Calculating a good investment... what I.R. % do you use?

[Luv2Travel]

I'm starting to look at IP2, although not sure when I will purchase, so just window shopping at this stage. However, what interest rate do you use, to determine if it's a good investment?

I'm looking at purchasing a house in Melbourne, and seems based on 7% interst rate and greater, nothing looks like a good investment as I would be out of pocket a fair amount. My goal is to purchase long term, so I am looking at a balance between reasonable yield and reasonable capital growth. I know cashflow wise, it'd be wise to budget on about 9% to ensure I can pay for it, but as far as determining whether it's a worthwhile investment, do you base it on an average % (if so what?), knowing that interest rates won't always stay high?

Yields are terrible at the moment, which I pressume is partly due to the recent growth in the market and rents are yet to catch up? I'm looking in the Altona Meadows area and examples I'm seeing is, to buy a house there, about $350-$400K yet rents are only around $300-$320/week! Using a high interest rate, and it just seems very expensive to buy there. Still not decided on the area, but that was just one I was looking at.

 

[birchcorp]

I like to consider I am a conservative investor. I am purchasing a property for around $1.1M over the next six months, to be comfortable with this decision I have worked all my numbers on a 10% interest rate. If you cannot work this very comfortably on 2-3% above the going rate then I would not participate. The place I see most people come unstuck is they move into what I call their fun money (extra money for holidays etc). Once you start spending your fun money on investments, Well, investments then become tired and so does your life. The other point is, there are many ways to increase cash-flow, this is one of the keys to being able to invest well and have a lot of fun money. Be innovative and you will find the balance.

 

[Luv2Travel]

Thanks for the reply birchcorp, I'm not sure if what I'm saying is clear, but I'm not talking about cashflow. I know I can afford 10% if I really had to (although it would probably eat up most of my 'investment money' savings each month).

I'm talking about interest rate that makes an investment viable vs. holding off and just keeping savings in an interest bearing account. Interest rates go up, and they go down, so is there an average rate you use when working whether an investment is a good one.

At the moment for example if I use figures of 9% on top of the not so good yields in Melbourne at the moment, it seems hard to justify buying anything. But long term I know interest rates won't stay that high, so you just suck it up and wait for the lower rates. So is there an average you use to work out if something is a good investment or not? My head is spinning a little, in fact I think I'm confusing myself in what I'm even asking.

In regards to the low yields now, do people use these yields as a bargaining tool when buying, i.e. work backwards? For example there is a 4 bedroom house, asking $400K but it returns $15,600 a year. If you were to say you'd accept 4.3% yield for that area at the moment, would you simple offer $363K?

Sorry, I have millions of questions, because I'm scared to take the next step.

 

[birchcorp]

Your right, The interest rate thing does not look good in comparison to how much you can make in the bank. But think like this, The house you are purchasing is leveraged. If you make 7% off $40,000 in the bank = $2800. Work the numbers on what you have to do beat this in a property. i.e. $400k property = 8% p.a. = $32k and an increase in rent over time that will effectively reduce the amount you are paying. Yes there is a cost now, it is the delayed gratification thing that prevents most people from investing, remembering, this is one of the biggest reasons most people do not invest.

It is perfectly normal for your head to be spinning, what I suggest to people in these times, is to take your time. Time is in abundance. Keep learning as you are, and try to enjoy the experience.

Re: Negotiating the property price, do this as you wish, you are the boss. It is your money, so you get to set the rules.....

I'm signing off for the day.... I am back in the market myself, with an appointment to look at a property in 30mins.

 

[bene313]

Thanks for the reply birchcorp, I'm not sure if what I'm saying is clear, but I'm not talking about cashflow. I know I can afford 10% if I really had to (although it would probably eat up most of my 'investment money' savings each month).

And then....

I'm talking about interest rate that makes an investment viable vs. holding off and just keeping savings in an interest bearing account. Interest rates go up, and they go down, so is there an average rate you use when working whether an investment is a good one.

How about this..

What makes an investment "viable" in the first place? It is the return of that investment compared to another benchmark rate. Return being yield rate + growth rate.

Typically the benchmark rate which makes an investment viable or not is the interest rate at the time, or perhaps you could use the 5 or 10 year fixed rate, plus some additional rate of return for risk.

This is because if you did have your money in the bank you would only be getting between the current and say 10 year rate as a return, with almost no risk.

So say the 10 year rate is 8%, and your risk factor requires 2%. Total return required is therefore 10%.

IP1 has 10 year figures annualised at yields of 4% with expected growth of inflation or 3% - total return is 7% annualised.

IP1 of 7% < required rate of return 10% = do not buy IP1.

 

[Luv2Travel]

Thanks Bene133, I know, I think I'm jumbling up all my questions into one big heap. The idea of buying a property with negative cashflow of almost $300 a week just seems a lot for a $370K property, but as you correctly pointed out I need to work it out as a % return, so that means the property would need to increase about 4.2% a year in capital growth to break even and make it worth while. Putting it like that, doesn't seem so bad. I think I just want someone to pat me on the head say it's ok, just do it.

 

[Bigtone]

Thanks Bene133, I know, I think I'm jumbling up all my questions into one big heap. The idea of buying a property with negative cashflow of almost $300 a week just seems a lot for a $370K property, but as you correctly pointed out I need to work it out as a % return, so that means the property would need to increase about 4.2% a year in capital growth to break even and make it worth while. Putting it like that, doesn't seem so bad. I think I just want someone to pat me on the head say it's ok, just do it.

given Melb has just had 2007 boom, 2009 boom and first half 2010 boom, why buy here, you can get a better yield but far more importantly a better chance for capital growth in other cities right now

 

[Luv2Travel]

given Melb has just had 2007 boom, 2009 boom and first half 2010 boom, why buy here, you can get a better yield but far more importantly a better chance for capital growth in other cities right now

I initially was going to look in Quakers Hill in Sydney but thought it was just all too hard buying interstate and thought I'd stay in my own familiar backyard. I really don't know, my head is spinning.... so I'll stop asking questions, for now.

Thanks.

 

[Rob Williams]

I think I just want someone to pat me on the head say it's ok, just do it.

<pats head> "Just do it"
I still recall a conversation I had with Rixter a couple of years ago. I'd just bought my 4th IP in 6 months or so and was having a break.
I was out of cash and equity and feeling like I was at my limit.
Then Rixter asked when I was buying the next one. "When number 2 daughter finishes school" I told him.
He thought I was going soft or mad or both.
He was right. I was constraining myself with my own limited thinking and self imposed comfort zone.
I started to look at things from a different perspective and became more comfortable with the concept of doing 105% lends using equity from the existing portfolio to fund additional purchases, purchase costs and capitalised interest.
Within a year I had another 3 and I've never looked back.
Only you can work out what is right for you. Other peoples opinions are just that. Opinions. Based on their experience, circumstances, risk profiles and objectives.
One thing I will say, though, is that you often meet people who regret what they coulda or shoulda done years ago. You don't meet too many who regret what they actually did do.
Which one do you want to be in 5 or 10 years time?

 

[Luv2Travel]

One thing I will say, though, is that you often meet people who regret what they coulda or shoulda done years ago. You don't meet too many who regret what they actually did do.
Which one do you want to be in 5 or 10 years time?

Very true, I just got off the phone to my friend who initially sparked my interest yesterday to buy now instead of waiting a year or so. He is the one who has helped give me the motivation and courage in the past, and it's worked for me so far, so I'm standing on the ledge ready to jump.

So, am going to meet with the bank, and sort out my finances, and then the fun bit... shopping!!! Far more exciting shopping for houses than shoes.

 

[tobe]

I like to buy properties that cover their face, ie not very negative cashflow. In capital cities that is sometimes hard, but there are ways to increase cashflows.
renovation, change of use, to share house, student accom etc, short term rental. Subdivision etc etc. There is always properties outside capital cities to look at too, some regional centres have performed quite well capital growth wise, and returned a better rental yeild.