Strategy in today's market

[inspire]

Hi all,

I've spent the past couple of weeks reading through Somersoft, visiting REAs, inspecting properties, talking to mortgage brokers (thanks Medine!)... Now I thought I had a reasonable plan to begin with but I'd like to hear your opinions.

I'm currently 25, in a relatively high income and stable job, earning about $75k pa gross (which will probably go up to about 90k next year). I currently "own" my PPOR ($230k mortgage with approx $270k in the offset). I'm looking to hold onto whatever I buy for at least 10-15 years. I've worked out I could afford to have about $400/w invested without any significant impact to my lifestyle (I've been setting that amount aside for the past couple of weeks)

I started off investigating 2br flats in the South Yarra/Toorak/Malvern areas (got as far out as Camberwell and Hawthorn East) in the $300k region, hoping to rent out for about $270-$280pw (about 4.6% yield). I've been using Peter Noarke's spreadsheet to crunch the numbers and I could probably afford 3 of these sorts of properties, based on cash flow, if I space out the purchases over a couple of years.

An alternative I was considering was to purchase a 2 or 3br townhouse in one of these areas (cost ~$600k), which would return probably a slightly lower yield (probably only about $470pw rent, 4% yield).

The spreadsheet has the apartments going cash flow positive in about 15 years or so, whereas the townhouse would probably take closer to 25 years...

I guess the issues I'm facing and the questions I have are:
- Would it be better to buy a number of smaller, higher yielding (but still CF-) properties or one larger, more expensive one?
- I'm relatively time poor (I work 1 in 3 weekends) so it'd be difficult to attend auctions, inspections, etc. In fact the only reason I've had time these few weeks is that people have asked to swap shifts etc. with me.
- OR... should I be looking elsewhere for investment opportunities? What does everyone think about the inner eastern suburbs of Melbourne in terms of where it is in the property cycle?

Thanks everyone in advance for any thoughts you might have.

 

[WillG]

Based on your age (25) and income you are probably interested in growth.

My only advice is to "keep it simple" and do your due diligence.

I reckon you should buy small for your first IP and learn from that. Doing this will give you more options for your 2nd & 3rd.

Your circumstances will probably change in the next 5 to 10 years (family, children, travel & job), so flexibility will be important.

As your investing knowledge increases with practical experience, your goals will probably change and you will probably start looking at different deals and areas.


Remember that the most important thing is TAKING ACTION !

 

[inspire]

Thanks for your reply WillG.

How does everyone determine whether a property is worth buying? I've just been using the spreadsheet, being analytical about everything - determining the per week cost of the investment and the time it takes for me to recoup the investment.

What sort of numbers should I be aiming for? They sometimes seem to have little bearing on reality? I mean if I limit myself to the areas I mentioned before, it seems that going small would be the way to go (better cash flow, similar growth prospects), yet it seems intuitive to me that the bigger the risk you take (by investing in one $600k property vs. 2 or 3 $250-300k properties) the higher the return should be?

Justin

 

[WillG]

> What sort of numbers should I be aiming for ? <

Good question. This will depend on your goals and the timeframe you allow to achieve them.

For example, if your goal is to get a net worth of $2mil in 5 years then you should probably focus more properties that have the necessary capital growth than great cashflow.

If your goal is to buy 20 properties in 5 years then will probably have to focus on IP's with good cashflow otherwise you may may run into serviceability problems.

Having said all of that, I opt for a mixed portfolio with some IP's that generate good cashflow and other IP's that generate good cap growth

 

[MJK]

Inspire,

You have a relatively high income so I would not discount the value of buying newer property for depreciation benifits to increse those yeilds a bit.

MJK

 

[grubar30]

The spreadsheet has the apartments going cash flow positive in about 15 years or so, whereas the townhouse would probably take closer to 25 years...

Hi inspire,

You can do better than this....15-25 years before you stop reaching in your pocket to cover the shortfall?....who put that into your head?

My number one piece of advice is searching for better yielding properties....for example, you mentioned $300K property returning $270-$280pw...no way, don’t do it.....your money can work better for you....5.5-6% yields minimum, are what you want...you can get these in blue-chip suburbs too, so don’t worry about that…from what I'm reading, your strategy is long-term buy and hold, waiting for the big pay-day during the next boom...that pay-day will be much bigger if you can hold onto more properties, and at 4.6% yield, you'll it the serviceability wall a little prematurely....yes, I know this sounds like stating obvious, but that 15-25 years caught my eye as a mentality you don’t want to get into.

George “leverage till you drop” Grubar

 

[The Y-man]

- Would it be better to buy a number of smaller, higher yielding (but still CF-) properties or one larger, more expensive one?
.

It can come down to your risk tolerance and capacity to support.

1. vacancy
2. liquidity
3. Rental market

Cheers,

The Y-man

 

[The Y-man]

An alternative I was considering was to purchase a 2 or 3br townhouse in one of these areas (cost ~$600k), which would return probably a slightly lower yield (probably only about $470pw rent, 4% yield).
.

Any reason why you'd go townhouse in these areas? At that sort of price, you are going into a full blown period home territory....

http://www.realestate.com.au/cgi-bi...=&fmt=&header=&c=66827013&s=vic&tm=1164181404

While the returns might be a bit ordinary at present, there should be quite a good scope for CG (especially since we are back to 2003 prices)


Cheers,

The Y-man

 

[inspire]

Thank you everyone for your replies. The advice has been extremely helpful!

As I've mentioned my initial strategy is to look for places in blue chip Melbourne suburbs for good rental yields -- I'm actually going to put in offers on a few (after missing out on one last week that I'm kicking myself for)...

My budget currently allows me to buy an unrenovated 2br flat built in the 60s and 70s. What sort of things should I be looking at, and what should I be watching out for?

Another thing regarding figures - what sort of benchmarks should I be looking for? Grubar30 suggests 5.5-6% yield (I assume that for those sorts of yields I would be looking in the lower end of the market - the 1 and 2br apartments?). Is there some guide to when a property should eventually become CF+?

These are some specific figures of two places I am looking at, both in the Toorak/South Yarra/Prahran region.

- 2br unrenovated apartment, block of 16, set right behind a train line. No carpark. Asking $255k. A renovated flat in the block next door is asking $270pw rent (5.5% yield). Holding cost is about $76pw after taxes.

- another 2br unrenovated in a block of 27, top floor. On a main street. One car space on title. Asking $280k, lease in place for $290pw until August 5.3% yield (currently the tenants have a bed set up in the living room!). Holding cost is $82pw after tax.

I'm somewhat directing my questions at the Y-man, mostly because I seem to have a similar approach to investing to him, but are these figures typical of what I can expect in the area? If I assume 1% growth over CPI, the net present value of these places becomes 0 after about 4 years, and they both become CF+ in the 15-18 year range (assuming 95% LVR)

Thanks again for your help!

(also, if I am going to put in offers they are going to be about 10% below what they're asking for...)

 

[JIT]

(also, if I am going to put in offers they are going to be about 10% below what they're asking for...)

Work out what the property's value is by yourself first, then make an offer, don't rely on the quoted 'asking price' to guide your offer - this is totally unreliable, and I feel it is not the best approach, but many people still seem to do this?

GSJ

 

[The Y-man]

I'm somewhat directing my questions at the Y-man, mostly because I seem to have a similar approach to investing to him, but are these figures typical of what I can expect in the area? If I assume 1% growth over CPI, the net present value of these places becomes 0 after about 4 years, and they both become CF+ in the 15-18 year range (assuming 95% LVR)

Thanks again for your help!

(also, if I am going to put in offers they are going to be about 10% below what they're asking for...)

Our 2BR apartment in Prahran is valued at $280k, and gets about $250pw in rent (you might get a bit more now).

Car spaces are very important in the area.

I must say I have never calaculated at cf+ date, as I intend to keep it as CF- as possible until I sell it.... i.e. equity is drawn down as soon as I get even a sniff of captial growth....

Cheers,

The Y-man

 

[tubs]

Hi there

I'd be looking at houses, not apartments personally. If you can take a hit of $400pw then you can clearly go negative, so I'd be looking at the inner suburbs of Melb and Bris (not CBD) which have high cg prospects. Residex sell reports of these suburbs, and estimate growth over the next 5 and 8 years pa.

Tubs

 

[hkr]

Grubar,

I am finding it pretty difficult to get 5% yield in blue chip suburbs...what type of properties(or strategies) are you looking at to get this return...

 

[alwayscurious]

5% return.

A couple of quick searches in Brisbane show some that fit that criteria..

Example 1.
block of land 190K. Build house ~ 175K. Costs approx 15 - 17k on top.
Time to finish ~ 6mths
Rent current on similar ~ 350/wk (conservative)
Rent when built ~ 380 /wk (based on current rent growth, over next six months).

That's nearly 5% and it is in a great growth suburb in Bris. (Victoria Pt

Example 2.
Purchase price $259K (older house, Deagon, Brisbane)
Projected rent = 270/wk after clean up. (under 5k spend).
That's approx 5% gross return. Net after tax is actually lower than Example 1 due to nil depreciation aspects.
Growth prospects not quite as good as 1, but.. OK

 

[TheAnalyst]

Inspire, from your posts, I find you are very knowledgable on property investment. Maybe you got from the books?

 

[inspire]

Again, thanks everyone for your replies.

Essentially everything I've learned is from reading the forums... I've spent the last couple of months trying to absorb all the knowledge I can and I think its time now to put some of the theory into practice!

I've had a couple of setbacks (getting offers knocked back as they were too low, many weekends inspecting of properties recommended by agents that were out of my price range/made poor investment choices/about to fall apart, etc) but I'm hoping to start my portfolio in the next couple of weeks.

I've been plugging numbers away into the spreadsheet, running scenarios. Could anybody please comment on the below:

Assumptions:
I know I can afford to invest about $20,000 pa - I've been putting $400pw aside from my salary, living below my means etc.
No immediate plans to start family etc (maybe when I've finished my training in about 8 years)
Interest rates will remain steady the next 5 years (or I can fix my interest rates for the next 5 years)

If I find and buy properties in blue chip suburbs with average of 5% yield and about 1% holding costs (body corporate/council/water/insurance/contingency for vacancies etc), at a 95% LVR this means that I can hold about $1million in property. (of course the banks might not see it that way and it might take a couple of years to work my way there)....

I've calculated that with an average growth of 1% pa, I would have equity of $266k after 5 years, and holding costs of ~$144k, for a total (for lack of a better term) gain in "net worth" of about $122k..

If yields were closer to 4%, then holding costs total $199k, for a total gain of $67k.

I get the feeling that I'm missing something here!

As long as there's positive growth (even 0.25% above CPI), and even at yields of 4%, the annualised return is on the order of 5% (okay, at that point it's probably worth just sticking the money in ING)

I'm not considering the opportunity cost of investing in better performing assets (or even a straight savings account) but it seems that if you can afford to service the negative gearing (and you have the tax benefits), that eventually things turn around...

Risks are of course related to negative growth in the property market and interest rate rises (although this can be offset a little bit by fixing the rate). Also risks include prolonged periods of vacancy, unexpected repairs, rental yields for not remaining at 5%.

Does this plan seem sound to everyone?

 

[Peter Parker]

Does this plan seem sound to everyone?

Sounds OK, and it should work if:

a. House prices rise by CPI
b. Rents rise by CPI
c. Your wage rises by CPI (and therefore also your savings assuming a fixed %)
d. Debt stays the same and interest is stable

a & b means that the property will eventually become CF+, so you can buy more, assisted by the increased income from c. and declining repayments (as a proportion) from d.

A cheapish IP (yielding 5%) recovers almost half its costs from rent. If you're on a good income, you might be able to get another 2 or 3% back from tax.

So this leaves about 3% of the portfolio value you need to put in each year. If property rises by CPI (approx 3%) you will 'break even' initially but be ahead in later years as the amount of increase necessary falls to 2% then 1%.

If you can save $20k pa and this is your 3% then it sounds as if you can afford a portfolio of about $600k almost immediately (say in the first year or two). This is 3 x $200k IPs or 4 x $150k IPs. Then with bits of equity and improved cashflow it might be possible to buy one more every couple of years or so.

You will eventually run out of tax deductions, but this will be partially offset by properties recovering more of their costs (eg 60% not 50%). To help, a switch from lower yielding/high depreciation (new) to higher yielding/low depreciation (old) could help.

Get rich gurus base their figures on 7-10% capital growth each year. But if you can devise a strategy that just needs 3% growth each year (ie CPI) to 'break even', then I think this is safer (70% of years might have capital growth >3% but only 30% of years capital growth >10%).

Peter

 

[sue78]

Thank you everyone for your replies. The advice has been extremely helpful!

As I've mentioned my initial strategy is to look for places in blue chip Melbourne suburbs for good rental yields -- I'm actually going to put in offers on a few (after missing out on one last week that I'm kicking myself for)...

But that's not a good rental yield. If your aim is good rental yields then you can do much better than that. Does that yield % take into account body corporate fees?

For CG it's always better to buy something with land content.

You are doing well....you could afford 5+ IP's straight away as long as the yields are good and the rent pays for the mortgage.

If you are worried about vacancy then you should consider a house. Units generally have a higher turnover of tenants whereas famillies rent houses and stay on for longer periods. My relative bought a brand new house 10 years ago and it was rented to the same tenant up to this year. Finally kicked them out and increased the rent to current market price. The new tenant will probably stay for another 10 years.

If you were to ask me how many years our properties will take before it becomes cashflow + I can't even tell you. It's good to know but not a good mentality. I like Grubar's advice. If you buy more properties, leverage your risks in all areas then surely, some properties can become cashflow + in less than 10 yrs.

 

[The Y-man]

If you are worried about vacancy then you should consider a house.
.

My counter argument to this would be that for the price of one house, you could pick up 2 to 3 units/apartments. The likelihood of having all 2 or 3 vacant at one time is lower than having one house (your entire portfolio) vacant.

Units generally have a higher turnover of tenants whereas famillies rent houses and stay on for longer periods. My relative bought a brand new house 10 years ago and it was rented to the same tenant up to this year. Finally kicked them out and increased the rent to current market price. The new tenant will probably stay for another 10 years.
.

If there is a higher turnover, then perhaps there are more opportunities to increase rent?

Cheers,

The Y-man

 

[Bandita]

But that's not a good rental yield. If your aim is good rental yields then you can do much better than that.

For blue-chip, high growth, inner city suburbs of Melbourne, 5% or higher is actually a pretty decent yield, and quite difficult to find. 4% is more typical. And that's for units. Houses are much worse. Unless, of course, you find something on a main busy road or on the train line - but your growth will suffer greatly.

Just my observations.

Cheers,
Jen