Hi all
Round 3 of the sharing of what I learned over the weekend.
Some of you may have already seen this as part of the conversation in one of the earlier topics on this forum, but I thought I’d just make it a separate topic altogether.
The idea of “money in, money out”. Basically in the instructor’s words: make the money on the buy.
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So how many of us are stuck after we buy 1 or 2 properties? Problem is once we buy, we found that we either:
a) Don’t have enough cash to be used for next investment’s deposit
b) Don’t have enough equity without waiting for a good a few years
c) Even if we have enough cash / equity, our borrowing power is maxed out without getting a better job because the property’s cash flow is negative.Sounds familiar? Yep, that’s my current situation and a situation that I try to get out of.
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The instructor said in the class that: If you need to take out the deposit from your saving account every time you buy your next investment property, then you are asking for bankruptcy.
While I had some difficulty understanding that initially, but now it makes sense to me.
Basically this is saying once I buy my first investment property, and I need to folk out my own cash from saving to buy my next one, then my first investment property must be cash flow poor (and by extension this means I don’t have borrow power to sustain the equity I pull out of my first investment property).
Using an example:
1. I buy my first investment property at 500K, and the market value for that is 500K. Then I either need to take out money from my saving to as my next deposit or wait for a good few years for the property value to go up in equity and take that out.
2. Suppose I buy that at 450K and the market value is 500K. So the property is 50K below market value, which means I have 50K instant equity. Great!
But wait a minute…. If the property is cash flow poor (such as if the property is negatively geared), that means if I don’t keep a good job (so I get a bigger pay cheque), then even if I try to pull that 50K out, banks will have low or no confidence that I can service that 50K (plus whatever additional loan that form the 80% of lending required to buy the next property).
So essentially I am pretty much stuck for a few years before I can get a nice amount to be used as deposit again. But then, once I folk out that nice amount to be used as deposit, I am stuck for a good a few years again.
If I keep on buying like this, then I don’t even need to wait for a property market crash…. even if the property market is going up, but the moment I lose my job is the moment I become bankrupt, and we all know that job stability is increasing becoming an obsolete concept in 21st Century and Digital Age.
What we want is property that is both below market value as well as giving good cash flow. One important thing to remember is that once I pull equity out of my property, this means the loan for that property increase (because we are borrowing more money in the form of equity release) and cash flow will decrease as a reuslt, so when buying investment property, it is imperative that we take into consideration that cash flow needs to stay positive AFTER equity has been pulled out as well. This way, we can use the “money-in, money-out” approach and things then becomes a 3 step process:
Step 1 – Buy below market value
Step 2 – Pull equity out without having to wait (it is below market value, so instant equity), and still maintain positive cash flow even after equity release. — So far I found this requirement is pretty hard to satisfy in Australian market. Yes, it is possible to find many under market value properties (as demonstrated by many investors who run different property seminars) before we pull the equity out, but in many cases, once we pull the equity out, cash flow start to look pretty bleak unless we wait for a good a few years for our pay cheque to catch up, so it is pretty hard to use the “money-in, money-out” approach in a effective manner.
Step 3 – Buy the next one, no need to take a chunk of our own savings accounts each time we buy, since we are using profit to buy and our cash flow is still positive after we pull out the equity.Hi Steven,
One point not mentioned (probably wisely, as it is not a “given” on any particular day, week, or year) is the trend in the area of purchase. e.g. If the Property Clock is showing between 7 and 10 o’clock, then there is a good chance that you will be the beneficiary of some equity lifts simply by holding property in an area where values are growing.It is a cycle, so the opposite will be true too at some stage, but hey, if you are wanting to “go again” quickly, won’t it make sense to purchase in an area where it appears to be in a rising market right now? Add “buy low” to “rising market” and watch your equity soar !! Even add a reno if it makes sense to do so,
Benny
Hi Benny
What you said is very true, and this in fact will touch base on the next sharing which I will be typing up.
Without going into any details into that topic, the way how the class room was teaching us is that: we don’t try to time the market, and instead we use a strategy that will work whether the market is going up, stalls or going down, because our cash flow is healthy.
So if we get both equity soar and cash flow, that’s fantastic, its an added bonus for us.
if the market stalls and we don’t get more equity, that’s OK
if the market crashes and our property drop in value… well, let’s say we won’t be too happy about the drop in value but we are not worried due to cash flow continues to be healthy and cash flow is what protects us.More on that topic in a separate thread.
Good to hear they are covering that too. For mine, doing that for a FIRST IP is a good way to get you moving. The more things on your side, the better. And, if it works well, do it for your second too.
But you are right – if the deal is good, it should stand alone even in a bad market. And yes, cashflow is King !!
Playing devil’s advocate though, if I were selling property to my students, I wouldn’t want them to ONLY buy properties that are in an upward trend cycle either!! That could cruel my chances of selling 70% of the properties I want to “move on” !!
(Benny’s finger touches his nose…..)
Benny
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