The equation

Thanks for the advice so far, Next question is, We have 2 properties that we purchased without a lot of investigation. Both close to home, we thought they where well priced and would grow in value over time with a good rent. I guess the question is whats a good rent and whats a good capital growth. We have run out of puff as we have eqity in the properties and would like to buy another but we are worried about paying for it. It sounds like a few people hit the brick wall as we have, but you guys seem to keep on buying properties so you must be cash flow positive, when we are cash flow negative (before tax breaks). Any advice would be great.
 
Your question is "I guess the question is whats a good rent and whats a good capital growth?"

What is a good rent and good capital growth is relative for each purchase and person.

It is my understanding that a good purchase provides for either/all of the following:
  • After taking into account fair market rent and 30% cost of holding against that rent and the total cost of finance that this is as close to 0 as possible (or at least after taking into account tax benefits) that the property is relatively neutrally geared.
  • The cash that I put into the deal is returned to me as soon as possible. this is the return on investment. Ie if you put $10k into the deal and the property grows after all costs by $10k, then you have made your money back and everything else beyond this is a bonus.
  • So a good rent is either going to provide you with cashflow or help you support the property. And a good capital growth is going to be greater than your "total cost of holding". Everything else beyond this is a bonus and you are effectively being paid to hold the asset.
The reason why people can "leap frog" into buying more properties is they do one or more of the following:
  • they ensure that the extract there equity out at the earliest possible timeframe (either by adding value and refinancing) or just waiting for another refinance or by selling at a profit. This enables the next purchase to be completed either by buying more or just having more capital to work with for future purchases.
  • they ensure that there debt servicability ratio is looked at. Ie if you dont have a high income but support 2 highly negative geared properties then all of a sudden the banks roll back the red carpet and you cant get any more money to buy more property. so all the time you have to be balancing what you are buying against your debt serviceability ratio to make sure you dont hit that wall.
Hope this is of some help

Best Wishes

Corsa
 
Good advice from Corsa.

I personally dont like to have more than 80% LVR (have at least 20% equity as a barrier), as thats when you have to start worring about things like mortgage insurance and you generally become less attractive to the banks, not to mention that on a large portfolio over 80% starts to get a bit risky.

<KS>
 
jasper said:
we thought they where well priced and would grow in value over time with a good rent. I guess the question is whats a good rent and whats a good capital growth. .

In Melbourne, a general aim would be to outperform the histroical median growth for the entire city (about 8%pa ?? I am sure someone will correct me).

We tend to look for suburbs that performed at around 10~14% pa (compounding) in capital growth over a 10 year period.

In these types of suburb, you'd probably aim at rental returns of 5-6%, but that is very ball park.

Hope this give some ideas.

Cheers,

The Y-man
 
jasper said:
It sounds like a few people hit the brick wall as we have, but you guys seem to keep on buying properties so you must be cash flow positive, when we are cash flow negative (before tax breaks). Any advice would be great.

Hey Jasper,
I assume you have your loans on you IP's as interest only - if not then this may be an option to free up some cash flow to purchase another property. I am sure one of the expert brokers on this forum could help you with that.

Another option is to maybe take the self management path that duncan_m took (and others have - myself included :) ), as discussed in the profile on him in the latest API magazine. If you are comfortable with this, it may also free up some cashflow for you :)

Cheers

Mike F
 
Corsa said:
After taking into account fair market rent and 30% cost of holding against that rent and the total cost of finance that this is as close to 0 as possible (or at least after taking into account tax benefits) that the property is relatively neutrally geared.
Corsa
Can you expand on the maths for me? whats 30% of holding costs?, Use one of my properties as an example
We built it for $216K, 100% PI loan, Now valued at $365K by bank (probably could sell it for $330K).
We are getting $260 per week rent for it. We used equity to buy our second property.

Thanks
Jasper
 
Hi Jasper

No worries. 30% holding costs is typically what the bank take into account as a proportion of your rental income the costs associated with holding the property (ie rates, water, property management, repairs etc).

So in your case, with Rental Income per week being $260, then you will probably have around $78 per week of costs associated with the property ($260 * 30%). On top of this assuming your interest is 7.07% and you borrowed 100% of your building costs of $216,000, then this will equate to $293 per week of interest only costs. On top of this because you built the property you will be entitled to depreciation. An estimate of this is your building cost $216,000 * 2.5% which equates to $103 per week and Furniture & Fittings of $3000 per year equates to $57, therefore total Non Cash deductions per week would be $161.

Therefore, your cashflow per week for this property will look something like the following:

Rental Income $260
Less Property Costs of $(78)
Less Interest Costs of $(293)
Net Income before tax $(111)

Less Non Cash Deductions of $(161)

Net Income after Non Cash deductions = $(273)

Plus Tax Savings Assume you are in the 30% tax bracket ($273 * 30%) = $82

Net Income After Tax Savings = $(191) per week

Or $(9945) per annum


In terms of your equity, if the property is now worth $360,000 on a bank valuation then you can refinance the loan to 80% of this value. Which means if your loan is currently $216,000 then you can refinance to 80% ($360,000 * 80%), so your new loan is $288,000 freeing up $72,000 of equity for your next purchase. If you borrowed 100% of the building costs, then your return on investment is going to equal whatever your total interest costs have been while being built + your cost of holding as calculated above.



Hope this helps with your analysis.

Best Wishes

Corsa
 
G'day Corsa,

Noticed your calcs to Jasper showing $191 loss per week.
Net Income After Tax Savings = $(191) per week

Or $(9945) per annum
Is it fair to say that ACTUAL Loss is only $30 per week (as Non-Cash deductions of $161 don't hurt the pocket?).

Is there an "accounting" reason for saying it as you did?

Regards,
 
Hi Les

Nope, you are correct, I did the calcs in a rush!

Amended as per below.

Sorry for the confusion :eek:

Therefore, your cashflow per week for this property will look something like the following:

Rental Income $260
Less Property Costs of $(78)
Less Interest Costs of $(293)
Net Income before tax $(111)

Less Non Cash Deductions of $(161)

Net Income after Non Cash deductions = $(273)

Plus Tax Savings Assume you are in the 30% tax bracket ($273 * 30%) = $82

Net Cash Income After Tax Savings = $(29) per week

Or $(1508) per annum
 
I agree partially with the argument that Depreciation does not hurt the pocket but we definatley need to keep into account the Reduced Cost Basis for the Capital Gains purposes when the IP is sold...

Its not all free.
 
G'day djones,

A salient point, and worth mentioning:-
I agree partially with the argument that Depreciation does not hurt the pocket but we definatley need to keep into account the Reduced Cost Basis for the Capital Gains purposes when the IP is sold...
WRT Building Allowance, I believe you are correct. Thus $103 per week gets the 30% (in this case) Tax deduction - or $31 returned to you.

Although I've heard of other Depreciations being affected (someone - an Accountant - mentioned "balancing charge" or some such) I don't believe that Fittings etc are usually included in this "Cost Base" thing - can others confirm? Corsa? Coasty? Mry? Dale? Anyone?

Its not all free
Ah - but it can be (as I'm sure you know.....) Don't sell :D

But even if you DO sell, the effective CGT calc still gives you "50% discount" (if held > 12 months). Meantime, if you've been able to compound the $31 /wk over time, simply because it was available to you, the effect of the CGT down the track can be severely minimised, yes??

And then, you might choose to sell when you've retired (which MAY - or may not - reduce your Marginal Tax Rate below 30% - depends on the total Capital Gain...) Too many variables to put numbers to - suffice to say that the $31 /wk might end being a very cheap loan to you. ;)

Regards,
 
Thanks

Corsa said:
Hi Les

Nope, you are correct, I did the calcs in a rush!

Amended as per below.

Sorry for the confusion :eek:

Therefore, your cashflow per week for this property will look something like the following:

Rental Income $260
Less Property Costs of $(78)
Less Interest Costs of $(293)
Net Income before tax $(111)

Less Non Cash Deductions of $(161)

Net Income after Non Cash deductions = $(273)

Plus Tax Savings Assume you are in the 30% tax bracket ($273 * 30%) = $82

Net Cash Income After Tax Savings = $(29) per week

Or $(1508) per annum


Thanks Corsa (and everyone else) for your help in my education. I think the fog has lifted just a little. A last question on this matter. Is that a good return ? The capital growth has been great $216K to $365K in 3 years but I'm not so sure about the rent return.
 
jasper said:
Thanks Corsa (and everyone else) for your help in my education. I think the fog has lifted just a little. A last question on this matter. Is that a good return ? The capital growth has been great $216K to $365K in 3 years but I'm not so sure about the rent return.

The Capital Growth equates to 69% over the life of the investment or 23% annualised growth.

Assuming the property has cost you after tax $(29) a week to hold then this equates to $(4524) over the life of the investment ($29 * 52 weeks * 3 years). You had mentioned borrowing 100% initially so therefore we can assume that your only cost has been your holding cost of $(4524).

On that basis, your investment of $(4524) has generated $149,000 in equity and therefore your return can be expressed as $149000/4524 = 3294% which is great.

You are effectively being paid to hold this property rather than the other way around.
 
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