Hi,
My partner and I are looking to build up a property portfolio over the short to medium term, with a view to eventual retirement – probably a situation many fellow forum readers are in. We are looking for everyone's thoughts on what the ultimate arrangement for a property invetment portfolio is. If you were to start from scratch (as we are), how would you structure your purchases, how would you finance your purchases, and why?
I understand a lot of this is dependent on personal circumstances, so I will give you some background information on us.
– We are both 26 years old, and have relatively well paying jobs (around $80k/annum each).
– We have purchased a $600k PPOR inner city house 12 months ago, and will be turning this into an investment next month (rent approx $560/week) – this has had little growth in the past 12 months, so is probably worth the initial purchase price. We had thought we would move back into this within the next 6 years to ensure PPOR status.
– We are looking to purchase another property (IP – around $600k inner city Melbourne, rent approx $550/week) in the next couple of weeks.
– My partner works for one of the big 4 banks, hence we have been able to have only a 10% deposit with no LMI. We will be using this arrangement for our next IP – of course open to new ideas from others as to better ways to do this?
– If we purchase this 2nd IP, we will have property worth $1.2M and debt worth $1.1M – quite risky, but given our ages we are comfortable having a risky portfolio in the short term to hopefully build some equity.Given our goal of having children in approx 4 years, meaning I will likely be working part time on/off for a few years at this time, what is the best structure for our IP purchase, and any subsequent purchases? I have read a number of the posts on trusts, and these interest me – however up until now we were planning on just purchasing property's in both our names for ease of obtaining finance, servicing the loan etc.
Note, our strategy is to buy quality inner-city property's, as close to neutral/positively geared as possible (ie/ 3 bedroom property's to boost the rent etc), and hold these long term. Given our ages, we figure if we can buy 5 such properties in the next 5 years, and manage to service the loans on these properties, by the time we are 40 or 50 they will have appreciated in value. We are not too concerned with any short term fluctuations – of course apart from the fact this will constrict us in obtaining new finance.
We would love to hear any thoughts, comments, suggestions or other views.
Thanks,
Fi
Hi Fiona, welcome to the forum. Great that your planning your financial future. You stated that you intended to move from your PPOR soon to make it an IP. No problems there, lots do it. However, where do you intend to live then and what sort of rent will you be paying?
According to an online mortgage calculator:
Your new planned IP
Loan $600,000
Say 5 .25% (interest only)
Weekly repayments of $605.
Rent of $550.
So instantly you have to come up with approx $200 per month for each IP plus I presume your rent.
Buying in the inner city will mean an older place with more maintenance and few deprecation right offs. Maybe limited room for extension or improvement to increase value.
You could certainly pull it off on your current income but your backed into a corner with minimal growth for a while ?who knows how long.
Why not plan for something smaller initially. I'm sure most people do. We did.
A first IP of that value in relation to your income is huge.
Your debt to value or loan to value ratio wolud be significant and may hamper future lending until there is signficant growth in the market.
Use a separate lender for each property, it becomes really messy later on (believe me)
Good luck.Hi Lalibella,
Thanks for your comments. I know we are looking at a very large investment (and debt). One of the reasons for this is that we are very fortunate to be able to live rent free for the next year or two (my parents are moving overeseas and would like us to look after their home).
Hence, we will need to come up with approx $400 per month to cover the shortfall on 2 IP's – that's $200 per month for myself, and $200 for my partner. Given the no rental expenses, and our relatively high incomes, i think we should be able to cover this cost. We also aim to keep an emergency fund of $10k for anything that pops up unexpected (do most people do this?).
As for why we are looking at inner city property's – we know the melbourne market quite well, having already purchased a property, and prior to this rented a property within the same suburb. Hence, i guess there is a 'comfort' factor for buying the IP there – we know the tight rental market, and feel confident we can rent out our first property well, and any subsequent IP's.
In addition, we have found looking at property under $500k (and even higher than this) we are up against huge competition – first home buyers. We have seen many houses in this sub $500k bracket go for much higher prices, as first home buyers are 'desperate' to purchase, and many are purchasing with emotion. We are keen to avoid this bracket (although at the $600k price point, we will still not completely avoided this).
May i ask why you suggest using a different lender for each property? Also, is the best set up to have an interest only loan, with an off-set facililty so as to build up 'accessible' equity to use for the next purchase?
Thanks,
Fiona
Lalibella,
you don't need to use different lender for different property,, you just need to structure it properly
(i.e. one loan against one property.. not X-collaterised)Fiona… I think it is a bit ambitious with the 2nd IP of 1.2 million… remember GFC is not ending yet… may be just the beginning of the crisis…. the full impact is till next year when unemployment hit 8.5%.
Hi Fiona, rent free for a year or two!!! Good for you and what a great opportunity to get the ball rolling.
Firstly :
"Given the no rental expenses, and our relatively high incomes, i think we should be able to cover this cost. We also aim to keep an emergency fund of $10k for anything that pops up unexpected (do most people do this?).Yes as I stated before that amount would be achievable on your current income.
A few questions. ( you don't have to reply
Do you have any other significant debt? Credit card, personal or car loans?
Who pays the rates / maintenance / utilities on your folks home while they are away? (lucky buggers, good for them).
Emergency fund. Yes, many people have it in the form of cash or a line of credit. Absolutely essential and its good insurance for hot water services, leaking roofs or anything. This amount should increase in proportion to the amount of properties that one has."Hence, i guess there is a 'comfort' factor for buying the IP there – we know the tight rental market, and feel confident we can rent out our first property well, and any subsequent IP's.''
Probably a common reason to invest in a particular suburb that you are comfortable with. Nothing wrong with that, just very limiting. Particularly if the properties are 500k plus.
"In addition, we have found looking at property under $500k (and even higher than this) we are up against huge competition – first home buyers. We have seen many houses in this sub $500k bracket go for much higher prices, as first home buyers are 'desperate' to purchase, and many are purchasing with emotion. We are keen to avoid this bracket (although at the $600k price point, we will still not completely avoided this)."
I'm aware of what your saying but its still not a sound reason to base your investment decision on. there are bargains everyday, everywhere. As your aware the FHOG will be wound back later this year so this will not be an issue."May i ask why you suggest using a different lender for each property?
Its called Cross Collaterization and its a trap for young players. Richard, help me out here please?
Go to Qld007 web site and look up Richards reason against CC. Very convincing arguments. Were attempting to unravel our CC finances at the moment. A night mare as the bank 'owns us" and we can no longer get finance with them. Actually not enough for our needs. Any bank, regardless of your partner being an employee will limit their exposure to you eventually.Also, is the best set up to have an interest only loan, with an off-set facility so as to build up 'accessible' equity to use for the next purchase?"
There are several schools of thought for IO and P&I loans. We have a mix of both, suits us for our particular circumstances. IO loans free up a bit of cash to service other loans, however that has to be considered against the principle not decreasing and gaining less equity.
We have an offset account, works for us.So, a few thoughts. You guys are young and you may want to travel. The bills still have to be payed.
Babies can happen anytime since finding the cause…..
Fiona, I would highly recommend that you continue to read widely in relation to Real Estate. Any Aussie author is worth reading.
Do your subscribe to Australian Property Investor? A great read. I'm currently reading a book by the Reno Kings. Stories unlikely to be replicated anytime soon though.
Finally talk to at least one or two Mortgage Brokers, preferably one with an IP.
As I said before, locking your self into so much debt so soon may not be the best option. It could reduce your borrowing capacity if capital growth is stalled.
Just my thoughts. I'm no expert, so ask lots of questions.
Good luck.Thanks God of Money for the clarification.
In retrospect I would have preferred a separate bank for each property. Much cleaner. Will be soon….Fiona, looking forward to buying the properties off you for a bargin, when you go broke in a few years.
Have you got your rates fixed? What will you do when the interest rates go back up to 8-9% in 3 yrs on 90% LVR. Scary!!
Loan $600,000
Say 8.5% (interest only)
Weekly repayments of $980.
Rent of $550.Aprox $1730/mth, then other costs. For 2 properties, $3500 + all costs.
"5 of these in 5 yrs". Clueless. The kind of people we see on Today Tonight crying about the big bad banks taking their homes.
And the interest rates will go even higher than that with the amount of money governments around the world a spending.
Haha, little growth over the past 12mths, hehe. So you've already caughed up $32K in interest alone, and you call that investing. Prepare for little growth for a bit longer at that price range.
Lalibella, thanks for your constructive feedback. You obviously know your stuff. I do subscribe to Australian property investor, and I am starting to read a number of property investment books… i will look out for the Reno Kings book you suggest.
In particular have noted your comments regarding reducing future borrowing power. If we were to pursue this second IP purchase, we will definitely look to limit all risks (ie/ lock in interest rates at current low values, take out landlord insurance) – although we do recognise some risks will be out of our direct control (ie/ a rise in rental vacancies).
Any further constructive feedback or suggestions would be appreciated.
Fiona, your risks are more than just a rise in interest rates & vacancy factors. The rental market has performed strongly over the past 2 years with yields rising dramatically – this is not sustainable (for renters), expect lower yields hence lower rents especially if you are anticipating that property prices to rise. Those who watch property watch all factors and understand that yield and house prices travel in opposite directions – you may not have seen this yet in this cycle with extraordinarily low vacancy rates however as the market turns yields will drop and rents will stagnate.
Fiona, are you also factoring in on the (rent approx $560/week) management fees of 8-9% =$515.
Even if you fix, it's at just under 7% now, and fixed rates will just rise from now on if you wait (5 and 10 yr bond yields are rising), so the fixed rates will as well.
Loan $600,000
Say 7% (interest only)
Weekly repayments of $810
Rent of $515
= 1200/mth + all other costs.The point is that it's clear that you have not even done a basic calculations. "Note, our strategy is to buy quality inner-city property's, as close to neutral/positively geared as possible"
This seems to go against your "actual" strategy of being highly negitively geared.??
560/wk rent on 600K is 4.85% rental yield.
7% fixed interest rate + 2% holding cost = 9% = Very negitively geared.Where do you get neutral/positively geared from ??
Most investors even in a booming climate would be thinking twice about 90% LVR (some buffer in cause of unexpected emergencies). Most investors in a recession would tell you they are comfortable with a max of 70%.
Personally, we are waiting till early next year to buy the next IP (after all the FHB frenzy is over), and are sitting on a comfortable 41% LVR waiting to pounce with 2-3 more investment properties in the next 12-24mths. There will be plenty of distressed FHB in 12mths.
Yes and we are on 200K combined income. Damn, 1.1million debt with 90% LVR in these conditions. Good Luck!!Also, if you parents are away for 2years, where will you live after that?
Fiona,
There is an old saying, "set peace of mind as your first goal – and build your life around that".
Best to grab a hold of Steve' s latest book /CD and really soak it up. At your age and your current combined income levels all you need is a plan. A plan that will not cause financial stress and one that embraces unforseen changes within the economy with contingencies set.
As Investor888 stated above, "Damn, 1.1million debt with 90% LVR in these conditions".
Best Wishes
"We are looking to purchase another property in the next couple of weeks."
I'm curious Fiona. Did you end up getting the 2nd investment property?Fiona, first of all I'd say that it's great to see that you're planning your financial future so early.
Don't let doom & gloom preachers deter you from executing your plans, but do you sue their challenges to ensure you have a robust plan and that you are well protected against the downside. I personally believe that Australian property will be an excellent long term investment, but in the short term the ride might get tough as interest rates will go up in the next 1-2 years and maybe quite fast. Lending criteria will continue to remain tight and property values will not rise anytime soon, but I don't believe they will drop far or fast either (except in the top end of the market where we have already seen this).
Instead of going for the $500k bracket in which you're comfortable spend some more time doing research into up and coming growth areas and consider buying something in a lower price bracket but with plenty of potential to add value. This is not a time to overstretch and if you've read Steve's books he's given some good tips about what level of LVRs you should have during different times of the economic / property cycle.
Also, have you established a 6 month emergency fund which can keep you going if for whatever reasons you encounter a reduction / loss of income (e.g. job loss) or major unanticipated costs…really a basic requirement in your financial plan especially in the current environment.
Hi, Fiona
Here is what I think.
You will have to factor in low capital and rental growth for the Melbourne market for the next few yrs on a worst-case scenario, and also considering if you and your partner can handle a 2% increase in interest rates over 2010 and 2011. While it looks affordable to hold onto a negatively geared property now with interest rates at a 49 yrs low, it will go back up again in by next year for sure.
What sort of investment strategy are you looking at? Any renos involved, or are you buying near new? This will affect depreciation.
Investment vehicle – Trust or personal names? Say if you decide to start a family and you go off work for a while, any negative gearing still has to be split between the two of you. With a lower income, the benefits are less too.
Considering your combined incomes of $160K, your emergency fund of $10K is small. I agree with one of the other forumite in that you need to build up a personal emergency fund to cover 6 months living expenditure. Also, would recommend a reserve investing fund of at least 6 months to cover your IP payments, with this reserve eventually building up to 1 yr. Job loss is always a possibility in this current economy.
Buying 5 IPs in 5 yrs at over $500K each will strain your servicibility. Perhaps you want to consider a slower rate of accumulation. Not to say what you want cannot be achieved, but it is more of a case of how much sacrifice.
Regards
Daniel Lee
Do you have any other significant debt? Credit card, personal or car loans?
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