Planning for CIP No.1

[younguns]

Evening all.

It seems like forever since we first joined SS and started learning from all the amazingly generous people who share their stories and advice here.

For the last 12 months we have been bogged down purchasing our PPOR and trying to finish the reno we planned. To cut a long story short, the bank came up very short with the funds we needed (after we had already gutted the house i might add!) so all our spare cash has been going into our house instead of our CIP deposit fund.

We can finally see the light at the end of the tunnel though and are hoping to purchase CIP no.1 in 2013

I have a couple of finance questions I would really appreciate some advice/feedback on to assist with our planning.

In an ideal world we would LOVE to break the magic $1mil mark to maximise returns and hopefully secure a quality tenant and minimise our risk.

Are banks still asking for a 30% deposit plus costs when it comes to a commercial property purchases?

We plan to refinance our residential IPs to fund as much of the deposit as we can.

We have been advised we will only be able to gear up to 90%. Is this still the case if we are refinancing to purchase an income producing asset like a CIP? Are banks going back up to 95% again?

The reason I ask is because our current RIP debt is $1,966,000, with our portfolio estimated at $2,330,000.

If we can only leverage up to 90% then $130K will not go very far towards a 30% deposit on a $1Mil CIP!

If we can't get our hands on any more cash from the portfolio should we a)buy a cheaper entry level CIP asap or b) save the extra cash we need to get a better quality CIP asset and delay purchasing our first CIP by 1 to 2 years?

We are really keen to get an income producing asset asap to take the pressure of my husband's income but want to do it the right way.

Looking forward to your comments.

Cheers
younguns

 

[Aaron_C]

Getting 95% LVR especially on what is essentially a cash-out is next to impossible these days unless your serviceability is just through the roof.

As for commercial property LVRs - the maximum you could ever go is 75% LVR and that's assuming that the security is AAA and you are a strong client. But it is very much a case-by-base basis.

 

[Belbo]

Why not consider another RIP that gives you CIP-like returns on a 90% LVR? Of course this means a mining-region town, but there are small one horse towns and then there are very big service towns. Yes, you've still got resi tenant constant bulldust to handle, but in CIPs you've got major vacancy risk these days too, and the former in time could still be a stepping stone to the latter. Just a thought.

 

[Dazz]

Hi younguns,

Think we've met before - not sure of your tag - if so, hello !!

I reckon Aaron is pretty much on the money there - it's all decided on a case-by-case basis.

The very thing that you wish to retract from is the very thing the Banks are attracted to the most - your husbands wage. Don't mention to them that he wants to retire soon.....they'll run a mile.

Rough numbers for what I'm seeing out there at the mo' are cash outs on ressy stuff up to 80% and deposits for CIPs typically 35% plus costs....although the Banks would like to see more than 35% usually, the more hurt money you have to stump up the better they like it.

I see your LVR on the ressy stuff is just over 84%, so you don't have much to play with.....practically nothing at all. That reno you just paid for may turn out to be a very expensive one.....you'll only know how expensive 10 years hence.

You sound as keen as mustard, but your non-fear of debt in a current Banking climate like this is brave indeed. If I was a credit decision maker in a Bank, I'd probably deny your application with those numbers you have.

My recommendation would be to start off small. You won't get a big flash place, and you won't get a big flash Tenant, but what you will get is the entire formal process of financing and Lease wording, which will be invaluable to your knowledge toolkit when you tackle something bigger.

You cannot read about this stuff, no-one has ever written a book about the nitty gritty of buying CIPs.....certainly not to the level of detail needed to give newbies any level of comfort or guidance.

 

[younguns]

Thanks for the quick response all.

Aaron, we do have good servicability (hubby earns well over $300K a year in a FIFO role and I'm also about to return to work). I guess we will find out how much (or little) that is worth when we refinance after our reno is complete!

Belbo, we have not ruled out buying in a mining town to generate some extra cashflow. We are just a little nervous about the risks involved. I understand the risk of vacancy with CIP, but we would really only look at buying one if it had a solid lease (5 years+) and had good potential for growth. The idea of paying top $ for a mining town property and if things don't go well being left with a big mortgage and no income really scares me.

Dazz, we have met before It has been a while I know! Things haven't quite gone to plan with the new PPOR. We have learned some very valuable lessons!

You are definitely right when you say we are keen as mustard. It is probably our biggest asset while being our biggest liability at the same time! We are trying to sit down and set some new goals at the moment. As we really don't have a plan we are working to right now. We are trying to work our way backwards from where we want to be (replacing my husbands income with income generated from our assets) and it is not an easy task trying to forecast what we can buy and when and for how much etc etc.

I suppose our first step is to finally finish our renovations. Then refinance and get as much money out as possible and then see what options there are available to us. Starting small sounds like a good idea to me

Thanks again

 

[matto_]

Watching with interest. In similar position, would like to find some CF+ to add to our port.

 

[younguns]

Good to know we are not the only ones out there in our position matto. I will make sure I post what we decide to do once we have managed to refinance

 

[Trogdor]

I think you are better served by waiting until you have lower gearing and also a material cash buffer before you buy your CIP (sorry, I don't think you elaborated on cash buffers).

If you are buying a $1m CIP, I would suggest you would need as a mininum:

- 250 - 300k deposit plus stamps and legals (Adelaide bank, for example, lends to 75% for CIPs in metro areas). So you are looking at 300 - 350k all in deposit.

- Cash buffer, I think you'd be nuts unless you had 100k of cash or cash like (i.e. unencumbered blue chip shares) buffer buying a CIP in that price range (unless perhaps you had a national tenant and significant security).

We bought our first CIP in end of 2009, and second CIP early 2011. Almost identical CIP's (actually neighbouring properties).

First one has not had a day of vacancy, though the original tenant did not exercise option. During the period between notifying and having to vacate another tenant bought the fitout, and moved right in. Not a day lost of rent. Rent generally paid on time for the last 2.5 years or if late only a few days. Very happy here.

The second CIP, well that is a different story. We bought it vacant confident we could fill it easily. We did, it took about 2 months. No problem. You normally offer up 2 months rent free in this market (for a 5 X 5 lease on this occasion). And one months' agent fees. So thats 5 months of no rent there. The pricks of tenants defaulted 2 or so monhts in on rent. Not because they didnt have money - but because the two business partners fell out with each other - and nobody wanted to cover the other in start up mode. Idiots. Kicked them out straight away. Took 2.5 months to relet. Another 2 months of incentives plus 1 month agents fees. Thats 5.5 months this time around.

So in total, in a year of ownership of CIP #2, have had 10 out of 12 months without rent. Bad luck, sure - but it happens. And nothing you can do - as you can see we've had no problems reletting in a short period both CIP's (0 downtime for one, and 2 and 2.5 months each time for the other). But you can't control defaulting tenants. They dont just stop paying if they go broke, they also play chicken with you around suing them. Keep in mind at this end of the market security deposits are low - and often managing agents will be reluctant to hand these over to you for anything more than arrears (i.e. for general damages) until you get your lawyer involved.

As of next month will be back on full cashflow for both.

The defaulting tenants have real property in their own names (my solicitor has done title searches and they have given personal g'tees) and I'm now suing them. You have make a call in these cases if they have assets and if you will pursue. No other way to get losses out of them. But thats an aside - the moral of the story is I have not lost a wink of sleep - as our income from jobs and other investments supports this level of vacancy without a problem and we have large cash buffers. Even with one CIP not earning we still save lots every month.

How would you feel if your tenant defaulted and you had a $1m CIP loan at 8%+? And on one salary too it must be harder for you guys if you have a job loss.

Food for thought.

Not saying dont go for it (in fact the opposite) - just saying make sure you have planned for the downside and can withstand it. I don't think you can at the present point in time.

 

[HiEquity]

Excellent post Trogdor. It would certainly be interesting to know whether you have any success in pursuing those personal guarantees. Younguns has received some excellent advice in this thread - there is nothing I can really add to it.

 

[Trogdor]

Thanks HiEquity.

Will certainly be interesting. Am doing it as much as a learning experience as anything.

Am quitely confident. We shall see.

 

[Rolf Latham]

So in total, in a year of ownership of CIP #2, have had 10 out of 12 months without rent. Bad luck, sure - but it happens.

be thankful u arent on a loan product with an annual review, even though u might have tons of "external serviceability" some lenders dont like it when their prime security has little rent, and will thus "force" a write down of the value of the property .


ta
rol'f

 

[younguns]

Hi Trogdor. Thank you so much for sharing your story and your advice. I'm going to show this to my husband

We have always been so keen to rush into things and just 'have a go'. But as we have taken on more debt over the last few years it has become quite clear to me the importance of a buffer. We really have not had much of one for quite some time and it is something I often think about.

We always thought we were young and just wanted to purchase as much as we could as quickly as we could. But it has become very clear to me recently that everything does not always go to plan and you need to plan for the worst.

Your story illustrates really well how things don't always go to plan and you would be very right when you say we would not be able to afford to hold a vacant $1mil property for a prolonged period of time at this stage. Unless we see significant growth in our 2 perth properties over the next 12 months (not likley!) I think we will hold off any new purchases until we have built a good cash buffer up again.

Do you mind me asking how you managed to fund your first commercial property purchase? And it is very exciting to see you were able to buy another one so soon after your first. Was this using equity from your first CIP or other means? The reason I ask is because my hubby would love to aquire 3 $1mil+ properties over the next 8 years to eventually replace his income. It seems like you are well on your way to achieving this...

Thanks again

 

[younguns]

Not fun!

be thankful u arent on a loan product with an annual review, even though u might have tons of "external serviceability" some lenders dont like it when their prime security has little rent, and will thus "force" a write down of the value of the property .


ta
rol'f

I didn't realise lenders could do that! Something else to keep in mind ...
Thanks Rolf

 

[Aaron_C]

Fantastic post Trogdor. Do you mind telling us which industry your CIP tenants are in? You say deposit bonds are pretty low in that industry so I am curious which one you are referring to.

 

[Trogdor]

Rolf - agree that was through good design rather than good luck. I purposefully ed for a "no review" product - hence Adelaide Bank. Their DSCR cals for servicability capture external income also, and have no review clauses. On the downside you pay probably 0.5% or so more (from best guess) for this.

Young - Depoisit was from borrowing back up to 80% for resi IPs / PPOR and also savings. Melb had a good growth spurt in 2009/10 and also we save quite a lot (sadly probably more through saving than through asset growth). They also are not the world's most expensive CIPs (650K and 675K respectively). Probably the only thing I'd have done differently is parked CIP2 purchase for a couple of years and gone a $1.5m+ instead, but now we're not buying anything for prob 3 or 4 years and then will be in a position to buy a biggie on sensible gearing. We also balance with shares (both in and out of SMSF).

Aaron - I've had quite a few different industries in there. 1 x cafe, 2 x fashion / retail, 1 x Real estate agent. Not sure if you or other Aaron posted the mixed use WA Dev - but the CIPs are similar to that sort of thing (i.e. the ground level in a small mixed use low rise, with two levels of resi above). Right next to the beach. That sort of thing.

 

[Aaron_C]

Thanks for that reply Trogdor, I appreciate you taking time out to share. I can't wait to take my first step into CIP but my money is already tied up in development and I don't want to leave myself exposed if things turn to ****. My purchase will hopefully be in the $5m+ space to make it a worthwhile purchase as I find anything below that is just asking ridiculous prices.

 

[HiEquity]

Thanks for that reply Trogdor, I appreciate you taking time out to share. I can't wait to take my first step into CIP but my money is already tied up in development and I don't want to leave myself exposed if things turn to ****. My purchase will hopefully be in the $5m+ space to make it a worthwhile purchase as I find anything below that is just asking ridiculous prices.

Just wondering whether the equity for this would come as part of a consortium or this is something you can do on your own? It's just that when I consider the issues associated with consortiums the smaller properties suddenly look more attractive after all... and there are still a few properties around with decent pricing below the $5m level.

 

[Aaron_C]

Just wondering whether the equity for this would come as part of a consortium or this is something you can do on your own? It's just that when I consider the issues associated with consortiums the smaller properties suddenly look more attractive after all... and there are still a few properties around with decent pricing below the $5m level.

It would definitely come on my own. Using Trogdor's buffer figures as a guide I would need about 30% deposit + 5% stamp duty + 1 year rental buffer @ 7% = 42% so I would need $2m approx to fund that purchase. Not many people can come up with that kind of money which is why I aim for the higher end of the market - especially with subdivision potential to unlock value with lower cap rates as the pieces become smaller.

 

[Trogdor]

It would definitely come on my own. Using Trogdor's buffer figures as a guide I would need about 30% deposit + 5% stamp duty + 1 year rental buffer @ 7% = 42% so I would need $2m approx to fund that purchase. Not many people can come up with that kind of money which is why I aim for the higher end of the market - especially with subdivision potential to unlock value with lower cap rates as the pieces become smaller.

What sort of CIP are you looking at in that price range Aaron? Office / Industrial / Retail / other?

If you can afford it the bigger the better, definitely agree. Much better class of tenant.

 

[Trogdor]

Aaron, one more question - noticed from your signature you are MB.

What is the lowest CIP loan rate you can get hold of now without periodic reviews?

At 8.2% fixed with ADL now (3 yr fixed) from a 75% LVR, but wondering if you tip in capital to get to say <60% or < 50% LVR if you can get materially better rates.

Big difference to the c. 6% resi rates (variable) these days....