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First IP - How much to spend?

Discussion in 'General Property Chat' started by jprops, 25th Jan, 2016.

  1. jprops

    jprops Well-Known Member

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    Hi,

    I've been loitering this forum for a few months and this is my first question.

    We are looking to invest in the Brisbane this year. I'm thinking to get the best block of land as close to the CBD as possible.

    We have a houshold income of 220k before tax and currently have 170k in savings that we need to get out of our "High (read as low) Interest Savings Account" into an investment. We'd like to buy our PPOR in around 4-5 years time as our daughter starts school.

    At this stage my strategy is to buy something in the 600 - 700 k price range, looking for Capital Growth, and borrow at 88% LVR using some of the remaining cash for light reno to add value and increase rental yield.

    As I'm a first timer here, I'm not totally confident of this plan, but I think it's a solid one. What do you think about this strategy? Is it stretching it too far? Would you look at buying 2 cheaper properties?
     
  2. Foxdan

    Foxdan Well-Known Member

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    Is your strategy to buy and hold or is your strategy to buy and then sell in a few years (assuming capital growth)?
    As a general rule of thumb, higher value properties will have a lower rental yield. So 2 X smaller properties might provide better cash flow.
    If you plan on selling after brisbane has finished its current growth cycle, it also might be better to opt for 2 cheaper properties so that you can sell them in different financial years and spread the capital gains tax across 2 separate years.

    Just suggestions.
     
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  3. jprops

    jprops Well-Known Member

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    Thanks for your response. Spreading CGT across two years with 2 properties is something I hadn't thought of. My thoughts are to buy and hold - accessing the equity to fund further IP's before purchasing the PPOR.
     
  4. MsAli

    MsAli Well-Known Member Premium Member

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    @jprops - welcome to PC!

    Good thinking about buying IP's prior to purchasing your PPOR. If you purchase well, it will definitely be a leg up when you come to buying your home.

    As Foxdan suggests, when you do the cashflow analysis of the 600k-700k purchase you will find it will unlikely be neutral or positive cashflow. Unless of course, you are using strategies such as renting room by room.

    Here are my thoughts:

    Scenario 1: 2 x 350k
    Pros:

    • Lower entry price
    • Possibility for a better rental yield
    • Possibility for Neutral/Positive Cashflow
    • Vacancy for one property means part of the mortgage is still covered
    • Sell one, hold the other property
    • Help with servicing (assuming a high rental yield though, 7% more like it. Not quite easy to achieve as the market has moved)
    Cons:
    • Lower quality demographics
    • Lower potential for capital growth (depends on the market however, note you are looking in Brisbane)
    • 2 x council rates / 2 x water rates
    • 2 x solicitor fees / 2 x B&P
    Scenario 2: 1 x 700k
    Pros:

    • Better demographics
    • Better potential for capital growth (higher demand from owner occupiers)
    • Possibility to buy a development site - that you can DA & Sell, DA & Build/Sell, DA & Build & Hold
    • 1 x council rates / 1 x water rates
    • 1 x solicitor fees / 1 x B&P
    Cons:
    • Higher buy in cost
    • 1 x rental - so when vacancy happens, you pay mortgage on the whole amount of 700k
    • Negative cashflow / holding costs
    • Impact on servicing & hence future purchasing due to the cashflow position
    • When you sell, you sell ONE; incur tax on one property alone in the same financial year
    Your thoughts?
     
    Last edited: 25th Jan, 2016
  5. jprops

    jprops Well-Known Member

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    Thanks @MsAli

    I like how you've broken this down. How will servicing be impacted exactly? Is it purely because it is likely to have a lower yield?
     
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  6. MsAli

    MsAli Well-Known Member Premium Member

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    Indeed
     
  7. wombat777

    wombat777 Well-Known Member Premium Member

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    The issue that you may find down the track is that if you intend to buy additional IPs later you may hit a serviceability wall if you go for the option of buying in the $600k to $700k range. Serviceability is king due to the APRA changes last year. In this environment, chasing yield is important and hence look at lower value properties. Yield per $ is generally better in the sub $350k price range.
     
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  8. Big Will

    Big Will Well-Known Member

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    700k is buying at the top end of Brisbane.

    Myself personally as I saw you are in Sydney what if you bought a house for 500-600k @ 80LVR on IO and parked money in the offset and used that to help service the loan. During the 5 years it should become more self sufficient as the yield could be about 4.5% so be neutral or positive.

    When I did quick number crunch of 500k purchase (400k loan 80LVR) @ 6% IO, 4.5% yield, 6% growth (avg), 2 weeks vacancy, inflation 2%, being professionally managed and no deprecation on building or fittings.

    On day 1
    Effective Loan $330,000 (400k loan with 70k in offset)
    Cost per week ~ $34 a week
    Equity ~ 146,000 (170k - purchasing costs)

    After 5 years
    Equity ~ $316,000 (minus 170k amount invested ~ $146k equity gained)
    Cost per week ~ $18 pw

    Great case scenario (7% growth, interest rate 4.5%, yield 4.5%)
    Day 1
    Cost per week ~ paying you $26 pw!

    5 years
    Equity ~ $347,000 (~177k equity gained) and if 8% CG Equity ~ 381k (~204k equity gained)
    Cost per week ~ paying you $42 pw.

    Bad case scenario (5% growth, 4% yield, interest rate 7%).
    Day 1
    Cost per week ~ $99 pw

    5 years
    Equity ~ $284,000 (~114k equity gained)
    Cost per week ~ $85 pw

    Then when you are ready to purchase your PPOR you can move your original money (~50k after purchasing costs) plus equity gain (~80% of it) out of the house to purchase in Sydney.

    Up to you but this would allow you flexibility and able to rent to a larger rental pool without going into the low social economical areas.
     
  9. Steven Ryan

    Steven Ryan Mortgage Broker Business Plus Member

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    Welcome @jprops.

    I think your plan is a very solid one. First, check with your broker that you will be able to access any value you add on a purchase like that (and also check when you will hit a serviceability wall AFTER the first one so you can plan for IP2, IP3 etc) before making a move, but if you can, I think it's a great idea. I reckon the $600k-$700k mark is the sweet spot to have you pick of the bunch close to the CBD (5-10km). I bought something in that range mid last year.

    You will encounter a serviceability wall, probably sometime soon after you hit 7 figures of debt so one idea to maximise your position might be:
    • Buy 1 @ $700k and reno to add value and improve cashflow
    • Pull out $100k equity and use it to;
    • Buy 2 x $300k (aiming for 6% yields)
    Then you might get stuck for a bit but you'll have a nice spread of stuff close to the city and a bit further, and reasonable cashflow.

    On the face of it, you're in a good spot to make a big impact on your future :)