Hi Everyone,
I've recently started looking more seriously at investment properties. Before I venture out into the abyss of further debt and (hopefully) tax benefits, I'm concerned with what an acceptable property yield is on an investment property? Most of the properties I've been looking at so far have a yield of about 4-5% p.a. At the initial stage of investment I've worked out for myself there will be some negative gearing consequences, which I'm prepared to wear, but at some stage down the track, it's bound to turn into positive gearing (theoretically and ideally speaking).
I also own my own home, worth about $450K, with $135K owing on it, so I plan on using that equity to secure the IP. From what I've read in previous posts, that's the best way to go about obtaining a new IP and reaping all the benefits from it. I would assume most investors have started out the same way, building a steady property portfolio as a result. They say the first home is the stepping stone to the rest… Please give me some reassurance of that
Having also read that once the first IP becomes positively geared, an investor could use the profits from that IP to purchase a new one, which can again become negatively geared. All the tax benefits obtained from those exercises can then be utilised to reduce the current home loan on the residential property and pay it off faster and sooner. Sound advice, perhaps?
I'm also curious as to whether it's more beneficial to have the IP in my name only or a Family Trust?
All responses and previous experience advice will be greatly appreciated!
Thank you.
Hi Ms T
Firstly welcome to the forum and I hope you enjoy your time with us.
Whilst using the equity in your PPOR is a way of securing your first IP purchase it is how the equity is used that is more important.
Rather than offer your lender the balance of equity i would personally structure the arrangement differently.
Look to secure a Line of credit behind the current ppor home loan and use this facility to fund the 20% deposit and acqusition costs for the first IP. I will assume that your current loan is linked to a 100% offset account.
Then using a separate lender or separate faciity secure a loan of 80% of the purchase price of the investment property solely on the new IP itself. This avoids cross collateralising the loans and will avoid problems down the track.
Once the IP increases in value look to increase the loan to maintain the 80% lend and use the additional funds raised to paydown the line of credit.
Repeat for each property.
Unfortunately it is unlikely your Bank manager will have idea or exeperience in how to structure an investment loan other than to cross collateralise the securities which is certainly of benefit to the Bank and not you.
A good independant mortgage broker can assist in this arrangement.
Secondly in regards to the entity to use when purchasing your IP.
Certainly a Discretionary Family Trust has added benefit when it comes to Asset Protection or the ability to distribute the surplus income to the named beneficiaries. If however the property is negatively geared then you will be unable to claim the losses thru the Trust.
There are a couple of further considerations but with the equity you have you appear to be on the right track.
Richard Taylor | Australia's leading private lender
On Gatherum Goss and associates website there's an article by Steve Navra "Rental Reality" http://www.gatherumgoss.com/Navra.pdf
I haven't analysed any areas using Rental reality but it coud be a useful tool to consider.
Personally on my resi properties I've bought in areas I considered to be attractive because of access to services etc, but in areas the locals did not like because of their perceptions of the area which reflected the areas a few years earlier and not as they are when I bought.
I think you need to factor in risk as well ie what percentage you need to receive above the risk free rate of return. In the US treasury bonds are traditionally regarded as risk-free. At the moment in Australia, term deposits because of the gov't guarantee might be a reasonable approximation to a risk free investment.
Simplistically, not taking into account tax and deptreciation issues
So if you invest in a term deposit at the moment a 25K term deposit would get around 4.5% per annum say
So if you're buying for $300K and put down $60K, then a $60K TD will give you 4.5%, $2700
compared to 5% gross yield $15,000 less $240K at 5% = $12000, say $5500 for rates, insurance, agents, repairs – loss of $2500
So you will need Capital Growth of $5200 just to be even with the term deposit.Now if interest rates go up your costs wil go up. The Reserve Bank etc say we're at the bottom of the cycle, so if we say average interest rate will be 7%, you're actually losing $7300 cash and need $2700 as well to get where you would hvae been with the term deposit.
So you need capital growth of 3% roughly on the property just to stay square with a term deposit.
But with a TD your money is available, it might take 9 months to sell an IP, so you need to fcator in to your pricing illiquidity risk, interest rate risk, legislation risk eg vendor duty, market risk. Maybe other risks.
Having said that, I acknowledge that many people who kept money in term deposits have not found that to be as good as other investments.
In addition you can do things with property to increase your return and therefore improve its capital growth.
Hi,
Thanks for your replies so far.
Richard, I don't have a line of credit against my residential property, nor an offset account against the loan. I'm very cautious when it comes to line of credits or maxing out a loan for an IP (as is the case here) to pay off another loan. Although I do see where you're coming from.
I'd like to think if I cross securitise my current home with the new IP, down the track with all fingers crossed, the new IP's sale price will be adequate to pay off that loan, which will remove my residential home from the IP loan. Plus I don't have those loan facilities set up you mentioned, and want to use as much of my equity as possible, to a reasonable extent, for the new IP.
I also plan on setting this whole thing up myself, without having to deal with a broker. I'll just go through my lender through normal channels. Main idea at this stage, though, is to gather as much information as possible for my benefit, so I know how to deal with them without being forced into a loan I don't want to obtain.
I'm thinking with the equity I have and which I can use, I won't need to obtain MI on the new loan, and won't wait years until I can save 20% of the property's value in order to secure it.
Thanks again.
To be honest i fail to see why you have an opposition to use a Line of credit or an offset account especially given the interest savings such products bring with them.
Remember unscrambling a cross collateralised loan is not as easy as you thing especially in the current climate.
The fact you want to use as much of your equity as possible in your own home seems a strange decision in respect of asset protection as most investors try and use as little as possible.
LMI wont be payable if the loan is under an 80% lend anyway but you would never save and put in 20% deposit whilst you have a non deductable interest by way of a home loan.
I think you might want to re read your original post and response as i am not convinced you fully understand the processes involved and the reasoning behind my suggestion on your funding style.
Richard Taylor | Australia's leading private lender
So what you're saying is that if I wish to purchase an IP for $300K, at 80% lend I'll get $240K from the bank. The other $60K I can use from the current built up equity I have, by means of a second loan/line of credit, which will be used to fund the starting stage of it all. And in reality, the other $240K will be secured against the new IP. On the other hand, though, will the $60K secured against the residential property be tax deductible, as it's been used for investment purposes to begin with?
Re: offset account and line of credit – I've never gotten around to ever doing it. I don't think the savings are *that* great, compared with putting more into the loan whenever possible, which really reduces repayments and the loan/interest in the long-term. Might have to look more into it, nonetheless.
I believe this is generally a good strategy, assuming you still have a sizeable PPOR loan balance and your regular income can service the loan:
1. Pay off as much as you can on your PPOR.
2. Get a LOC against the equity you have on PPOR (your PPOR now has two loans mortgaged on it)
3. Use the LOC to fund new IP deposit+cost (so that all of its interest is deductible)
4. When you receive rent from IP also put all of that into PPOR loan first (assuming negative gear is beneficial)
5. Max out all loans to 80% of property whenever you need more fund or values have raised enoughFrom tax saving point of view, your primary aim at this stage is to pay off your loan on PPOR completely, leaving only LOC. So at the end of the day, your maximum available fund will come from the following (1) an LOC equivalent to 80% of your PPOR, and (2) Excess equity to 80% of IP, if needed.
Keep doing this until you retire from property investing…. then you can sell a few IP, pay off all laons, and live on the rest till death do you and your properties part..
Sorry but this is clearly not the case.
putting more into the loan whenever possible, which really reduces repayments and the loan.
In most cases your repayments stay the same and the amount of interest reduces. Of course it works exactly the same way as an offset account. Difference being is that once you have paid the loan down any funds redrawn have to be for investment or the loan becomes contaminated. Whereas using an offset account this is not the case as stated.
Also if you ever change your mind and decide to rent out your PPOR then of course you have lost all of the interest deductability by paying the loan down.
Richard Taylor | Australia's leading private lender
Richard, I'm not sure which loans you're talking about, but every time I put a lump sum (when I can afford it) into my loan, I make my lender recalculate both repayments and interest (at no cost to me), which definitely reduces as a result of the lump sum. It's helping me out this way, and reduces my minimum repayments. I can then, on top of them, make extra repayments to save years and interest off the loan.
The rest is now becoming clearer and the post has certainly helped me in making a decision how to set up the IR loan.
Thanks.
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