Finance

[WebBoard]

From: Mike .


How do I get at that equity?
From: Owen
Date: 6/15/00
Time: 12:38:31 PM

Hi All,

There is a question I have been unable to get an answer for even though I have read just about every entry in this forum. It is how do you realise the equity in a property if the gurus say an IP must be +ve not -ve, keep below 80% LVR and don't cross collateralise (the investment must stand alone). Let me give you an example. Note this example doesn't use real figures, just examples to explain the concept I'm trying to get a handle on. Here goes.

Say I have an IP (IP1) I bought for $100k. I borrowed $80k IO loan for 5 years @ 8% = $6400 pa = $125 pw. Luckily my rent is exactly $125 pw so the property is neutral (no extras included in this example). I have managed a huge 25% growth in the 1 year I've owned it (I wish!!!) so it is now worth $125k. I've found another property (IP2) that I want to purchase. It also costs $100k and to keep the LVR to 80% I can only borrow $80k. This means a $20k deposit, which I don't have. Luckily I have an IP with $20k equity in it.

My question is how do I get this equity out without breaking any of the guru rules above? Below is how I am thinking it could work.

Option 1 : I could get a second mortgage on IP1 (can't refinance because it's IO) for $20k which maintains the 80% LVR however no bank will loan me this amount IO so my interest payments will go up significantly. In addition to this the rent hasn't grown (isn't it always the way) so now IP1 will be -ve. Rule 1 broken.

Option 2 : Borrow 100% for IP2 with $20k secured on IP1. This means IP2 will be -ve and cross collaterised breaking 2 rules.

Option 3 : If I did have $20k cash and used this as a deposit, it locks it up until the properties go significantly +ve through rent increases and I can pay myself back. I can't borrow the new equity because I may have had that $20k set aside for something personal so the interest would not be deductable and anyway, borrowing creates the same problem as above.

The example above could be multiplied out too. Say I have 5 IP's with $10k equity in each and what to buy IP6. I have $50k equity available but would have to cross collaterise to get at it and it could force all the IP's to -ve gearing.

Can the forum please reply with their collective wisdom and help me get my mind around how I approach this. My reality is I have 1 IP -ve geared and are looking at IP2 and need to know how to buy it (large deposit or small) with the goal to buy many more following the same strategy (high yield, +ve geared, stand alone). This one of the last things I need to get sorted out in my own mind before moving forward so all help would be welcome. Thanks.

Owen

 

[WebBoard]

Pierre

Reply: 1
From: Mike .


Re: How do I get at that equity?
From: Pierre
Date: 6/16/00
Time: 8:10:12 PM

Good question.

I hope to get along to an IP finance seminar in Sydney on 24 June that will address these issues, and the question about companies asked by Eric.

If I do make it, I'll put together another epic and post a summary of the thoughts. I may not make it because I might find myself at my wife's side with our first child (hoo-ray!!!!). She's already a day late.

In the mean time, think about this ...

Are you saying that you can't renegotiate an IO loan because you have fixed the rate??

1.) You don't have to take an IO loan at a fixed rate. At the moment, I think fixed rates are too high, and even though they provide you with some peace of mind, I don't think rates will go up too much further (famous last words I know!).

2.) Besides, even if you do take an IO fixed loan, you should still be able to renegotiate your finance after a year on IP#1 to borrow more against it (get hold of the equity). You may have to pay break costs if rates have fallen, but if rates have stayed the same or risen, then your break costs will be NIL.

So, even with an IO loan, after your wonderful 25% gain in a year, you should be able to:

* have your IP#1 revalued (remember - get a full disclosure of the valuation and a copy of it)
* renegotiate finance on IP#1 - borrow more secured against that property.
* Use the extra money borrowed to finance the deposit/costs of IP#2.
* do it all over for IPs#3 up.


The answer looks like it may have been in front of you all the time. Maybe you just need to find out if your lender WILL renegotiate your IO loan after 1 year, and WILL accept a revaluation after six months to a year so that you CAN refinance and accesss your equity. If your lender can't do these things, find one that does.

Remember, without (the right) finance, the best property still won't be available to you. Follow Will's, Geoff's and other's advice in selecting the right property, but make sure your finance is set up optimally, because without the right financial structure, you will be held back in aquiring more properties. (Here endeth the sermon).

Pierre

T+ one day and waiting patiently

 

[WebBoard]

Les

Reply: 1.1
From: Mike .


Welcome, fellow "numbers" man !!!
From: Les
Date: 6/15/00
Time: 7:19:47 PM

G'day Owen,

Congratulations on a well thought-through and complete summation. I am impressed at the effort you've put into the post.

What I would say is that "the rules" are a terrific guide - but I don't think they are of the "break them at your peril" class.... Jan herself said that in your early years you may not have sufficient equity to be able to do things the way they "should" be done, and thus bending rules that you are OK with might be a necessity.

For myself, I advocate not cross-collateralising with your OWN HOME. I haven't yet reached the "borrow against IP's" part yet, so can't comment from experience. However, I would think you can borrow separately from IP#1 to clear $20k (via LOC, 2nd mortgage, redraw, or whatever). As you say, this then makes IP#1 negative. Can your wage handle this? Do the extra Tax deductions (with 221D) make it a possibility?

How about a wee bit of "diversification" in Real Estate? e.g. go for a highly +ve geared property every 2nd time, and maybe -ve geared every other time. Thus the "cordial mix" (thanks, Sue1) is neutral or +ve.

Re the 80% rule, yes that saves (LMI, losing sleep, etc.) and is a prudent way to approach IP's - especially if your risk profile suits a more conservative approach. But most lenders will go to 90% (some even higher?) and if you have put $10k into a property of $100k, and it "screams up" 25%, then your Return on Investment leaps to 250% when geared 10:1 (as opposed to 125% at 5:1). But, yes, there may be more risk (maybe not, too).

Jane P also pointed out an important tenet, too - i.e. to buy under Market Value. That is a great way of ENSURING a huge jump in value in 1 year, thus providing the next deposit for your next IP.

Others will have their preferred ways too - you need to decide which "way" you are comfortable with. Are you comfortable with "bending the rules" if you can prove to yourself that you will do well by bending them? "A question for Will" posting talks about a whole 'nother way!! Check it out - could you go with this?

I know this won't provide all of your answers - your questions will grow and change as you move on - but there are a wealth of investors here, each with their own style, rules, etc. Hopefully others will expand on Jane's and my comments (even disagree? .... shudder!!) - hope it helps.

Regards, Les

 

[WebBoard]

Jane P

Reply: 1.1.1
From: Mike .


Re: How do I get at that equity?
From: Jane P
Date: 6/15/00
Time: 1:13:09 PM

Hi Owen

My two cents worth comes from personal experience as well as info on this board. I currently have 2 IPs, with good equity in total. I'm just about to purchase another 2 IPs based on this equity.

I am looking at is setting up a Credit Line Facility with my bank. Basically, this means the Bank will make available ready cash up to 75% (I think) of the equity I have in my IPs. This means I effectively have around $100K at my disposal. I would then use this as my DEPOSIT for my next 2 IPS and then borrow from another insitution the 80%. (Jan Somers suggests this and another poster on this forum does it all the time).

The only sticking point is pos or neg gearing. This depends on the rental income you can ask (at market value) and the purchase price of course (the less you borrow the less repayments on interest only, of course). So, we need to purchase properties at under market value where possible (and not always possible). That's why you put out multiple offers at a time, under market value and hope that one of them accepts based on desperation, etc. It does happen.

This method I think doesn't mean you are cross-collateralising but it does mean that on the initial IP1 you are increasing your loan and pay interest only on the portion you use. Be careful not to use this for personal use as the interest will not be tax deductable. Hope this helps a bit. PS. Have you read any of Jan Somers stuff??

Cheers, Jane P

 

[WebBoard]

David

Reply: 1.1.1.1
From: Mike .


Re: How do I get at that equity?
From: David
Date: 6/19/00
Time: 11:14:22 PM

Jane

A question for you. After you take out these LOC's against your existing IP's, and then go to the third lender with your deposit, do you tell them about the other loans or do you forget to tell them?

I suspect that may make all the difference - unless you have a relatively high income. I would be interested in anybody elses thoughts on this matter as well.

Regards, David

 

[WebBoard]

Bob

Reply: 1.1.1.1.1
From: Mike .


Re: How do I get at that equity?
From: Bob
Date: 6/15/00
Time: 8:45:09 PM

Just to add to Jane's reply (and I'm not trying to teach Granny to suck eggs) when you ask for a line of credit on IP1, you get the joint revalued so that the bank can understand that there are gains in there.

 

[WebBoard]

Brendan

Reply: 1.1.1.1.1.1
From: Mike .


Re: How do I get at that equity?
From: Brendan.
Date: 6/16/00
Time: 3:53:38 PM

Hi guys, If you have an IP that is valued at 150K and you owe 100K IO for example, by setting up a LOC facility to access the equity or borrowing against the equity for the purchase price of the new IP, it shoulden't effect the gearing of the first IP. When you have calculated your cashflow for the second IP using the total purchase price + costs, this includes the amount you have borrowed from the first property! i.e the deposit is secured against IP1 but IP2 is paying for it. Therefor if both are cashflow+ based on cost of purchase, they should remain that way?

Brendan.

 

[WebBoard]

Owen

Reply: 1.1.1.1.1.1.1
From: Mike .


I think I get it know...
From: Owen
Date: 6/19/00
Time: 11:37:34 AM

Thanks heaps for all the replies. After digesting the ideas I think the best plan is a combination of all the replies. It looks like this.

1. A LOC secured against the equity in the various IP's to remove my own house from the loop.
2. Use this for deposits for more IP's and pay off ASAP using all available income.
3. Diversify propery purchases between high growth (to get the equity) and high yield (to get the income).
4. Kick back with a good glass of red.


Thanks again for all your replies.

 

[WebBoard]

Littlemaze

Reply: 1.1.1.1.1.1.1.1
From: Mike .


More Q's on How do I get at that equity?
From: Littlemaze
Date: 6/22/00
Time: 1:44:32 PM

Thank you for Owen for asking the question as it has been a burning one for me for a while! Thank you all for the answers, the light finally went on!

I just need to clear up one niggling thing...if you have a LOC on your own home and you don't want to cross collateralise on your first IP, you draw down on your LOC to use it as a deposit on your IP. This way the IP stands alone and your house is out of the loop. How do you keep track of the interest on the LOC as now you have a mixture of purposes for the loan?

A portion is for your own home (assuming that you don't have 100% equity) (non tax-deduct) and a portion is used as the deposit for the IP (tax-deduct). Have I got the wrong end of the stick or is there an easy way to track the interest on the LOC to claim as a tax deduct?

Advice will stop my mind ticking and sleep will be better!!!!

 

[WebBoard]

Pierre

Reply: 1.1.1.1.1.1.1.1.1
From: Mike .


Re: More Q's on How do I get at that equity?
From: Pierre
Date: 6/22/00
Time: 4:04:07 PM

You're on the right track. All you need to do is make sure your lender will split the LOC into two portions. One is for residential, the other for your IP. See some of my and Owen's other posts for more details.

I know for certain that St George and NAB will allow this. Ask your lender if they can. The second portion of the LOC should be able to be treated as a separate account, and can be issued its own statement. Thus, the tax accounting nightmare goes away.

Pierre