Hi all property investors out there!
I was just wondering whether the approach of say buying say 3 or 4 property investments and then instead of saving for more deposits you actually try to pay off the loans as quick as possible, so that you save a bundle in interest and also eventually have alot of passive income as the rental income will easily cover rates, land tax, management fees etc. Then once you have around say $8000 of free passive income p.a on each property, you can easily acquire more and more properties from there.
Is there a flaw in this approach, I mean, i undeerstand that you do have to use alot of your personal income at first but wouldn’t it pay off in the end?Hope to hear your opinions on this issue!
Regards Fudge111[
]Hey Fudge
I think it depends on how many properties you own – and the resultant paperwork nightmare etc. But to get around that, I’m hiring an employee to do it for me.
Personally I would buy as many properties as i can as fast as I can. If they all make money weekly, then they look after themselves, and you can also participate in any capital gain across a larger number. If you have 4 properties that each go up by $10K, you have an extra $40K of equity. But if you have 20 that only go up by $5K, you still have $100K to either buy more, or sell a couple to pay down some loans.
My two cents.
Cheers
MelHi Melbear,
Point taken, I spose the main reasons i hope to invest is to keep the properties as rental properties for as long as possible, i know it could be harder to refnance with say less equity, but however with all the extra passive income it shouldn’t be needed.
I also see many of the posts about *Time* and I think it sure takes alot of time to research areas for property investments, so i suppose my rationale is that it will also free up alot of time if you are simply paying off investments you already have then putting alot of your free time into finding new deals, plus as I mentioned earlier, huge savings in interest will occur too!
Any other opinions?
Fudge111[
]Hi Fudge
Several things come to mind.
1. If you buy 4 properties at once, you may be out of the market for a while due to finance constraints. This has several consequences:
a. if there is a crash you’ll miss out on bargains
b. if a good deal comes up you might not be able to take advantage of it
c. all properties will be bought when you are comparatively new to investing. If you buy two now and two in 6-12 months, you might be able to get better returns on the later two as you’ve got better at finding opportunities.2. Paying properties off quickly diminsh the loan term and saves interest, but is only worthwhile up to a point. To reduce a 30 year loan to 15-20 years requires relatively small extra payments and saves lots of interest. But to drop a 10 year loan to 5 years saves little interest and requires massively higher payments. I could think of better uses for the money unless you’re in a hurry to pay the debt pronto.
3. To keep up contacts and to keep you looking and researching, maybe an approach of buying two properties now and one every 2-3 years might be better. Otherwise you might lose touch and have to start your research over again once your first 3-4 are paid off. Also if you buy at regular intervals, you will be buy in all markets. If you buy cheaper yield rural properties in booms and growth properties in busts, you might be able to enjoy an effect somewhat similar to ‘dollar cost averaging’ used by share buyers (buy fewer in boom, more in bust) and get higher average returns (in theory of course).
Peter
You need to consider what your return is on the cash invested. If you take out P&I loans then you are steadily increasing your cash investment in the property.
Interesting thing when you play around with the numbers is that the more equity you have the lower your return.
Probably best explained by an example:
Property $175,000
Int rate 7%
Rent $300 per weekSceanrio 1: $10,000 equity. Positive CF (ignoring expenses) is $4050 so a return of 40.5%.
Sceanrio 2: $20,000 equity. Positive CF is $4750 but return is 23.8%.
As you can see you obtain higher returns from having a lower equity.
And as melbear point out the more properties the more chance of capital growth.Thanks Peter,
I definetely wasn’t going to buy 4 properties all at once, but we would hope to be able to pay off the properties in around 5 years or less, obviously, we’d prob have a year or so gap between each investment, as you pay off each house you have more passive income to pay off the others and it will slowly free up your personal income up to the point where you can simply keep using passive income to acquire more investments and very little of your own income. I would prob aim for houses around $150-180k.Is this feasable?
Fudge111[^]
Fudge it’s alwasy feasible if you have enough income. 4 properties in 5 years sounds pretty optimistic to me, but I’m only on a 5 figure income. It all depends on your numbers.
One other point about paying principal, I can show you mathematically that there is very little difference between IO and P&I if you are in the top tax bracket, when you take inflation into account.
Regards, Jim.Thanks for your advice Jim,
Well we will have 2 incomes to source our investments, i say will due to the fact that both broz and 1 are still at uni and are yet to have full time jobs, I will become an accountant and she is planning to be a midwife.
Another fact is that when you pay off your loan quicker all the loan repayments will be tax deductable too so you will not need as much money to pay them off as you really think, especially if you are in the top tax bracket, this is different to the deposits that you have to save up for which will be 100% out of pocket, where as a loan repayment could only be 52.5% out of your pocket.
Sorry if this confuses everybody, tried my best,Fudge111[
]Also Jim, I think my post was misleading, i meant to say that we would acquire all the properties perhaps within 5 years, definately not pay them all off, sorry about my inaccurate post,
Fudge111[
]Hi F&B, There’s nothing wrong with your idea if that is the approach you want to take. It may not be the quickest way or save you the most tax or interest, but if you can manage it and do it then go for it. Your idea was what I was trying to do when all my friends were in the -gearing mode, when I first started investing. My goal was to acquire 6-10 props and have a passive income of 6-10K a month. I know this is probably a lot less than most people on this forum but it’s all the money I need to do what I like doing. With all the hype about + cash flow properties my goals started to change and I started to think about doubling and trippling this goal. Then my wife ask me do we really need to do all this? I’ve gone back to my original goal and when this is achieved, maybe I will find a new goal. ( a 20kg barramundie)
C2
“Is it true the more you owe the more you grow until the bank steps in?”
F&B, as C2 says, you can change tack whenever you wish. Just do it, and develop strategies and goals as you go, but let them be dynamic, depending on how your equity and income progress.
My comment on the inflation issue is based on the simple fact that your interest costs just 51.5% of 6% after tax, which would be close to inflation.As a budding accountant, here’s a little assignment for you: Work out your future net worth after 5 years if you (a) pay all your positive cash flow back into the loans as principal payments and
(b) if you use them to buy blue chip shares directly, that all pay at least 4.5% fully franked dividend, and capital appreciation on average say 7%Assume the IP appreciates at 7% also. Provided you have a 5 year time scale, then the shares should hopefully achieve that as well.
My point is that principal payments are in effect only about a 3% investment after tax, but if you pay into an investment with 7% capital gain as well as dividend income you will do a lot better. While it is nice to reduce the debt to increase your saftey buffer, a more agressive approach may end up with a much larger future worth. With a 5 year time scale, this approach is not so aggressive. I suggested shares rather than property, because you can start the 7% compounding immediately, eg each month or 3 months. The effect would be similar if you could keep the property acquisition going with a reasonably short time span, but while your cash is sitting in an offset account, or as principal reduction, then it’s only earning 3% after tax, ie it’s not being leveraged. As soon as you own more than 20% of your property, you are increasing your safety buffer, but decreasing your earning potential.
Hope this makes sense, even if it’s not sensible! Jim
Thanks Jim.
Yeah, I think I would have to be put in the bracket of people who are a little more cautious and take a few less risks.
And you are correct that we can change our tack whenever we like. I mean, I’m sure I’ll find a few great +ve cf properties which if already earning passive income from day one i will just leave them to prosper.
Obviously though we most likely will have a few neg geared properties that we could pay off a bit quicker so that we have less risk and essentially then make our 8%-10% return on the purchase price for many years to come once we fully pay the loans off.
This approach will take a few years of living a little poor and pouring most of our incomes into it, however, we are both only 20 and it won’t hurt us for a few years, especially if I stay living at home and pay a little less rent than i would out in the real world, (when you take out bills i will not have to pay, nor food)
We still have plenty of time to change our minds but i know i will do all the sums and see which strategy best suits the kind of people we are and what we want out of our investments. Maybe it could be shares, who knows?
Thanks everyone for all this input, it’s been a real eye opener!
If anyone else wants to have their say then I would love to hear from you.Thankyou, Fudge111[
][8D][][]Sorry Guys,
The last point I want to reiterate was one i made in my 2nd post in this thread, is the one of *time*.
Sure, i may not get the returns doing it this way compared to buying many more properties, however I really don’t look forward too much to spending every second of my free time (which we are trying to achieve more by investing) trying to find more and more investments, if I see a deal sure I’ll follow it up but this way just paying off loans takes hardly any time at all, and i will be able to relax more to things i love to do for leisure,
I need to find a good balance between the 2 i think
Regards
Fudge111[][^]Hi Fudge & Broz,
Your Quote:
“Another fact is that when you pay off your loan quicker all the loan repayments will be tax deductable too so you will not need as much money to pay them off as you really think, especially if you are in the top tax bracket, this is different to the deposits that you have to save up for which will be 100% out of pocket, where as a loan repayment could only be 52.5% out of your pocket.”I’m not an accountant, but I always thought that only the interest from an investment loan was tax deductable, and anything over that was not. So my understanding is that you would not be able to claim these extra repayments as a deduction.
Someone please correct me if I am wrong,Keep smiling,
Sue []“Be careful not to step on the flowers when you’re reaching for the stars”
mmm, thanks diclem,
I must say I didn’t get that opinion from Steve’s book, but you could well be right, i’ll ask him that i think.While I’m at it I did a few sums on 2 different ways to go about investing in the same house, as i am only young, if I make errors anywhere then please point them out
Property 170k
Weekly Rent $280Deposit (20%) 34,000
Stamp Duty 5,860
Closing Costs 1,000
Initial Outlay =40,860Plan 1: loan 7% 25 years $136,000
Annual Rent 280*51= $14,280
less
Annual Repayment= $11,535
Rates= 800
Insurance= 400
Management Fees 9% 1,285
Land Tax (unimproved) 170
Total Costs $14,190
+ve cash flow $90p.a
After 25 yearsInitial Outlay (40,860)
+ $90*25 yrs 2,250
Total Loss (38,610)Plan 2: Loan 7% 3 years $136,000
Repayment p.a = $50,391
total rep over 3 years $151,174Annual Profit
Rent 14,280
less rates, ins, man fees etc 2,655
Profit per year $11,625
After 25 yearsOutlays Initial: (40,680)
Loan Rep (151,174)
=(191,854)Profits $11,625*25 yrs
=$290,625Total Profit $98,771
There you go, hope my sums are correct, i know however using plan 2 you will not own as many properties and therefore have less capital gains, but anyway, just something to think about.
Fudge111[]Hi Guys,
This looks good initially. However some points:
Plan 1 – Your money $38610
Plan 2 – your money $156979– I don’t know how to work it out, but I am sure this is not a good return on your money.
– You have put all your eggs in one basket
– By using this money to buy properties in different areas, you increase your chances of capital gains
– Several properties will also help you deal with vacanciesJust my 2 bobs worth,
Sue [
]“Be careful not to step on the flowers when you’re reaching for the stars”
Fudge, you are forgetting tax in your plan 2. You don’t have the interest deductions to counter rent, as you’ve paid off the loan so quickly.
Don’t forget, also, about time value of money. The figures over 25 years disguise the huge effect of inflation. In plan 2 you are investing a lot of dollars from today, next year and the year after that, as opposed to plan 1 where you are spreading your dollars over 25 years. It’s not just inflation. In plan 2, you are giving back dollars that could be earning 7%. You only save 3% when you pay back principal, as I’ve said before. You should perhaps be looking at just figures for the next 5 years. 25 years is stretching it a bit. Your rates will increase, your rent will increase etc etc. You are ignoring depreciation as well in your calcs. This has a big effect on your early cash flow.Jim.
Hi Jim, I take on your points, however i understand alot better when i am shown a practical example.
In my plan 2 when I do not include any of the loan repayment as a tax deduction, i include it in initial outlay 40,860+151,174=$191,854
There will be around 16,000 of this that is tax deductable.
Then there is the 11,625 profit per year, i am just assuming that rents, rates and tax increase by inflation for simplicity. Well this 11,625 would be taxable income which may decrease to $6,500 in your pocket, i acknowledge that.
However there is also 16,000 of taxable deductions in the first 3 years which means taxable income in first years is not 11,625, but closer to 6,290.
I’ve probably just confused everyone again, but I am trying to understand things more clearly
Fudge111[][]Hi Fudge,
I have always prefered to invest in property to keep for the long haul and to eventually live off passive rental income from those properties. I buy properties every year or 2 now and reduce debt considerably at the start of the loan. Yes your ROI will decrease because of your increased equity BUT dont forget your cash flow will increase because theres less debt. Plus its a guaranteed return !
I think you’ll be in a better position if a crash were to hit as you’ll have more equity to play with which will allow you to buy up bargains. I do agree with Peter in that you have to hit the loan in the beginning to see the biggest Interest savings.
I have a LOC for as long term as I can get it, in case my income were to change down the track. I then can make the minimum payments if needed.
I went through plan 1 and came up with a few different figures for cash flow, but I used your tax effects. And like Jim said depreciation is a biggie !
Plan 1: loan 7% 25 years $136,000
Annual Rent 280*51= $14,280
less
Annual Repayment= $11,535
Rates= 800
Insurance= 400
Management Fees 9% 1,285
Land Tax (unimproved) 170
Total Costs $14,190Arent annual repayments ( 7% * 136000 = $9520)
Total costs therefore = $12,175
Tax effect on $2105 profit = $989 Paid.ie($9520+$800+$400+$1285+$170-$14280)*47%(Top Tax bracket)Cash Flow = (-$989+$14280+Depreciation?)-($9520+$800+$400+$1285+$170)= $1116 PA or $21 PW
I couldnt see my addition signs in the preview, hope they are there.
I just realised that Stamp duty, Agents commissions, conveyancing costs or any other improvements are all capital costs and cant be claimed against your tax. Instead they reduce your gain for CGT purposes on sale. Loan establishment fees can be claimed over a 5 year period I think.
I do believe that only the interest portion of your repayments (not the principle part) are claimable.
Cheers
Oz
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