Somersof Flawed strategy?

[Janfan]

Please help a confused wannabe.

I was browsing a thread yesterday about how to manage IP payments( can't remeber how to post links) that started me thinking about costs.

Anyway my take was that, sophisticated strategies aside ,using "somers" type approach ie median properties at median rent will cost money to hold. We can debate the range of costs but in essence if it costs money to hold properties how do
we ever become finiancially free unless its via cash flow positive
properties, which seem rare, and not in keeping with my understanding of how to go about things.

So back to Somers methods ,having just attended the latest Brisbane seminar I thought the scernarios may be helpful.

Average investsors salary 55k& 45K, property was 340K, rent 295/wk lots of figure on growth , costs etc but all pretty standard
bottom line117/wk holding costs.

jump to the retirement goal setting bit where the target was 7 properties to achieve 1ook income over 20years.
How is this achieved ? the cash flow section shows a growing poitive cash flow over the years. How is this possible when the details show 117/wk holding costs per property, which presumably will only get worse 'cos there is only so much taxable income to offset.


thanks in advance for any replies

Janfan

 

[Andrew]

Over the longer term, rents increase while the principle
owing on the loan is eroded in real terms due to
inflation.

If you pick the right property it's value will rise due to
rising demand and the loan reduces in real terms.

If you can buy a decent sort of property at the right
time in the cycle you can be confident of it doubling
in value over 10 years, rents should go up in proportion
to the property's rising value while an interest only
loan (say for 100% initially) is now only 50% of the
value of the property. Keep it for another 10 years
and the loan amount is just 25%.

If it's not positively geared after 10 years then you've
done something wrong.

I don't think that Jan's strategy is a get-rich-quick
scheme, more of a get-rich-slowly-but-surely.

andy

 

[Janfan]

Andrew,

thanks for your reply.

'pick the right property" , isn't that the point?

Jan's system is using about 5% yield which is not +ve
within 15Yr and certainly doesn't match the example used at the seminar, and would certainly get in the way of portfolio building

I used the seminar examples 'cos I consisder them relavant to my own area and situation. In Jans books(older data) she uses the example property 140k purchase and 180K/wk rent this is pretty nearly cash flow positive.

But this means that we need at LEAST 7% yield or the masterplan doesn't work. This is probably achievable for the
more experienced/ skilled investor but it is not mentioned at the seminar or any thers I have been to that use the 5% figure as
workable and easily achievable.

Janfan

 

[Bill.L]

Hi all,

Janfan, Even though I have not been to the Somers seminar, my understanding from the books is that an important ingredient in the recipe is the ongoing reduction of the debt level.

In Building Wealth, Jan uses the example of the couple who pay off their PPOR first, then continue to put in the same amount(ajusted for inflation), while continueing down the IP path. I can't quote the exact figures or page numbers as someone borrowed my copy.
Using the concept of paying down the loans(or even using offset accounts to save for greater deposits), plus the effect of inflation on rents and the ammount you put in, plus cap growth, then the recipe has worked over the last 30+ years.

Of course there is no guarantee that the same formula will work over the next 30 years, as of course conditions will be different, but I cannot see a better or safer investment philosophy around.

bye

 

[landlubber]

Janfan,
Seminars are no substitute for study.
Have you read Jans book "More Wealth from Residential Property"? From your questions it seems not .

Totally recommended .
Good luck.
LL

 

[Janfan]

Bill.L

Thanks for your response.

I don't claim to be an expert on Somers. I have read the books and now attended the seminar - don,t have the PIA software
maybe I should to answer the questions - or maybe somone who attended

Debt reduction is not mentioned.
IO only loans are used to minimize holding costs.
All monies are aimed at aquiring more property.

Using the seminar figures as I previously indicated 2 properties
have a holding cost of 810/mth falling to 410/month for the first 5years.

The seminar shows raising cash savings from year 1 which can't be correct.
if I am right this is rather exspensive, definitely not everybody's cup of tea
unless higher rentals are achieved which is not indicated or stressed.

I am harping on a bit cos as you know frm my last post on
OTP/new v established I am trying to find my way, and I am trying to keep my eye on the bigger picture.

I am not seeing the sort of rental returns that I had hoped for
in the new stuff the$ gap seem typical ie buy 330k rent
280-300/wk or 400k rent 350/wk.

so does that mean I have to look further afield. Seek out better returns?

or does that prove that prices are too expensive.

Janfan

 

[Janfan]

Landlubber,

Some seminars are good value for money.
you may need to be a little more to the pont with your posting.

As it happens I have just picked up a copy of more wealth

a quick flip inidicates an updated version of earlier books.

Though I note the figures are based on a 160K property at 200/wk rent. Note the seminar is more recent and uses 340k prop
at 290/wk rent . IMHO that is in line with Brisbane median figures and seems to tie in with what I am trying to say.

holding costs for median property at 5% yield are too expensive

finding better than 5% yield takes skill and experience

Janfan

 

[landlubber]

Hi Jan fan,
I agree entirely with your observation. Some seminars are good value, and they can provide a positive "jolt" that books cannot.
Yes, Jan's "More Wealth..." is a re-vamp of earlier books, but still a very good source of information.
In this game we will always be faced, in general,with the choice of "high growth" or "high yield" ...as you would be fully aware from this forum. It's very rare to get both. (Ipswich two/three years ago did it .) It's normally found in the smaller pockets and in regional centres, but you do have to "dig" IMHO.
Peace .
LL

 

[Les]

G'day Janfan,

I suspect the seminar has simply been updated to fit the date.

When I "kicked off" with IP's the returns were not hard to find at 6 - 8% (e.g. in 2000, price 140k, rent $200 pw). NOW, that same property has estimated value of $250k, and rent is still only $220 pw. Thus, as price has soared, the yield has dropped from 7.4% to 4.6% !!! (Remember a recent poll which asked "would we buy the same properties today?") In my case, the answer is NO in all cases !!!

Now, that might just affirm your comment re "are the properties valued too highly?" And, I'd have to say, if you are wanting a yield of 7%, you might have to keep looking!!! Jan also said in her seminars that there is an inverse relationship between yield and growth. i.e. As Capital Growth kicks in, yield starts dropping (these two are in lock-step and CAN'T be separated).

Anyway, back to what seems to be your primary question

We can debate the range of costs but in essence if it costs money to hold properties how do we ever become finiancially free unless its via cash flow positive
properties

In my recollection, Jan advocates buying properties as/when you can afford to hold them. I guess it would follow, that you will likely buy less of these in "low yield/high growth" times, and more in "high yield/low growth" times. (sort of dollar cost averaging for IP's )

When nearing retirement, Jan suggests selling a few, using the growth gained to pay down the outstanding mortgages on the remaining IP's (certainly "do-able" if held for long periods). That then swings your remaining IP's into "severely +ve cashflow" to fund your retirement.

That's as I remember it, Janfan. For +ve vs -ve discussions, use Search (I'm sure we've been that way before - once or twice...)

Regards,

 

[Janfan]

Landlubber


seems like we generally agree

Les , thanks for the patient reply.

I guess I was a little suprised at the holding costs( and a little annoyed that the seminar figures 1) weren't accurate 2) more importantly didn 't stress the risks we have talked about)

I suppose most people would say tough thats life - it is not as easy as it looks or seems

Luckily I have enough cash flow to fund some IP's even though
haven't yet got a good enough grip on the basics.
But in keeping with my reading I am trying to keep an eye on the bigger picture.

so I could

1) accept large holding costs from median type approach
2) keep looking for better returns , though I feel that would keep me out of the market altogether
3) look atr the reno path - although I don't think this suits my
personality or lifestyles at the moment
4) keep learning

but get out of the "gunna" stage I currently find myself in.



Janfan

 

[voodoo]

Hi janfan,

When I started out I purchased the PIA software and everytime I saw a propety I was interested in I would put in the figures.
I purchased an IP just over 12mths ago and have just recieved my tax return and must say that the software was very accurate.

I highly recommend the PIA and I won't purchase without it..

I must agree with Les. I would not purchase the IP today, that I did 12mths ago, as the returns are not there now because of the great CG it has made.

e.g
12mths ago, purchase 165k, rental return $200wk
today - 250k, rental return $220wk

These returns are not to bad, but in my situation I dont like to be to much out of pocket as I have a limited cash flow at the moment.

I am still looking for more IP's but I cannot find good returns at the moment, so I will sit until I find the right property.

cheers,

 

[Bushy]

Well done Janfan,
It sounds like you are doing something that a lot of newbe investors aren't- you are doing your sums. It takes all emotion out of the game .As mentioned earlier rents do increase but I think the best thing to do is to purchase a property which compliments your income when you are in a position to buy. ie

(A) If you are in a high tax bracket you can probably afford a -ve cashflow as long as the growth of the property exceeds your losses
(B)If you have a minimal wage you might try for something which is neutral or +ve with less growth, your rents will increase and then you will be in a position to buy a property like (A) above.

The end result will be a portfolio of properties that look after themselves with little impact on your current income.You might start out with type (A) and then(B) or the other way around.
Regards Bushy

 

[Aceyducey]

Janfan,

Bear in mind that if the Somersoft figures don't work for you, perhaps you need to look at other approaches to property investment.

Horses for courses....

Cheers,

Aceyducey

 

[Peter_Tersteeg]

Here's a link to another post where I describe how a conservitive investment strategy could give you a retirement income of $42k, buying a total of 4 IPs and your PPOR, then waiting 30 years until retirement. All figures are in todays money, so with inflation the $42k may well be $100k in 30 years.

http://www.somersoft.com/forums/showthread.php?s=&postid=72963#post72963

This example simplifes the situation, but given that most of us want to be far more active than what I've described, a comfortable retirement income should be easily acheiveable through property investment.

 

[Bill.L]

Hi all,

Janfan, It is interesting how two people can read the same book and come away with a completely different picture of what was said.
I'll have another go to explain my understanding. The example given in the book More Wealth(I even got the title wrong before because I don't have the book in front of me), uses a young couple who purchase their PPOR and accelerate the payments. After paying off the home they then embark on the IP trail. However instead of just letting the rent pay the expenses, they continue to put into the deal the same % of their income as when they paid off the PPOR. They then have 3 sources funding the IP, rent, tax deductions and their input. After time with growth in rent AND their input, there is enough equity to continue the process(add another IP) and so on.
On the numbers that you have produced, it would seem that the process will be too slow for your liking. However it all comes back to what you can put into the deal. If you cannot save while funding your IP then you may have to look for another strategy.

Too many people have taken a get rich(whatever that means) slow strategy and turned it into a get rich quick strategy. They then wonder why the figures don't add up.
The future can never be predicted with any accuracy, but one thing that I will guarantee you is that in 10 years time the current levels/relationship between interest rates, yields, cap growth and inflation will be different to today.

bye

 

[Kevmeister]

Janfan:

If you employ Jan's method for investing in residential property you may well have to fund a shortfall since rent may not cover interest+expenses. This of course depends on what you buy.

I only know Melbourne, and at the moment is it extremely difficult to find a positively geared investment in the Melbourne metro area, and to a lesser extent even a positive cashflow property.

If you wish to subscribe to Steve Navra's approach for when to buy, do a search on "Rental Reality", which is effectively a test to preclude you from buying when prices are too far ahead of their rental return. Steve's "Rental Reality" equation suggests that Melbourne is too overpriced at present (or rents are too low, amounting to the same thing).

But back to the Somer's technique. Andrew has already noted that after 5-9 years or so the property in question will become positively geared as the rent catches up. More importantly, the property value has hopefully increased substantially.

The whole idea of using property as an investment vehicle is the amount of leverage it offers you. If you can buy a $300K house today, rent it for say $250 per week, you may well have a shortfall of $100 per week (after allowing for the tax benefits of negative gearing). That's $5200 per year "out of pocket".

*But* (and it is a *but*) if you can get 8% growth on that $300K property, your property value has grown by $24K. $24K of growth kind of makes the $5K holding cost look not too bad.

The loan never increases but the value of the property does. At 8% growth, say, in five years your property is worth $440K but you still have a $300K loan. There's $140K of equity in that property that belongs to you. Of course, you've paid out $26K or so to gain the $140K.

If you sell, you won't realise the entire $140K because you'll have to take into account the purchasing costs (mainly stamp duty) and the selling costs (mainly agent's commissions), and you will presumably have to pay CGT (maximum of 24% or so allowing for the 50% CGT discount). But by this time, that $140K equity is sufficient to gain an equity loan of say $110K (80% LVR) to buy the next property (the median of which has now increased to $440K). This is another shortfall to fund, so you can see that you need very deep pockets to keep this up for anything but a very small number of properties.

Also, after 5 years the rent may have increased at the rate of inflation (3% say), so the original rent of $250/week is now $290 per week. Still doesn't cover the interest, but it has reduced the weekly holding cost.

At the end of the day, investors who go for negatively geared property are looking for capital growth in order to make their money. In areas of extreme growth the rental income almost becomes inconsequential. Imagine that $300K property if it achieved 25% growth (not that uncommon during our "boom"). A $60K increase in equity - the rent is obviously "cream" but you would still have made money even if you didn't have a tenant paying *any* rent. But with anything negatively geared, never forgot that you are buying in anticipation of something happening and that is obviously riskier - you are paying out money today in anticipation of achieving growth, and that growth represents your future "profit".

People buying positively geared properties are usually accepting the likelihood of reduced growth (if any) but the yield from their property is sufficient to cover the expenses, with a small surplus providing their additional income. It's a classic case of "a bird in the hand is worth two in the bush".

Which strategy you ultimately choose depends on your risk tolerance, your income, job stability, all kinds of things.