Hi everyone,
Short time viewer, first time poster!
Just need some motivation for making the next move in the property game. Here is my current arrangement.
Have a PPOR with a P&I loan owing 209K, the property is worth about 275K (loan repayments is $330 p/w)
I have just been approved a loan for about 300k for an investment property (including costs as I have no deposit)
I live in Melbourne and want to buy a IP in or around my home (Ringwood) or within the eastern suburbs closer to the city. I know there is no crystal ball but I can't decide if I should buy a 1 bedroom apartment very close to the CBD (eg Richmond) or buy a 2 bed unit in my home area. Both of these types of properties I have looked at are quite old and built at least 30 years ago. (little bit worried about future levies from the BC). Doing some rough sums either one will cost me aboout 150-250p/w to hold (neg gear).
Just wondering is this normal? Do people but properties and pay this much to hold each week? I take home about $700 p/w so I will be highly geared but have my partners income to help with living expenses.
I know the rent will increase over the years but how investors make them positive or neutral if they use investment only loans?
repayments on 300k are about $500p/w. I can't see either of these properties gaining that for a long time. My goal is to buy and hold for at least min 10-15 years.
Is there investors who use P&I loans for their IP's so they can also gain equity and pay less Interest on the loans?
Does anyone see it a problem if I keep buying IP's in just my name? as I earn more then my partner (about 60k per year) as I don't really understand trusts and other options.?
I guess I just need some opinion on what to do next, I want to buy as many properties as I can and not scared of debt or neg gearing.
Thanks for any help guys!
Welcome VI!
I would highly recommend reading some books on property investing over the next month or so. Things in the property market tend to get a bit quiet over xmas, so it won't set you back much time-wise or money-wise. The knowledge you gain will be more than worth it.
There's a good choice of books by Australian authors around. Read a few. This way, the opinions that you base your investment strategy on will be yours. Knowledge is power!
Daedalus
If you are a cashflow investor you wouldn't touch either of them; especially with little depreciation left on the bulding and fixtures/fittings. but if you're not scared of neg gearing, then go for it. just try and buy the best property you can in the chosen area. his doesn't mean the best condition; it means best for position, add-on value potential, depreciation, rental demand etc.
If you are a cap growth investor, you need to ask yourself f the areas are going to boom soon, are they booming now, has the boom ended etc.
If the prosepects for either scenario above are not good, then find another area that you can afford that will give you better cashflow, better tax benefits through depreciation and better cap growth.
You may do better by looking further afield for a property with land that may have subdivision potential for adding more value. There are no BC costs with houses such as this, so the cashflow may be better.
virgininvestor wrote:Hi everyone,
I know the rent will increase over the years but how investors make them positive or neutral if they use investment only loans?repayments on 300k are about $500p/w. I can't see either of these properties gaining that for a long time. My goal is to buy and hold for at least min 10-15 years.
Is there investors who use P&I loans for their IP's so they can also gain equity and pay less Interest on the loans?
To the last question – sure there are. Here's a quick example of why some people choose P&I.
Scenario:
- $300k purchase price
- 100% financing @ 8.5% over 25 years
- 4% starting yield growing in line with inflation at 3% pa
- 30% tax rate
The weekly cost for P&I is initially $73 higher than IO, and this rises over time (at a rate slightly above inflation because only the interest portion of the loan repayment is deductable). However, at no time does the cumulative benefit of tax relief exceed the benefit of reducing the outstanding principal amount and the resultant decline in interest costs (all principal payment effectively compounds over time).Note that 'Net Equity after Costs' is poorly named. It is actually as follows:
cumulative rent
minus
cumulative cost of mortgage payments
plus
cumulative capital payments
plus/minus cumulative tax deductions/additionsNote also that no consideration has been given to capital gains. The very simple reason for this is that it does not change the dollar difference between the outcomes, only the dollar value. After all, the two examples are for the same property. So if the value of the property is $600k at 25 years, the P&I investor would have a net equity position of $303k (up from $3k if zero capital gain), the IO investor a net equity position of $160k (up from negative $140k). If the property was worth $1 million after 40 years the P&I investor would have net equity of $1.03 million and the IO investor $619k.
I could have stuffed up the maths*, but it looks to me like P&I is a perfectly sensible option. I suspect many people who advise (without exception/caution/consideration) IO loans for property investment are either mortgage brokers trying to maximise their trailing commission or other investors who have been duped by such mortgage brokers. This is not to say that there are no situations where IO loans would be preferable to P&I. Sure there are, but investors should not simply assume that IO is best for their situation.
Cheers, F. [cowboy2]
* If I have, I'd very much like to know where and how (to save embarrassment!).
Nice graphs F,
Only a couple of points to add:
You can still pay off the principal if you have an IO loan. Your reasons not to do so may include:
1) your desire to deploy that cash into other investments, perhaps leveraged. If these investments are successful then the money will have worked harder for you. Also, there's a lot of accumulated cash flow between those two curves – at least $50/week. If you compound that quarterly at 4% over the 25 years you end up with $111,921 in cash. This should not be ignored.
2) affordability. i.e. you can afford the IO repayments but not the P&I repayments.It comes down to your risk profile and your investment strategy. Note that the x-axis is in years, not months.
Daedalus
Daedalus wrote:Nice graphs F,
Also, there's a lot of accumulated cash flow between those two curves – at least $50/week. If you compound that quarterly at 4% over the 25 years you end up with $111,921 in cash.Much more than that actually. But wouldn't it be easier to chuck it into the loan for 8.5% compounding (minus the lost tax refund) than to keep it out chasing a 4% net return?
As I said, P&I isn't the best decision for everybody. I'm just surprised at the blanket assumption that IO is!
More indeed. It pays to understate.
The 4% was not intended as an attractive alternative, but as an indication of the effect of that cash compounding in other investments. Of course, if you can't do (significantly) better than the 8.5% with the cash, you'd be nuts not to pay off the principal.
Daedalus
Daedalus wrote:It comes down to your risk profile and your investment strategy. Note that the x-axis is in years, not months.But which one would have suit a high risk profile investor? Which option carries the highest risk? Sure, I've charted years, but it doesn't matter – the net position is always in favour of the P&I investor.
The only obvious way I can see for regular people with just a couple of IPs to benefit from IO loans is if they put all the savings generated by using IO into paying off their non-deductible debt first, then switching it back to P&I for the investments. That would require a fairly high degree of discipline. And it raises the question of whether they would be better paying off their non-deductible debt before buying negatively geared speculative investments…
Cheers, F. [cowboy2]
foundation wrote:But which one would have suit a high risk profile investor? Which option carries the highest risk? Sure, I've charted years, but it doesn't matter – the net position is always in favour of the P&I investor.
The only obvious way I can see for regular people with just a couple of IPs to benefit from IO loans is if they put all the savings generated by using IO into paying off their non-deductible debt first, then switching it back to P&I for the investments. That would require a fairly high degree of discipline. And it raises the question of whether they would be better paying off their non-deductible debt before buying negatively geared speculative investments…
Cheers, F. [cowboy2]
You appear to have assumed that I'm promoting IO over P&I. Not actually so. I'm suggesting that people explore the various impacts of how they allocate their capital.
BTW For clarity, my position is that IO is higher risk, because the IO investor is betting that they can get those significantly-better-than-8.5% returns. This would typically inolve further gearing, which increases the risk.
The question of paying off non-deductible debt is an interesting one. Haven't done analysis, but since property investment (from my perspective) is largely about reaping the benefits of compounding, time is required. The longer you leave it, the less time you have, so the less compounding etc. The hare and the tortoise come to mind.
Ironically enough, I had paid off all non-deductible debt before swinging into property investment. I wish I had started sooner. The real secret to success is time.
Daedalus.
There is no correct answer to your question; however there are several options that you should be aware of in order for you to make the correct decision for your future plan.
Here are a few of my thoughts on reading this post.
I have just been approved a loan for about 300k for an investment property (including costs as I have no deposit)
It doesn’t matter a fig how much the Banks will advance you when calculating your future plan, it is best to work on the figure that you can afford to contribute annually to your savings/retirement portfolio. That is to say that if you can only afford to contribute $5,000 a year or $100 per week then you need to find the property that will provide that short fall. Don’t put you neck in a noose relying on the fact that rents will rise and you may earn more next year, this is a sure recipe for disaster. What if interest rates rise, rents don’t go up or you don’t get the pay rise? The people who have trod this path in the past are the ones that tell you all of the short comings of property investment.
There are programs available that help you to calculate rates of return and short falls. Jan Somers company puts out an easy to use Property Analysis called PIA.
Foundation gives the story on borrowing using the P & I method. While I am not about to argue the toss on this method, I would suggest that you look further into it. I believe that when you borrow P&I you limit your future borrowings due to lack of future serviceability. Perhaps a better way would be to opt for an Interest Only loan that allows for you to make an annual lump sum payment to reduce the loan value, this way you can achieve the same result but make the payments if and when you can afford them. I am not a Financial Adviser or a Finance Broker so you should make your own investigations to make sure that my statements are correct. If your future plan was to purchase only one other property then the P&I method may well be the way to go as this is the conservative method. However I believe that another way to make money is to borrow as much as you can afford to service and get other people to help you meet the interest payments (tenant and Tax man) while you accumulate the capital gain on the amount of money invested.
The best way that I can explain this is to share an example of one of my clients. He has (more or less) purchased a unit each year from me since 1994. Total cost of Purchases $3,273,000 with a book value of $5,340,000 (conservative). His annual rental income on these properties is $250,640. His Interest Only payments on $3,273,000 at 7.5% are $245,475 so he is actually earning $5,165 in rental income per year. The real kicker is what happens over the next ten years. Allowing for normal property value increases, his current portfolio will have a book value of $10,680,000, an annual rental return of $448,812 or which he will require $261,840 to service the debt leaving him an annual income of $186, 972 and a Portfolio with an asset value of almost 7.5 million.
JonI live in Melbourne and want to buy a IP in or around my home (Ringwood) or within the eastern suburbs closer to the city. I know there is no crystal ball but I can't decide if I should buy a 1 bedroom apartment very close to the CBD (eg Richmond) or buy a 2 bed unit in my home area. Both of these types of properties I have looked at are quite old and built at least 30 years ago. (little bit worried about future levies from the BC). Doing some rough sums either one will cost me aboout 150-250p/w to hold (neg gear).
It really depends on what reasons you are investing.
If you need the cash flow then these properties aren't going to be for you as you will be paying out of your pocket.
If you are investing to reduce your taxable income then they aren't really going to be of much benefit as the build cost of 30years ago were far cheaper then today and your depreciation will be minimal. Also the building can only be depricated for another 10 years so if you intend on keeping it for up to 15 years you aren't going to have any building deprection after that time. You are also going to limit your resale market to mainy home occupiers as most investors aren't going to invest in a property with no building depreciation value.
The only real reason to invest in these properties would be if this is the entry point of the property market in Melbourne is at this price and you forecast future capital growth on these properties. Inwhich you should study the growth rates in both these areas and make your decision based on which property will be of more value in the future.
But as mentioned by earlier posters read all the books you can and attend as many seminars as you can. There are numerous different investment strategies based on your needs.The simple issues here have somewhat covered. Understand what you can afford first and foremost. Cash is king and investing is no fun if you have no life. Secondly – do not waste time on an investment that you don't see growth in. Property does not have to be seen on a ten year return basis. Many groups will suggest this as it provides sufficient time to cover their lack of knowledge on market movement. A well researched property investment should provide returns in 12 – 24 months.
Hey everyone
Thanks so much for the input, I did not expect all the responses so quick and professional. Who needs accountants, lawyers, planners when I have you guys!!
Here is an interesting story about my adventures since the last post. I have been looking all over eastern Melbourne for an IP, as I was coming home last night I noticed a new for sale sign on a unit across from my PPOR (I actually view a unit in this lot before I brought my PPOR) I inspected it, had my building inspector through and have just made an offer tonight, after all the calculations it was thus far the most highest yielding and has great Cap Growth. So hopefully I will be successful.
After all I have read and seen I feel that P&I loans are more effective for IP's. It promotes forced savings (As i think many people will not add the amount of principal payments in a P&I loan into an IO loan) and it increases your equity whilst lowering the % rate. Also lenders will always offer less on IO loans because they can only look at it over a 25yr period and not 30yrs (as 5 yrs is IO) I found I was able to borrow at least an extra 25-30k on P&I giving me access to much better rental and CG properties, making me more money in the long run. Besides you are taking a big gamble that your IP will increase over time faster then the % rates and IO payments. I would rather be forced to pay $ 100-150 pw in principal payments because this can be redrawed whilst lowering your payments.
Thanks again guys for the help!
virgininvestor wrote:Hey everyoneThanks so much for the input, I did not expect all the responses so quick and professional. Who needs accountants, lawyers, planners when I have you guys!!
Just don't take anything here as gospel! I know you were just being complementary, but it's best to leave matters of law to the lawyers and matters of tax/finance/accounts to accountants unless you can confidently and reliably assess them yourself. You sound like you've been pretty thorough though. Good luck with the unit.
I'm genuinely surprised to hear the following:
Quote:Also lenders will always offer less on IO loans because they can only look at it over a 25yr period and not 30yrs (as 5 yrs is IO) I found I was able to borrow at least an extra 25-30k on P&I giving me access to much better rental and CG properties, making me more money in the long run.I thought it would have been the other way around! Can any of the mortgage brokers check and compare the lending limits of a single borrower for IO and P&I loans? Thanks.
With regard to your specific situation, because you have non-deductible debt on your PPOR this might have a bearing on the overall results of your IO / P&I decision. But forgetting about the PPOR and considering only the investment, I've drawn the same conclusion as you – the benefit of building equity exceeds the pain of paying a little extra. Note: This is not advice. Everybody should assess their own situation. But it works for me.
Cheers, F. [cowboy2]
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