What To Do Next With 1st IP – Advice!

Hi Jay,
I penned a few lines to see if my thoughts might help – here we go:-

The “numbers” should help to tell you the way forward. Using Steve’s investing mantra, an investor’s goal is largely to “Make the most money, in the least time, with the lowest risk, and least aggravation”.

So, let’s now look at your “Today” vs “other options” in numbers and see where they lead us.

Today:
Value $480 Equity $150k Income $460/wk = $23k pa = 5% return (gross). (using a 50 week year)

Option 1: separating upstairs and downstairs. The layout of the house would allow for the two levels to be separated with private access. Some structural renovation required. Rent for the two individual levels would fetch around the $650-700 mark (currently $460).

So here, Jay, you would need to make an educated guess re the cost of splitting the two areas to become self-contained. For the sake of the exercise, I am going to say $20k for renovations in the “numbers” and you can make changes as you get proper quotes:-

Option1:
Value $550k (est) Equity $200k Income $650/wk = $32.5k pa = 5.9% return (gross).
In example above, I have made a couple of assumptions:-
1. That the value will lift from $480k to $550k thanks to the extra Income – that might be invalid though, so re-do that number if needed.
2. The $20k for the renovation may be wildly inaccurate – adjust as required – you know your house, I don’t.
3. I guessed that the Equity would be $70k shown, less the $20k spent for the reno – so $50k extra.

Option 2: Leave as is and stick with cosmetic reno. It’s pretty tired at the moment and has potential for value adding (built in 70’s, lots of windows need replacing, bathroom updates etc.) then keep and use equity for next IP

Option2:
This is a harder one to guess at – but perhaps you take a guess at the “numbers” based on what you believe needs to be done. I have one question coming from your words though – “Why are you needing to replace windows?” That is hardly part of most cosmetic reno’s, and maybe not likely to add any value either. Think long and hard about that option.
Bathrooms updated, yeah sure !! After 40 years, a refresh there could lead to a serious lift in rent based on how well the reno went, and the call for rentals in your area. I guess the current tenants would need to find other accom while you renovate (there is a cost in that too – loss of income while mortgage payments go on, and then there is the cost of the reno itself). Hmmm.

Option 3: still do cosmetic reno, but rather than hold, sell and cash in, freeing all equity for future investing. I lived there up until a year ago so no CGT.

Option 3
That is nice having no CGT to pay. This option also frees you up to think about “What next?” You don’t share finance details (e.g. what amount of borrowings you and your wage can handle) and that could be your next limit to consider BEFORE selling. Are you needing Growth next? Or Income? What investment type would give you the better outcome? e.g. buy/reno/sell? Buy/reno/hold and rent? Buy to develop? Buy commercial? Once sold, will this put you in a better position to move forward? etc.

Locked into your decision-making should be “OK, if I am about to sell, how is the market in my area going? Do I need to expedite the sale? Is a reno necessary at all?”
By selling this one, do you have the capacity to buy perhaps THREE other IP’s – or just one, but a whole lot bigger/better? Sydney appears to be peaking now – but does that mean Central Coast might have another year of growth before its peak? Or not? Can you sell into that peak after a reno?

I think my judgment is being clouded due to emotional investment as to whether reno’ing and holding would be better or selling. It’s on the central coast so is going pretty well at the moment and I feel it is an area that always will to a degree because of it’s proximity to Sydney. And that’s why I’m not confident in pulling the trigger so to speak.

I found that my own decision-making was assisted greatly by “the numbers”. It became easier to make a move once the numbers had convinced me of one particular way being better than another. Try running a few different scenarios using numbers as accurate as you can and see where that takes you.

Of course, the last two phrases of Steve’s mantra need to take some precedence too – e.g. risk and/or aggravation. Making a bit less money, but being able to sleep at night can be preferable to making the very most you can using a risky strategy that has you frantic. ;)

Hope that gives you something to chew on, and perhaps leads to an optimal conclusion for you,

Benny

Hi Jay,
Seems you got a lot out of my thoughts – I’m happy, as that was what I intended.

You asked:-

Also, just wondering why you calculate the return off the total value. Wouldn’t you calculate the return off money owing aka your investment? So 480pw = $24,960, @ $380k investment = 6.5% gross return. No?

There are several ways of calculating such things. I like using Rent/Value of House x100 as a Gross figure when comparing which one to buy. Sure, by considering other options, you can learn more about your investments, but these might be for once they are owned. One other common one is CoCR (Cash on Cash Return) and that looks at Cash Returned/Cash In x100 to get a percentage. This can often have HUGE returns (even Infinite, if you are able to put no Cash into a deal).

I prefer the way I chose, simply because, if instead you chose to add a larger deposit, it looks like you are getting a fantastic return when really you aren’t (the return on the Deposit itself is deemed to be 0, but your Return looks better – a case of “lies, damned lies, and statistics” :p )

Here’s an example (using your figures from say 10 years on). You have held the property another 10 years, and have now cut the mortgage down to $200k. The return from rents has lifted, and 10 years later, you are getting $700 a week ($35k in a year of 50 weeks).

So, 35/200 x100 = 17.5% return. Well yes, it is sort of valid, except that all of the equity is sitting there unused, and returning nothing to you, as all Income is deemed to be coming from having the mortgage.

Instead, by using the Income vs Property Value (usually Cost Price), there is no bias toward one or another property. In fact, it could be said that, doing the calcs that way, one can be more easily compared against another when looking to purchase one, as they are all deemed to be fully mortgaged.

Later on, you can look at NPV’s and CoCR’s etc. Each has their place. Steve is a full bottle on all of them (I’m not) and he has written about each of these in his new Product called STEPS. It is a very comprehensive Due Diligence program that takes you by the hand and explains ALL of those things in much detail.

Also, by comparing Income vs Current Value (include Equity adds from renos) rather than Cost Price, you get a more realistic look at whether this place should stay in your portfolio. e.g. What if No-Risk Govt Bonds return 3%, and your renovated house in 5 years is now valued at $800k, but rents are still just $30k pa. Then you have ONLY 3.75% return. Would there be a better return somewhere by selling this one up? Would you be happier to take the 3% from the Bonds and sleep well at nights by selling up? Or, should you get 8% by buying a Commercial Property instead?

Hope that helps a bit more,

Benny

I like being conservative re returns. See, if you are thinking “I am getting a 6.5% return”, you may think that is pretty good – but it is only good because of the way the calc is performed. It might then blind you to the fact that “you maybe should be selling as the real gross return is nearer 4% perhaps”.