Equity vs Servicability

I noticed a discussion about multiple cheap vs single expensive property. In my situation I am a single income teacher, with no real prospects of a significant income increase. I currently own an investment property in Brisbane with 300k equity ($400 cashflow positive a month) and and am deciding my next move.

Initially I wanted to target high growth assets, thinking I could use equity to fund my next purchase. However, I'll find myself reaching my Servicability ceiling very quickly, even if I have huge growth.

Would I be better off targeting higher yield properties: town houses, apartments and non major citiy houses that wouldn't impact my Servicability as much. In order to grow my portfolio, which path would be more beneficial considering my moderate income?

 

Equity is the equivalent of the bank having security against their loan if something goes wrong. It doesn't make the payments for the loan.

Serviceability is the analysis that your income is high enough to support your expenses.

Both are components in qualifying for a loan, but they are different and one can't substitute the other.

You've asked the question which strategy would be, "More beneficial considering my moderate income?" The answer is the strategy that increases your income.

The problem with cheaper higher yielding properties is they don't really increase in rent over time. These properties are often in lower socio economic locations where many are in low income employment or government benefits. Their incomes don't increase much, so the rents also stagnate (along with house prices).

If your basic strategy is to buy and hold, a better rental strategy over the long term might be to look to where rental income has growth. A 3% yield with 10% annual growth is going to be far superior to a 5% rental yield with 2% annual growth fairly quickly.

 

Depends what you think the tradeoff is between yield and capital gains. Even what is considered a high yield (positive cashflow) property probably won't increase your serivceability, so you still hit the wall eventually.

Portfolio 1: larger, higher yielding properties but with lower capital growth.
Portfolio 2: smaller but higher growth, probably through selling and upgrading to a more expensive property.

 

What's the end goal?

Cashflow properties don't usually increase borrowing capacity by much (if at all), so you need to think about what the end game is for each property.

You might find that rather than simply relying on organic growth and existing rental yield, you need to look for assets that can be "forced" into providing more yield and growth...when borrowing capacity is tight, each asset you own has to provide max bang for buck.

 

Do you think granny flats would be a suitable strategy for my situation? Some argue that the 120k build price would be better spent on another deposit? But that deposit is useless if my servicability is already exhausted.

My sttategy is to buy and hold. But I've started to think that growth won't be as meaningful if I can't use that equity anyway.

 

A granny flat tends to be a good way to increase cash flow and affordability overall. The cost to build vs the increased income is a fairly good yield equation.

My general observation is that they don't really add much value over and above the cost of building. The increased income (given the cost to build) isn't going to be enough to get you into another property in its own right.

So overall a granny flat is a net benefit, but not a solution to serviceability on its own.

 

The 5k pa surplus can be used to reduce debt
So say your equity is $300k and your debt is $80k (so about 20% LVR) your $5k could bring your debt to zero so you are still growing your equity even with little property growth.

 

I was more implying, since Servicability will be an issue for me; would it be worthwhile pursuing a granny flat strategy. Since both growth assets and high yield assets both will struggle to grow my portfolio, should I focus on maximising the yield from what I am able to buy?

 

At the moment I've been putting the surplus into an offset along with savings. My understanding was that it is more effective in offset than paying off the principle. I have about 30k in there.

 

I guess I'm saying that a granny flat would probably improve your cash flow. It may improve your serviceability a little, but it might not. This depends on the actual cost and the actual additional rent you get. I'm fairly confident that it would not be a game changer though.

 

Yes.

 

Considered periodically selling a property? The transaction costs can be large, but it is one way to keep buying when you can on service say 2 properties.

Sort of like this:
How to Mini-Retire on Just 4 Investment Properties How to Mini-Retire on Just 4 Investment Properties

 

With the CGT and transaction I feel like it could take a while.

What are your thoughts on buying a house and granny flat, paying it off as fast as possible and then having the combined rent to contribute to the next property?

 

I would be using an offset account instead of paying it off and extending the loan back to 30 years every time you buy a property.

It would be a slow but sure way I think.

 

But if I don't reduce the debt, how will my servicability improve?