Hi All
I have a couple of properties for capital appreciation purposes but soon want to build up my portfolio with cash flow properties.
I have a query. I have been reading Steve Mc Knight's book "$1,000,000 in property in one year". He states the following on page 115:
"You may be wondering "why didn't you just refinance to assess your equity instead of selling?" Well, we wanted to avoid over-borrowing for two reasons. First, substantial debt places you at the mercy of rising interest rates and second, lenders become nervous around highly leveraged property portfolios. In order to secure ongoing finance to fund expansion we needed to borrow no more than 80% of the purchase price, while also being able to show our improving financial position on our tax returns." On page 121 he states that he "funds acquisitions using recycled profits rather than debt" and, in relation to two people he helped he advised that "by using recycled profits they would avoid having the noose of higher risk associated with too much debt".
I am a bit confused. From what I have read on some of these property forums it seems that the popular way to do it is to buy the IP, renovate it to improve the capital value, then use the equity created by the improvement to buy a new property. Which seems to be what Steve advocates against.
So my question is this: do you agree with Steve on this point? What do you recommend as the best way to get the deposits for each new IPs? If you think the way to go about it is via the equity created by capital improvements, how do you avoid the risk associated with doing this?
All responses welcomed and thanks in advance,
Leilah
There are two schools of thought on that:
1. sell the property and take the cash profit and use this as deposits on more properties, thus minimising the debt. This improves the LVR (Loan to Value Ratio) and the cashflow, but the R.O.T (rate of return) drops with more cash used. The good news is that the more cash is used, the better the chances of finding a positively geared property.
2. access the increasing equity to do same as above. no cash is needed in this option.The problem with option 1. is when selling the property there are selling costs and CGT, which eat up a good chunk of your profit and then there is the trauma involved with selling the property.
The problem with option 2. is you can only access a certain percentage of the equity and because there is no cash involved, the rent return may not cover the interest payments on the higher amount of borrowed funds. The good news is you can keep acquiring properties with little or no cash and increase the portfolio and widen the base of wealth, and your R.O.T can be very high.My personal view is if you can obtain properties that are CFP (this is more difficult to do in the current climate but can be done) then it is better to go with option 2. Buy and never sell is my philosophy.
The problem with creating equity with capital improvements alone is you need to be very careful about costs, time and the state of the market. Many people try to do this and end up only adding the same amount of value to the property as the cost of the improvements.
A well selected property in an area with good cap growth prospects will increase in value anyway.If you manage your debt well and don't get too over-exposed with high LVR's, having more debt is not an issue, as all the other factors are contributing; rent, cap growth, tax deductions etc.; you simply add more zeros.
For example, if you have one property worth $200k with an annual 8% cap growth rate, and 7% rent return, on 7.5% loan interest, LVR of , say, 60% then there is no difference between that and if you had 10 properties all the same and it is a fairly safe position of debt relevent to equity.
Hi Marc
Your response was very much appreciated. I think I am going to print it off and have a think about it. Everything you say makes a lot of sense.
Thanks a lot for your help,
Leilah
L.A Aussie wrote:There are two schools of thought on that:1. sell the property and take the cash profit and use this as deposits on more properties, thus minimising the debt.
This is also the only true way to 'lock in the value' or 'withdraw equity' without exposing oneself to the possibility of unattainable valuations which can become very problematic in future. I've posted examples of this before (people unable to sell their house/unit for the price they 'need' having borrowed against it).
Personally, I'd prefer to own $500,000 of unencumbered property assets than $6,000,000 of assets with $5,000,000 of debt. If house prices do double every 7 to 10 years (I don't expect them to), why would I need $6 mill of assets anyway? My $0.5 mill will return $500k over period one, $1 million over period 2, $2 million over period 3… and by that time I'll be retiring in extreme luxury. If the capital gain is lower than this, I'll retire with less luxury, but I'd suggest more than I would have if I was trying to carry many millions of dollars worth of debt…
I would rather keep the property rented out and sell in retirement or if i really had to. The loan would be interest only and fixed. At least by keeping the property you are still gaining capital growth whilst also using the equity to buy other investments. I would only advocate selling IP properties in order to pay off your PPOR (bad debt). CGT and agents commissons drain profit from the deal.
Personally, I'd prefer to own $500,000 of unencumbered property assets than $6,000,000 of assets with $5,000,000 of debt. If house prices do double every 7 to 10 years (I don't expect them to), why would I need $6 mill of assets anyway? My $0.5 mill will return $500k over period one, $1 million over period 2, $2 million over period 3.
If your are not leveriging the banks money you will take much longer to build up a substancial portfolio if property goes up say on average 10% PA then 10% of $500,000 is $50,000 as aposed to 10% of $6,000,000 $600,000 no guessing on which option makes you richer.
I'm of the view that your investing "style" really depends on your personal situation, taking into consideration issues such as time, cash flow and family. What works for one person may not suit another. Also as your experience increases you tend to broaden your investing style. So I'd suggest you start small, keep reading and researching and take steps as and when you feel appropriate.
James007 wrote:If your are not leveriging the banks money you will take much longer to build up a substancial portfolio if property goes up say on average 10% PA then 10% of $500,000 is $50,000 as aposed to 10% of $6,000,000 $600,000 no guessing on which option makes you richer.Psst! Have you back-tested your theory with historical data?
James,
Don't get him (Foundation) started on the data and stats! He IS the king.
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