Loan term vs Lease term

[JIT]

Hi,

If I buy a property on a 3 year lease and had a preference for fixed interest rates, is it prudent to get a 3 year fixed rate loan to match the term of the lease?

If so, does it need to match exactly, or can the fixed rate loan run a couple of months after the end of the lease term (and assuming any options are subsequently taken up)?

Thanks.

 

[Aaron_C]

Personally I wouldn't do that. At the end of the fixed term you have to reapply for the loan again for rollover. If your tenant has absconded for some reason and you have no lease in place at the review stage, you are ****ed unless you can come up with more cash. The less annual reviews, the better.

 

[Dazedmw]

Ideally you would want the bank to be reviewing their security just after the lease term has commenced. A bank and a valuer will look at a lease with 2.9 years to run much more favorablely than one with six months to go.

If they match up that is fine while the tenant is exercising options if you can show the bank/valuer that the option paperwork has been done. But if the tenant vacates it would be an issue.

 

[JIT]

Ideally you would want the bank to be reviewing their security just after the lease term has commenced. A bank and a valuer will look at a lease with 2.9 years to run much more favorablely than one with six months to go.

Thanks Dazedmw, that makes more sense.

 

[Trogdor]

JIT,

1. Have you considered a loan without reviews? For example, our two CIPs are with Adelaide bank at present. Its a long loan (20 or 25 yrs, i cant remember, i think 25) with NO reviews.

2. The big 4 should do 15 yr loans with no reviews (or at least do for private banking clients)

3. That said, BBSW + margin loans are a fair bit cheaper, but with reviews. I met with my big 4 private banker recently to investigate this option for down the track when my fixed rate and break fee periods expire. Havent done much DD but did get the impression that if a tenant vacates and you get reviewed, its simply a deduction of that income at worst case, so if you can service the loan from salary, dividends or other rent sources then you'll be ok,. He also told me closer to the time if i do want to switch to this type of product he could run the numbers on 1 vacancy, 2 vacancies, RIP vacancy, 1 job loss out of 2 (couple) and then i could form a view on risk tolerance. I suggested this as an exercise to help me gauge risk and he was ok to help out in due course.

Do any brokers have experience on item 3?

 

[Trogdor]

Hi,

If I buy a property on a 3 year lease and had a preference for fixed interest rates, is it prudent to get a 3 year fixed rate loan to match the term of the lease?

If so, does it need to match exactly, or can the fixed rate loan run a couple of months after the end of the lease term (and assuming any options are subsequently taken up)?

Thanks.

Having just reread your qn i should also point out fixing rate does not equal reviews.

Examples:

1. Adelaide bank, no reviews, can fix for 1, 2, 3, 5 yrs at any time. When the fixed rate expures its back to variable.

2. A big 4, offers 2 year reviews fir their bbsw + margin loan. You can then have 30, 60, 90 day, 1 yr etc BBSW. Reviews are still every 2 yrs.

Brokers on here should be able to comment with more expertise on what products other banks offer.

 

[JIT]

JIT,

1. Have you considered a loan without reviews? For example, our two CIPs are with Adelaide bank at present. Its a long loan (20 or 25 yrs, i cant remember, i think 25) with NO reviews.

2. The big 4 should do 15 yr loans with no reviews (or at least do for private banking clients)

No reviews would certainly be better, will check about this with my lenders.

3. That said, BBSW + margin loans are a fair bit cheaper, but with reviews. I met with my big 4 private banker recently to investigate this option for down the track when my fixed rate and break fee periods expire. Havent done much DD but did get the impression that if a tenant vacates and you get reviewed, its simply a deduction of that income at worst case, so if you can service the loan from salary, dividends or other rent sources then you'll be ok,. He also told me closer to the time if i do want to switch to this type of product he could run the numbers on 1 vacancy, 2 vacancies, RIP vacancy, 1 job loss out of 2 (couple) and then i could form a view on risk tolerance. I suggested this as an exercise to help me gauge risk and he was ok to help out in due course.

Do any brokers have experience on item 3?

This is interesting, I don't know anything about this sort of financing, I'd also be interested to hear from the brokers or others who have used this sort of finance before?

Aaron_C, I think I remember you saying that you were using this for one of your developments??

 

[JIT]

Having just reread your qn i should also point out fixing rate does not equal reviews.

Noted, thanks Trogdor.

 

[Dazz]

If I buy a property

....that has indeed been the precursor for all of your questions over the past 6 or so years....

It dawned on me a few years ago, that all of your thousands of questions posed over the years have been more than adequately answered, and yet action still has not taken place.

Unlike Trogdor, who took action a few years ago and is now in the position of being able to confidently answer your questions and then some.

I would humbly suggest you also note the difference between knowledge gained from forums and books and asking questions, vs actually getting in there warts and all and doing it.

I can confidently say you've certainly cost yourself many many millions of dollars in lost opportunities by asking these questions and not taking action over the years.

 

[JIT]

Haha, yes, I expected another kick in the backside post from you Dazz.

I'm not too fussed, but I understand if you are getting a bit annoyed.

The issue Dazz is that my planning time-frames are way beyond most.

So when I asked the Moderators to setup this sub-forum back in Nov 2006, and first started asking questions about CIPs, I had only just bought RIP#1.

The plan was always to get to 4-6 RIPs worth $3M-5M before buying any CIP at all, a bit like you did actually, but maybe a bit more deliberately (as I was copying you!)

That objective was only achieved in 2011, then 2 RIPs were subsequently sold in 2012 to improve cash flow and let go of high maintenance RIPs.

Now with RIP loans fixed at 5.59% and my JOB income more stable and predictable, the overall house is thankfully in much better order.

From my perspective, everything is still going to plan, almost perfectly actually, albeit a bit slower than I expected.

Sometimes other less predictable things get in the way of even the most well laid-out plans.

Nonetheless, I'm not too phased.

I don't live or die based on my investing outcomes, this is all just for pure enjoyment.

I'll continue with my plan and keep asking the right questions, even if it annoys you a little.

Criticising and embarrassing me isn't really adding any value to this thread, but I hope you enjoy it.

And I am well aware of the difference between knowledge and action/experience, I've bought 6 RIPs in 6 years, I've not exactly been sitting on my bum, twiddling my fingers doing nothing...

....that has indeed been the precursor for all of your questions over the past 6 or so years....

It dawned on me a few years ago, that all of your thousands of questions posed over the years have been more than adequately answered, and yet action still has not taken place.

Unlike Trogdor, who took action a few years ago and is now in the position of being able to confidently answer your questions and then some.

I would humbly suggest you also note the difference between knowledge gained from forums and books and asking questions, vs actually getting in there warts and all and doing it.

I can confidently say you've certainly cost yourself many many millions of dollars in lost opportunities by asking these questions and not taking action over the years.

 

[Dazedmw]

JIT,
3. That said, BBSW + margin loans are a fair bit cheaper, but with reviews. I met with my big 4 private banker recently to investigate this option for down the track when my fixed rate and break fee periods expire. Havent done much DD but did get the impression that if a tenant vacates and you get reviewed, its simply a deduction of that income at worst case, so if you can service the loan from salary, dividends or other rent sources then you'll be ok,.

I'm no expert in this area so I wondered if you could clarify. When you say "reviewed" you mean the bank reviews the serviceability of the loan? I had though that was so and usually a valuation would be required at this stage? I guess the issue could be that with the property vacant the market value could be decreased resulting in LVR troubles so not just looking at a shortfall that could be met by your salary. Or am I on the wrong track here?

 

[Aaron_C]

I'm no expert in this area so I wondered if you could clarify. When you say "reviewed" you mean the bank reviews the serviceability of the loan? I had though that was so and usually a valuation would be required at this stage? I guess the issue could be that with the property vacant the market value could be decreased resulting in LVR troubles so not just looking at a shortfall that could be met by your salary. Or am I on the wrong track here?

They revalue the security every few years with bank bills. If the property becomes vacant before that time then it will impact both the valuation and the LVR - a double whammy. Of course if you could service the loan with other income it's not an issue but why would you buy an investment if you weren't relying on the income to support the loan in the first place? It means nothing and usually annual reviews involve lots of paperwork which is very tedious.

 

[Dazz]

Haha, yes, I expected another kick in the backside post from you Dazz.

Your expectations have been met then.

I'm not too fussed....I'm not too phased.

No problem then. Cool as a cucumber.

Criticising and embarrassing me isn't really adding any value to this thread, but I hope you enjoy it.

That isn't consistent with what you said previously. You're either not fussed and not phased, or you are affected by criticism and embarrassed. You can't be both. I take no pleasure from seeing an obviously smart guy suffer from an extreme case of analysis paralysis. Please don't presume I enjoy seeing you sit there for 6 years and not invest in CIPs after the myriad of questions having been answered in minute detail.

The issue Dazz is that my planning time-frames are way beyond most.

Clearly, and as I mentioned, there is a substantial opportunity cost associated with that extreme length of planning.

From my perspective, everything is still going to plan, almost perfectly actually

Congratulations are in order then. More power to you.

I've bought 6 RIPs in 6 years, I've not exactly been sitting on my bum, twiddling my fingers doing nothing...

Agreed, and once again you are to be congratulated - certainly well and truly above the average Australian when it comes to investing......but you must appreciate my comments were focussed on the access you have had, via this forum, over the past 6 years to all manner of advice and questions posed regarding CIPs with no discernible action yet taken.

Extreme lengths of planning prior to action being taken is all very well, I just wish you had of disclosed that fact more than 6 years ago at the start.

 

[JIT]

...but you must appreciate my comments were focussed on the access you have had, via this forum, over the past 6 years to all manner of advice and questions posed regarding CIPs with no discernible action yet taken.

I appreciate your point and you are right, and that's why the Commercial Property sub-forum was created, so it has served (and continues to serve) it's purpose well for me and for many others here.

Purchasing a CIP 2, 3, 4, 5 or 6 years ago was just not possible for me. The equity was not there. RIPs are the base/foundation, and it takes time for this to develop and to be able to setup the LOCs and manage the overall cash flow position to start investing in CIPs. To me purchasing the RIPs was always about taking action to get myself into a position where I could afford to buy CIPs. I couldn't have done that with the after-tax cash savings from my income alone.

 

[Trogdor]

They revalue the security every few years with bank bills. If the property becomes vacant before that time then it will impact both the valuation and the LVR - a double whammy. Of course if you could service the loan with other income it's not an issue but why would you buy an investment if you weren't relying on the income to support the loan in the first place? It means nothing and usually annual reviews involve lots of paperwork which is very tedious.

The way it was explained to me is that they do not require a formal revaluation every two years, but rather the focus is on servicability. I do need to sit down later this year and get more details on exactly how this works.

That said, of course you would buy an investment if you were not relying on income to support the loan. In fact, I would suggest buying a investment where a long term vacancy can sink you would be a bad idea. You don't go into it expecting a vacancy as a base case, but it is very realistic to expect vacancies from time to time and I'm much more comfortable knowing I can indefinitely hold in such a situation from other income.

The benefit of this it seems is it also enables me to tap cheaper term funding if I decide to (as it mitigates this risk).

 

[Aaron_C]

The way it was explained to me is that they do not require a formal revaluation every two years, but rather the focus is on servicability. I do need to sit down later this year and get more details on exactly how this works.

That said, of course you would buy an investment if you were not relying on income to support the loan. In fact, I would suggest buying a investment where a long term vacancy can sink you would be a bad idea. You don't go into it expecting a vacancy as a base case, but it is very realistic to expect vacancies from time to time and I'm much more comfortable knowing I can indefinitely hold in such a situation from other income.

Whether you rely on the income in reality as opposed to what the bank deems you to rely on are two different things and this is the point I was trying to make.

 

[Trogdor]

Whether you rely on the income in reality as opposed to what the bank deems you to rely on are two different things and this is the point I was trying to make.

Sure good point, and one worth investigating with a bank and understanding the numbers on before signing up on a term loan.

 

[HiEquity]

JIT,

1. Have you considered a loan without reviews? For example, our two CIPs are with Adelaide bank at present. Its a long loan (20 or 25 yrs, i cant remember, i think 25) with NO reviews.

Yes I've got a product like that. All was going well until I got a very apologetic phone call last month saying that we are reviewing your loan. Basically saying that the full intention was that the loan wasn't a reviewable product when we set it up but that ASIC were now insisting they review all their CIP loans annually now in order to maintain their licence. Of course the loan contract I signed gave the bank full authority to do something like this at any time so it wasn't a complete surprise - more of a disappointment.

So don't be surprised if that product without reviews doesn't quite stay that way...

 

[Trogdor]

Yes I've got a product like that. All was going well until I got a very apologetic phone call last month saying that we are reviewing your loan. Basically saying that the full intention was that the loan wasn't a reviewable product when we set it up but that ASIC were now insisting they review all their CIP loans annually now in order to maintain their licence. Of course the loan contract I signed gave the bank full authority to do something like this at any time so it wasn't a complete surprise - more of a disappointment.

So don't be surprised if that product without reviews doesn't quite stay that way...

Wow, thats a real pain. Hopefully it all went well in the end?

The thing which is quite disappointing isn't that they review you, but rather that they do charge a premium for a product pitched as non-reviewable, when in fact you could be paying quite a bit less for a term loan.

I guess once you passed the review, it could be never or a long while until they do this again, or did they state they reviews would be periodically conducted in future?

Are you comfortable saying which bank? I've had my first Adelaide CIP loan from Feb 2010 and so far nothing like this.

 

[Trogdor]

Whether you rely on the income in reality as opposed to what the bank deems you to rely on are two different things and this is the point I was trying to make.

Sorry, one more thing. For Aaron / Dazz, others, who are more familiar with BBSW + margin term loans.

When the 2-yearly (or whataver the period is) review comes up, what do they look at:

- just servicibility on their model?
- any factoring in of capital value movements? Am I correct in understanding no formal valuation of the property, but do they make any assumptions or take into account capital values?
- anything else?

The other thing I was thinking is that if you get the LVR < 50% BBSW term loans would be a good option as if (heaven forbid) you were badly reviewed there would be some no or lo doc options out there to tide you over until things improved. Does this thinking have any basis / merit?