I thought I would put together a little scenario to see how different people calculate their ‘REAL’ returns on investments. I will post my calculations in a few days….
Scenario – Return on Investment Property
Jack is in the highest marginal tax bracket earning $80,000 per annum and decides to buy an investment property in NSW for $100,000. He borrows $105,000 at 6.75% per annum to complete the purchase and to pay all closing costs (assume costs total 5% of purchase price).
His interest only repayments total $590.63 per month. The property rents for $150.00 per week giving him a total of $650.00 per month.
He sells the property in five years and does not receive any pay increases in that time.
Is this a good investment?
Assume 10% per annum growth in property value, 2.5% inflation per annum and 3% selling Agent commission.
Good luck!
Robert Bou-Hamdan
Mortgage Adviser“Assume 10% per annum growth in property value”
If you make this assumption then the rest of the numbers barely matter (within sensible ranges) and the answer is yes.
An exceptional investor could possibly achieve this, with luck on their side. But why not use sensible numbers that the average investor will achieve.
Rough math: (capital gain-inflation)=7.5%, by “rule of 72” (yes it’s not a rule per se, but a linear approximation to the exponential), that is ~ 10 years to double. So in a decade houses will costs 12 times the average salary in Brisbane. BUT… at todays rates, the interest would exceed NET income.
The long term trend is for property to appreciate with inflation. So 2.5% might be a better number for this exercise.
Going by the numbers The Mortgage Adviser provided, it looks as though this investment would only just keep pace with inflation (between 2.5%-3%) per year over the 5 years.
So it seems to be maintaining its “real” value but not really making you any money in terms of net worth.
What are other people’s thoughts? What did you come up with Mortgage Adviser?
Cheers,
Jason.“Assume 10% per annum growth in property value, 2.5% inflation per annum”
So it is exceeding inflation by 7.5% pa. And seems to be roughly neutrally geared. Even with 5% cost in and 3% out, it’s a truly inflation beating proposition. Unless I totally missed something [eh]
I will post my rough figures (as I am not an accountant) soon but I am looking for what sort of number people come up with after the 5 years – ie: what do you walk away with after 5 years and does this number make you believe this investment is good?
Robert Bou-Hamdan
Mortgage AdviserAt a quick glance:
Roughly neutral gearing, roughly 55k gross profit, 50% CGT concession… Vendor tax thing…. I’d say you’d clear about 35k?Whichever way I look at it, any guaranteed positive return on zero down is good, regardless of inflation!
If only life were so easy.
Cheers, F.[cowboy2]
I generally use IRR as a measure for all standalone properties.
Need to make some further assumptions.
rates & management fees 10% of gross rent
maintenance & insuracance 5% of net rent
2.5% capital depreciation of full $100K outlay
all tax based on maximum 48.5% rate ($80K is $10K above maximum rate now but will be phase in point for the maximum rate in the future)
rent, maintenance, management, insurance increase in line with inflation.As no money outlay from our pocket I assumed the $5000 overand above the price borrowed to be a -$5000 initial outlay.
Will have cash flows of:
Year 0 -$5000 (purchase)
After Year 1 +$374
After Year 2 +$856
After Year 3 +$938
After Year 4 +$1023
After Year 5 +$49377Thus get a 64% IRR, not bad at all for a $5000 investment!
CPI adjusted amounts for the above:
After Year 1 +$365
After Year 2 +$815
After Year 3 +$871
After Year 4 +$926
After Year 5 +$43642or the equivalent of $41620 all in today’s $, a nice tidy sum.
Got any more of these sure fire money makers????
All things are possible to the person who believes they are possible.
Whateve the mind of man can conceive and believe, the mind can achieve.
Napoleon HillI get these figs:
After 5 years, ppty worth $161,051
less purchase costs and selling cost = $51,220 capital gainAfter CGT, this becomes a profit of $38,800.
The property would probably be cashflow neutral but negatively geared, so maybe a bit of tax would have been saved during this time as well. If rents increased with inflation, maybe a small profit would emerge.
So for a cash outlay of $nil, the person made $38,800 after tax in 5 years.
Not bad, but SIS made this in 6 months!
Terryw
Discover Home Loans
Mortgage Broker
North Sydney
[email protected]Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
http://www.Structuring.com.au
Email MeLawyer, Mortgage Broker and Tax Advisor (Sydney based but advising Aust wide) http://www.Structuring.com.au
I get following figures:
the property is negativly geared $29/week or $1500/annum
value of property after 5 years= $161,051
rental yeild = 7.8%
IRR (5 Years) = 76.58%
Gross profit after 5 years = $47,690
less $11,351 CGT = $36,339
less 3% ($4831) selling agent commission = $31,508 net Profit (Not including depreciation)I think for some people this is better than nothing, but with an income of $80000 I probably would go for better quality homes near the coast.
jsandso
Scenario – Return on Investment Property
Jack is in the highest marginal tax bracket earning $80,000 per annum and decides to buy an investment property in NSW for $100,000. He borrows $105,000 at 6.75% per annum to complete the purchase and to pay all closing costs (assume costs total 5% of purchase price). His interest only repayments total $590.63 per month. The property rents for $150.00 per week giving him a total of $650.00 per month. He sells the property in five years and does not receive any pay increases in that time.
Is this a good investment?
Assume 10% per annum growth in property value and 2.5% inflation per annum.
MY RESULTS
$80,000.00 Gross Income
$7,800.00 Rental Income-$7,087.50 Interest Expense
-$2,000.00 Running Costs (Property Manager, Insurance, Maintenance, etc)$55,488.47 Net Income before property
$54,825.41 Net Income after property year 1,2,3,4,5$110,000.00 Property Value Year 1
$121,000.00 Property Value Year 2
$133,100.00 Property Value Year 3
$146,410.00 Property Value Year 4
$161,051.00 Property Value Year 5$161,051.00 Property Sale Price
-$105,000.00 Loan Repayment
$56,051.00 Capital Gain (assumes costs deducted)
-$6,796.18 Capital Gains Tax (25%)
-$4,831.53 Agent Commission (3%)
-$3,623.65 Vendor Tax (2.25%)
-$3,315.30 Reduced Income (5 years)$37,484.34 Net Capital Gain
Effect of Inflation
-$1,370.64 Income Year 1
-$1,336.37 Income Year 2
-$1,302.96 Income Year 3
-$1,270.39 Income Year 4
-$1,238.63 Income Year 5-$250.00 Capital Gain Year 1
-$275.00 Capital Gain Year 2
-$302.50 Capital Gain Year 3
-$332.75 Capital Gain Year 4
-$366.03 Capital Gain Year 5-$8,045.27 Total loss from inflation
$29,439.07 Real return over 5 years
In my opinion, the negative impact on cash flow would have a greater effect on the real return figure presented above.
I guess what this thread shows is how different people look at a particular investment. I am certainly not an accountant but I thought my figure was conservative. I believe it could be even lower yet most people came up with higher figures. Hopefully an accountant could give us their comments.
Most people would be very happy with this sort of return over 5 years but it took huge capital gains to achieve it. I have not done the figures yet but would like to see results if the property only grew at a rate of 4% per annum. I will post these figures in a few days.
Robert Bou-Hamdan
Mortgage AdviserHi Mortgage Adviser,
I breathed a sigh of relief when I saw your figures. I thought I had miscalculated something when everyone was saying this was such a great deal.
(I should correct my original post though – I meant to say the property would return 2%-3% in real value terms each year over 5 years – rather than “..it would keep pace with inflation..”).
I agree that your figures are conservative & that you are right when you highlight that this minimal return is achieved with 10% growth. Indeed, what would it look like at 4%!
IMHO this example highlights the difference between people who are sophisticated investors vs unsophisticated investors.
Sophisticated investors focus on calculating the real costs & reutrns, whereas unsophisticated investors generally have “less refined” accounting practices – ie, I bought it for $200K, cash flow neutral for 5 years, then sold for $250K, therefore I made $50K. I think your example highlights that working out real returns is more complex that this.
Good on ya!
Cheers,
Jason.Hey Guys,
i really like Rob’s example, as an investor… this would be very similar the way i would caculate his figures…
though as an investor… this is how, i would make this property work so hard and to ensure that over the 5 years.. this one property investment has now turned into 5 – 10 property investments, from just the one investment property..
first things that i would do is, increase the property value, and to ensure that the property is going to increase in both growth and cashflow is… (providing, capital or equity… which everway…)
** buy property – at 105% finance (assuming bank, allows refinance of property, immediately after settlement or after 1 year, due to the property being geared at 105%
** relying on capital growth for one year, and small cosmetic work to the property, and ensuring rentals are being increased every 6 months at a rate of $5 – $10 (or increasing rentals to accurate current market appraisals)
** now from some quick caculations, if i can increase the property up to the value of $130,000 with an apprasial from a valuer, or from the growth of the market moving up north…
or sitting on the property at 10% growth each year annulised. (year 3 – property value $133,100) from caculations, would have to seat on property for 3 years before draw down of equity…
** but caculated at my return rate of increasing rentals at either $5 every 6 months or at $10 every 6 months, i should or would be in a position to draw down equity within 2 years, instead of waiting for the 3rd year, but based on this assumption, i will stick with 3rd year to draw down equity, and how i use the velocity of money to increase property portfolio quite quickly..
next post will show the effect of increaseing rentals every 6 months at a rate of $5 vs $10 over a 5 year period.
Cheers,
sisProperty Value
$110,000.00 Property Value Year 1
$121,000.00 Property Value Year 2
$133,100.00 Property Value Year 3
$146,410.00 Property Value Year 4
$161,051.00 Property Value Year 5Rental Increase @ $5 (every 6 months) ($5 x 26 weeks)
Year
1st 6 months
2nd 6 months
(jan- jun) (july – dec)1
$130
$260 (increase cashflow of $390 for the year)
2
$390
$520 (increase cashflow of $910 for the year)
3
$650
$790 (increase cashflow of $1440 for the year)
4
$910
$1040 (increase cashflow of $1950 for the year)
5
$1170
$1300 (increase cashflow of $2470 for the year)Over a 5 year period and the rental being consistently increased at $5 every 6 months, you would have collected an extra income of $7160
******
Rental Increase @ $10 (every 6 months) ($10 x 26 weeks)
Year
1st 6 months
2nd 6 months
(jan- jun) (july – dec)1
$260
$520 (increase cashflow of $780 for the year)
2
$780
$1040 (increase cashflow of $1820 for the year)
3
$1300
$1560 (increase cashflow of $2860 for the year)
4
$1820
$2080 (increase cashflow of $3900 for the year)
5
$2340
$2600 (increase cashflow of $4940 for the year)Over a 5 year period and the rental being consistently increased at $10 every 6 months, you would have collected an extra income of $14300
*****
At $5 Increase (real rental increase over 5 years)
now being realistic again, over a 5 year period and increasing the rental at $5 a week, every 6 months for the 5 years, in actual true fact, you have only increased the weekly rental up by $50 per a week, by the 5th Year
At $10 Increase (real rental increase over 5 years)
now being realistic again, over a 5 year period and increasing the rental at $10 a week, every 6 months for the 5 years, in actual true fact, you have only increased the weekly rental up by $100 per a week, by the 5th Year
Cheers,
sis** in next section, i will show why the market value or market apprasial for the property at $105,000 needs a very important apprasial of $130,000 (why $130,000 is very important as it unlocks the key to wealth, and being very conservative still)
ok.. dont ask me next how i came up with around $130,000 (its simply i play figures like this all the time, and i have my own formula for caculating, what figure is actually need, so that the property can be drawn down immediately to access equity, if the property is geared at all different LVR levels..
the actual true figure is around the following $129,629.37 but i have rounded it off to $130,000 to make my example much clearer and easier to understand…
now based on our example again, we are now into our 3rd year of keeping this property its current market valuation is roughly around…
$110,000.00 Property Value Year 1
$121,000.00 Property Value Year 2
$133,100.00 Property Value Year 3
$146,410.00 Property Value Year 4
$161,051.00 Property Value Year 5based on this information, i know that i can, go directly to the bank or my broker and tell them, that i want to draw down my equity to 90% of the new market valuation and still keeping in mind i have a debt of $105,000 still with my lender, its the difference between my debt and my new market valuation, its that equity i want in between, (as its the real equity that i can invest)
$130,000 * 90% LVR = $117,000
remembering we have a debt of $105,000 orginally our true equity that we can access is..
$117,000 – $105,000 = $12,000 true equity and still were within our 90% LVR
now also keeping in mind, if we had been, saving our collected extra rental income, and not looking at any other collect or save income…
we have also the following funds we can invest…
Rental Increase @ $5 (every 6 months) ($5 x 26 weeks)
Year
1st 6 months
2nd 6 months
(jan- jun) (july – dec)1
$130
$260 (increase cashflow of $390 for the year)
2
$390
$520 (increase cashflow of $910 for the year)
3
$650
$790 (increase cashflow of $1440 for the year)Over 3 years, we have the following extra funds that we can invest… $2740
*****
Rental Increase @ $10 (every 6 months) ($10 x 26 weeks)
Year
1st 6 months
2nd 6 months
(jan- jun) (july – dec)1
$260
$520 (increase cashflow of $780 for the year)
2
$780
$1040 (increase cashflow of $1820 for the year)
3
$1300
$1560 (increase cashflow of $2860 for the year)Over 3 years, we have the following extra funds that we can invest… $5460
*****
Going back to the information we know and have. we have 2 different amounts to invest, depending on how much you had increased your rent over that time and also put away in savings..
Approximate Funds we can Invest
$12,000 + $2740 (from $5 rental increase) = $14,740
or
$12,000 + $5460 (from $10 rental increase) = $17,460
Cheers,
sis*** more food for thought for the moment.. but ill show you now, how we are going to invest that money and buy more property very quickly but still very conservatively…
Hey SIS,
You certainly love the gearing to maximum levels!!!
There is a much simpler way to magnify returns from this investment by using an offset account when you consider the income earned being relatively high.
Couple this with your plan to gear as much as you can when equity presents itself and you can purchase additional properties in a very short period of time.
I think the negative cashflow position with each property using similar figures as the example would be a problem for some if they try to grow too quickly.
Robert Bou-Hamdan
Mortgage AdviserApproximate Funds we can Invest
$12,000 + $2740 (from $5 rental increase) = $14,740
or
$12,000 + $5460 (from $10 rental increase) = $17,460
****
from the 2 available funds we have above, and realisticly for myself, (knowing that my rentals are consistently being monitored and increased) i will only do the example on the funds of $17,460
our job now is to find another property, at roughly around $100,000 we want to invest $10,000 dollars as a cash deposit so we can have a 90% LVR (realisticly were still 100% and more geared) and we are on the assumptions that the closing cost for the property will be around 6%
** so in total, we need roughly an estimated figure of $16,000 to close our next property deal, we are also on the same assumption, that property is having an annulised growth of 10% a year
based directly on this information, we do find a property for $100,000, we purchase the property with our 10% deposit and use our extra funds to secure the deal.
we are still in our current 3rd year and only own 2 properties so far. Our new property we just purchased has gone up 10%
$100,000 * 10% growth = $110,000
we raise the LVR and drawn down the equity to 90% of the property’s new market valuation
$110,000 * .90% to realise new 90% LVR = $99,000
*****
$99,000 – $90,000 (orginal borrowed amount, due from our 10% cash deposit, from drawing equity from orginal property) = $9000
with this equity we now can take it across as new cash deposits.. and with our rentals being constantly increased and monitored, in our 3rd year, we have managed to buy 2 properties, have a redraw facility of $9000, plus we still have our 4th year, were both properties can increase at a growth rate of 10% each, from this we should be able to buy another 2 properties in that 4 year (on the assumption the properties are being purchased at around $100,000 with 10% growth annulised)
based on that caculation (and cause im sick of typing now… lol and its mothers day)
we should have bought 4 properties by our 4th year of purchasing, that very first property, but by using effective money management and investing in areas of 10% growth..
.. you can have a guess.. how many properties we should have by our 5th year and investing conservatively….
Cheers,
sisps.. anyways.. this is all based on assumption, and future figures could be wrong, as growth can change and same as rentals, but also, in the examples used, such expenses and other fees for property keeping and management were not used.. but as an easy guideline, ive taken out those figures.. yet remembering…
… we never once acessed any monies, that were availabe from the person in our scenario… who was earning a very nice income of $80,000 a year… and could have invested in more property and funded all property expenses, such as what the rental.. could not cover…
Hello Robert, my evaluation is illustrated below:
Future Value of Property:
FV = $100,000*(1+7.5%) to the power of 5
= $143,562.91Capital Gain:
= $143,562.91 – $105,000 = $38,562.91
Net Return:
Property Sale Value less disposal costs:
Disposal Costs:
CGT = 50%*38,562.91*48.5% = $9,351.51
Agents Commission = $143,562.91*3% = $4,306.60
Therefore, the net return (cash in hand)
= $24,903.60= $24903.60/$105,000 = 23.72%
Regards
Antonio
Thanks Antonio,
That is a great example of more conservative calculations. I agree that taking the inflation rate out of the capital growth as it accrues is more prudent and the correct way to do it. I was going to do the calculation this way in the 4% growth example. It makes a MASSIVE difference.
I was also going to include something about the opportunity cost of the negative income position while holding this investment. A few less beers per week for some investors can be a deal breaker!
Robert Bou-Hamdan
Mortgage AdviserHi Rob,
thanks for your post.. it is maximum gearing.. probably more suited for a young couple not a couple in there 50’s and 60’s, but yes your correct, if we did put that excess and rental income into straight offset facilities, the equation, would be definetly be different and the return rate would be much faster.. and bigger.. and in all honestly, its something i would definetly do.. or may place it in the stock market.. (but again.. maybe better in an offset account due to the market violatility.. lol)
but what maybe i should address to everyone is.. because my exposure is 90% LVR or leverage (in the scenario), that this same caculation and portfolio growing can be done on an 80% LVR portfolio, minimising LMI fees and exposure levels, and depending on the investor, how conservative they want to be and there risk profile…
the advanatages of a lower LVR is, less exposure, but higher cashflow returns, yet lazy equity is sitting and doing nothing.. but its being risk adverse.. and safe guarding yourself..
well off now.. but.. its been an interesting morning..
Cheers,
sisHi There,
This is one of the deals I would never even need to do any figures on.
If I bought this sort of deal I would need my head read.
Cheers,
Byron SamByron Sam
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