Having read some material but as yet, not ventured into property investment, I am having some difficulty explaining to my wife how investers can accumulate property after property when one's cash flow (income from wages) to service interest only loans, does not change. Can anyone give us a straight forward answer please?
Explain how one can keep accumulating property
- Thread starter Mustang
- Start date
Mustang said:
Given that particular condition, you can NOT grow a property portfolio beyond what you can currently service (and remember this may be several properties) unless:
1. the property generates more cash from rent than all expenses combined
2. you generate more income from other sources (eg shares, CPT's)
Hope this helps...
The Y-man
You cannot usually accumulate property after property. There is always a limit.
The limits depend on:
.How much you're borrowing (especially with one institution- $1M pushes the friendship). There's a percentage limit, as well as an absolute limit. Over 80% lending will probably incur an additional cost.
.How much you can service- whether you can keep up the repayments, allowing for bad times.
.How much the property is worth.
.How much income you get. (rental income will usually be cut back to allow for vacancies).
There's probably other things.
How can you accumulate?
.Choose high growth properties. You can borrow more
.Choose high income properties. You can service more.
Yes, that's a contradiction- usually, high growth does not come with high income.
The people who really can accumulate have strategies. It can be done. But it takes work to get past the critical mass.
The limits depend on:
.How much you're borrowing (especially with one institution- $1M pushes the friendship). There's a percentage limit, as well as an absolute limit. Over 80% lending will probably incur an additional cost.
.How much you can service- whether you can keep up the repayments, allowing for bad times.
.How much the property is worth.
.How much income you get. (rental income will usually be cut back to allow for vacancies).
There's probably other things.
How can you accumulate?
.Choose high growth properties. You can borrow more
.Choose high income properties. You can service more.
Yes, that's a contradiction- usually, high growth does not come with high income.
The people who really can accumulate have strategies. It can be done. But it takes work to get past the critical mass.
It's simple. If you can't service the loan you don't get the money.
Debt can kill you. Your bank would love to lend you the money and their only concern would be if your default would became part of an avalanche of such defaults.
In spite of what you may read, absolutely no investment is fool-proof. Bank policies reflect that truism.
Debt can kill you. Your bank would love to lend you the money and their only concern would be if your default would became part of an avalanche of such defaults.
In spite of what you may read, absolutely no investment is fool-proof. Bank policies reflect that truism.
or - like us - after reaching your max (which we have done at 12 properties over 6 years) you take a breather for a year or so until rents and/or capital growth catch up.
however, while this breather from buying new property is taking place we are building 3 townhouses on a property we own - so the rental income off this property will become substantially more than it currently is, and will offer a better return than if we bought 3 separate properties. for example - 3 separate properties at $350kea and rent for $300/wk equals a return of $900/wk for an outlay of $1,050,000. this development costs $100k/site + building/landscaping costs of $165k ea = $265k but will still bring in $300/wk equals a return of $900/wk for an outlay of $795,000. hope that makes sense as it is rather late at night for me.
basically you have to invest smarter during this lull period and be creative in the ways you can create money out of nothing - read more on value adding, ie, subdivision, small development, student housing etc.
however, while this breather from buying new property is taking place we are building 3 townhouses on a property we own - so the rental income off this property will become substantially more than it currently is, and will offer a better return than if we bought 3 separate properties. for example - 3 separate properties at $350kea and rent for $300/wk equals a return of $900/wk for an outlay of $1,050,000. this development costs $100k/site + building/landscaping costs of $165k ea = $265k but will still bring in $300/wk equals a return of $900/wk for an outlay of $795,000. hope that makes sense as it is rather late at night for me.
basically you have to invest smarter during this lull period and be creative in the ways you can create money out of nothing - read more on value adding, ie, subdivision, small development, student housing etc.
Mustang said:
Rent goes up, increasing your cashflow. My first IP rented for $215pw when I bought it, and is now renting $275pw. Or, use the equity in your IPs to invest in something that gives you income higher than the mortgage interest. e.g. LPTs, some shares, bonds, etc.
You can also do sub-dividing, development, vendor financing, money partners, etc.
All of which is academic for you, isn't it? Why not buy one, then see what happens? If you only end up having one IP, that's still one more than you would have had. People DO buy property after property. Unless you're doing it yourself you probably won't believe it. A lot of people started investing not even believing they could own one property. When I first started, if you'd told me 6 years later I would have the IPs (and debt) that I do, I would have said you were nuts.
In practice, you buy one, get used to the cashflow, wait for rents to go up, maybe buy a few shares that also grow, and eventually you figure you have the cashflow to buy more. During that time you catch one of more cycles.
Bottom line, though, you're better off buying than not. If you only end up with one extra property at retirement, that's better than nothing. How many times have you heard the line 'if only we'd bought the house next door'?
Don't think TOO far ahead and paralyze yourselves. Run the numbers on one property, buy it, then get used to it.
Alex
ramone_johnny said:Remember if you dont invest - its $300 a week pension, bowls and death.
RJ
Sorry, off topic, but I love lawn bowls (and the related cold version, curling). Tried it first when I was at Uni many years ago, and more recently my wife and I had a few lessons at the local club. So for me retirement will involve bowls and death, whether or not I invest.
John.
Mustang said:
You've been given some good advice above.
There comes a time in most property investors careers where they hit what is known as the 'serviceability wall'. There are a few creative ways around this, however for the average person this isn't until property number 3 or 4 (?? - I might not have this correct, I'm a little different from average and am not sure). As mentioned previously if you can reach this level you'll be light years ahead most.
Some of these creative ways are what Y-man has listed. They are basically ways to convert equity to income.
I also think we will move to more asset based lending as in the US (where LVR is almost everything and DSR is almost nothing).
I am not the most knowledgable person regarding investment in property as I am still new, however a few things that I have picked up is that their is roughly 3 different ways you can grow your property empire. These are:
Although this is pretty much common sence for anyone looking to invest or even buy a home, it cant be understated that the majority of the profit you make occurs when you sign the contract to purchase. Look for a property that is below the current market value, buying a property below cost automically generates you a return. In this market they can be found as well if you look and do your reaserch. Personally I think areas up and around Newcastle are going to be a strong bet in the next 3 - 10 years.
Re create - Renovate , build, exstend, develop Adding value to your investment will also generate money for you.
The above scenrios will not only improve your cashlow and value of your property but increase the banks valuation that in turn will allow you to borrow more.
Lastly
Buy, hold, borrow into equity Building up your profolio and borrowing into the equity to accumlate properties.
Although this is pretty much common sence for anyone looking to invest or even buy a home, it cant be understated that the majority of the profit you make occurs when you sign the contract to purchase. Look for a property that is below the current market value, buying a property below cost automically generates you a return. In this market they can be found as well if you look and do your reaserch. Personally I think areas up and around Newcastle are going to be a strong bet in the next 3 - 10 years.
Re create - Renovate , build, exstend, develop Adding value to your investment will also generate money for you.
The above scenrios will not only improve your cashlow and value of your property but increase the banks valuation that in turn will allow you to borrow more.
Lastly
Buy, hold, borrow into equity Building up your profolio and borrowing into the equity to accumlate properties.
How does this increase income? Assuming that you borrow money to renovate to get higher rent, you still have to pay the interest on the renovation costs??
Mustang, I'm in the same boat as you. I'm looking for my first IP. Equity is not a problem for me, I could afford to borrow enough for a few properties, but couldn't sevice this debt. Part of my plan was to purchase 2 IPs in the next year. However I found myself worrying that buying a certain property would prevent me getting another one. e.g. if the first IP costs $1500/mo to service and the second $1000/mo, I would not be able to buy both if my servicability limit was $2000/mo.
I have come to the conlusion that it is better to just get the best deal I can on the first IP, and then see how it goes and worry about the second one later. One is better than none!
More Info
http://www.somersoft.com/forums/showthread.php?t=22826&highlight=equity
This link might add to the comments made on this thread. Good luck
http://www.somersoft.com/forums/showthread.php?t=22826&highlight=equity
This link might add to the comments made on this thread. Good luck
leapyeah,leapyeah said:geoff, can you expand more on what you regard as the "critical mass" point, please?
Geoff will no doubt pitch in as well, but I would think this point is where you hit one or both of your borrowing limits. i.e. Your Debt Servicing Ratio (DSR) or your Loan to Valuation Ration (LVR).
Your DSR is a constraint based on your income or cashflow. Banks will only lend to you if you can afford the repayments.
Your LVR is a constraint based on your net worth or equity. Banks will only lend a certain proportion of the security valuation to you and expect you to pitch in a bit yourself.
To overcome these hurdles is what takes investors really to the next level IMHO. I haven't done this myself yet so still consider myself a novice entry level investor.
Here's some of the ways you can overcome these hurdles:
DSR:
You can use your spare equity and turn it into a periodic annuity in the form of a cash bond. You can then use the income from the cash bond in the declared income on your future loan applications.
You can also invest in positive cashflow asset categories such as managed funds to help your servicibility equation. So long as the managed fund beats your borrowed cost of capital then it is positive cashflow and can count towards servicibility for other loans. Note that banks do discount this income though.
You can increase the yield on your current investments bya myriad of methods such as just putting the rent up, or by adding value to a property via renovation or development as described below.
Time increases your DSR. Increasing rents and increasing personal incomes all help your servicability equation.
LVR:
"Buying wholesale" is a term Michael Yardney uses to describe developing properties to get them for below market value and thereby create both equity and a good yield. This allows you to acquire more properties quicker.
Conversely, cosmetic renovations have been shown in the past to create equity by adding more value than the cost of the renovation.
Paying down your debts is an obvious way to increase your LVR but is a relatively slow method.
Again, time helps your LVR too. Properties typically go up in value so a revaluation can show more equity able to be drawn down via an LOC and used to purchase more properties.
That's just a brief summary of my thinking in this regard. I'm currently at the limit of both my DSR and LVR so will need to start getting creative to continue to acquire more properties, or specifically to be able to afford to develop my current MUH development site. I think my servicability is OK as I've purchased positive cashflow managed funds which help my servicability equation, and I'll probably be able to scrounge together enough equity from my existing assets to tick the LVR box too. A formal feasibility study on the development should assure the bank that they can safely invest in my development provided I can service the loan.
Cheers,
Michael.
Thanks guys. What I was really after was what is it that you view as "critical mass"?
I understand about DSR and LVR, but I guess I was really wondering if there is a point (eg. a portfolio size combined with LVR, or some such) which you regard as critical mass - something where a whole new array of financing options may open up or you have "made it to the next level" somehow.
I understand about DSR and LVR, but I guess I was really wondering if there is a point (eg. a portfolio size combined with LVR, or some such) which you regard as critical mass - something where a whole new array of financing options may open up or you have "made it to the next level" somehow.
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