Ok, being new to the game, I’m probably naively wrong, but can someone please explain where I’m wrong regarding my conclusions as follows:
I’ve been reading Steve’s blog, which is cool, and helpful. I cam across this dummy “Profit Plan” and summary:
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***Draft Profit Plan***
PROPERTY ADDRESS: 123 Smith Street
PURCHASE PRICE: $300,000
CURRENT ESTIMATED VALUE: $450,000
CURRENT LOAN: $210,000PROFIT STRATEGY: Growth (i.e. Capital Appreciation)
DESIRED GROWTH IN 2006: $15,000 (3.3%)
EXPECTED CASHFLOW IN 2006: -$7,000
NET RETURN: $8,000 (1.7%)It’s amazing, doing a simple statement like that allows you to see how your assets are really performing. That is, a 1.7 net pre-tax return is likely to be less than having your money in the bank, and there’s a lot more risk in holding bricks and sticks.
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Now I understand the whole point about making only $8,000 return for that givin the scenario. However, wouldn’t return also be judged by the fact that (at say $250 rent a week negatively geared), the tennant and tax man have reduced the loan amount by another $13,000, which has cost me (or steve) nothing. Shouldn’t this $13,000 be taken into account when calculating return?
A more ideal situation (in a negatively geared property) would obviously be where the expected cashflow is closer to $0, thus increasing the profit margin by a lot more.
Please, someone shoot me down, tell me how wrong I am, and explain how it happens in the real world, rather then uninformed theory in my head [blink].
Thanks so much,
DanielDaniel,
I am new to the game as well, but here is my take on what you have said.
The difference between buying the mentioned property as compared to putting the money in the bank to me is:
* First you would need to come up with the $$$ to put in the bank, if you borrowed money to put in the bank, the interest rates on loans are always higher than interest paid for savings, therefore making a loss.
* $8000 nett return means roughly $150 a week extra cash in your pocket, which can then be used to further your property portfolio.
* Buying further properties of the same sort would mean $150 times the number of properties you own, and it all just multiplies from there. Once you get the first few under the belt, you have more available cash for borrowings, increased equity etc, meaning that you actually do not have to outlay limited amounts of your own cash to make $150 a week per property.If I could find a property offering $150 a week or $8000 pa return then I would be doing my DD in regards to area, rental market etc, that is a good return.
I am not sure if I have answered this too well, but it makes sense to me, anyone else please add to this, as like i say I am a novice, but just my 2c worth.[biggrin]
FATMAN
I assume the property is negatively geared on an interest-only loan. The rent-shortfall is costing the owner $7000 per annum. The only ‘profit’ in the scenario is the capital gain of $8000 for the year, which as explained, is a pathetic return on investment, although I would consider this a 3.3% return (8/240) rather than 1.7% (8/450).
Cheers, F.[cowboy2]
Originally posted by foundation:I assume the property is negatively geared on an interest-only loan. The rent-shortfall is costing the owner $7000 per annum. The only ‘profit’ in the scenario is the capital gain of $8000 for the year, which as explained, is a pathetic return on investment, although I would consider this a 3.3% return (8/240) rather than 1.7% (8/450).
Cheers, F.[cowboy2]
Hi foundation,
What makes you think it’s on an Interest Only loan? I understand that if it was, that the only ‘profit’ would be capital appreciation, but if it was a normal loan, wouldn’t ‘profit’ also include the amount which has been payed off the loan by the tennant and tax man? [glum2]
Firstly, that Steve’s scenario doesn’t make any sense otherwise, and he’s usually pretty thorough. Secondly because it’s clearly defined as a “PROFIT STRATEGY: Growth” rather than “PROFIT STRATEGY: Cashflow” or income… If I were assessing the value of a P&I investment, I’d certainly consider all income net of costs to be the return.
Anybody else have any thoughts? I don’t want to find I’m leading Dan up the path, and I may well be, because mainly I’m distracted by a memory of a decent cafe that used to be at 123 Smith St, Fitzroy…
F.[cowboy2]The cashflow return should be calculated on the the equity or cash put into the deal, in this case $90K plus stamp duty and other expenses. The cash on cash return is not so bad if you look at it this way. If the property is really worth $450K and it was purchased for $300K it doesn’t really matter what the cashflow is anyway, you would flip it.
Regards
AlistairYou’re probably right foundation… I’m just trying to grab hold of these concepts. If it is an interest only loan, the calculations make sense
… however, if it was a normal loan, i would have thought the hole which the tennant and tax man are burning in the amount owing (along with the calculated return) should definately be taken into account. I’m guessing that, in that scenario, that the goal would be to pay the loan out, and own a fully CF+ property, with only ongoing overheads to pay, and all rent to collect?
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