Dual Occs vs cheap high yield IPs as a vehicle to build a portfolio

We only build a few at a time and we price each contract carefully, right before a spot opens up under warranty and only after the land has registered. It minimises the gap between contract being issued and commencement . That alone removes a lot of the risk others are carrying, as we just don't have hundreds or thousands of fixed price contracts out there at old prices waiting for land to register .

 

@euro73 - keen to hear how the numbers stack up these days in some of the places where you are building with the land and build costs spiking since we last chatted - circa 3 yrs ago!

A concern I had re NDIS type accommodation with great yields is the over capitalisation on the build to the tune of twice the average build cost, thereby restricting its offloading potential for a very long time.

Would you be able to provide any high level numbers for what your deals are looking like - i.e land area, buy price, build cost & timelines to finish and expected yield etc...

Will greatly appreciate any input.

 

we don’t have any involvement with NDIS

Tamworth and Armidale are the focus for 2022/23 . Tamworth more so than Armidale to be honest , as there just isn’t any suitable land there at the moment and they have crazy crazy crazy trade shortages - particularly concreters and brickies , who are being brought in from Coffs and Lismore and being paid accommodation and meals allowances - something we won’t do as it adds too much to the price .

Current build price is @550k . That’s for a 280m2 turn key product . Land price has nothing to do with us as we don’t sell land but right now lots of 700-1000m2 are ranging between 200-270k but people buying now will find there’s almost nothing decent available that will register for 12+ months - they have extreme under supply right now and local builders have limited capacity to deliver volume . In addition , there are a number of anti investor covenants on most contracts so the chance of any meaningful rental volume being delivered is almost nil . They already have extreme vacancy rate issues and extreme rental inflation has arrived - all exactly what we anticipated - just like Orange. Just like Bathurst . just like Dubbo . Just like Goulburn .

A few months ago our clients were buying land at 145-170k. Rents are anticipated to be mid - high 500s per week for the 4 bed house and low 300s per week for the 1 bed granny flat. May go higher given the vacancy issues . They were estimated to achieve 450 and 250 6 months ago … again - these increases are exactly what we anticipated . That’s because we look for these trends. Cheap land . Low number of local builders with limited capacity for output . Falling vacancy rates .

the 2 storey product you see in the walkthrough link above is in Goulburn . It was @457,500 build price . I believe the 700m2 lot that it’s built on was @195k ( land is 450k + in Goulburn now ) . So the package cost them mid 600s . They are about to sell it in for mid - high 900s . They exchanged on the land over a year ago so they will have a CGT concession and with the amount they clear they will pay off approximately half their mortgage in Schofields . They have purchased 2 lots in Tamworth for sub 200 which we will build for them next year . . So effectively they will have double the income coming in ( 2 dual Occs instead of 1) and will be paying off half the mortgage size they would otherwise have had on their owner Occ - so it’s worked brilliantly for them ( and many others ) and their home should now be paid off in less than 8 years . Then they can reinvest the several K per month they would otherwise have still been paying towards Schofields and attack the dual occ debt at Tamworth - if they get those dual Occs paid off 20 or so years from now and the rents inflate by just 50% from todays levels (820-850 per week per dual occ ) they should be unencumbered with over 120k income . Of course , as the debt comes down and the rents grow they will have the equity and the borrowing capacity to add several additional dual Occs along the way over the next few years , and that will mean they can speed that process up further - Think of it as buying an extra 15 or more 16k of net income when you buy one of these and use IO for the first 5 years . That means you can make at least 80k in additional principal repayments towards PPOR over the first 5 years , or towards the Dual Occ debt once you get past that PPOR stage and start reverting the first Dual Occs to P&I - so it’s fairly easy to see the pathway to get well past that estimate of 120k rental income if they decide to be aggressive in the coming years . The regional boom has really turbocharged the dual occ proposition… and shows no sign of slowing as affordability is still very comfy in these sorts of locations. That , combined with acute rental shortages is a fantastic mix for those investors who have seen these trends . This is why my signature line says - Pay off PPOR faster . Improve borrowing power . Retire with a 6 figure income

 

@euro73 Please correct me if I am wrong: $200k land, $550k build, are most of the positive cash flow from the depreciation, as the yield isn't that impressive even for a dual occ?

 

Almost all the positive cash flow is pre tax. A very small amount is from depreciation

750K @ 2.85% IO @ $21.375K
Other costs @ 7000
Total Outgoings @ 29K per annum

Total Rental Income @ 44K per annum ( 850 per week)

Pre tax surplus = @ 15K ( 44 minus 29 )

Depreciation @ 18K. ( although we expect it to be higher with new build costs factored in)
Refund@ 32.5% = $975 NET CF+ @ $15,975
Refund@ 37% = $1110 NET CF+ @ $16,110
Refund@ 45% = $1350 NET CF+ @$16,350

Variables
If the depreciation amount is higher than estimated here, the results will be better than estimated here
There may be further rate rises
There may be further rental increases

Results
16K of extra repayments ( $1333 per month) onto a 300K P&I mortgage @ 2.5% P&I
Time Saved. 18 years and 6 months
Dollars saved $81,551


400K @ 2.5% P&I = 16.5 years saved and 97.3K saved



500K @ 2.5% P&I = nearly 15 years saved and 110K saved


600K @ 2.5% P&I = 13 and a half years saved and almost 121K interest saved




These figures only tell part of the story though. Because the Dual Occ's are totally self sufficient, none of your income is quarantined for holding costs on loss making INV assets. For most investors that's going to mean they have additional capacity to make additional extra repayments , over and above the 16K per annum being produced by the Dual Occ's. In my experience, which is vast, investors have been able to retire O/Occ debt in less than a decade.
Who doesn't want to pay their house off much faster to free up equity and borrowing capacity and lifestyle options faster? You can certainly sell if a boom comes along, as many of our investors have done in the last year...but you dont ever HAVE to sell because of cash flow pressures. Those who have sold have then made significant lump sum payments onto their O/Occ mortgages, and then they have replace the 16K they were getting from that location but purchasing another Dual Occ in our next location.... or as many have done, they have purchased 2 more ( as they now have the equity and borrowing capacity to do so because of the debt reduction) and replace the 16K with 32K of NET extra income. This sees them with half the mortgage or better, typically.... but . double the capacity to make extra repayments. Potent . But if you were to assume these assets were purchased only for long term income and no booms ever occurred again, they still do the job very nicely as outlined above .

 

Thanks for the detailed post - So approx 5.7% net if no borrowings & pre depreciation..?

 

The actual yield will always be variable. Rates up. Rates down. Rents up. Rents down. What's more helpful is to measure the value of 14, 15,16K of surplus cash flow to a portfolio over time . To future borrowing capacity. To amortisation. To equity harvesting. To eventual income outcomes at retirement, which is supposed to be the entirety of the exercise.

We all know there has been phenomenal growth across 30+ years because of very expansionary credit polices; there can be no argument about that. Yet we also know that the majority of investors never get past 2 or 3 properties in spite of all that growth, and that we have failed to see a majority of investors reach strong financial independence in spite of all that growth. People may decide to try and argue that fact but the reality is that only the exceptional few have achieved those strong results. That should indicate that growth doesn't make investors wealthy ; growth only makes exceptional investors wealthy. For the majority, what the evidence 30+ years later proves overwhelmingly is that when you are required to use income to prop up assets that cost you money to hold, you end up cash flow poor and asset rich instead . I don't know about you, but I'd rather be cash flow rich. For example, I'd take 200K per annum ( while still owning the unencumbered assets ) over 2 or 3 million once (and no longer holding the assets) every day of the week. That's only the income side of the argument though. There is now the lending side of the argument to consider; it has been there for years but people have forgotten because of the RBA and APRA sugar hit.

It didn't really used to matter if you speculated for growth rather than investing soundly for income, because in the pre APRA era you could run weak yielding assets IO forever without ever needing to requalify or worry about servicing, and the tax man propped you up along the way. Lending wise it was as generous and easy as it could be; particularly in the decade or more leading to the GFC. If we are being honest we should also acknowledge that holding costs often reduced for investors who started in that era as we saw consistent rate cuts for almost all of the 90's and noughties and onwards, except for a couple of brief periods during that 30 years. This set of ingredients allowed investors to bake a certain kind of cake. They could hold large portfolio's with minimal outlays, maximise deductability and never have to seriously consider holding costs. Yet, in spite of all those advantages it still didn't produce a generation of cash flow rich retirees. The cake certainly rose and certainly produced equity ,it just didnt feed with very much income Why? Because they didn't retire debt . Weren't required to. Weren't taught to. And why would they? They had all the goodies on offer from lenders throwing money at them and they could have their cake and eat it too ( excuse the pun) ..so who could blame them? But still ...we must be honest in reviewing the outcomes it produced; and they are for most people - modest. They take far longer to clear O/Occ mortgages and are almost always forced to sell INV properties to clear the significant debt still sitting against them, and with whatever is left after that and taxes, it isn't generally sufficient to provide a business class income for retirement. Economy perhaps, but not business or first. Wholly and completely unsatisfactory in my book after all those years . The evidence just does not support the arguments. Why do we have a growing reliance on age pension? Why do we have people unable to live without imputation? Why are investors still so reliant on NG to keep portfolio's viable?

The post APRA era obviously presented a different set of rules; rules that came very close to creating a significant P&I cliff in 2020/21 that would have created quite severe holding cost issues for 50% + of loans - until emergency rate settings and assessment rate settings came along and deferred the problem; and for the last 18-24 months or so people seem to have forgotten what the very recent lessons of 2016-2020 should have taught them; that holding costs matter and borrowing capacity matters, and debt reduction matters to both. We are now headed back towards a set of circumstances where policy settings normalise and will start to reintroduce the P&I discomfort for many investors in coming years. Higher actual interest rates are only the first stage; money is obviously still very cheap and plenty of people have deferred that issue by using cheap 2,3 year rates that will give them a little relief for a little while. But the higher assessment rates and the inevitable tsunami of HEMS increases coming in the 2nd half of this year and beyond , combined with lenders reducing DTI ratios , will all be waiting for those investors at the end of their IO periods and I think it's safe to say these pages will once again start reading tales from those who ignored these simple lessons. For me, that set of normalised policy settings is where and when the real value of assets that can wash their own faces ( and then some) should be seen in the context of a portfolio.

 

Have you thought about going into SDA accommodation, since it will essentially do the same thing with using cash flow to pay down the debt, as far as I can tell, if you do the SDA accommodation well, its easy to market to the general population if you do want to sell down? I am sure there's a need for SDA housing in regional as well, as disability dont discriminate regional vs city.

 

We have looked at it closely a few years ago , but found the industry to be amateurish at best . We approached multiple providers in Orange and Goulburn and couldn’t even get someone to return a call or an email to come and see the product . Having dealt with community housing providers managing some NRAS properties , the thought of dealing with another industry of hopeless cardigan wearing public service types , but this time with zero property experience , kind of turned me right off to be honest . I was able to add NRAS to most of the 4 bedders that form part of the Dual Occ's in Goulburn so the clients have 7 star cash flow until June 2026 and 5 star thereafter.

Having said all of that , I definitely like it’s potential and fully intend to try and gauge interest from providers in Armidale and Tamworth later this year when we get our first few completions done . If they can be ar$ed …. ??? nd if they will do head lease agreements so the risks sit with them not my clients . But I also have a limited number of June 2026 NRAS credits available to be transferred to the Dual Occs in those locations.... so again, I feel no pressure to reinvent the wheel.

For me , while it adds a layer of complexity that I personally have no problem with and could turbocharge things, I have a product that works extremely well without any of the additional fit out requirements , without reliance on a fragile network of seemingly hopeless providers and the potential for extreme tenant volatility… so there’s no real need if viewed that way .

It’s also worth noting that to get absolute biggest bang for buck you need to go into high physical needs and actually be tenanted …. and that’s not only horribly expensive to fit out and will absolutely attract massive valuation shortfalls , but those tenants don’t like living in shared accommodation so our product isn’t right for that space as the main building is a 4 bedder . So it would be a white elephant that would have cost several hundred K extra to build , for no return . Got to be across all these fleas . If my builder partners and I were to try and produce a product suited to SDA our 4 bedder would be far better suited to improved liveability where fit out variations are minimal and with the granny flat providing OOA loading . Could then tweak it with overhead sprinkler loading and it would obviously also attract some regional loading as well … so as I said I do intend to show our first few builds in Armidale and Tamworth to local providers to gauge their appetite . But it has to be fit for purpose .

 

Very true, why fix something not broken.

Very interesting insight, I get it though, its hard to get disability support in general in regional, providers pay way above market rate to attract health practitioners, only for them to leave in 6 months.

I think tenants in general dont like to share, the reason 4 bedders are the highest amount in payments is no doubt a cost saving exercise from government point of view. RPI was saying that 2 bedders seem to be the best compromise. Please keep us in the loop! Your signature is going to change to the "original debt deduction gladiator 2.0" if you can make it feasible!

 

2 bed does appear to be best bet for high physical or robust. Main residence and OOA. But we wont build a 2 bed product on a whim and a prayer. Unless a provider enters a pre build head lease where they carry the responsibility for leasing it and our client gets paid either way , we wouldnt even go past an initial chat about it. It would be like building a massive commercial building somewhere and then hoping that Bunnings leases it from you. The correct approach would be to get the lease with Bunnings ( or whomever) agreed first- then build it for them. Otherwise - white elephant . Its not like these highly specialised properties that you are 200K + underwater on ( valuation wise/fit out cost wise) from day 1 can just be leased to Mary and Jimmy if the provider cant fill them.

 

I had a similar strategy when starting, didn't know very much back then. Here's some things I wish I did:

Upsides of new dual occs:

- Tenant quality will be better given the houses are new. I was surprised by this, but its definitely my experience. All my headaches come from existing older properties, not the new ones.

- The product makes the yield 'safer' as its new (noting location risks are well managed).

- Rents generally fall materially after a few years. Renting an older home vs new home does that. I'd model it with a 20% fall in rents after 3 years (can add back CPI though) and first tenant changeover (I've bought 4 new places and this was the average rental fall).

- H&L packages may have some initial uplift, you generally buy a little below market when doing the work and save on stamp duty too. Not sure if the construction part is a positive in this environment though, there's a greater risk attached to it given market conditions and rampant inflation/shortages.

- Euro is great at assessing deals though and usually navigates some of the risks by being a sharper operator then the rest of market.

Upsides of high yielding older properties:

- Higher growth rates generally on offer given land is being purchased, not depreciating buildings
- Lower quality tenants likely if the properties are too cheap and of poor quality - making it feel less safe.
- If serviceability allows, you can create 'rinse and repeat' strategies to recycle your deposits and go again from the growth. This part is debatable but some experts have some pretty good results at this as they move locations based on short term uplift potentials.
- Many good BA's target this approach too, so you can find good operators too.

Overall impact on lending should be similar across both approaches, its just rental yield that feedbacks into lending.

Goodluck!

 

Good summary @Redom

I have been exploring for a number of years 'sweet deals' which in my dictionary consist of big land in metro or large regional with lots of dev potential with good rental yield in the interim i.e until it's ready to develop .... Like having your cake & eating it too!

SDA - I have met all large operators and thoroughly recommend RPI but the overcapitalisation part on build (especially now with recent build price spike) has you holding an asset which is fully optimised of its potential with great yield but you would likely lose money if you were to offload to general market as they are in outlying suburbs on small land or regional but cost twice the normal build price... Perhaps in retirement, I might consider it.. The other issue is absence of guarantees for a tenant until all investment has been made..

Dual Occs/ New H&L - Outer suburbs/ regional focus and would work great for some wanting yield however more value attached to a depreciating asset - as you outline. I still believe it's a great strategy in hindsight as it would've worked for me incredibly well, if I had invested in @euro73 's projects 3 odd years ago when I spoke with him. And no doubt it remains a great proposition now, if you work out his deal str which appears solid.

I fund projects without borrowings so I explore deals which give me dev potential & good yield so I can pounce quickly when I see one. I bought an acre site in Mel metro 2 yrs ago which will give me 18x 3/4 bed TH when I am ready to develop and is also on a 15 yr lease to a retirement home provider providing 6% net yield (100% outgoings paid by tenant) increasing at 4% per annum and has no land tax either!

Bought a couple of rooming houses in Frankston, again with zero land tax and yields are over 6% but great development potential.. so enjoy good yield and then develop in 10 yrs when values are approx double.

I have bought multiple blocks of units in Cairns & Rockhampton over the past 18 months however all of them have additional land to add more inventory on in the future. So, they are netting c5.5% net and with the option to develop further.

So when I compare any deals / strategies like SDA, H&L, Dual Occs etc Vs the ones I secured in the last few years, I end up over-thinking those and give them a miss in the end! Partly because I am quite far away from retirement phase and the pure-yield proposition isn't interesting enough and partly because they are boring (great for yield but I love working the numbers..!) and I can't milk them harder!

 

You should be buying larger lots in Tamworth for subdivision. Dual Occ on one, Dual Occ on the other... 4 rental incomes instead of 2 rental incomes, from 1 lot ( well, two ). Plenty of 1200M2 + lots to do this with.

Or just flip them like these guys did. Purchased 1282M2 for 190K in June 2017. Subdivided into 2 x 640M2 lots and sold them for 265K each

ANOTHER ONE SOLD BY BURKE & SMYTH!

 

Or maybe a JV of some kind with a larger pay packet!! I would love to explore acreages / large sub div, commercial warehouses etc...

I was part of an initial 2 and then 3 party JV with another developer with a1500 sqm site in GC early last year... The developer built many dozens of towers in Mel & Syd over past 30 years and this was going to be his last hurrah.. I know him well and decided to partner up. The project was going to be 75 stories tall and returned $65m in PBT to us on very conservative numbers on Sep 2020 GC's numbers - they are up 35% since then. I went all in but then my QLD based lawyers went overboard in their DD and long story short... overplayed the 5% risk scenario so much that, I pulled out last minute, mainly on the advice of my mrs.. she thought it was best I listened to my lawyers... as I kept playing devil's advocate on it.

This tower is now 102 stories tall dev and returns $110m+ to the 2 remaining JV partners! My total investment was around $3.5m... rest was to be financed.. builders appointed - fully funded!

So.. I am trying to wash away that regret of not taking that risk with taking over a juicy JV project! with a great upside and working the deal and crunching numbers etc..!!

 

Hindsight is always 20/20, it could have gone either way and I would say with $3.5 mil, its better to be safer, since how much more do we really need and can you afford to lose $3.5 mil? I agree with your missus

 

Bloody hell what a story. We all have our “ones that got away” but also “ones we dodged”.

 

How would your calculations stand today? It doesn't seem like a viable idea for all environments.

 

No the interest rate is too high to follow this acquisition approach . To make it worthwhile today you need to focus on finding properties that are under rented and improve the rentals. But the vendors have not adjusted/accepted the higher funding cost.
Market yields need to be 2% higher than funding

Since that posting my focus has been on improving rentals on existing properties.

 

How do you do that in commercials where lease is usually 5-10 years long with fixed increases.