Justifying PPOR and IPs

[Zeddy]

Hi all

I have two existing properties, which I am about to refinance to draw on equity and make a third purchase.

IP #1 (Apartment)
Purchase date: 4/10/07
Purchase price: $278,000
Current valuation: $299,000
Initial loan amount: $224,000
Current loan amount: $210,700 (LVR: 70%)
Rental income: $410 pw
Cashflow: -$1,800 (2010-2011 FY, largely due to installation of tiles throughout the entire building costing some $2.5k)

IP #2 (House on 632 sqm land)
Purchase date: 15/12/08
Purchase price: $270,000
Current valuation: $292,000
Initial loan amount: $216,000
Current loan amount: $171,100 (LVR: 59%)
Rental income: $310 pw
Cashflow: -$440 (2010-2011 FY)

Cash in hand - $30,000

Current rental paid - $220 pw

Now I am looking at buying a third property (IP #3 & PPOR) @ $410K, with the following scenarios:

Scenario A - Lease the whole property out (move back in with parents)
Rental income: $340pw
Net cashflow: -$150pw

Scenario B - Lease two bedrooms, live in the third)
Rental income: $270pw
Net cashflow: -$140pw (My own "rental cost")

Scenario C - Lease out three bedrooms, live in the fourth
Rental income: $405pw
Net cashflow: -$80pw (My own "rental cost")

Scenario D - Live in it by myself
Out-of-pocket expense: $600 pw

The land is large enough to subdivide. I have seen numerous properties in the region that have already subdivided and built on. It has easy access to public transport to the city, and I am of the belief that the area is due for a rise in value.

I would like to purchase this property with the intent of living in it for 5-10 years, then possibly subdividing and developing.

So from this, I have drawn the conclusion that it is cheaper in the long run than renting if I purchase a property, live in it, and rent out the other rooms (Scenario A can be treated as a contingency plan in the bizarre event that no individual tenants are happy to sign on). It is most likely I will go for scenario B.

The thing that is given me greatest pause however is that it is significantly cash flow negative in the tune of $140 pw. My previous two properties will cost far far less to hold that this one. Psychologically this is my barrier.

I would like to invite comment on my current portfolio and the suitability of IP #3/PPOR.

1/. Am I doing the right thing in having a significantly negative cashflow property given the possibility of falls in property value?

2/. Is my justification of reduced "rent" a valid one? Or is my logic flawed? I am 29 years old and might consider a family in the next 2-3 years. This potentially has a huge impact on the investment cashflow.

3/. Do people think that controlling a block of land with development potential is worth the significant out of pocket expenses?

I would greatly appreciate any comments and thoughts. Be as rough as you like.

 

[Zeddy]

Apologies for the wall of text if it's too much, I think I got carried away thinking out loud.

 

[Bigtone]

Apologies for the wall of text if it's too much, I think I got carried away thinking out loud.

stop paying the loans off, just pay interest only to reduce negative cashflow as much as possible.

u r in a good position, just need to understand how to structure finances properly for your future possibilities and u will be fine

 

[MIW]

Apologies for the wall of text if it's too much, I think I got carried away thinking out loud.

Q1. No one has a crystal ball of wether they will fall be static or rise and property falls are much more static than stocks. I agree about having an Interest only loan and perhaps any excess in the LOC for any unforseen problems. As long as you have some buffer then you should be ok. Also if you are an employee fill in a form and submit to your employer to free some more cash (instead of waiting till end of Tax Year you can get a variance on tax so talk to your accountant about it).
Q2. Not at all. I have reduced rents sometimes to get tenants very quickly and it worked or when market dictated it.
Q3. Never developed myself as I am the 'Turtle' investor in the 'Hare and the Turtle' story (you know the Turtle who did one thing well, just travelled at constant speed and crossed the finish line first, before the Hare who was jumping all over). So that's my personal strategy, I buy when I can afford, never sell and do the same thing over and over again by repetition (have accumulated 13 properties now since start in year 2000). I actually paid 20% on each property so I did it really the SLOW WAY. It's not exciting but it takes time so the strategy is not for everyone.
Negative gearing? Well, once you stop accumulating then the loans will remain constant/same but over time rent increases will make your properties neutral or eventually positively geared. The question is whether you do not over commit yourself and that depends on your strategy and your risk (what you feel comfortable with). Just have a plan B always for worst case scenarios.
Just general point is to set a goal/plan to see what you want to achieve and continue learning on past mistakes (never give up). Keep educating yourself too! I hope that helps.

 

[Zeddy]

stop paying the loans off, just pay interest only to reduce negative cashflow as much as possible.

u r in a good position, just need to understand how to structure finances properly for your future possibilities and u will be fine

I wasn't intending to pay off my loans. But where else can I store my cash? I don't have the understanding or time to dabble in the share market. My intent was only to store the cash in those mortgages until such time I had enough cash to make another purchase.

Q1. No one has a crystal ball of wether they will fall be static or rise and property falls are much more static than stocks. I agree about having an Interest only loan and perhaps any excess in the LOC for any unforseen problems.

My loans are all IO. The broker has advised however that the bank will push very hard for the loan for IP#3 to be I+P as it will also be a PPOR. I have asked him to try as much as possible to get it to be IO. Can I tell them I'll live at home with the parents to get it to be IO?

As long as you have some buffer then you should be ok. Also if you are an employee fill in a form and submit to your employer to free some more cash (instead of waiting till end of Tax Year you can get a variance on tax so talk to your accountant about it).

Very good idea. Thank you.

Q3. Never developed myself as I am the 'Turtle' investor in the 'Hare and the Turtle' story (you know the Turtle who did one thing well, just travelled at constant speed and crossed the finish line first, before the Hare who was jumping all over). So that's my personal strategy, I buy when I can afford, never sell and do the same thing over and over again by repetition (have accumulated 13 properties now since start in year 2000). I actually paid 20% on each property so I did it really the SLOW WAY. It's not exciting but it takes time so the strategy is not for everyone.

Did you rely heavily on equity gain for this? As I started in 2007, and the GFC hit one year later, I feel that my capital gains have been pretty mediocre at the moment (largely bearable due to cashflow). I have been looking at it in the vein of "at least property prices are coming down, I can get some cheap deals!", but I can't help but feel the lack of equity gain has slowed my acquisitions.

Just general point is to set a goal/plan to see what you want to achieve and continue learning on past mistakes (never give up). Keep educating yourself too! I hope that helps.

Working on it! That's why I listen to the wise people on the SS forums.

 

[Zeddy]

Also, is that negative cash flow going to significantly affect my borrowing capacity/serviceability?

I'm thinking the answer is YES - but for < $200 per week, the cost of NOT living with parents is worth it!

Until they rocked up and said they'll pay me $20k in advance to rent the entire first year from me, as they are re-building their own home.

 

[jrc77]

I wasn't intending to pay off my loans. But where else can I store my cash?

IMHO Best place would be in an offset account linked to your PPOR mortgage.

Regards,

Jason

 

[Zeddy]

IMHO Best place would be in an offset account linked to your PPOR mortgage.

Regards,

Jason

You are quite right. I will have that with my new finance. The old setup didn't have that, as I didn't know better when I first started buying.

 

[jaycee]

You are quite right. I will have that with my new finance. The old setup didn't have that, as I didn't know better when I first started buying.

You're on your way Zed !

 

[Zeddy]

Yo're on your Zed !

Sorry... what?

 

[MIW]

How to grow equity from property?

Did you rely heavily on equity gain for this? As I started in 2007, and the GFC hit one year later, I feel that my capital gains have been pretty mediocre at the moment (largely bearable due to cashflow). I have been looking at it in the vein of "at least property prices are coming down, I can get some cheap deals!", but I can't help but feel the lack of equity gain has slowed my acquisitions.

Working on it! That's why I listen to the wise people on the SS forums.

Five ways of building equity that I can think of:
1. Save up for it over time
2. Wait for the market to do it
3. Pay P&I loans rather than IO loans (also using offset accounts is useful)
4. Renovate and add value
5. Buy well at the start (under true valuation).

I did it the SLOW WAY by saving up over time from income... but QLD properties grew very well only after few years. I have all stand alone loans and paid 20% deposit for answer 1 above. Sorry, one loan was P&I so paid off about $20K over time. Also first 3 loans were 50% only as we sold our land and became serious. So we had lots of equity but never used it. That was just us, novices, scared, but serious about investing for our future.
However, it was my hubby and me investing so 2 people. Also, I bought under different structures to minimise land tax and for other reasons (joint names, Superfund, Trust - for asset protection).
I must say that GFC does not help but I think the strategy you adopt is important. We purchased only brand new houses, at first within 12kms to CBD, great depreciation but paid a premium with the main aim for capital growth. We never buy in regional areas or for positive cash flow so it really depends on your strategy. Also at different times like now, buying below median price and adding value may be the way to go.
Also we started in QLD when the property cycle was not rising. We like to buy against the trends, so I think QLD is great to buy now then WA, then VIC then NSW (we invest only in those 4 states).
The hardest job is at the beginning where you need some equity, so just don't over strech yourself, adapt to a strategy that works for you. I have a friend who's a single mum, on $60K with $2.4 mil portfolio, buying old affordable properties, adding value, refinancing and so on. So think about the five answers above. I am sure there may be other ways too so other comments are welcome...
Read “How to Grow a Multi Million Dollar Property Portfolio in your spare time” by Michael Yardney to educate youself. I think that book explains lots of things and may help you to decide on your strategy. It was very helpful to me....

 

[jaycee]

Sorry... what?

How did you manage to quote my old post at 3.332pm.... AFTER I edited it out the mistakes that made you ask what? at 3.29 pm

 

[MIW]

How did you manage to quote my old post at 3.332pm.... AFTER I edited it out the mistakes that made you ask what? at 3.29 pm

What can I say I'm late night person..... However it catches up with me by the end of the week so I am logging off after this....

 

[Zeddy]

Quick update.

I made an offer for $399.2K that was accepted. The last price paid in 2009 was $445K.

Settlement will be in early December.

I'm quite happy with the purchase, no buyer's remorse at all.