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From: Mike .


I/P by mistake...what to do now?
From: Brenton
Date: 5/8/00
Time: 3:53:20 PM

Ok heres one for the books. My wife encourages me to look at a more care free lifestyle here in Adl. We currently own free hold a property worth $320,000 give or take a little and I am 35 and she is 32(no children). The property we are in is 1/2 an acre with an indoor swimming pool, outdoor tennis court, 38 sq two storey home etc etc. A little to look after but not impossible.

We go and buy a 10 year old townhouse in North Adl which is a very convenient inner metro location( just off Melbourne St) only walking distance from the city and loads of shops and restaurants in North Adl.

After weeks of deliberation after settlement, "We" both decide to stay in the property we already have and not make the big move. The North Adelaide property rented fairly easily for $280/week but of course it is costing me in excess of $450 a week after all fees. I have the tenants on a periodical and there intention is to stay until the end of the year.

Now, the big question, with GST and the end of the world predicted shortly after, what do we do? Are prices in properties likely to suffer from the crossed armed mentality of I am not spending money any more because of GST or is this a short term attitude adjustment. And with that, the market may not see any gains for some time as we have bought at the peak in "some" peoples opinion? Do we sell immediately and recoup as much as possible? I estimate a definite $20K loss regardless as stamp duty was $12K of the $292K borrowed.

I am not scared by this as we have other business interests we hopefully can work capital losses against capital gains. I am discouraged by our lack of insight as the outcome and repercussions of our decision to not reside in the North Adelaide property. Do we sink more dollars into it over the next 2-3 years and try and get the yield up a bit? Or just sell it off and look for more positively geared property which is very possible in Adelaide?

Anyones suggestions and previous experience would be much appreciated. Regards Brenton [email protected] Ph 08 82852400 fax 08 82852411
 
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Helen

Reply: 1
From: Mike .


Re: I/P by mistake...what to do now?
From: Helen
Date: 5/8/00
Time: 10:23:47 PM

Sounds good to me. I offer nothing technical as an answer but agree with Adam to keep for a few more years before you re-evaluate the situation. As Adam says, it seems that you don't need the money, so leave it for a while. BUT...the important thing here is to feel comfortable with the situation yourself, do your figures, seek professional advice. It's you who needs to sleep at night without the worry.
 
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Andrew S

Reply: 1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Andrew S
Date: 5/9/00
Time: 2:01:30 PM

Hi Brenton, I'm still quite new to property investing and hence these are just the opinions of a beginner.

Firstly looking at the numbers you have given I guess the property was purchased in the high $270K's. The rent return at $280pw is not great. I have no knowledge of the Adelaide rental market and it depends on the specific location, but I would definitely recommend assessing if you can get more than this.

Are there any low cost improvements you could make to increase the weekly rental? Your $450 per week looks to be just your interest on the $292K loan (Interest Only based on 8%) but correct me if I am wrong. There will of course be other expenses. I assume you are aware of all of the deductions you can claim such as the capital depreciation allowance on the buildings at 2.5% per year of construction cost and depreciation on the fixtures. (At ten years old the value of the fixtures may not be much but depends if anything has been refitted etc.) And of course the tax deduction on the loss.

You may find that in the end with all deductions that it may not require as great a weekly contribution as you were expecting, but the return is still not great.

The other side of the coin is that as you say you became a property investor by mistake, then you need to consider if this is really the type of investment that you want. If as you say you are prepared to take a 20K hit then you may want to sell out and invest on something else. You could even sell out and buy another investment property that is giving a better return, ideally cashflow positive.

It really comes down to your own personal circumstances and what type of investments you want. In any case you definitely need to run all of the figures by an accountant (one who is PI savvy)

Andrew PS these are just the opinions of one person!
 
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Sue1

Reply: 1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Sue1
Date: 5/9/00
Time: 2:16:38 PM

Hi Brenton Just a thought, but you don't mention if you have the IP Loan at Principle & Interest or Interest Only.

Since you originally intended to live in the unit I am betting that you stuck with P&I. If you change over to Interest only as all smart property investors do, you will see your repayments reduce by a huge amount.

Of course you will not be paying off the principal but the intention is to use the money you save to put towards your own home loan which is not tax deductible or towards other investments. Lower repayments can make a big difference to your comfort zone and its only the interest you can claim on your tax anyway not the principle.

You might know all this and I might be preaching to the converted but if not think about it. Over time the loan will shrink in comparison to the value of the prop with capital gains anyway. A 20,000 mortgage 20 years ago was a big deal, now you can get a credit card for that amount!

Cheers Sue1
 
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Debbie

Reply: 1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Debbie
Date: 5/9/00
Time: 2:33:56 PM

Brenton, what sort of loan do you have? If you have a P&I loan, can you refinance to a IO loan and then do some relatively inexpensive value adding to increase your rental. It also sounds odd to me (OK I'm from Sydney and don't know Adelaide) that a property that close to the city isn't giving a better return.

What sort of agreement do you have with the tenants? If they are monthly could you consider letting them go and spending a week or two giving it a little face lift (fresh paint, new carpet, Andrew G's Cable TV, revamp the courtyard, sky lights etc), then fully furnish and put it up for corporate rental. You could almost double your return.

there's my 2 bob, good luck, Debbie

PS. By the way, what was the purchase price?
 
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Brenton

Reply: 1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Brenton
Date: 5/9/00
Time: 9:20:09 PM

HI Debbie,

Many thanks for your comments. I went interest only as we new we would sell the property we reside in and the property power was the easiest way to deal with this. I do admire your comments regarding corporate rental as it definitely lends itself more to this style of dwelling if I cleaned it up and furnished it for sure. The tenants in there right now are on a periodical and are really great in regards to any upgrades I want to do while they are there so maybe I could kill two birds with one stone while the tenants are there. A few upgrades and the property would be very appealing for sure.

I thank you for taking the time to respond as we are very new to this and opinions of people who have been down this path are greatly appreciated. I cant say exactly what I will do right now but I will be sure to get back to you on the outcome for sure.

regards, Brenton
 
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Adam

Reply: 1.1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Adam
Date: 5/8/00
Time: 7:58:41 PM

Hello If It was me I would hold onto it. It sounds like you don't really need the money, and if you've set it up correctly you should get a pretty good tax return, which would reduce that loss a fair amount.

I have 3 properties in Adelaide valued conservatively at $600000 and I lose about 300 a month (after taking tax return into account). I should also point out I'm only 26 years old, and if you asked me honestly if it scares me to have a 400000 thousand dollar loan I would say yes, however if I had sold my first property because I was scared it was making a loss I would have nothing, so give it a couple years, at the very least you will recoup the stamp duty, and all other costs.

Regards Adam
 
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Brenton

Reply: 1.1.1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Brenton
Date: 5/9/00
Time: 9:52:46 PM

To Helen, Andrew S, Sue1, Adam and Debbie, many thanks for all your replies. It is so helpful to hear what you have had to say and the various experiences that you have had and learned from.

I will be discussing the situation with my wife over the next few days and would enjoy the opportunity to post the results of our talks for further comment. Once again, thanks for all your help. Below are a couple of clarifications from questions asked by you all:-

The sleeping at night was a good point. Honestly, we had just got debt free and when we decided not to make the move, I suppose the sleeping at night issue was more about the loss of being debt free for the first time ever after working so long to achieve it.

I have come to see that if we had of specifically been looking to find an investment property or two, the choice we made was not the best investment choice and more a lifestyle choice. However, it almost makes me think we should be looking at some positively to slightly negatively geared properties regardless of our decision to sell or stick it out with North Adel.

I suppose Adam is right in the fact that there would be better opportunities with greater returns for sure. Sues comments regarding the worth of money also made me think about whether or not we use North Adelaide as a forced savings fund and regain some equity in the property over the next 3-5years to make it a fairly minimal cost to us and whilst still having tax advantages. The big question in my mind is rising interest rates and our ability to keep a fairly reasonable investment if values did not rise it the next ten years.

The North Adelaide townhouse initially sold for $260,000 back in 1990 so it has not seen a very good return for the previous owner. So I suppose is it that it will see a better return in the next 5-10 years or am I expecting everyone to have a crystal ball.(haha)..I like the idea of being able to keep it as an option for myself one day however I suppose I cant have it both ways.

I responded to debbie separately regarding the dress it up and offer it more as a corporate rental which may offer a better return fully furnished. Sorry, the other question Debbie had was in regards to the purchase price. Purchase price was $280,000 with around $12,000 in costs, totalling $292,000. Debbie does have a point as it may be an avenue of increasing the cashflow of the property if done correctly. Whilst it means a few dollars to spend, it will probably be a much better return. We probably did panic a little by taking $280/week as some have suggested that a townhouse of its size and double car parking should have been more like $320/week but 5 weeks of advertising had $280 max being offered and we needed to make a decision to put someone in the property to recoup some interest being paid. Being a periodical, it makes it easy to either sell or spend time adopting Debbie's ideas of corporate rental and change of tenant.

One thing I notice in all your comments is a very strong belief that no matter what, whether it be interest rate rises, property value slumps etc, you are all very confident in your long term investments in real estate. This helps me greatly to think more clearly and with a degree of insight that you are all providing me with. I actually wish the chap who bought the property in 1990 had paid $190K proving a good investment over 10 years. I imagine 1990 was a bit of a high for dollars paid?

Once again, may thanks, and i look forward to any comments anytime from all of you.

Regards Brenton
 
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Brenton

Reply: 1.1.1.1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Brenton
Date: 5/10/00
Time: 12:49:55 AM

Hi Adam,

So what are your predictions from inner metro Adl as you have the the odd property of a fairly high value?

If I sank $60K into the North Adl property and fixed the interest rate to say 8% for a few years, do you think the result would be better than accepting a loss right now?

The budget tonight was hard to interpret with residential housing likely to take a hit if I understood correctly. There is a part of me that is probably more scared of the interest rate rises more than anything else. How long would you fix for with the current unsure US based interest rate climate?

I think if Greenspan says yep, lets keep moving up, Australia will feel compelled to follow. anyway, send me your thoughts if you can and lets see what I can do to make a more informed decision.

seeya, brenton
 
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Adam

Reply: 1.1.1.1.1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Adam
Date: 5/11/00
Time: 3:07:38 PM

Hello Funny you should talk about fixing interest rates I have just swapped my variable for fixed 6.99 to 7.95 for 3 years, this makes a difference of about 300 a month to my repayments but at least I'm going to sleep at night. With interest rates going up slowly (but consistently) it reminds me of the old frogs in the frying pan (ie turn the heat up slowly and frogs will fry themselves, turn it up fast and they will all jump out).

Also the fact that everyone is saying they think interest rates won't go up much more (the masses are usually wrong). As far as property in Adelaide is concerned (I'm not an expert) I believe that prices have probably peaked, I don't think they will drop (not much anyway), but will probably keep pace with inflation for the next few years (I'd wait for the next boom before considering selling even if its another 6 or 7 years away).

You never know if you've got kids, and they move away from home, and you don't want to maintain a huge home, you might reconsider moving closer to town.
 
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Brenton

Reply: 1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: I/P by mistake...what to do now?
From: Brenton
Date: 5/12/00
Time: 9:17:12 AM

Hi Adam, Your illustration regarding interest rates is correct in my mind.

I also think you are right regarding the long term picture for this property and the possible option to reside in it in years to come. I have 14 days to get my paperwork sorted out for the same deal at 3 years at 7.95 however it represents little change as my property power is at 7.9% anyway. I have $224K fixed and the remaining $68K is my goal to get paid in the next 2-3 years. I think if I regain some equity in the property and use it as a forced savings account, it may be a good way to keep me disciplined. I can still pay $10K a year of the $224 if I get really ambitious but lets see how business goes.

Its funny, I originally bought the townhouse now to live in with the idea that in 5 years time, affording it may be a problem. Over the last month, I have managed to taint it with so much negativity as far as possible increases that a good relook at the entire situation has given some clarity. It's help from all you guys that has brought me back to logical thinking and for this, many thanks.

I think you could be right, inflation rises may be it for some time, but I am starting to think, if it does that, and I still have the option one day to move in, then this would be much better than a $20-$30K loss. It is costing me around $6700/year to keep after taxes and depreciation so a bit of inputted cash to the loan may make sense to take it back to a $2000 - $3000/year cost.

Once again , many thanks for the input. Any other thoughts, pls feel free to pass them on. I am all ears.

regards, Brenton
 
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Andrew G

Reply: 1.1.1.1.1.1.1.1.1.1.1
From: Mike .


US Rates
From: Andrew G
Date: 5/10/00
Time: 7:44:51 PM

Brenton,

It's not that we will FEEL compelled to lift rates but is is more of a necessity. It is worth understanding as it will give you a much better handle on international economic forces and as a result be able to make wiser decisions. A book on global financial markets or better still currency and international interest rate markets will give you heaps of information (probably more than you would like).

The other big advantage it will give you will be options others would never consider to protect themselves from interest rate rises. E.g. If you believe in the strong connection between our markets and the US you could hedge your interest rate exposure in the US bond or futures market.

A similar approach could be taken here as the correlation between our market and your interest rate will be much greater (and therefore a much more effective hedge). The margin on a 10 year bond futures contract is $2,000. The 3 year contract is only $700. This could be better than giving the bank additional interest now and hoping the rates then go up fast enough to make it worth it.

When a bank fixes your rate at say 8% they just go out into the market and sell a bond at say 7%.(They pool many loans together to package them into something another large bank would buy who wants exposure to the Aussie market.) This way then now have all their cash back in their pocket (to loan out again) and they collect the 1% from you. Does not sound much but 1% of $1 bn is $10 mil. Better still they can then do this again and again as it cost them very little money and they have nothing tied up in the deal. I have always wanted to be a bank they have it made. (Please understand this is a VERY basic explanation.)

Hope this helps.

Andrew.

PS Let me know if this doesn't make sense and I'll try explaining again, that's if you are interested.
 
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geoff

Reply: 1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Risk from Interest rate rises
From: geoff
Date: 5/11/00
Time: 12:28:03 AM

How do you put that into real PI investor language. If you have $800,000 worth of loans the traditional alternatives are: Fix all or some of the loan . How do property investors use futures to offset their risks of interest rate rises. When does it become economical to use these strategies. what is the cost?..and what are the pitfalls?
 
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Andrew G

Reply: 1.1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Alternative to Fixed Rate
From: Andrew G
Date: 5/17/00
Time: 8:55:28 PM

Like everything there are a number of approaches so I'll go for a basic one. There are many variables which I won't try to tackle or mention now (if you are really interested you will find them as you research further).

A 10 year bond futures contract has a face value of $100,000. Just say you have $100,000 worth of loans. To protect yourself you can sell a contract (go short) so any movement up in interest rates will make you money in the futures market. In this case say you sold at 7.5% and the market moved to 8.5% you would make around $8000. So very crudely your repayments have gone up 1% but you have made $8000 in the futures market to compensate for this.

This way you have basically fixed your interest rate without giving any money to the bank.

What you do with the $8K is up to you. If you drop it on the principal of the loan then you will reduce you repayments. You could use it to just make the extra interest repayments for a few years.

Remember this is not a perfect hedge as the underlaying security of the contract is not your interest rate but the yield of the 10 year government bond but it works quite well.

When is it economical? What are the costs? What are the pitfalls? I'm not sure what you mean by economical. If you mean is it cheaper than fixing with the bank, then the answer is yes. The costs are quite low. It should cost you nothing to set an account the the fee is per trade and this won't be much (~$50 shop around it really varies). The pitfalls are many but this should not put you off. There are many for the new player who hasn't done their homework. The more you understand the more of them you will see (as anyone who trades futures will see from the above example). A good book to start with is "Getting Started in Futures".

The beauty of this system is that you can lock in your rate (to a degree) and if they don't move then it costs you nothing. You can also break out at any time, just call your broker. If the rates drop then you will lose money but on the other side you will be saving money on your loan to compensate for this. Yes, you are taking a punt on rates but everyone in the IP market is anyway so you are just taking a more thought out approach to deal with it. Also you don't have to pay the bank premium rate to lock in. You lock in at todays rate.

Does that help? Does it make sense? Is it of value? I hope so. It is really quite exciting the more you learn about it.

Andrew.
 
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geoff

Reply: 1.1.1.1.1.1.1.1.1.1.1.1.1.1
From: Mike .


Re: Alternative to Fixed Rate
From: geoff
Date: 5/19/00
Time: 6:55:53 AM

Thanks Andrew That sounds like an interesting strategy. I've never considered futures since being "burnt" in the 70's. Closed my mind to it I suppose.

The problem I've found with switching to fixed rate loans is ...by the time you consider fixing (ie when the variable goes up), the banks have already moved the fixed rates in preparation for the rush. That's why they are the banks! Have you taken out this hedge for yourself currently?

I suppose the best way to learn is to actually do it in a small way and find out the nuances. I never ceased to be amazed at the number of strategies around. For every problem there is a solution. Of course many solutions have their own problems (called risk) you then minimise the risk to a level you are personally comfortable with by accumulating the knowledge to measure them. Who would want to "work" for a living - that really is risky! Investing is just too interesting and you get paid very well (if you get it right)

Thanks, geoff
 
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