Hi All
I have an investment property which I purchased in 1997 for $79K, and started renting for about $130/wk.
With the recent property boom, I have been told that it is now probably worth about $250K. However, the rent is still only $140/wk, and because the house is small and a bit old, I am unlikely to get much more than that.
Now, if I compare the rental income to what I paid for it, it seems to be doing pretty well. However, if I compare the rental income to what the property is supposedly worth now, it is just not pulling its weight.
I am now considering buying another property (possibly a small commercial one) with a view to maximising rental returns instead of worrying about capital growth.
The decision I need to make is whether I should sell the house and use the money to buy the new property without increasing my current debt level by very much, or should I use the equity in the house to borrow the whole amount for the new property and keep both?
If I sell the house, I won’t increase my level of debt (and hence interest) very much, but I am going to have to pay a hefty amount of CGT,
If I keep the house, I won’t have to pay CGT, and I will get to have both rental income streams, but I will also be in debt – and accruing interest – much more.
I guess what I need to do is to weigh up the loss of CGT against the extra interest, but my problem is that I can’t even seem to get my head around how I would actually compare the two sides.
It seems that the more I think about it, the more I seem to be trying to compare apples to wheelbarrows[wacko]
Can anybody please offer any formulas/calculations/algorithms/rules of thumb that will help me compare the two options in a meaningful way.
Thanks
Sorry of this post sounds a little confused, but I certainly am.Hi Two Sheds,
A few years ago, I bought my first investment property for $125k and rent was $125pw. Interest rates were at 8% at the time. So not a very good return at all.Then I bought a second property for $27k which rented for $100pw which vastly improved my cashflow. So much so, that I was then able to hold the first property until capital growth had improved.
First property then increased to $185k but rent was only $140pw, so I sold it and payed out the loan on the second property and my own home as well.
With a whole lot better cashflow, I then went on to buy lots more properties. Sometimes selling the capital growth ones which had poor rent returns or lots of maintenance hassles and using the money to reduce debt and then go shopping for better cashflow ones.
I do ‘what if’ senario’s all the time on paper to see how I can improve my financials and my property holdings.
Last year the bank said no more borrowing as they thought me overborrowed. So I sold a capital growth house which I had purchased for $105k only 2 or 3 yrs before with original rent of $170pw. I got $220k for it and rent at that time was still only $180pw.
“It’s what you do with that money which is most important”.[grad]
In my case, I paid off two of my other properties to reduce debt and improve cashflow. Then I went shopping again and bought 3 cashflow positive properties, 2 neutral properties (which with a rent rise are now positive) and one negative one for capital growth. My bank never knocked back any of my applications although they did their usual ‘tut tut’ about it all.[biggrin]
In my case, because I have such a lot of depreciation which I can claim against rental income that when CGT gets added to it, there is very little if any tax to pay.
You will have to factor in the CGT into your ‘what if’ senarios to see if you are better off or not. If it gets too much to get your head around, (especially to indexing in calcuating your CGT), then try getting your accountant to do some figures and CGT calculations for you, even if it is just to confirm your own calculations.
If you want to get out of a hole, first stop digging.
TwoSheds
Simplistically your figures are relatively easy
Purchase Price $79K +
Costs on acquisition +
Costs on selling =
Cost base for CGT
Subtract sale price from cost base. Divide this by 2 as you have owned the property 12 months.
eg Cost base $100K, selling price $250k, capital gain $150K, taxable Capital Gain $75k at 48.5c/$ maximum tax $36375. Don’t worry about the indexation Brenda referred to as in your case that might increase your cost base by a few thousand, to keep things simple say $5000 but your taxable gain would be $145,000 as there is no 50% discount if you use your indexed cost base.Therefore you would have available to invest in your new investment $250k less CGT less selling costs less payout of old debt.
Say this left you with $150k
The interest you would save will depend on the interest rate eg 6% 9000, 8% 12000 over 12 months
Compare this with your current return $140 per week less rates, insurance, interest on existing debt. You’ll obviously have to do your own sums.
Then say the result is $5000, the difference between the interest you’ll be charged on the commercial loan and this $5000 is your saving. Say at interest of 8% you will have saved $7000. This will have cost you the CGT and selling costs. Work out the return that you would expect and how long you are going to hold the commercial property for and compare this with your saving. You should take into account that the money you have paid out in CGT is dearer money than the savings you get in future years.
There are a few other factors:
a. You will have also incurred an opportunity cost by selling some equity you could borrow against if another opportunity arose in the future.
b. Potential for rent increase on house
c. Potential for rent increases/ vacancies on commercial property.Your accountant can help you calculate this.
You also need to look at your comfort level.
You might also consider if you don’t sell the house now, you could in the future ie you’re not burning your bridges once and for all.
Maybe look at refinancing the house, using the increased debt for the commercial property and borrowing the balance needed on the commercioal property so you get the benefit of residential interest rates on more of your debt and avoid cross-collateralisation.
Whatever you do borrow a few extra k to keep in case a rent payment is late so you’ree not under pressure.
I’m in a similar position to you. The decision I made earlier this year was to keep the res property – admittedly an easier decision as that property is still offering a gross yield on current value in excess of 6% so my figures are different to yours.
crj
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