Over geared? Problems with high LVRs?

[tobe]

I bought all my properties exactly when I had just enough equity and income to get an approval from the bank. Initially I bought for cashflow, and I was pleasantly surprised when I got some capital growth early on, which I used immediately to leverage further. I had landlords insurance, and fixed roughly half of the debt.

The economy, and the lenders opinions have changed recently, and my personal circumstances have also changed (family wise) so this year I am going to consolidate to 80% LVR before buying again.

I see nothing wrong with leverage per se. Its how it is used.
It is a powerful tool. It can work for good and evil. Its important to be educated, and to mitigate risks where possible. Its important to know your own risk profile, and have investments that suit. Are you comfortable holding a property underwater? Can you commit to working full time for the next 5 years (some gen ys cant)? If rental yeilds tanked, and you lost your job, would washing dishes still leave you enough to buy beans and rice and top up the mortgage shortfall?


If you have done the homework, on you, the property, and the wider economy. If you have mitigated the risks. then go for it.

By the way, there is nothing wrong with having a bet each way, and perhaps buy the next one for yeild, or at a lower purchase price. It can spread the risk, and smaller mouthfuls are easier to digest.

Good luck!

 

[Fuzzboy]

BayView & steveadl,

My view is that your profit/loss made is determined by the growth in equity that you put into investment (IRR on funds invested), regardless of how much the asset price appreciates or depreciates over time (sale profit/loss is only one component). With a higher LVR your risk of eating into your equity base is greater, than if you have lower LVR, because you are exposed to higher interest costs that are associated with a higher LVR.

Essentially, if your highly geared you need greater capital growth in the asset price to make a profit, but if you have low gearing your returns are more insulated from volatility in the asset price. This is exactly why those A-REITs with lower gearing are seen as much better stocks, because they can weather the falling asset values in the coming months and increased interest costs much better than those with higher gearing.

Cashflowplus,

I will be self-managing the property so I have n’t allowed for management fees, rental vacancy is extremely low in this area at the moment and I have allowed for a small amount of maintenance but just forgot to mention it. I do take your point though; any potential purchaser would factor some of these costs you have mentioned in assessing their net yield.

Tobe,

I totally agree, my strategy in the long-term will be to deleverage my portfolio to mitigate against the volatility of the market in the long-term. But currently, my view is that in select areas that have been stagnant for a while are ripe for growth, so im happy to gear up on these investments. Again, my risk profile is high so, because im more confident of the security of my job and personal circumstances im to gear up.

 

[steveadl]

With a higher LVR your risk of eating into your equity base is greater, than if you have lower LVR, because you are exposed to higher interest costs that are associated with a higher LVR.

It also depends at what stage you're at in your life/investing journey. I have no problem with high leverage when starting out, on the other hand if in your first post you said you were a 55yo planning to retire in 3 yrs then the strategy would have to be different.

Growth is the key (for me at least) when you're young and you want to expand your asset base I assume. As I'm not planning on selling any time soon, I'd much rather have 2 properties at 95% than one at 70%.

I believe there is also such a thing as being too cautious at the expense of growth, especially if you have contingency plans for different scenarios. A lot of the investors on SS would not have taken on anywhere near the amount of debt/risk I have over the last few years, but hey - I know my finances, and by leveraging higher my asset base is double what it would be if I had been conservative, and I'm still happily plodding along.

But there's no right or wrong, each to their own.

 

[chilliaa]

Hi all,

I'm new to the forum and just purchased my first IP two months ago in Elizabeth Bay (Sydney). I borrowed at a 95% LVR with LMI capitalised, with net yield of 4.75% and an interest rate of 5%, it will most likely be positively geared after depreciation and tax. I also used my FHBG to reduce my deposit/equity and avoid stamp duty. With the left over money i have, i am looking into to buy another IP around the inner city. I would only be able to fund my next purchase if i can get another loan with an LVR of 95% and LMI capitalised.

Despite the banks reducing their max LVRs for new customers to 90%, my broker says he can get the 95% lend for me from my exisiting bank.

Do people think i'm overgearing? Is it common for investors to continually accumulate property on high LVRs without getting into too much trouble.

I'm only 22 and would expect my income to grow strongly over the next few years to cover interest costs for an expanding portfolio. Does anyone have any overgearing experiences or advice for me? I understand that gearing multiplies profits and losses, but im confident i can get enough capital growth in the assets i buy to make the numbers stack up.

Fuzz.

Difficult question to answer, but i look at it from this perspective:
*foreget depreciation benefits offseting your personal tax returns. Lets just look at the 'natural' figures. (this way we can estimate your ability to service the loans if you loose your job and have difficulty servicing the loans with no more tax benefits).

Your net yld is 4.75%.
Interest rate is 5% (now im assuming this is either a honey moon rate, or on a professional discount package of some kind).
Now if interest rates rise by 2% to 7% you would have a differential of 2.25%.
Can you 'afford that' and if you borrow futher will you be able to 'afford' the further $ amount in differentials. Forget about your job, im not sure how high paying it is, but assume you had to get a low paying job to make ends meet, deduct your essential spending and then calculate whether you can survive for a couple of years.

This basically determines your downside risk and these are always the type of calculations i do before progressing with any investment that uses debt.

 

[JIT]

I don't have a problem with high LVR's, I've bought 4 at 95%-97% LVR!

But I'm <30 y/o and have a secure income.

 

[BayView]

BayView & steveadl,

My view is that your profit/loss made is determined by the growth in equity that you put into investment (IRR on funds invested), regardless of how much the asset price appreciates or depreciates over time (sale profit/loss is only one component). With a higher LVR your risk of eating into your equity base is greater, than if you have lower LVR, because you are exposed to higher interest costs that are associated with a higher LVR.

Essentially, if your highly geared you need greater capital growth in the asset price to make a profit, but if you have low gearing your returns are more insulated from volatility in the asset price. This is exactly why those A-REITs with lower gearing are seen as much better stocks, because they can weather the falling asset values in the coming months and increased interest costs much better than those with higher gearing.

You guys are twisting the point here.

My whole context of "loss" is to do with after-sale cashflow. My point of view is to do with the risk of having a high level of borrowings (LVR) when there is a possibility of a forced sale.

It is purely a CASHFLOW scenario. The purchase price, or market value, or the I.R.R or whatever you want to look at is not what I'm talking about.

It's simply; I owe $X, I have to sell, I am left with $X. The difference is I have more after the sale than the debt, or less than the debt.

Hence, less dollars owed (low LVR) means you are safer from ending up with lots of debt and no house after a forced sale.

Some people say 95% LVR is ok - they haven't seen a huge loss yet and they are delusional that nothing can happen.

I've seen it happen.

But, do what you all want.

 

[Bradsdad]

well aware of this. but he bought the property 2 months ago and already has a net yield of 4.75%, implying it is rented. A no mention of it being a PPOR for 6 months.

Not jumping to conclusions, just raising a suspicion

Also the fact that your existing lender would (Ummmmm a lender using thought ) be aware that you applied for the FHOG (assuming you applied through them for it). If you need to use the rent on this property questions should arise as it's only 2 months old.

 

[Bradsdad]

You guys are twisting the point here.

My whole context of "loss" is to do with after-sale cashflow. My point of view is to do with the risk of having a high level of borrowings (LVR) when there is a possibility of a forced sale.

It is purely a CASHFLOW scenario. The purchase price, or market value, or the I.R.R or whatever you want to look at is not what I'm talking about.

It's simply; I owe $X, I have to sell, I am left with $X. The difference is I have more after the sale than the debt, or less than the debt.

Hence, less dollars owed (low LVR) means you are safer from ending up with lots of debt and no house after a forced sale.

Some people say 95% LVR is ok - they haven't seen a huge loss yet and they are delusional that nothing can happen.

I've seen it happen.
But, do what you all want.

First let me say that I'm not saying wether a high gearing is good or bad in this circumstance but like BV I have seen someone come a cropper.
I had a client back in my days of working for a major lender who accumulated 11 properties at 95% + LMI in just over 3 years. He kept using any available equity plus cash to get the next one. His biggest problem was that he was in IT and on a very good wicket. The IT bubble burst and his income dropped by 50% (was still on a good wage). All of a sudden repayments became a struggle and before he knew it he had to sell down drastically. By capping the LMI he was left with little if any change.

Sometimes smaller steps are required rather than attending a seminar and taking just the attractive bits from it.

 

[steveadl]

Some people say 95% LVR is ok - they haven't seen a huge loss yet and they are delusional that nothing can happen.

I've seen it happen.

But, do what you all want.

My point of view is influenced by the fact I have an iron clad (and increasing) income, which is not at risk. Which is why I always preface the high leverage argument with 'as long as you have a stable income' type of comments.

With stable income, assets decreasing in value - whilst sucky - will not have great effect other than to slow down expansion plans for a period.

 

[Piston Broke]

My view is that your profit/loss made is determined by the growth in equity that you put into investment (IRR on funds invested), regardless of how much the asset price appreciates or depreciates over time (sale profit/loss is only one component).

Considering someone else has the money you want to purchase with, maybe their view is a little more important.

im confident i can get enough capital growth in the assets i buy to make the numbers stack up.

So was everybody else...
It's good that your motivated, but too much motivation can be expensive.
Talk to your bankers calmly and don't make over the top claims about your self.
Listen carefully to what they say, there is much info between the lines.
The also want the business, and what policies may prevent them saying, they often hint at in different ways.

And btw allow 25% for expenses. It seems a reasonable deal and high LVRs are the only way to start, but if your strategy is to buy many IPs at >95% LVR then you could be heading for trouble (if you can get the finance).

 

[investor888]

Steveadl

fact I have an iron clad (and increasing) income, which is not at risk.

Nothing is iron clad. What happens (on a 95% LVR) if you have an injury, and can't work for 3mths, etc.

It probably people like you who take excessive risks, and then we see on ACA crying "ohh poor me" when something goes wrong and you loose.

Get rich quick, but don't come crying for sympathy if something goes wrong. Here is so often, with stupid Storm investors, property investors now in negative equity, etc.

 

[steveadl]

Steveadl

Nothing is iron clad. What happens (on a 95% LVR) if you have an injury, and can't work for 3mths, etc.

It probably people like you who take excessive risks, and then we see on ACA crying "ohh poor me" when something goes wrong and you loose.

Get rich quick, but don't come crying for sympathy if something goes wrong. Here is so often, with stupid Storm investors, property investors now in negative equity, etc.

Lol, you're a happy little camper aren't you! Sorry I don't watch that pathetic ACA drivel, so won't see me on there. But I am getting rich relatively quickly, thankyou for your concern.

And this will really make you love me - if I have an injury and am out for 3 months, I'll actually earn more than I normally do. My business will tick along as usual with my manager, and on top of that I'll also receive an insurance income equivilant to my current income for the period that I'm out of action (so in effect will make double what I normally do). I'm assuming of course you've heard of this thing called 'insurance'?

Sorry to burst your little bubble. Best not to judge people, just like I don't judge the young guy at the beginning of this thread starting out asking about high LVR's.

 

[contrary]

And this will really make you love me - if I have an injury and am out for 3 months, I'll actually earn more than I normally do.

gee, you have a lot of faith in income protection insurance. I supoose you would if you believed the broker. I've heard of more people not paid income protection insurance than paid.

Also, I'm not sure if it still applies, but if your income protection is more than a certain amount (50k/year), you are not covered by the FSA/ombudsman. I think income protection is actually quite different to say automobile insurance, where the process and outcome are relatively straightforward. Not quite as straighforward as you describe, particularly for high income policies.

 

[travelbug]

im confident i can get enough capital growth in the assets i buy to make the numbers stack up.

Fuzz.

Hi Fuzz.
Just wondering what makes you so confident about your Elizabeth Bay property when many are concerned (generally speaking).

I like Elizabeth Bay. I have one there myself (well Potts Point really) but the agents try to pass it off as Elizabeth Bay (sounds better). I've had it 15 months. +ive and increased equity already. I'm happy.

 

[steveadl]

gee, you have a lot of faith in income protection insurance. I supoose you would if you believed the broker. I've heard of more people not paid income protection insurance than paid.

Also, I'm not sure if it still applies, but if your income protection is more than a certain amount (50k/year), you are not covered by the FSA/ombudsman. I think income protection is actually quite different to say automobile insurance, where the process and outcome are relatively straightforward. Not quite as straighforward as you describe, particularly for high income policies.

Meh, it's a risk I'll take for the relatively small premium each year. As I said, my business revenue will continue to flow in regardless, so the previous posters pathetic response to me doesn't apply.

 

[travelbug]

Steveadl

Nothing is iron clad. What happens (on a 95% LVR) if you have an injury, and can't work for 3mths, etc.

It probably people like you who take excessive risks, and then we see on ACA crying "ohh poor me" when something goes wrong and you loose.

Get rich quick, but don't come crying for sympathy if something goes wrong. Here is so often, with stupid Storm investors, property investors now in negative equity, etc.

Why do people have to shoot others down all the time.

I guess it has to go on your outlook on life.
You thought the above.

I thought "lucky guy to have security. He must have an income stream that doesn't rely on him being hands on, ie a business or the like".
Or he could have had +ive geared properties that he's living off.
There are many ways you could have a "safe" income stream. Not everyone works for wages.

Tall Poppy syndrome I think. If they grow too tall someones always there to try to cut them down. Easier than trying to grow tall yourself I guess.

 

[investor888]

Nothing to do with tall poppy syndrome.

I'm just sick of hearing the stories everywhere of people 1) who want to get rich quick (overextend), and then find themselves in trouble, or 2) people who bought, wasted their money on luxuries, and then find themselves in trouble later.

Good on Steve for getting to where he is with high leverage. But it only needed one thing to go wrong in that time, and I'm sure he would have been one of the complainers. Maybe in the last large boom it made sense to have 95% LVR's because prices were doubling in 3yrs, etc. But the ballgame is different now, and I think the growth will be much smaller now, so 95% LVR's are a lot more risky in this period.

Had the share market gone up, I'm sure the Storm people would have gone on endlessly about what financial geniuses they are having leveraged to the hilt, and made a fortune. But the market when they other way, and any now it's everybodies fault but their own for such stupid high levereage on share.

Each to his own. Good on Steve for the financial genius he is, with his high LVR strategy )

 

[Propertunity]

IBut it only needed one thing to go wrong in that time, and I'm sure he would have been one of the complainers.

Look that is a big assumption. I, like Steve, am very highly geared - and more so in the beginning years BUT knowing Steve, neither he nor I would be "one of the complainers" I assure you. If things had gone badly for us - then we'd suck it up and blame ourselves, dust off our feet and get back in the game.

Maybe in the last large boom it made sense to have 95% LVR's because prices were doubling in 3yrs, etc.

You obviously do not understand the RE cycle if that is what you think. RE does double in the last couple of years of a 7 - 12 year cycle after an extended flat period.

But the ballgame is different now,

No it is not. It is the same as always. The SYD market for example has been flatish (up a bit, down a bit, sideways a bit) since 2003/4. Here we are 6 years later. This, if it behaves as it has for the last 140 years, this is the beginning of the upswing. This IMO is the time to be geared to the back teeth and to mitigate your risks as much as possible by not overpaying, doing DD, buying at or below the median, having income protection insurance in place etc.

and I think the growth will be much smaller now,

The market does not care what you (or I) think. The market is IMO primed to go. Auction clearance rates have been nearly 80% for a while now. 65% was what was normally considered to be a boom. We'll see - time will tell.

so 95% LVR's are a lot more risky in this period.

Rubbish! They are no more risky than at any other time - as long as your risk mitigation strategies are in place.

We obviously hold different views of the market

 

[investor888]

Like I said, each to his own. While I would love the property to boom again, I think you are delusional there. "this is the beginning of the upswing. This IMO is the time to be geared to the back teeth". " The market is IMO primed to go. "
Haha ) You don't work as a realestate agent do you??

But we'll come back in 12-18mths, and see who was right. Some are happy to be more conservative with the LVR, and pick up the scraps when people start getting into trouble in 12-18mths.
IMO, I think subprime 2.0 is a year away in the US (from early-mid 2010) - Alt-A and Option ARMS. Anything that happens in the US, impacts the rest of the world.

But delude yourself that we are heading into a boom, and 95% LVR's are a good idea currently. I can see a lot of pain with 95% LVR's currently.

Rubbing hands together!! Money to be made when greedy fools jump in.
http://www.somersoft.com/forums/images/icons/icon10.gif

 

[Token Funder]

Look that is a big assumption. I, like Steve, am very highly geared - and more so in the beginning years BUT knowing Steve, neither he nor I would be "one of the complainers" I assure you. If things had gone badly for us - then we'd suck it up and blame ourselves, dust off our feet and get back in the game.

Personal observation only but:

As someone who regularly deals with the failures, in my experience it is the gear/buy/equity release/gear/buy borrower that is least likely to "suck it up". Funnily enough, it is the ordinary OO that is least likely to to start screaming like a banshee and blame everyone else involved in their property journey rather than allow the words "personal accountability" cross their lips.

It has always struck me as similar to certain elements of the farm lobby north of the NSW border - a fiercely independent lot until someone threatens to take their subsidy away at which they all start to sound like shaggy Marxists.