,

 

[simonjulie]

But I'd be real interested if any members have made substantial moves in understanding UCV..... It has never seemed to make much sense to me,
Regards,

I agree Les
At one point in time I used a formula to measure strength in the market for particular areas. UCV% to sale price. The higher the %age the weaker the market.
There could be some truth in that but there are too many other variables to be a reliable measurement.
Simon

 

[handyandy]

$100k a year implies around $2m in net assets, with low debt because if you assume returns on assets < your mortgage rate, the higher the debt the lower your returns. I did some projections on my own portfolio, and I found that even when I have net assets of $5m+, I might still have zero cashflow because of my LVR. But you can run the numbers yourself. Just be very careful to include ALL costs when projecting into the future.

Hi Alex

The whole idea is that you either let that doubling in 7-10 year reduce your LVR by half or you sell down reducing debt with the profits.

In either case it is a long term project and certainly not an overnight success.

Cheers