Another Yield Strategy Thread - Borrowing Capacity

Hi everyone,

I am seeking guidance and moreso general comments for the finance part of a yield strategy. The aim is to buy multiple properties over time as soon as the next deposit is ready. I am particularly interested in everyone's thoughts on how each purchase is likely to impact borrowing capacity in today's lending environment.

Background: I am generally much more interested in the land and location component of property. I've always thought houses are king, but seeing the land component in some sets of 3 or 4 units (old style, walk-up), I can see these too can have significant land value. It will be slow for me to accumulate multiple houses in today lending environment.

I'll run you through the following scenario for an average income earner. My numbers are in regards to cashflow. I have set my loan repayments at 7.5% P&I and assumed net rent of 80% of rent to try align towards what a typical lender would be looking at. Are these reasonable assumptions?

Region: Moreton Bay, QLD
Property Type: Unit/villa,
Purchase price including costs: $200k
Deposit: $40k
Loan amount: $160k
Rent: $280 pw ($1213 pm)
Net Rent: assume 80% of rent: $970 pm
P&I repayments if interest is 7.5% on a 30 year loan: $1118 pm
Cashflow Balance per year (net rent - P&I loan repayments) -$1776 per year

How would this purchase change my borrowing capacity? What if I replicated this 2 more times. Now my balance on cashflow per year on all 3 would be about negative $5k per year (~$100 pw) .

Over the next 3 years if each year I rose the rent on each 3 properties by $10 per week, given the above assumptions, the hit to my cash flow is now not even $1k a year. If interest rates hold at say 5% per year and I make P&I repayments at this rate only I would have payed off $8k per property (24k for all 3). If this was the case I would have a surplus of $1.3k per property per year which will surely go to miscellaneous expenses. Over these 3 years I would also be saving and adding to an offset account.

Assuming I have the deposit available, at this point I could go again? Maybe buy 1 or 2 more or 5 more... I am wondering what kind of a hit the above would have on my likely borrowing capacity?

Haha Just running through some numbers of different scenarios. I think buying is easy, buying again and again not necessarily so...

Thoughts?

 

There's a lot more to it than the figures you've given. You need to have a broker properly analyse your full finances and get proper advice.

 

Thanks Peter. Yes I suppose it wouldn't be that simple.

 

Many moons ago, before I was a broker, even before I was an accountant I used to spend many hours doing calcs about potential scenarios which never eventuated but I NEVER asked for help from a professional.

Have an understanding about what you want to do but don't sweat the details of something that doesn't exist, let the pros do that for you.

 

What I found in regards to borrowing power in today's lending climate is that you can have all the equity in the world, but unless you have an income to unlock it, the only way to access it would be to sell, which certainly doesn't lend itself to the "Buy/Hold" strategy, or even the accumulation of multiple properties.

Working out a rough borrowing capacity with a broker based on your income will give you a benchmark to go off, that figure is unlikely to change mush unless you drastically increase your income by either getting a second job, spouse or major promotion.

 

Or reducing debt

 

Firstly - every dollar you borrow is assessed at between 7 and 7.5% , and P&I...

Secondly, every dollar of rental income is assessed at 80% ( 70% in some cases )

So the quick conclusion is this; you need a yield of @ 10% just to be considered cash flow neutral by a lender servicing calc. You need more than 10% to be considered CF+ by a lender servicing calc. Liberty are the exception to this rule. These properties noted above arent even close to that level of yield . You will hit a ceiling after a small number of purchases , and unless you sell, pay down debt, win lotto or get a LOT of extra income, you will be stuck, and no amount of growth will get you unstuck - unless you sell.

PS - you havent allowed for stamp duty

 

Thank you very much @euro73, @Archaon, @Tom Simpson, and @Peter_Tersteeg.

I see there are fatal flaws to the plan if it stands alone. I see what ya'll are saying about seeking professional advice... I'm running through various scenarios and feel awkward approaching my broker with random questions.

Thanks again, I appreciate everything you guys do for one another (and me) on here

 

If that's something you are being made to feel by the broker...find someone new. But if as I suspect its something you are making yourself feel... you needn't be concerned. Your broker probably prefers that you toss ideas around with them. Borrowing capacity has changed MASSIVELY in just the past couple of years.

Anyone you are discussing property with who is not actively borrowing money in THIS post APRA market, is very likely to be offering you very poor advice based on outdated policies that worked for them but are unworkable for you. Ultimately, they may mean well, but they dont know what they are talking about if they arent borrowing money regularly right now. They will end up offering you really misleading advice. Accidental it may be, but misleading nonetheless Talk to your broker or talk to one of us here

 

Yeah, too complex and changes too often, in fact it is hard for brokers to keep up I reckon, unless they are writing for every lender every week, which is not likely.

 

Its not the frequency or variety of the changes so much as the fact they are all, one way or another, the same change. I/O lending is now under a quota, and its being restricted and repriced.

From that , a series of consequences will follow/are following, not least of which is the myth busting end to the "equity is borrowing power" argument.

 

Yeah, but the lenders all keep changing other parts of the calculation as well, and it will go one for some time before it settles.....

 

Yep, but thats my point. While each lender is fiddling here and there and everywhere, its all aimed at one thing - meeting the quota. In the end, they will all end up fairly homogenised.

Its just like APRA 1. AMP came out early and went 47bpts and everyone oohed and ahhed. Within a year, everyone else had done the same, but in 3 increments of 15-20 bpts. Same result in the end. This is no different. Take NAB for example, and their decision to introduce reduced debt to income ratios. Expect many or all to follow that.

Its over for the equity harvesting model. That model relied entirely on ever expanding borrowing power, which was possible because of ever expanding debt to income ratio's. So as a business model, it was effective. Investors who used that business model saw great results. Now though, debt to income ratio's, LVR's, basically- how much and how quickly you can borrow and re-borrow, are being severely curtailed. Its literally an inverted situation so the business model needs to be inverted. Debt reduction or income increases ( or both preferably) will be the only way to deal with these policy changes, because debt to income ratio's are exactly that - DEBT vs INCOME

Under these rules, Dividend Reinvestment Plans , where CF+ properties are used to generate "fully franked dividends" which are then reinvested towards debt reduction (non income producing, non deductible debt first) will serve investors better in the long term, if they have aspirations to be able to continue to borrow to expand, without needing to sell.

 

Yes, I see they are all working to the same end (by force), all I was pointing out is the fact that even brokers will not be able to know by using last months rough calcs, cause this week/month goal posts have moved around again, so you have to sit down with all detail to know who you can do what with this month.

Even when they reach the end goal, it is not likely they will all be exactly the same at the same time, otherwise they may as well all merge right now and we can have one online calc and do away with all brokers, I do not see that, but it may be somewhat less competitive ?

Let's face it, the whole process is complexity by design. People cannot ask generic questions like the OP and get a sensible answer, many things are taken into account, as said, complexity by design.

 

@dabbler and @euro73 All your comments are very interesting. I certainly think one very good thing about all these changes is that hopefully it protects the integrity and sustainability of the Aus property market... Would be nice.

The world won't stand still I guess... Will get there.... Life's good

 

These things should have been rolled out as RBA was cutting rates IMO, but as per usual things are done at the 11th hr once it seems there is a problem.

We will see what the effect is over time.