help with buying 2nd property! – part 2

Dear Shel,

Knowledge is power; miss-information is a killer The first step to buying property is to establish your buying or lending capacity. For those of you with un-allocated money from a super fund or another source this is easy. For the rest of us you will need to make an appointment with your lender and establish the limit of your lending capacity. Once you know how much you can spend this is often where the confusion begins. Almost every agent claims that their listing has excellent returns and growth; both now and in the future. An agent by definition is working on behalf of the vendor and thus cannot be trusted to give you a balanced opinion of the entire market. In many cases the reality is they don’t actually know. It’s amazing how many agents out there who have never taken the plunge as a first home buyer, let alone a second investment property. The same could be said for quite a few stock brokers and financial planners who don’t actually trade but are some how qualified experts to give advise to others. It’s a bit like trusting a car salesman who has never owned a car or held a drivers license. In Real Estate; when you do find an agent that is highly knowledge and has a national perspective their not exactly going to promote a suburb, town or city where they don’t have a listing to sell. The lesson to learn here is being careful who you listen to; knowledge is power and miss-information is a killer. What’s your strategy?If you want to build a stable and successful portfolio you need to have a solid strategy. Many people make the mistake of buying too many negatively geared investments where the rent doesn’t even come close to paying the interest repayments of the home loan.When you are considering buying an investment property you need to make your decision based on the calculator and not your heart. In other words, it is more important to ascertain the return on investment rather than the aesthetic presentation of the property.
Therefore, every time you look at a property you need to perform the following calculation Rent X 52 weeks (Annual Income)___________________________   = Return on Investment                     Purchase Price  Example 1 Purchase Price: $395,000Rent: $270 p/w $270 X 52 = $14,040
_________________ = 3.5% Return on Investment
$395,000 Alternatively you can secure a cash flow positive investment that will come close to paying for itself and in some cases generate a small income. Example 2
Purchase Price: $335,000Rent: $650 p/w $650 p/w X 52 = $33,800 _____________________ = 10% Return on Investment $335,000 The real danger in buying too many negatively geared investments is that eventually your lender will deny further finance. They will base this decision on your need to commit your disposal income to make up the difference in interest repayments and other outgoings such as rates, property management, insurance, maintenance etc. Whilst saying this it important to have a balanced portfolio. Positive cash flow properties are generally found in regional areas which usually don’t have as much growth as negatively geared investments in capital cities. Therefore if you are planning to buy 4 properties over a period of time, then your strategy should be to buy 2 properties with a return close to 10% in a regional area, and 2 properties in a high growth capital city with a return of 6%, which will give you an average return across your portfolio of 8%. In this way the positive cash flow properties will offset the negatively geared investments. When reading this, some of you will be asking yourself “well 8% is only going to cover the interest repayments and in the future maybe not even that what about the rest?” That’s where a tax depreciation schedule completed by a quantity surveyor comes in. If you own an Investment Property, you are eligible Under Division 40 & 43 of the Income Tax Assessment Act to claim depreciation on all Items of Plant contained within the property. Secondly, if constructed after 1985, an allowance of either 2.5% or 4% is applicable on the construction cost, depending on its start date.  When taking out home loans always opt for interest only. It is critical to remember that when investing in property your buying time, not real estate. To explain, based on property doubling every 7 to 10 years, a property bought for $300,000 today will be worth between $900,000 to 1.2 Million at the end of 30 year loan. Whilst reducing the principle saves the amount of interest you pay over a 30 year period, it again places a limitation of the amount of properties that you can secure within the same time frame based on the extra commitment. In other words, most investors that have 5 or 10 properties would not be able to physically continue to buy any more if they were to pay interest and principle on all of their loans. By always opting for interest only loans you will be able to buy a lot more properties within the same time and thus earn a lot more in capital gain. This one simple concept could be difference between retiring comfortable and ending up as a self made millionaire. Buying Checklist No matter what month or year; there will always be an area of Australia that will be a buyers market (i.e Sydney) and there will always be a sellers market (i.e Brisbane and Adelaide). Regardless of which market you are buying into you need to focus on suburbs which are low entry and stack up against the following checklist. 1) Ask an independent person’s opinion of the town, suburb, and street.2) Obtain data in relation to past quartly growth and median sale prices.3) Private and Public Developments (Check state or local government development website for details)4) Close to major shopping centre, good schools and other infrastructure that will attract good tenants to the area.5) Within reasonable drive of Major Arterial Highway & Public Transport leading in and out of city.6) Demand for tenancy (Obtain vacancy rate as a percentage.)7) Population Growth (Increased or Declined in the past & future predictions, check 2006 census for details) Employment & Industries to sustain demand for tenancy.9) Is there any work to be done on the property? (Structural or cosemetic)10) Obtain photos of surrounding homes and streetscape from the agent (If buying sight unseen)11) What is the land size in sqm (land appreciates, buildings depreciate)12) Current Rent13) Market Rent (If the property became vacant, how much would it rent for in today’s market)14) Year Built (Important to know for tax deprecation schedule)15) All outgoings such as Rates etc

Hi, some areas of concern here. Before you tumble headlong into alligator waters, CHECK CAREFULLY.

1) You should not have to borrow to pay off personal debt. This is not tax deductible. The bank will also NOT lend you for that purpose.

2) Your Adelaide PPOR now when it becomes a rental should be used to finance your next property which should have a yield of around 4 % A house in Adelaide @ $400000 should rent for around $320 per week. Don't bank on higher rental as it might not
be realistic. Your shortfall would only be about $300 per week to pay for the 2nd house. The 1st house already pays for itself.

3) What you'd be doing is to make the 1st house help pay for the 2nd. Say you buy House 2 for $400000. That puts you -ve geared for $20000 a year [a round figure to take in management, vacancy & other costs]
  a) this will give you a tax break of about $7000 while you rent interstate
  b) if you buy House 2 new, you get another $10000 depreciation in Year 1 That is another $3000 worth of tax refund.

If I were you, I'd buy House 2 with the view of making it my PPOR a few years down the track. Then when you sell House 1, it's
still your primary residence & you keep all the capital gains. You can then pay off House 2 [a free house to live in] or gear House
2 to fund the next investment property.

This strategy works – i stumbled upon it by accident when I had to work overseas to fund my houses!

Note that it works best when you are paying tax.

Be aware though that although you can still get "bargains" in Adelaide, we're coming off 6 months of red hot property sales. The price you pay for House 2 will be today's price, at the top. We don't know where the exact peak will be.

Whatever it is, your outcome will be good only if your purchase is sensible. so the due diligence is still what will win you something.

My post is very long because it concerns me that you're a fairly new investor. I hope it goes well for you.

Kum Yin