A question of taste?



From: RM .

Message Text:

Fellow colleagues, learned friends and mental giants. I have a question that I would like an answer to.

Assume I purchase a property in Dogsville and it returns a rental yield of 12% but only 2% Capital Growth. Most would say this is good cashflow but hardly enough to provide you, the purchaser, a ticket to leisureville.

I now take 6% of that cashflow (from the Dogsville property) and invest in a better (2nd) property in Greatville (assume equal purchasing value) that returns a 4% rental return but say 10% capital growth.

Would not the combination of Sloth (Dogsville) and Sin (Greatville)combine to give me an average rental yield of 8% and an average capital growth of 6%?

I understand that this is all hypothetical, but doesn't this fictitious scenario show that the combination of a poor performing (low capital growth/high rental yield) and a reasonably performing (low rental yield/high capital growth) mix of properties provide as good a return as some inner suburb properties in this heated real estate market?

I am keen to be shown the error of my ways.

Thanks RM
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Reply: 1
From: Michael Yardney

RM I don't think the logic is correct.
Firstly you pay tax on the rental profit so you are only left with one third or one half of it after tax, as opposed to the capital gain on your Greatville property which is tax free, and which you can eventually borrow against.
Also assuming you only had say $50,000 to invest, I think you are suggesting buying Dogsville with it and then purchasing Greatville out of the cashflow. You need more than cashflow to purchase another property - you need another say $50,000 equity and this will take a long time to accumulate with the money left after tax on your rentals.
A good way to do the type of sums you are talking about is to use Jan Somers PIA program and compare the Internal Rates of Return for 2 properties, one with strong cashflow and one with strong capital gains and poorer cashflow.
Capital gains always wins. Your rentals pay the mortgage, but its the capital growth that will make you a property multimillionaire!
Also as the value of your property goes up so does the rental return, in other words the rate of increase you will get on your rental will be much higher in Greatsville.
Michael Yardney
Metropole Properties
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Reply: 1.1
From: GoAnna !


I think your theory works.

This strategy allows you to hold a high growth property without feeling the pain of negative gearing. That's because the shortfall can be paid out of the rent from dogsville. It is also ok risk wise because if you lose your job your ips are not at risk...as they are self sustaining at worst.

I do not agree with Michael in regards to his view that this is not the way to achieve wealth. If you merely collected negative geared high growth properties you would soon run out of the ability to service your loans. (not to mention the time you would need to wait until they provided sufficient income for you to retire) Positive cash flow properties make the banks much happier and hence from my experience you would be able to borrow much larger amounts of money and therefore buy more. The growth properties would however need to experience enough growth to create deposits for both your cash flow properties as well as further growth properties.

I would also disagree with Michael in regards to paying tax on the profit from the rent. In your example this profit would be offset against the loss of the growth property.

I think most of us are after growth AND cash flow and your plan addresses both needs. People who collect growth properties only usually have some other form of cash flow such as a business or job.

Your plan only improves of course if you find a way to value add to the properties and increase the equity at a faster rate (even those in dogsville) or find properties with higher growth or higher return than those in the example.

I too look forward to others thoughts.

GoAnna !
Why not go out on a limb, that's where all the fruit is. (Mark Twain)
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Reply: 1.1.1
From: Donna Larcos

I'm kinda with Goanna. I have four
properties in Sydney now and have
capital growth to burn but the debt
serviceability is starting to need a
respirator. We have started looking at
higher return properties with perhaps
less "architectural integrity" so that I can
continue to support my addiction to the
capital growth properties here. I'll still
probably stay with properties in other
capital cities within 10K of CBD. The
capital growth might only be 3-4% and
will take 15 years to double instead of
7-10 in Sydney but as they are lower in
value they form a smaller percentage of
the portfolio overall. Handy to have
cashflow too if you still have evil
non-deductible home loans etc. that you
can throw it against. I don't have the
energy for renovations, wraps, flips etc.
I'm a lazy property investor. I should start
a club - LPIs Anonymous. I hate the
pressure of being proactive!
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Reply: 2
From: Glenn S

I agree to with RM.

I have 3 residential IP's in Sydney that are all -ve ( returning 5%) , but are showing good Cap Growth. The issue as GoAnna points out is serviceability. I also have a Commercial Prop. in Newcastle paying 11.5% on a 4 + 5 year lease to run. This Low CG property is paying for the other properties. Now I can get going with more Growth Properties. Otherwise you have to wait Till income improves.

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Reply: 1.1.2
From: Apprentice Millionaire

Way to go!!!
GoAnna, you have increased my confidence level 1000%! Bless you!
I have been looking at properties with +ve cashflow, mainly because as I have no income the banks will consider, I have to be able to service my debt.
I am currently buying a property which has the right return, and a good lease (tenant signing on for another two years). Getting that in writing helped my banker give me the nod! Bankers look at cashflow before capital growth, is that right?
As Donna said, it may take me a little longer to get the capital growth, but then a bit of capital growth on many properties that are all +ve geared should help me in time to go for the high growth properties! Am I right?
In French: "Tout vient à point pour qui sait attendre"! Something about perseverance.

Apprentice Millionaire
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Reply: 2.1
From: Les .

G'day Glenn,

I noted your question to the posting "Investment Structure" 25/9/01 - did you happen to follow up on Simon's advice?

My reason for asking is that I, too, was at the Canberra evening hosted by Steve Navra - and he has some very interesting thoughts (and perhaps solutions) for equity-rich, cashflow poor investors. I loved his "out-of-the-square" thoughts - real eye-openers !!!

Well worth seeking out the gentleman IMHO.



- "Eschew Obfuscation" - ;^)
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Reply: 2.1.1
From: GoAnna !

I agree Les that Steve Navra's solution was creative and workable.

I guess the point is that one way or another we need to create some positive cash flow. And positive geared properties are one solution.

GoAnna !
Why not go out on a limb, that's where all the fruit is. (Mark Twain)
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