Can higher yielding lower CG properties generate more finance?

Hi All

I was having a conversation with someone who suggested that higher yielding properties could in fact be better for leveraging into more properties than lower yielding higher growing properties.

As a rule of thumb I've always heard and read that typically 80% of any equity gained can be put towards new finance. eg (80/20 lvr) 500k property grows to 550k then there would be another 200k worth of finance available if keeping the LVR the same.

Is this below formula a real way to calculate additional loan capacity or is simply always going to be based on how much equity is stumped up only?

(PV*CG*LVG)+(R*RLVG*RM )

Property Value
Capital Growth
Leverage
Yield
Rent
Rent Leverage - % of rent taken into consideration
Rent Multiple - assumption of how many multiples of gross rent can be borrowed

Using the above a lower growing higher yielding property would be able to generate more finance than a higher growing lower yielding property

eg

PV 1.6m growing at 7% and yields 3.125% (50k) could generate an additional $409,600 vs
PV 1.6m growing at 3% and yields 6.000% (96k) could generate an additional $652,800

Assumptions:
Rent Leverage 80%
A rent multiple of 8

This was a new concept to me so I wanted to know whether the community here can verify this approach. I've also attached a spreadsheet for convenience.

 

the short answer is yes because more income leads to better servicing.

 

Equity/CG doesn't help borrowing capacity, cash flow does.
So you could have all the equity/capital growth in the world but if you don't have the borrowing capacity (cash flow) to access that equity then you're stuck.
$96K in rental income does not mean you can borrow an additional $652K either, rents are shaded to 70/80% for serviceability purposes and there are a few other limitations on banks servicing calculators.

 

what about the rent multiple? Is 8 a reasonable figure? the 652k figure is based on 80% being considered only. this drops to 576k if only 70% is considered.

Taking this approach, am I crazy or does it appear that it would be much easier to build an asset base via commercial property, all the while having more cash flow flexibility?

 

More income means more borrowing capacity.

Don't get too excited though. Rental income has only a tiny effect on how much you can borrow. A higher yielding property might only mean an extra $20k in borrowing capacity, it's unlikely to make a difference in the short term.

Instead think long term and go for the property that is likely to increase consistently over time. This will continuously increase your borrowing capacity and eventually it will be a difference. Many higher yielding properties might look good today, but the rent doesn't really increase over time, so it's never going to make much real difference.

 

Rental yield is capped and then shaded, not the other way around.

 

Unfortunately it's not that simple, it's reasonable but not accurate if that makes sense?

Commercial typically requires larger deposit, max LVR's of 70 - 80% however they generally have better yields if you've got a good tenant (now more than ever the tenant matters)

 

Hi. Would you mind explaning what this means? I'm not familiar with the term shaded in this context.

 

I hear what you're saying, but where commercial values are strongly linked to leases, presumably (strong tenants) with built in increases, surely its a steady way to get more finance?

 

Lenders like to minimise THEIR default risk. They like and prefer approval of low risk deals. It doesnt mean they will lend more by adopting more leverage risk to offset a reduced risk deal just because it has more cashflows. I think that is where shading could be described. You cant exchange one thousand dollars of one risk for a leveraged multiple of another. APRA require lenders to model counterparty risk and monitor it. If they did allow risk exchange, shopping centres would value their arse off. At present they are likely to face write downs. Example : Castle Towers in Sydney has just pulled the pin on a billion dollar re-development that had already commenced. Its cashflows went from hero to zero with covid. Lenders probably see the owner, QIC, as low risk but the centre as a massive future cashflow risk. No calculation needed. Its off the chart.

The expression - the bigger they are the harder they fall applies to lending. Covenants could apply to risk weighted deals. Cashflow falls and the deal gets withdrawn. No refinance, Its an auction.

Its like Virgin - even the Commonwealth Govt wouldnt lend to it. Using a formula you could argue lending should reduce as cashflow reduced. No, it ceased.

 

Just to balance out a prior comment: you could have all the cash-flow in the world, but if you don't have the equity to draw on, then you're stuck.

Are you in the "unfortunate" position that you've had way too much growth and you can't leverage from it due to poor cash-flow? Nice problem to have.

A permanent strategy for a temporary situation might be limiting. The strategy should change based on your current bottleneck.

If cash-flow is an issue, commercial could be the answer. But I think residential is an unbeatable starting point: lower risk, lower entry cost, easier analysis, higher leverage.

BTW I'd be careful not to simply assume growth just turns up. Ditto for rent increases.

 

Thankfully for me the only problem I have is whether I opt for 2nd resi or 2nd commercial over the next 12-18 months! I am just trying to ascertain what is going to be best in getting me that 3rd property. Cash flow not an issue. Currently leaning towards commercial as it will get me a 4th, likely resi, faster.

Thanks for all the responses, much appreciated!