Un-leveraged Residential Property - A DUD Investment?

Hi there,

Quick question, would you all agree that if you take the leverage completely out of residential property, it becomes a DUD investment??

Thanks.
 
Quick question, would you all agree that if you take the leverage completely out of residential property, it becomes a DUD investment??
I'd say it's still a good investment. 7% growth with (say) 4% nett yield. Most of the return is growth and so not taxed. Adjusted for risk (volatility) the return looks more attractive. Liquidity & entry/exit costs are a relatively big downside, but for long term investors irrelevent. Look at all those older OOs who've paid off their mortgage - they're done v. well out of unleveraged property.
 
If you owned 3 unleveraged properties you probably wouldn't need to work ever again.

You would have the nett rent and the cap growth, and for some it would be quite easy to live off part of the equity as well.

Say you had 3 x $200k properties, with $300 per week rent on each property(couldn't get this return today in a lot of areas, but if you bought a while ago and had paid off the loans, the rent could be at this level by now).

Assume the average growth of 5% cap growth and nett rent of $450 after tax and expenses. (these figures are probably a bit low).

You can access up to 80% of the equity to live off, assuming you could service the debt. Let's assume the Bank says you can only use 50% of the equity;

So, you can live off $300k, the properties are appreciating at $30k per year, but increasing each year. You decide to use $20k of equity. Interest per year on the $20k is $1,800 (at 8%). At the end of year 1, your equity has increased by $30k, but you've spent $21,800. Nett equity increase of $7,200.

So, now you have:
1. $450 p/w rent
2. $384 p/w equity use.

Total per week is $834 p/w to spend, with no loans outgoing, and your equity keeps increasing each year more than you spend.

I think I could manage on that. Wouldn't be dining at Vlado's every night, but life would be comfortable.
 
I like the idea of keeping the LVR high while I'm in growth phase, but later in life when I'm living off income streams coming from shares (purchased by borrowing against my IPs after a decade or so of growth), I think it's a good risk management strategy as I get older (ie over 50) to let the LVR drift lower and lower, until eventually the asset has no debt attached to it.

The final position would then be to have all the properties unencumbered when inherited by my children and other beneficiaries.

Unleveraged propery is a great low risk investment and asset, but it's worth keeping your larger plan in mind.
 
Right now I wouldn't be able to handle 90% LVR like I used to because the portfolio has gotten bigger. While an under leveraged residential property has lower returns than a highly leveraged res prop, I'd say as your portfolio grows you don't have to take as much risk.
Alex
 
If you had $1MM cash, and used it to purchase $1MM in un-leveraged residential property at the end of a boom phase in the property cycle, and the net yield was say 3% (rent - PM fees - rates - water - insurance), that means a net income of just $30k pa, and from a handful of nice +/- whinging tenants.

Sure you've still got all that 'equity' and you are likely to get continued capital growth in the long-term, but if, for the purposes of this thread, no further leverage or borrowings were involved, then apart from providing some hedge against inflation, this 'equity' or capital growth (that is 'unrealised') doesn't make much of a difference does it?

You're really just left with a lot of money in a very, very poor yielding investment.

You could alternatively take $1MM and invest it in the bank and get say 7.25% pa interest, or, $72500 pa, with no fees and no hassles.

Much, much better than 30k pa, but no inflation hedge of course.

Still sounds like a DUD to me...
 
If you had $1MM cash, and used it to purchase $1MM in un-leveraged residential property at the end of a boom phase in the property cycle, and the net yield was say 3% (rent - PM fees - rates - water - insurance), that means a net income of just $30k pa, and from a handful of nice +/- whinging tenants.

Sure you've still got all that 'equity' and you are likely to get continued capital growth in the long-term, but if, for the purposes of this thread, no further leverage or borrowings were involved, then apart from providing some hedge against inflation, this 'equity' or capital growth (that is 'unrealised') doesn't make much of a difference does it?

You're really just left with a lot of money in a very, very poor yielding investment.

You could alternatively take $1MM and invest it in the bank and get say 7.25% pa interest, or, $72500 pa, with no fees and no hassles.

Much, much better than 30k pa, but no inflation hedge of course.

Still sounds like a DUD to me...

Even more of a DUD with debt. Totally dependant on future pie in the sky.
 
this 'equity' or capital growth (that is 'unrealised') doesn't make much of a difference does it?

you could argue that the yield will continue to climb against the rising value, where as the interest on the bank account won't.

I would be happy to get a 3% NET yield!

the latest Smart Investor magazine showed resi property as the highest performing category of all, to my surprise.

even at the end of a boom, such as the one in Perth we just had, it looks as tho CG will continue on at 8% or so, which would prettty quickly destroy the cash comparison
 
If you had $1MM cash, and used it to purchase $1MM in un-leveraged residential property at the end of a boom phase in the property cycle, and the net yield was say 3% (rent - PM fees - rates - water - insurance), that means a net income of just $30k pa, and from a handful of nice +/- whinging tenants.

Sure you've still got all that 'equity' and you are likely to get continued capital growth in the long-term, but if, for the purposes of this thread, no further leverage or borrowings were involved, then apart from providing some hedge against inflation, this 'equity' or capital growth (that is 'unrealised') doesn't make much of a difference does it?

You're really just left with a lot of money in a very, very poor yielding investment.

You could alternatively take $1MM and invest it in the bank and get say 7.25% pa interest, or, $72500 pa, with no fees and no hassles.

Much, much better than 30k pa, but no inflation hedge of course.

Still sounds like a DUD to me...


You forgot the tax on the 7.25% interest, plus the fact that the capital is not growing in value. It is actually being eaten away by inflation.

Assuming the tax bracket is say, 26% (is that the minimum these days?) and the inflation rate is 3%, the nett return on the million would be something nearer to:

$72,500 (interest paid on $1 mill)
- $18,850 (tax paid on interest @ 26%)
= $53,650 nett cashflow
- $30,000 (loss of capital to inflation)
= $23,650

Nett gain is: 2.365% after tax and inflation. Ouch.

After 10 years at 3% inflation, the $1 mill is worth $700k.
Add to that the nett cashflow of $23,650 per year ($30k is used to live on as you said) for 10 years.

The nett worth result of living on the $1 mill cash for 10 years is: $936,500

After 10 years @ 5% cap growth in property (taking end of boom into account and using long-term historical records, and using lower than historical records figure) the $1 mill is worth $1.5 mill.

The nett worth result of living off $1 mill in property for 10 years is: $1.5 mill .

Rent increases not included.
 
You forgot the tax on the 7.25% interest, plus the fact that the capital is not growing in value. It is actually being eaten away by inflation...

The 30k is taxed too though, and I did note that inflation wasn't accounted for.

Even if the net worth increases, you can't take advantage of this without selling. And, for the purposes of this thread, I'm saying leveraging off this equity is not an option, ie. just talking about un-leveraged residential property.

What if you ignored the capital growth effect and did similar calculations but looking only at the dollar value of the rental income increasing over the 10 years? Rents grow as fast as inflation or wages, I think (not sure which one)?

How would this compare with the higher bank interest rate but no inflation hedge alternative
over the 10 years??

I'm no good with these calculations.

NB:
30k is $26400 after tax
$72500 is $56150 after tax

Thanks.
 
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JIT,

that's probably the real way to compare the two I guess.

If you were only able to use the income only from the cash (interest) and property (rent) as your living, the outcome would be;

Based on income only, using your model of interest paid (7.25% less tax of 26% plus 1.5% medicare = 27.5%) and nett rent (3%), the outcome would be;

$1 mill x 7.25% = $72,500 - $19,937.50 = $52,562.50 per year. (No whinging tenants either).

$1 mill x 3% nett = $30,000. (and whinging tenants).

My brain works too much in "nett worth" I suspect, and I always factor this into the investment return.

The other factor not mentioned is: How do you get to the $1 mill in cash to park in the ING account?

I couldn't save enough to get there in my lifetime.
 
NB:
I'm no good with these calculations.

30k is $26400 after tax
$72500 is $56150 after tax

Thanks.

Using these figures above...

If the rental income of $26400 pa increases by 3% pa, after 10 years compounded it would become $35479 pa.

If the bank interest of $56150 pa effectively decreases by an inflation rate of 3% pa, after 10 years it would become $41780 pa (using a reverse compound interest calculator on google).

Is that correct?!
 
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Hi there,

Quick question, would you all agree that if you take the leverage completely out of residential property, it becomes a DUD investment??

Thanks.


Its been quoted many times that one of the major benefits of investing in real estate is the leverage. Without the additional borrowed money the returns would greatly diminished and many wouldnt get a start.

If your the type who is constantly chasing the highest return, then yes RE returns are at a point where you could liquidate and move to another area. But many RE investors are in for the long term, and so long as they can ride the cycles will be well infront.

Having said this I think your topic is a timely one. Any highly geared investor who has CG as a centre point of their strategy could see difficult times, and could well be advised to move to a less exposed position.
 
Using these figures above...

If the rental income of $26400 increases by 3% pa, after 10 years compounded it would be worth $35479.

If the bank interest of $56150 effectively decreases by an inflation rate of 3% pa, after 10 years it would be worth $41780 (using a reverse compound interest calculator on google).

Is that correct?!

You appear to be missing the concept of dividends: payments out of the funds being a separate accounting entity from interest, tax, rent etc.

Excess income, being net income - dividend, can be reinvested in some types of fund such as cash deposits but not so easily with other funds such as rented property.
 
If you had $1MM cash, and used it to purchase $1MM in un-leveraged residential property at the end of a boom phase in the property cycle, and the net yield was say 3% (rent - PM fees - rates - water - insurance), that means a net income of just $30k pa, and from a handful of nice +/- whinging tenants.

Sure you've still got all that 'equity' and you are likely to get continued capital growth in the long-term, but if, for the purposes of this thread, no further leverage or borrowings were involved, then apart from providing some hedge against inflation, this 'equity' or capital growth (that is 'unrealised') doesn't make much of a difference does it?

You're really just left with a lot of money in a very, very poor yielding investment.

You could alternatively take $1MM and invest it in the bank and get say 7.25% pa interest, or, $72500 pa, with no fees and no hassles.

Much, much better than 30k pa, but no inflation hedge of course.

Still sounds like a DUD to me...

Interesting topic... especially since it is based on the proposition that the R/E market has topped .

Regardless,

I'd have to agree that there is some downside to holding any asset when yields are low and the asset class appears to be in for an extended downturn.

There are, however, exceptions...

There is a tax ruling (don't know the details) in which you could live in a 1M property (as your defined PPoR), have multiple people also living in it (paying you rent), and not have to pay any Capital Gains Tax or any income tax from the 'rent'.

There are, naturally, some requirements from the ATO... this must be a domestic living arrangement (ie shared bathroom and kitchen facilities for all people in the household) and NOT some kind of separate apartment structure or granny flat ... there are other requirements that I'll let you guys who know more talk about.

You can't claim the -ve gearing on any mortgage, but this is a freely owned property with no mortgage so who cares...

Basically, I would say that is probably the only way that I'd touch R/E right now.

What would I do with my dosh... I'm not sure.. there is a strong chance that the Stockmarket might also suffer with the credit squeeze... so perhaps Cash is king (ie. Major Bank deposits)... perhaps bonds, perhaps Gold/Silver etc...




As with any post, please check the facts before trusting the rants of an online poster... this is how it was explained to me some 12 years ago when I had a household of 4 people in my PPoR.... they paid my mortage and life was good.
 
Hi there,

Quick question, would you all agree that if you take the leverage completely out of residential property, it becomes a DUD investment??

Thanks.

The investment is what it is regardless of your leverage. Leverage is simply a financing tool that maginifies losses and magnifies wins for the owner. So the investment might be a winner or it might be a dud - then it is the leverage that magnifies this to your level of comfort.

Imagine a single house that has no leverage (i.e. You own 100% of it). If it goes up in value 10% you make 10%. If it goes down 10% you lose 10%.

Imagine 5 houses with 80% leverage (i.e. You own 20% of them - or you could say you own 1 house of the 5 outright - the rest is debt). If they go up in value 10% you make 50%. If they go down in value 10% you lose 50%.

So in both cases the investment performance is what it is (up 10% or down 10%). But the impact on the owner depends on their level of leverage. The first scenario above is lower potential return but also lower potential downside. The second is a much higher potential return but also a much higher potential loss.

In the USA I understand some states had financing where you could simply hand in the keys to the house if it didn't work out. In this case, then I'd take on as much leverage as possible - I get the upside, the bank wears the downside - beautiful. In Australia, it's not so simple so people would be more cautious.

Generally if the downside is somebody else's problem you would take on as much leverage as possible. See some of the big corporate CEOs for this principle in action - they win (big bonus) if the company wins but they are neutral ($0 bonus) if the company loses. So they have an incentive to go hard and add as much risk (i.e. leverage) as possible - why wouldn't they?

edit: 1 obvious reason for adding leverage is the tax deduction. maybe that is what JIT was getting at. but I don't know if your marginal tax rate multiplied by your debt interest would single handedly turn the investment from dud to great ...
 
Even if the net worth increases, you can't take advantage of this without selling. And, for the purposes of this thread, I'm saying leveraging off this equity is not an option, ie. just talking about un-leveraged residential property.

....OK,

This thread to me is akin to needing to climb a wall into a nicer garden, and turning around and questioning what we think about the second or third lowermost rung on the ladder needed to get us over the wall.

Who cares what that individual rung on the ladder performs like. As long as it launches you further up the ladder and eventually gets you over the wall and into the nicer garden.

Step on it, leverage it to move on up, and don't give it a second thought. IMHO of course.

JIT - I don't understand the purpose of this thread.
 
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