Getting Started

Discussion in 'Original Property Investor Forum Archive' started by WebBoard, 28th Jun, 2001.

  1. WebBoard

    WebBoard Guest

    From: Mike .

    Building a house and I just found Wealth through investment property ?!
    From: Rob
    Date: 10/22/99
    Time: 7:20:15 PM

    Hey all. I just stepped out onto the road of owning [building] my own home, the great Australian dream. Until recently, I understood the world in terms of having the loan and paying it out. Out of the blue, I found "Building Wealth...". My mind is now racing with the possibilities!

    OK, there are a couple of queries I would appreciate some property investment angles to consider and comment on.

    So my situation is this. I bought the block of land outright and the credit union have loaned me 100% of the construction value of the house, $140k odd. The credit union have taken a mortgage over the block and house. The loan currently a variable loan, daily interest, no penalty, no fees, flexible repayment type loan. The house is at putting up the frame stage. Oh and I'm single. So my cash flow is from a single source.

    So my plan was to take the 25yr loan in order to get the lowest minimum repayments and I was also going to share out the other two rooms. My thinking was that between rent and paying extra from my salary, I'd knock off the loan in about 8 - 9 yrs. Obviously this is an after tax mentality. If I was going to be sneaky, I would have used most of my salary for the loan and then lived off the cash rent therefore minimising [illegally?] the additional tax liability. But NOW a whole new world of opportunities have opened up.

    Until I read the book I didn't even know that I could potentially negatively gear 2/3 of the loan [3 person house, 2 pay rent], and claim a bunch of other deductions too... all while living in the place as well. I understand that there are CGT implications in doing this, but as I don't understand them, I'd like to ask where can I go to look into it??

    Jan's plan also seems to require at least having some equity in your own property to kick off the portfolio. So that means that this first loan *has* to be a P&I type loan. Is this a given? I calculate that the loan could be repaid in about 7 yrs using the 2/3 -ve gearing benefits [assuming I want to share for that long!]

    Now I'm entertaining other ideas of continuing to share where I am and turn the house into an investment property in order to claim full negative gearing benefits. Even so, the way I read the plan, the loan would still need to be a P&I loan in order to build equity. The down side of this though, is that I would have to pay rent. The dollars almost figure out the same way as if living in the place cause sharing or foregoing 1/3 of the rent by living in the place have the same impact on the bottom line. So I was wondering whether there were any views about the "living in" versus the "living out" scenario.

    I see some of the forum folk talk about making the first house IO while still renting a place. So that makes me ask, how do you kick off a portfolio after that first place if you never develop any equity????? To buy another place IO would mean you'd have to do some amazing sweet talking to get the bank to accept the investment property as the sole security for the loan? And doesn't that also mean that you're always well behind cause you have to fund your own rent, plus the difference between the taxman and renters on any properties you IO buy??

    Too many questions!!! Why didn't I find this book years ago????

    Look forward to hopefully a lively discussion with a single's investing point of view in mind.

    Thanks in advance. Rob.
    Last edited by a moderator: 5th Apr, 2017
  2. WebBoard

    WebBoard Guest


    Reply: 1
    From: Mike .

    Re: Building a house and I just found Wealth through investment p...
    From: Les
    Date: 10/22/99
    Time: 8:50:05 PM

    G'day Rob,

    An interesting set of circumstances indeed. In attempting to answer this, I will make a few assumptions:-

    1. "I bought the block of land outright" means you had paid cash, or have paid it out over a period - whatever, you owed nothing on it.

    2. "No penalty, no fees .." and common sense, tells me the land value would have to exceed $40,000 (otherwise you would have been paying Lenders Mortgage Insurance). For that value of home, I would probably guess the land is worth more like $70,000 (but that depends where you are from - land in Coonabarabran might be give-away compared to Campbelltown, for example).

    3. From your ability to pay off the loan in 8 - 9 years, I have estimated your marginal tax rate is (at least) into the 34% arena.

    So long as these assumptions are correct, then my thoughts/suggestions may be valid -

    CGT implications don't enter the picture so long as you DON'T SELL! There are also changes afoot (Ralph Report) which will change the way this is calculated into the future. (And that suggestion is valid DESPITE the assumptions ;^)

    re "Jan's plan ... requires Equity in your own property..." You have that already (the land).

    re "First loan HAS to be P&I" Not at all.

    re "..Loan could be repaid in 7 yrs using 2/3 -ve gearing benefits..." Try recalculating those numbers with 100% -ve gearing benefits (which is what you could claim if you stay in share and rent out this new property). But don't pay out the loan - go the IO way. Your Equity (currently the land value, minus any mortgage setup costs) will grow anyway over time. What did a similar property retail for in 1989 in that area? And in 1979?

    re "the dollars figure out the same way ..." Get FULL Tax deductions on a fully rented property, and pay for share out of your wage. Even if the tenant and Taxman are NOT making the property cash flow +ve, they are leaving you only a small amount to find out of the equation, and with a 221D you can get that Tax deduction back on a weekly basis to supplement whatever needs supplementing. And given that the "average" house appreciates at least 2% above inflation (worst case) then today's inflation (3%?) plus 2% means a growth in Equity averaging $140k (+$70k) x 5% = $10500 per year or $210 per week. That can offset a fair amount of rent, particularly if you include the 221D portion as well.

    As we all know, it WON'T go up absolutely that amount every year (it can even drop) but over time, it happens. (How much DID a similar house sell for in 1979?)

    And, Rob, you said you could pay the property down over 8 - 9 years - so use the money that you WOULD have used to pay down the loan to accumulate deposit monies for Investment property #2. Also IO, Tax deductible, etc. We'll have you sharing a house on the French Riviera in a few years (you could afford to ....)

    re "... fund your own rent, plus the difference between the Taxman ...? etc. A lot here depends on the Rental Rate of Return of properties in the area you are building. With a brand new property, you would be able to maximise the Tax deductions via Capital Allowance, but if the Rate of Return is (say) 5%, your Tax deductions are (say) 1%, and mortgage is 6.5%, then you are immediately -ve with Insurances, RE fees, rates, etc. still to come (all Tax deductible though).

    Because you already have so much Equity in the property (the land) I have calculated that with only $200 per week as rental Income, your house would be cash flow positive from day one. Depending on the area, it is possible (probable?) that you can get far more than that. Again, I've made assumptions re the actual (claimable) Building Cost - but run the numbers yourself, and I think you'll see that this property will be only slightly -ve geared. With a higher rent than $200, it could even be +ve geared, so start looking for property #2 - you tycoon, you.

    A final thought - cash in the bank counts as Equity, too. Even though it's better to maximise the borrowings (for Tax purposes), a cash deposit is "the other way" to expand your portfolio.

    Good luck, Rob - and come back again to let us know how you're going - or with more questions.

    Last edited by a moderator: 5th Apr, 2017
  3. WebBoard

    WebBoard Guest


    Reply: 1.1
    From: Mike .

    Re: Building a house and I just found Wealth through investment...
    From: Rob
    Date: 10/25/99
    Time: 3:37:02 PM


    Thank you *very* much for your advice. Very muchly appreciated! There's quite a bit there to chew over in your response but if you'll excuse me talking with my "mouth full" so to speak, I have a couple of comments in relation to your answer that I would appreciate yours (or others) further views.

    First: Your answer has helped to crystalise the potential possibilities. Why aren't we all doing this??!?!!?!?!?

    Second: Your estimated figures are about right.

    Third: I take it from your answer that it *is* actually legal/feasible to negative gear some portion of a property, in my case 2/3, even if you are living in it. This is eye opening! But this is the bit that concerns me because the tax man takes into consideration what was the principle purpose of the loan. [Note: I understand that you're just offering friendly advice and that I would need to get my own independent advice]. If the tax man deems that the principle purpose of the loan wasn't for generating income, I could be in trouble.

    Fourth: I guess my main point was that if I treated the house as a 100% P&I loan investment property, I would then need to pay rent (sharing is still acceptable to me) somewhere else in order to have a roof over my head. This rent money would be giving me no nett benefit. If I were living in the property instead, I figure the (share) rent I would have been paying would be about equivalent to the difference I would have to make up in the 2/3 -ve gear scenario. This amount is then at least contributing towards my own equity, whereas before it was completely lost. This is why living in the property even if only 2/3 -ve geared has a lot of appeal. Comments?

    Fifth: But now you've got me considering the possibility of the IO loan scenario. (By the way, ever heard of an institution going for a IO loan on a 2/3 -ve geared property??) Let me see if I understand this right. When completed, the house [middle west suburbs of Melbourne] should attract $220/week rent which at today's interest rates on the amount I've borrowed, would just about make the property cash neutral. So, I'm none the worse at this point of the scenario. SO I then approach an institution for an IO loan for property two, and so long as there's enough salary to cover rent [since I need a roof over my head] and the (IO liability-taxman-rent income) differences on two properties, I could justify purchasing a second property. So if i have this right then, property three would become viable when property two becomes about cash neutral?! If I keep going like this, in about 10 years there'd be a small collection of properties, of which I could sell a couple of the early properties to help pay off a swag of debt. I could then move into a property I wholly owned if I wanted to. I guess it boils down to needing to decide how long I'd be willing to pay rent for. Have I got this about right???? Or are there some subtleties I'm missing?

    Thanks again for your response Les.

    Cheers. Rob.
    Last edited by a moderator: 5th Apr, 2017
  4. WebBoard

    WebBoard Guest


    Reply: 1.1.1
    From: Mike .

    Re: Building a house and I just found Wealth through investment...
    From: Les
    Date: 10/26/99
    Time: 11:06:20 PM

    G'day again Rob,

    I don't have enough figures from you to be any more specific about your particular circumstances, but I thought I'd answer one (or two) particular parts of your reply. I hope your head isn't spinning, 'cos it might be about to start !!!! ;^)

    Re staying in share - you said "This rent money would be giving me no Nett benefit" - I disagree, and here's why.

    We are in agreement that you could likely purchase TWO investment properties, Interest Only, with full Tax deductions (as you have definitely taken the loans to purchase/build rental Investment properties). So let's look at one property (the one you're building).

    Valuation ($140k, +70k) = $210,000 minimum

    Mortgage (see below) = $170,000

    Repayments (I/O @ 7%) = $1000 per month

    Rental Income = $950 per month

    Total losses (cash and non-cash) = $850 per month

    Actual cash losses = $200 per month

    Tax reimbursed (221D) = $300 per month (if 34% marginal rate)

    Thus, you gain $100 per month (in cash) to go towards paying for your share accom. If your marginal rate is higher, so too is the Tax refund. Of course, this cash gain is HIGHER if you stick with borrowing the original $140k (approx. $230 per month instead of $100).

    But by borrowing the extra $30k (or more, but maybe then you'd be up for Mortgage Insurance), it gives you the opportunity of purchasing a SECOND property right off the bat.

    And remember (my previous answer) that 5% growth on ONE $210k property is $210 per week - why not make that two? Now, THAT IS a nett benefit, wouldn't you say?

    OF COURSE, the second property will not likely give the same positive cash flow - reason being you had ALREADY bought the land for house #1, so your mortgage was smaller for your $210k property (only $140k). So #2 will be negative (as you suggested), but its rents will rise, along with its value.

    Re "I take it that it's legal/feasible to negative gear some portion of a property, even if you're living in it" Rob, I believe that COULD be right, but I don't read anywhere in MY answer that stated that. I was always more in favour of 100% rental, and you rent separately - one reason being BECAUSE of what you said "If the tax man deems the principal purpose... etc". As I have never done the 2/3rds thing, I wouldn't like to comment - except to say it's not quite as "black and white" as 100% rental property, so do get advice.

    Re IO versus P&I, I always opt for IO for Investment property. One of my earlier answers (to another forum writer) documents the gains of IO vs P&I - probably the MAIN point being that it takes $200 earned (at 47% marginal Tax rate) to pay off $100 on your loan - and the Equity "leap" when you do that? $100 !!! (whoopeee ;^) Instead, get the full $200 benefit by gaining Tax deductions, and DON'T water them down by paying off principal.

    And, re your "fifth" - Yep - you sound like you've got the idea pretty good. Re the "subtleties" - yes, there are probably a bunch of them, but being subtle, they are often small potatoes. A couple of larger potatoes that spring to mind are:- Land Tax once you own a few more properties (but Jan puts them in perspective in her books) - and one other that I am becoming aware of is the "5 year crunch" (for want of a better description). This is where you've owned a property for 5 years, all depreciation is now written down, so Tax deductions drop, and rents haven't quite caught up, AND your 5 year IO loan is about to become P&I (as a lot of borrowers do, myself included). So, at the 5 year mark, cashflow reverts -ve, unless one also purchases other +ve investments to counteract them. I haven't hit that point yet, but I'll certainly be doing a bunch of reading, questioning, etc. before then. In fact, I think I will put that as a separate entry in this forum. Maybe Ian or Jan can throw some ideas toward that one.

    Hope this helps, (how's your head, Rob?)

    Last edited by a moderator: 5th Apr, 2017
  5. WebBoard

    WebBoard Guest


    From: Mike .

    Re: Building a house and I just found Wealth through investment...
    From: Rob
    Date: 10/27/99
    Time: 5:48:59 PM
    Remote Name:

    Thanks once again Les. Anyone got an aspirin for my headache?!?!

    It does look reasonably clear that there are immediate economic gains in relation to going 100% IO right off from the start. I'll need to consider this against the intangibles like living in someone else's (not as nice) place, and issues like; not having control over the space you live in etc - which I guess is a purely personal decision.

    I will look into the 2/3 -ve gearing scenario in much more detail and report back. I want to determine whether this is a feasible option. It might present a middle ground that provides **some** financial advantages as well an upgrade of accommodation.

    Keep up the good advice.

    Thanks again Les.

    Last edited by a moderator: 5th Apr, 2017