Negative Gear or Cash Flow positive

Hi Sanjiie

We use positive cashflow properties to support our higher capital growth, negatively geared properties.  More specifically, we use Vendor Finance as our positive cashflow technique and utilise this cashflow to build wealth in our buy and holds.  Good luck.

Cheers,  Paul

Thats the strategy i'm looking at getting into. Using wraps to get positive cashflow to offset the negative cashflow properties that will be growing me my wealth. Then when those negative cashflows turn into positive I will have lots of positive cashflow and will be set.

Chris.

Sure! I've negotiated with the vendor to lend me $150K of the purchase price; what that means is that this amount is not payable at settlement but at some later time; in my case I've negotiated 1 year. So I've borrowed 85% or $510K, but at settlement I only have to pay the vendor $450K ($600K less vendor finance $150K). This leaves $60K over to pay for stamp duty, legals, etc, which will leave about $15-20K cash left over.

So settlement happens, and at settlement I'm $15-20K cash richer than I was the day before – but I owe the bank $510K and the vendor $150K. Effectively I've borrowed 110% of purchase price, and yes, after purchase expenses I have negative equity for a while based on purchase price ($600K less $660K = – $60K), but given that I'm comfortable that the property's worth $800K as a warehouse, I actually feel that I have an immediate $140K in equity.

The property rolls along for a year, with me receiving the rental income and paying the bank the mortgage payment on $510K, and paying the vendor an interest-only payment on the $150K. The rent is high enough to cover both payments. And tenant pays outgoings, so I'm pretty much even or slightly ahead at the end of the year – let's say that I have $20K in the bank.

On the one-year anniversary of settlement, I have to pay the vendor their remaining $150K. (That's what a balloon payment is – a lump sum payment of principal at the end.) My plan is to refinance against the value as a warehouse, and increase my borrowings to $660K – the $510K I've already borrowed plus $150K to repay the vendor finance – which is 82.5% of the valuation as a warehouse ($800K – or hopefully a little more if I also get some market increase).

By "no money of my own in" I mean that I had no deposit, and no negative cashflow. The property entirely funds itself.

It's a thing of beauty, isn't it?

Thank you, Boing, for your kind words.

Vendor finance… look, it is difficult to get on established property, no two ways about it. (Developers are quite likely to consider vendor finance, but I prefer to buy something that I can instantly manufacture equity in, and that's usually not a new-build.) I think it's just a numbers game. I made about 15 to 20 offers incorporating a vendor finance component without even a nibble of interest, and ended up posting to several forums very frustrated, asking "how the heck do you get vendor finance?", late last year. Then ended up getting a vendor who was very open to it! And they are relatively unsophisticated; not the type I had good hopes would be interested. You never can tell… In this last instance I think it was entirely due to the skill of the agent.

The main advice that I got was to try and meet with the vendor and agent face-to-face to explain how it works, because whilst there are good real estate agents around, unfortunately, there are a lot of them who simply don't understand vendor finance, or can't be bothered explaining it to the vendor. So many of them seem to think there's something shonky about it, and keep insisting that the vendor "only wants a clean contract". In my experience, if the agent doesn't believe that your offer is a good one, the chance of them presenting it to the vendor in a manner likely to lead to acceptance is near ZERO. If you don't get the feeling that the agent supports your offer, ask to meet with the vendor and agent to present your offer personally. And sell the benefits to them.

In my case, I eventually found a motivated vendor and an agent who completely understood vendor finance and believed that my offer was a good one, and she achieved acceptance for me – quickly, too! In fact I even went back and asked for a bit more vendor finance (about 8%) because I had "run some figures" and not quite given myself enough slack, and they agreed – in exchange for a 1% interest rate rise. So now I'm paying 9% interest on my vendor finance, and they think they've had a win – even though I would have paid 12%

Lenders… as I've said many times before, you need a good mortgage broker. My vendor finance is completely disclosed and my lender still let me borrow 85% for a total of 110% finance. (25% vendor finance.) Some lenders won't do this, but many of them take the pragmatic view that they have first mortgage anyway, so it really doesn't matter how much vendor finance is involved, provided the borrower is sound. (ie that they're not needing vendor finance because they are way over-extending.)

Good luck!

When I referred to 12%, I meant that you usually have to pay approx 12% for a second mortgage or vendor finance, and I was quite happy to pay this much interest, but the vendors accepted my offer of 9%.

History: yes, I started smaller, but let's say I climbed the curve pretty steeply as I gained confidence. I bought maybe 5 or 10 standard $200K-ish resi properties (sadly didn't hold them; sold them all before I got educated when I got sick of the drain on cashflow ), to a $720K resi property that I've developed to be worth $1.6M (my student accommodation in Spring Hill, outlined in detail elsewhere), and now this purchase. Fortunately my hubby has a very strong PAYG income and we are both comfortable with debt, so I'm proceeding aggressively. If you feel comfortable with it, there's no reason (in my opinion) why you have to do smaller deals. The larger deals may not be any more complex or require any more work, but have the potential for much bigger profits (and losses, conversely).

I do, however, now find myself in your situation: spare servicability but no deposit, which is why I sought vendor finance. Other options: 106% LVR lend (resi only), personal loan or credit cards for deposit (of course you need an exit strategy to pay out this debt ASAP), second mortgage.

And yes, if you can add enough value with a reno and pull out extra equity from another property, then of course that's an option. Just be careful to draw the equity out as cash and pay a CASH deposit for the new purchase, rather than using an equity deposit, which has the effect of cross-collateralising.

Good luck!

Good morning. Don't be embarrassed – it's difficult to draw the line between making the explanation detailed enough, but not overwhelming you! So when you want more, ask away.

The first issue is protecting yourself from litigation, divorce etc – as you say, "asset protection", and is a reason you don't want to be cross-collateralised.

If you use equity from one property as a "deposit" on the purchase of another, the two properties are said to be "cross-collateralised". Let's say that you're purchasing an IP, in a Trust for asset protection, but you use equity from your PPR as the deposit. Something goes wrong at that IP – tenant trips on ripped carpet and severely injures themselves, for example – they sue, and get a big judgement. The Trust's assets – the IP – are liquidated. Because the assets of the IP include equity in your PPR, your PPR will also be liquidated, so that the litigant can access that portion of the PPR that were used to buy the IP. You will get the remaining portion of your PPR in cash, if that's any comfort, but you've lost your PPR.

There may be an opportunity to refinance your PPR and pay out that equity in cash, but whether you could do this in this situation is not something you want to gamble on. Better instead to refinance your PPR NOW, take the cash, and apply it to the IP investment.

The other issue is limiting the lenders' access to your portfolio. There is a lovely little clause in every lender's mortgage contracts that's referred to as the "all monies" clause. What it says is that any money (or other assets that the lender has a claim on, such as properties over which they hold a mortgage) can be used to satisfy any debt with that institution.

So let's say that you have all your finances with one bank. You have a PPR mortgage, an IP mortgage, and a bunch of cash deposits. Let's say that your IP goes bad – perhaps it's destroyed and for some reason it's not covered by your insurance because you didn't have the right policy (could write a book on that alone). The bank forecloses, and they don't get enough money from selling the IP to cover your debt. So then they take all the cash deposits, and they still don't have enough. So they sell your PPR, too. Note that structures (Trusts etc) that may protect you against external parties such as litigants etc as outlined above, generally won't protect you from your lender, as they usually require "personal guarantees" for all mortgages, meaning that your personal assets can be used to satisfy the Trust's debts.

If you instead had cash deposits with bank 1, PPR mortgage with bank 2, and IP mortgage with bank 3, it makes it a little more difficult for the lender to get everything. Admittedly, not impossible, just more difficult, because it changes the costs required to liquidate you. If everything is with one bank, it's very simple for them to liquidate everything. If they have to pursue multiple lenders, there are costs involved with the process required to seize assets from each other lender. If your portfolio is spread thinly enough, it may be uneconomical for them to get at the assets you have with other lenders. For example, if you have a $10K cash deposit with the same lender as has foreclosed, they'll take that with very little process required; if you have $10K with another lender, it may cost them near that much to do all the paperwork etc to get it, and the lender may decide not to bother.

Hope that helps and isn't too overwhelming. And don't take it as gospel – I'm just an amateur who's tried to educate herself, and this is what I've deduced.