Hi ppl,
I am currently reading Steve’s book and I am confused about a few points:
– I am a little stumped as to why he has divided the Annual net cash flow by the Initial cash needed to obtain a Cash on cash return figure. The initial cash needed is no longer yours right? (unless you assume that the price of the property will at least remain constant) This money is gone forever if we do not rely on capital growth. This is far different from putting say $20000 into a savings account and getting a return of 6% since your initial outlay of $20000 (which you would normally spend on ur deposit on ur home) is redeemable. So my point is what is the point of this CoCR figure if your initial outlay is no longer yours and according to the book you cannot rely on capital appreciation.
– It seems to make your property portfolio grow u need to have enough money for Deposits and settlement fees in the first place. It’s pretty hard to make this money just from the small income you receive from a positive cash flow property. The only way I can see that you will make enough money is to own a PC property for a while and hope that it will appreciate in value. Then sell this property to make a capital gain and this gain you can then use to fund more deposits for PC properties. Or does the theory go that you would use the equity of your first home to borrow enuff money for the full price of a 2nd property? Therefore you would no longer need money for a deposit?
It seems that this whole positive cash flow theory relies on Capital appreciation for it to work or am i wrong here.
Are my points valid or am I just talking out of my you know what? [biggrin]
I would appreciate it if somebody would shed some light on this. Thanks
EdHi Ed, welcome to the forum.
The money you put into a property has not gone forever; it is sitting in the property in some form – usually as a deposit. Of course, you can’t get at it all that easily unless you have a loan with a re-draw facility or if you sell.
The purpose of a CoCR is to find out what your investment return would be when compared to a deposit in a bank. In the case you mentioned; $20k @ 6%. Incidentally, a $20k cash deposit on a $100k property will easily kill any comparison on a bank deposit at 6%.
For example; the property under-performs and only increases in value by 5% per year for 10 years. By this time it is worth $150k. Assume you have also purchased a neg geared property, but it only costs you $10 per week AFTER TAX. At the end of 10 years your CoCR is:-
$150k (property value)
– $ 5,200 ($10 p/w out of pocket)
= $144,800
$20,000/$144,800 x 100 = 13.8% per year approx.In comparison, the $20k bank deposit is subject to tax on the interest earned, and bank fees. The true CCoR would be struggling to keep up with inflation.
It is true you can’t rely on cap growth in any property, but with experience and careful selection you can virtually guarantee it in the future. Historical figures prove that property goes up, on average, 7-10% per year. This is only an average. You can do much better than that with the right properties.
I agree with you that to make your portfolio grow you need more than cashflow. You need some cap growth and/or debt reduction as well. Obviously, the higher income earners can accelerate their portfolio quicker, but someone on a lower income can still do well if they maximise the cashflow, cap growth and work at reducing debt/increasing equity all at the same time. This is a learned skill.
Once you have one property, your equity can increase through adding value, cashflow, tax returns, cap growth and debt reduction.
You can be ready to buy again in a very short time. Then you access the available equity to use as a deposit on your next property. Now you have 2 properties (hopefully well selected to maximise returns) gaining in value for you. Your wealth can grow exponentially if you don’t watch out!
There is no need to sell and then buy again – this can end up being fairly expensive due to selling costs and cap gains tax.
Cheers,
Marc.
[email protected]“we get sent lemons; it’s up to us to make lemonade”
Hi and thanks for that reply L.A. Aussie. Just give me a few days to absorb what uve written
[smiling]Just got myself into a negatively geared property recently – guess ill be broke for a while. By the way how does one access equity for their next deposit?
Cheers
Ededwardc2 wrote:Hi and thanks for that reply L.A. Aussie. Just give me a few days to absorb what uve written [smiling] Just got myself into a negatively geared property recently – guess ill be broke for a while. By the way how does one access equity for their next deposit? Cheers EdTo access the equity, you need to restructure your housing loan so there is a Line of Credit, or some form of redraw facility attached to it.
The new, or restructured loan, is based on the valuation of your property and the lender will allow you to borrow up to 80% (some will allow even higher but I don't recommend it; especially if your L.O.C is on your PPoR), minus any outstanding loans.
EG:-
Your PPoR is worth $300k.
80% of this is $240k. So the Bank will let you use $240K
You still owe $200k on the loan.
Your available equity that you can use is $40k for a deposit on another property (this will also have to include purchase costs which normally run out to approx 6% of the property purchase price).This principle can be applied across all you properties, but usually results in cross-collateralisation which many feel is a no-no. This means that the combined equity of more than one property may be enough to allow you to purchase again, but using only one property maybe you can't.
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