Does anyone have time to help a novice with some general figures?

[whynot?]

Hi, I am sorry to bother you all, I am constantly lurking on this site but have no experience with investments as yet so I hope you dont mind me asking a question or 2?

A bit of background, We 'nearly' purchased our first IP last year but pulled out at the last minute as my husband was offered a share in the business he works for, and the monthly dividends recieved were too good to knock back. Unfortunatley we would not have been able to service both the business and the IP loans.

12 months later we start thinking about IP's again and at the same time our elderly neighbour passes away. We have been given the option to purchase the property at land value (420k, for a 1100sqm duplex block) with the old concrete house as a bonus. The house is only 2 bedrooms, but we can possibly turn the sleepout into a 3rd bedroom. Hoping to receive $300 a week rent.
Our house is 60sqm short of being a duplex block, we are on a corner block with her property next to ours. Oh, and this property is in Perth, 8 kms from the city. Our longterm plan would be to knock down both houses and build 4 new houses, maybe even 5 if the zoning changes in that time.

We cannot afford to purchase this ourselves and my dad is very interested in going halves with us. I am thinking this would mean we both loan (approx) $250k each to cover the purchase price, fees, a small reno, and have money left over to cover interest, rates etc.

If you have managed to read this far here are my questions.

1. IS it possible to loan the extra money to cover the repayments for that first year, more?

2. If not, and our loan repayments are for example $2000 a month and we are only getting $600 a month rent we have to come up with the extra $1400 how much should we expect to claim back to cover our repayments the following year?

I guess what I am really asking is at the end of the financial year how much is this property 'really' costing us in dollar figures?

Is there anyone out there who can offer any advice?

Christine

 

[wylie]

Hi Christine.

I am not too flash on figures, but we bought the house directly behind another IP we have to give us a big block.

We were advised (rightly or wrongly) to buy the second one in the same name as the original one (hubby's name) because down the track it could be messy to try to split the blocks, or build on them if they are in two different names.

I don't know if that is fact or not, but we did it that way anyway due to tax considerations.

Perhaps you should look into this as a start.

 

[troyhunt]

1. IS it possible to loan the extra money to cover the repayments for that first year, more?

What percentage were you intending on borrowing to begin with? Perhaps aim for the highest possible LVR (95 or 100) so your existing savings can be used to fund the cash flow shortfall. If you're referring to borrowing more than the value of the property, this will likely be an issue given it will leave you with negative equity. Lenders don't look too favourably on that!

 

[whynot?]

Thanks Wylie,

Your advice is appreciated. I am guessing there will be lots of things like this to consider, especially when it involves a third party. I will have to do some research on this.
Christine

 

[troyhunt]

2. If not, and our loan repayments are for example $2000 a month and we are only getting $600 a month rent we have to come up with the extra $1400 how much should we expect to claim back to cover our repayments the following year?

This is an extremely low yied (1.7% gross) so it's going to leave you very short on cash each month. Assuming there is no depreciation available you're left with a $17k hole in your pocket each year and that's before rates, water, maintenance, etc. I'd want to be very sure this is going to pay off in the long run because in the short term it's going to be a very costly exercise. About the only thing you can do to mitigate this (short of adding value and achieving a higher yield) is to put an income variation into the ATO ASAP so you realise the tax benefit of the loss immediately rather than waiting until your next return.

Good luck!

 

[whynot?]

Hi TroyHunt,

Thankyou for taking the time to reply. We have approx 45% equity in our current house so I was hoping we could somehow use that, and then borrow the total amount for the IP. Is that possible?

The $17k a year does sound scary, and I assume that means I would want the property value to go up alot more than that each year to make it worth our while.
I think we really need to think about this. My head is buzzing with different scenarios. Another option we were throwing around was that we borrow more money (possibly another 100k each) and build behind the existing one. This brand new one would be rented for approx $450 a week which would help with our repayments. As I said, we really need to put some thought into this and your advice has been valuable. Thanks again.

Christine

 

[wylie]

Forgot to mention that we have borrowed more than 100% and have borrowed to pay interest, so it can be done.

 

[troyhunt]

You could possibly use the equity in your PPOR to secure the loan at 100% (or more, as wylie pointed out); I'd be speaking to a mortgage broker to get some guidance on your options. Having said that, will it help solve your servicability issue? If you borrow to fund the cash flow shortfall you'll obviously be continually increasing your debt as payments fall due. If you're going to pursue this avenue, you might as well look at capitalising interest (another good mortgage broker discussion).

If you go ahead with this, you'd want to have a very clear exit strategy in place. What happens if rates go up? Or if you can't get building approval to construct additional residences? Or construction and consequently further cash flow is delayed? Don't get me wrong; it sounds like a great opportunity and if it was me I'd probably be forging ahead, just make sure you're able to meet the commitments you make and don't end up in a state of duress.

 

[Strannik]

This is an extremely low yied (1.7% gross)

3.4 by my count, but still a bit low

 

[troyhunt]

3.4 by my count, but still a bit low

Definitely 1.7%; $600/m (not per week) is $7.2k/y which is only 1.7% of $420k.

 

[Strannik]

600/month is due to their parents owning the other half
so you should use asset value of 210k, not 420k
if they dish out the whole 420k they will be getting 1350/month rent, so again we are back at 3.4

 

[Dazz]

G'day Christine,

Welcome to the site, and thanks for finally posting.....great to have people step forward.

I can fully imagine that you are indeed buzzing with different scenarios.....it's exciting stuff when an opportunity comes your way that is unique to yourselves. Not too often the place next door come sup for sale that you can turn into a development opportunity. Some people consider the neighbour should pay 10% more for the land, as it is worth more to them than anyone else due to the development opp. it opens up to them only.

As you asked - to the figures....based on what you supplied.

LVR or Equity side of things


Your place worth say 500K (cos it's a corner)
Their place say 420K (only cos you said so)

Total of land combined 920K (this is what the Bank will look at)

Your equity you reckon you've got 45% equity in your place - or 225K.

If you X-coll them together, you'll have 225K to put into the deal and you'll therefore own 24% of the combined, and the Bank will probably be happy to stump up the other 76%....seeing as though it's residential. In fact, they'll likely be happy to go to an 80% lend level on the combined, so you may indeed be able to borrow enough funds to pay fees and interest for the year.

This is the way they do it.

Say you owe 500 - 225 = 275K currently.

They'll take 0.8*(500+420) = 736K max loan.

Therefore they'll lend you 736 - 275 = 461K.

If you pay 420K for the joint, it'll leave you 41K for fees and interest.


If you do manage to squeeze 5 on the site, you'll have picked up the land component for (920 / 5) = 184K per site.....not bad for something only 8km from the Perth CBD.


Income and Cashflow side of things

As others have pointed out, the cashflow side of things looks horrible....but then you are acquiring literally a development site, so it ain't that bad - lots of people get zero input for years while putting a development together. At least you've got some cash coming in.

Rent = 300 * 52 = 15.6K p.a. (or 3.7% gross yield on the 420K price)

Interest cost on the 461K @ say 9% = 41.5K p.a.

Total holding cost of just the new property (ignoring your current loan) will be ;

Council Rates.....say 1K
Water Rates......say 0.8K
Land Tax..........say 1K (assuming this is all you own)
Insurance.........say 0.4K
PM fees............nil - just reach over the fence and slap 'em if they misbehave.

Total would be 44.7K p.a. outgoing

Nett outflow would therefore be ; 44.7 - 15.6 = 29.1K p.a.

Assuming you are on the 30% marginal tax rate, your refund will be = 0.3 * 29.1 = 8.7 K p.a.

Therefore, you will need to come up with 29.1 - 8.7 = 20.4K p.a. out of your own pocket.

That's $ 392 per week, every week.

It will need to capitally grow by (20.4 / 420) = 4.86% for you to literally "break even" during the holding stage.

Only you can answer if this looks OK or not.


Only you can decide if that cashflow bleed is comfy or not on your wages. Of course, your own loan and rates and taxes will need to come out as well.


I suppose Christine, if you have a decent income, the Bank would support you in this endeavour, although they are a bit gun shy at the mo'.


Why not plug the real figures into the above and take it into the Bank and tell 'em you have done your homework and you're and expert at this and have done it many times before.

Whatever you do - don't say that you got it off some clutz from an internet chat site. They'll run a million miles.


P.S. This is my first go at things like this as well. Lucky we are all just learning and spitballing the possibilities. Please don't drag me into court and sue me for giving advice that I'm not smart enough or qualified to give.


Good luck with your decision Christine.

 

[whynot?]

Dazz,

Thankyou sooo much for your post. I really appreciate the time you have taken to reply, and the extent of your reply too!

I have read, and re-read your post and will probably read it another 10 times so it sinks in. Your breakdown of everything is such a help to me.. thankyou!!

I am going to do some ringing around tomorrow, pay a visit to the local council and catch up with some Property Management friends to get a better idea of rent we could receive. Although the money we have to come up with weekly is a bit daunting, it is possible.. I am the spender in the family and can see many ways that we can cut back.

Thankyou again to everyone for taking the time to reply.

Christine