Has the game changed?

OK - I was thinking more in relation to someone paying the absolute min P&I repayments ie the P component isn't redrawable in that circumstance vis-a-vis someone really knocking their loan/s down with extra repayments.

Still, paying down anything other than PPOR debt is counterproductive in my view in the current taxation environment. Very annoying.

 

On a servicing calculator, if you remove non income producing, non deductible debt from liabilities, that debt is no longer being assessed at 7.25% P&I . When you later seek to add new investment debt , it also gets assessed at 7.25% P&I... so its a zero sum game at first glance. But because you are replacing non income producing, non deductible debt with income producing , deductible debt, your borrowing power starts to see improvements from the rent and addbacks/ gearing macro's applied in the lender servicing calcs. How much improvement you will see varies from lender to lender, but in all circumstances you will have superior borrowing power than you would otherwise have had if none of the non income producing, non deductible debt had been repaid.

To prove the maths, imagine this scenario;

You and I have the same income, the same number of dependents etc. We both have a 300K PPOR mortgage @ 4% P&I . You and I both own 2 x 500K INV properties . The debt is exactly $1Million and it is I/O for 10 years. My two properties are cash cows, each generating 8K per annum in surplus cash flow after tax. Your two properties are not, and they each cost you 2K after tax.

Over the next 10 years, I am able to pay down 20K per annum more on my P&I PPOR mortgage than you are. (8K + 8K + 2K)

In 10 years ( Nov 2027) you will owe the bank $235,707 + $500,000 + $500,000 ( $1,235,707)

Amortization Schedule Calculator

Loan Amortization Calculator in Australia Online| Loans Direct


In 10 years time I will have paid off the 300K P&I mortgage, meaning I owe the bank $0 for my PPOR + $500,000 + 500,000 ( $1 Million )

Extra Payment Calculator - Amortization Schedule

Now.. which of us has the superior borrowing power with which to harvest any available equity and add to our investment portfolio's? Is it you, or is it me? Even if your properties had grown twice as much as mine over that period and you had twice as much equity as me, which of us has the superior access to their equity? Is it you, or is it me?

Now, let's go one step further and say that once my non income producing, non deductible PPOR debt is paid down in 10 years, I can then ( if I choose) start paying down the debt on one of the two 500K INV properties as well. The surplus cash flow from INV #1 and INV # 2 could be redirected towards that purpose. So instead of 20K per annum being redirected to PPOR repayments, they start being redirected towards INV #1 repayments. But wait...there's more The $1432 per month that I used to spend as the minimum monthly repayment for the PPOR debt ( which you would still be paying by the way..for 20 more years) could then be added to this figure. So I could pay down INV #1 quickly, then repeat the process and pay down INV #2 even quicker...and INV #3 ( which I was able to purchase but you were not able to purchase ) even quicker. And then INV #4, 5,6 and 7 if I wished... ( none of which you would have purchased) And I could do all of this while you are still slaving away on that PPOR debt.

Just to be clear - even if got zero growth ( which I am not suggesting ) by using a dividend reinvestment plan I could own my PPOR and several INV properties outright in less time than it would take you to pay down the just PPOR.... and I wouldnt have needed to sell anything to do it, so I'd have the income stream from those properties as well .....You would not be in a position to start doing any of those things. So I would not only start to race away from you capacity wise. I would also be way ahead of you income wise...

And this is how debt reduction improves borrowing power. I have provided multiple calculators from multiple sources... they all say the same thing about the power of cash flow for dividend reinvestment / compound debt reduction. In an era where every dollar you owe is assessed at 7.25% P&I, it's a very simple concept

I am talking about dividends from a resi cash cow. NRAS is one form of cash cow. Dual Occ is another. The point is to reinvest whatever dividends/surpluses you achieve...towards debt reduction.

 

Love the methodical analysis @euro73! I get the logic & understand how its a suitable investment strategy for some.

Nonetheless, i think its worthwhile talking about both sides of your plan though.

Your main theory is about dividend re-investment. Dividend reinvesting is a useful financial strategy that helps pay of mortgages. It's appears to be one that a number of the more sophisticated forumites are using (e.g. @Jack Chen on his great story re paying down mortgage via LIC's).

In your plan though, you are effectively promoting using $1million of your increasingly limited borrowing power to obtain a $16k p.a. positive cash flow benefit. This $1million of debt is susceptible to risks associated with having debt:

• Interest rate changes.
• Potential swap to P&I lending over time.
• Market shifts (usually the assets that generate these yields aren't in typically viewed as the best areas).
• Property specific risks (asset replacement, fixing it up, etc).
• Risks associated with having debt & buffers that should be held.
• Did you say a 10 year interest only? You can kiss goodbye your borrowing power with CBA, NAB, Westpac, St G, Suncorp, Macquarie, etc.
• Higher yielding assets has less leveraging benefits today than it used to.

Prudent borrowers should prepare for these risks. I'd also be promoting borrowers to see how well this 'dividend reinvestment' plan works under more neutral finance assumptions (e.g. 6% P&I lending).

I agree with you when taking a relative analysis of property assets, that a higher yielding asset is 'safer' than negatively geared assets. It does handle debt better & reduces cash flow risk for borrowers. Nonetheless, the same fundamental analysis of buying property should hold. Good areas, good growth opps, value adding opps, etc will still be the name of the game in this environment.

 

Reduced fees, greater interest rate discounts, convenience of dealing with one bank/internet banking platform.

The higher the aggregate borrowings the greater the potential interest rate deduction may be.

To many properties with the one bank can present a concentration risk and doubly so if they are cross collaterised.

 

Just an example... you can insert any dollar amount you prefer. For example, I own 2 x Port Macquarie NRAS properties that cost me 250K each, which generate 11K CF+ each. There's 22K from 500K. Or, 44K from 1Million if you wanted to look at extrapolating things ....

The point of my post was to provide a simple example that demonstrates the value of debt reduction to borrowing capacity in todays regulated servicing calculator world. the debt amounts arent what was important. The removal of non deductible debt was the important part.

Whichever figures you use, borrower A and B will still end up in dramatically different longer term positions if one dividend reinvests and gets rid of their PPOR mortgage fast, and the other doesnt.

To your other points; I would argue that additional net income provides for far greater redundancy against each point you noted.

• Interest rate changes. CF + covers ones backside against this far better than CF neutral of CF-
  
• Potential swap to P&I lending over time. CF + also covers ones backside against this far better than CF neutral of CF-
  
• Market shifts (usually the assets that generate these yields aren't in typically viewed as the best areas). Hmmm.... how's Gregory Hills doing ?
  
• Property specific risks (asset replacement, fixing it up, etc). I dont really understand why this is relevant to borrowing power.... but again, having more surplus money is better than having no surplus money if these sorts of things come up, no? Equity doesnt pay bills... unless you can access it. cash flow pays bills either way.
  
• Risks associated with having debt & buffers that should be held. I dont really see how CF+ makes this any more of a risk than a property running CF neutral or CF- ... I would have thought that having surplus cash flow makes carrying debt less risky. Maybe I missed the bit in economics 101 where someone developed the theory that less surplus money is better than more surplus money.....
  
• Did you say a 10 year interest only? You can kiss goodbye your borrowing power with CBA, NAB, Westpac, St G, Suncorp, Macquarie, etc. Most new investors can kiss goodbye to borrowing capacity anyway, after a couple of purchases... especially if they arent making meaningful inroads into PPOR debt . This is the entire point. If the borrowing ceiling and the P&I cliff are both arriving far earlier then they have previously, cash flow /debt reduction must therefore carry more value now.
  
• Higher yielding assets has less leveraging benefits today than it used to. CG assets have less leveraging benefits as well... all resi assets have less leveraging benefits than they used to..... and again, this was my point. The difference is that debt reduction will restore some leverage over time, but growth wont... unless you sell of course.

I'd be interested in reviewing how comfy someone with a couple of growth/lower yield properties , who hasnt paid down any debt during their I/O term, handles 6% P&I versus someone with a good deal of cash flow and a good deal of debt paid down before their I/O terms converted to P&I... especially if all their surplus cashflow has been used to hold those properties . ie - theyve paid nothing off their INV loans and they've paid next to nothing off their P&I PPOR loans... I guess we will have to see how that plays out for individuals... that P&I cliff might feel a whole lot higher a fall when you only have equity as the defensive position rather than less debt and lower repayments as the defensive position...

The Dividend Reinvestment approach isnt simply about the 7,8 or 9K surplus...its also about not having to fork out for the 2,3,4K loss that is typically associated with lower yielding properties - especially older ones where depreciation is diminished...and worse still , old 2nd handers where depreciation rules passed the house last week making the tax breaks ( and therefore the cashflow ) a touch weaker ....

With new cash cows you have every dollar possible working down PPOR debt. Even if its just for 5 years... that creates a really handy buffer if the worm turns.

Or, take out that equity and put it all on black. Or on Red

But look, everyone's free to avail themselves of their own views and opinions . Its what makes the world go round.

 

And this is why manufactured equity for those willing to put in the hard yards remains the most robust and governance and market resistant strategies.

Im not talking large developments, im talking cookie cutter subdivisions with multiple exits and limited concern with lenders rule changes as you will only ever need to hold two properties.

Take your PPOR and leverage of the equity to purchase 1 investment at 80% LVR plus costs plus subdivision costs. Take a 500k property you will need about 50-70k to complete the process. Depending where the market sits at completion you can choose how to exit.
Take the profits and reduce your PPOR down, leverage and go again.

Hey it's not as easy and pretty as "negative gearing" but it's one of the safest, APRA resistant strategies available.

I'm sure they do exist but I'm yet to personally hear of someone who has not at the absolute very least broke even and took away from it a bunch of experience. Most people however tend to turn a decent (read as 100k's) profit.

I fully agree with @euro73 that debt reduction is the way forward, how you do it is totally up to you and your appetite. I'm just not a fan of tenants for the long term.

 

Am I barking mad or bang on the money?

APRA - the latest and greatest

 

Hmm some good points @euro73. I agree with you when you make a relative analysis between purchasing Sydney investments yielding 2% and your cash cows. Cash cows are safer & the cash flow makes it easier to manage the debt thats required to buy them.

I also think its very true that debt is riskier today than previous times. The macroeconomics suggest this. I think its great that forum contributors bang on about this message. Its great to talk about and often under-appreciated.

I'm not sold that taking on more debt & promoting it as 'deleveraging' or a 'debt reduction plan' actually works. I personally define 'deleveraging' and 'paying down debt', as, well, having less debt. Taking out $1mill in more debt and using cash flow proceeds to pay down debt, i don't really consider that deleveraging. At the end of the day, you can't spin the fact you have more debt overall & for a relatively long period of time.

Alternative deleveraging strategies using property:
- Buy, develop, sell. Use profits to pay down debt. Temporary periods of debt increases, but a clear debt reduction strategy in place.
- Buy, renovate, sell. Use profits to pay down debt.
- Value add on existing properties, use additional flows to pay down debt.
- Use savings to purchase high yielding ETF's/funds, use flows to pay down debt.
- Pay down existing assets. Not very creative, but it's deleveraging.

The common theme to all scenarios above is that it actually reduces debt levels. Most importantly, it reduces RISK associated with debt.

Yes buying cash cows is less risky than buying negative yielding assets. But, buying cash cows DOES NOT reduce your risk levels. It does not stand up to stress testing and may indeed put more pressure on borrowers because it involves more debt.

As a personal anecdote, i own multiple NRAS investments. They complement my portfolio well (thank you @euro73, Gregory hills is fantastic). Yes, they are far safer than my growth assets, and quite literally yield x4 some other assets. They need less buffers than my growth assets. Nonetheless, now, in a cycle where my investing strategy has switched to protecting my portfolio & deleveraging, I want to reduce debt levels and build resilience to my portfolio. My NRAS assets are part of the problem in the portfolio, it needs debt reduction. NRAS properties & cash flow positive assets add to my debt levels. My solution here isn't to go and buy more assets that add to my debt. That would, IMO, be reckless & not fit my overall intention.

Putting only my 'credit adviser' hat on, not a 'property salesperson', i think its important borrowers know that buying cash flow assets to hold indefinitely - this does not make you safer, more resilient & better able to manage debt. Not saying its not a good investment strategy (i've invested in this stuff myself!), its just not one that helps manage risks associated with debt (as it involves more debt to work!).

 

I like the way you think @Redom
These at the moment are the only options I'm looking at.
Besides the potential of selling off under performing assets.
I'm capped out through APRA changes so hit the wall with lenders who I'm prepared to hold long term debt.
I'm happy to keep buying and have capacity for ~$1.5M+ with other lenders
But I'm not happy to hold these facilities for >12-24months
In the last month I have either done or considered
- Paying down PPOR
- Purchasing high yielding shares with cash/debt recycle
- Attempt to buy property to flip
- Looking to buy property to develop/sell land without building

 

You'll find that Ive made the point many times that I am talking about people who wish to GROW their portfolio... not those who wish to SELL it or DOWNSIZE it, and to be fair I have commented many times that alternative options are selling or putting the cue in the rack .

When I write, I write to an audience who I assume to have PPOR debt, and who wish to GROW. I dont write for those without PPOR debt, or those seeking to sell up or put the cue in the rack, I dont write for those with mature portfolios already who availed themselves of pre APRA conditions and have held their portfolios long enough that they have matured. Nor do I write for those with larger incomes . I write for average Joe's and Josephine's with a PPOR mortgage who want to pay it down as fast as they can and then set about building a passive income for life. They dont have the appetite or the skillset to become mini developers or flippers ... For that audience and this credit environment - dividend reinvesting is the only way to achieve the two necessary criteria to do that safely

1. create equity that can be harvested
2. restore borrowing power over time

Now also to be fair, I havent ever pretended or advocated or implied or told stories about taking on additional debt being anything but taking on additional debt. Over the past 5 or 6 years my position on dividend reinvesting/mortgage reduction has centred around the deleveraging of non income producing, non deductible debt though. I have qualified that very clearly, over and over again... So to imply Im advocating taking on debt for the sake of debt is a nonsense... Its about purchasing income with tax effective debt and using it to reduce non tax effective debt. Plain and simple. And its why I disagree with this statement ;

"I think its important borrowers know that buying cash flow assets to hold indefinitely - this does not make you safer, more resilient & better able to manage debt"

This just doesnt meet the logic test. If every dollar of debt you take on generates $1.50 or $1.20 of income, or $1.75 of income..or any amount greater than it costs, and it assists you to retire non deductible debt faster, the argument doesnt hold water. It especially doesnt hold water if the non cash cow version of resi property costs you 10 or 15 or 20 cents versus every dollar borrowed....

You have also stated it doesnt stand up to stress testing... I have to admit I am more than a little perplexed... compared to what? A 4% "vanilla" resi yield? A 3% yield? 'cos if thats the benchmark, are we to conclude from your comments that resi property is just a flat out risk ? I ask because if extra income from higher yielding resi property doesnt stand up to stress testing and doesnt make you safer or more resilient... surely resi property with inferior yields represents far greater risk....

Would you offer the same argument to someone with a large,mature portfolio purchased pre APRA, using 15 or 20 x debt to income ratio's and 10 -15 years I/O, who has paid down none of the debt but has owned it long enough that it is generating cash cow levels of yield? Are they also in no safer or any more resilient a position than someone with sub 4% yields..?

I dont understand how that maths works ie how someone with more money coming in than going out is somehow not in a superior position than someone with more going out than coming in.... so we will have to agree to disagree on that one my friend...

 

Its because the debt & the 'cash flow' asset isn't certain to create you generate you that cash flow into the future. It has a good 2-3 year outlook, even 5 years, but not much further.

It is the same concept as 'payment shock' and the one you've educated forumites plenty on.

That is why 'debt backed' deleveraging is a flawed concept. You generally can't use MORE debt to implement a deleveraging plan. It doesn't stand up to stress testing. The other deleveraging options i mentioned in my earlier post do this far better, as they involve either extinguishing the debt created or just simply paying down debt in the first place (no new debts).

Why can't you use more debt to deleverage? Because the debt arrangements its backed by are likely to change. The same 'cash cow' doesn't produce the same amount of milk when this happens. For example, on my own investment, this is what it looks like when in 2-3 years time, the IO period expires & interest rate settings move to neutral.

You can't educate people about how debt arrangements change, that theres a payment shock, that borrowers will roll over to P&I eventually...and then assume it doesn't happen to cash flow assets.

Plans like the following all have holes in them:
- i will refinance to a near 30 year loan term - this is highly uncertain and will depend on individual arrangements at the time. Also, if rates rise as expected in coming years, this will be far harder to do.
- i will get a 10 year IO period - most borrowers aren't on this, and plenty of lenders don't actually offer it. If you are on it, you're likely to be capped at the knees with most lender serviceability calculators.
- i will fix my rates at current market rates indefinitely - our finance market doesn't allow this.

To communicate the issue with debt back deleveraging, i own multiple positive yielders (NRAS). These are very useful and serve a purpose. They've grown well over time & are decent assets that have performed well.

They are however, NOT a medium/long term deleveraging plan to pay down my owner occupier. This is because these NRAS assets will move from +$5000 to -$5000 p.a. in years 5+ beyond when the debt terms change on them. As a prudent investor and borrower, i need to prepare for this & hence don't bank on the +5k into perpetuity.




IMO, this is a good exercise for borrowers to be aware of. Preparing for this & ensuring adequate resilience to your portfolio before making additional purchases.

I completely agree with you that NRAS & other investments will hold to cash flow analysis better than other assets though. I disagree that they can be bought as long term debt deleveraging assets. When basic prudent assumptions are made, these assets don't do that.

 

Great debate by two PC heavy weights.
You both make great points and Ultimately both of you are right, it's just really all about a persons risk appetite.

 

Couple of things, while trying to respect your privacy

If this is for Gregoiry Hills, you didnt borrow 446K, because the purchase price had a 3 in front of it

if its for another purchase, you didnt borrow 99.11% ... 446 against 450K ..

So perhaps those numbers need to be reviewed....


You also havent accounted for the reinvestment of the surpluses in the first 5 years ( or 10 years) towards PPOR debt reduction. What does amortised total debt end up at? What does this mean to total monthly repayment across the portfolio? What does this mean to total borrowing power versus not having repaid any debt? Its not about an individual property in an individual year... its about compounding amortisation

As I said... I write for those seeking to GROW their resi portflio and retire non deductible debt. I dont write for those seeking to only retire debt without growing the portfolio, as your suggested strategies would require.

- Buy, renovate, sell. Use profits to pay down debt. This assumes growth. We have already seen what has happened in just 5 months of capped I/O quota's and tighter LTI ratios . Expecting a buy renovate and sell approach to produce similar results to what it has in the past requires an enormous amount of faith, especially if the 6% P&I you used in the above example hits all the "vanilla" yielding properties and all those younger PPOR properties we all know have been gobbling up I/O these past few years, in 2-3 years time. You have to really question whether you'll get a growth return on your risk in that environment. Also important to consider 4-5% IN costs and 4-5% OUT costs as well, plus the reno costs + CGT. There's an awful lot that can send someone broke doing this... perhaps 30 years of easy credit have made this kind of thing appear almost risk free... perhaps a little bit of success in the last couple of years before APRA ramped it up with Round 2 has made people confuse thir abilities with their ambitions ... perhaps an entire generation has never seen a serious kick in the arse or a 10 year period of stagnation /very low growth. So I would caution anyone believing theres quick easy money to be made by simply buying, renovating/value adding and flipping to give that some thought. Lets see how many flippers do well with tight credit and when the P&I cliff arrives for those with no Plan B. This sort of thing, while potentially a fast track to debt reduction ,requires you get it exactly right every time, without fail. Every move has to be a winner. If you make any errors you are snookered. Could be years before you have either equity or borrowing power to try again... and even if YOU get it right, all those young PPOR I/O borrowers will be rolling over in the next 2-3 years and might suck all the growth oxygen out of things anyway.

In the end, whenever a strategy assumes growth, I always just have one question - where is the borrowing power going to come from to keep these prices moving onwards and upwards?


- Value add on existing properties, use additional flows to pay down debt. As above - I assume you mean adding a granny flat or similar? This is why I have moved to dual occ. But I dont see how this version of a cash cow is any different to any other version of a cash cow...

- Use savings to purchase high yielding ETF's/funds, use flows to pay down debt.
This is a great idea... if nothing else it means some diversification is happening. But you have to have the kind of personality that can deal with the rollercoaster of such an approach. I invested 200K or so in SMSF monies into this stuff a year ago... I stock picked and I'm up @ 24%. I invested 100K in personal cash into the 5 "top" ETF/LIC products a year ago as well.... barely treading water. By way of comparison, I could have placed 100K into 2 x cash cows as "seed costs" and be making 16-20K per annum.... yeah I'd have debt but as long as I can sell it for what I paid for it in 10-15 years Im still getting 16-20% returns on equity. There's nothing in the world of ETF's /LIC's or planet earth that is doing those numbers safely, except resi cash cows...

- Pay down existing assets. Not very creative, but it's deleveraging. Do you mean sell?


The problem for many people is they just dont have the money or the time or the knowledge to do reno's or flips.... but they do have the ability to get one or two cash cows. And more people fail at reno's and flips than succeed.... so if we are going to consider risk as a criteria for one approach versus another, I'll take the "more money coming in than going out" over the longer term over the short term "hope" of kicking a goal doing a reno...

Anyhow... however its done, whatever floats your boat... paying down PPOR debt , credit cards, personal loans is the place to start. Get amongst it...it will reap serious long term rewards

 

I'm not really advocating or telling people what to buy. It's not my domain & there are far more experienced and well versed people through the forums that are better placed to educate others on. I was just telling people who are looking specifically at 'deleveraging/dividend reinvestment' some property strategies that actually deleverage and reduce peoples debt.

For those that are interested in the finance & credit side of 'cash cows', or any 'very high yield investment strategies':

What is the 'cash' performance of 'cash cows' over 10 years:

These so called 'cash cows' or any 6% yielding property are unlikely to be materially cash flow positive over the medium term.

When signing loan documents at the set up of a loan, for most mortgages written, these are the rough terms of the loan:

• 5 year IO period, average interest rate for 5 years at ~5.20%.
• Move to P&I at 6% in years 6 and beyond (assume a more neutral cash rate in 2022). You talk a lot about this happening to people and the need to be prepared, but then you don't apply this logic to your investment strategy.

Lets model out a 10 year cash flow analysis of a 'cash cow' & input the time value of money function that helps compound over time.

Results:

• + $30k in cash over 5 years. Leads to around $38k in debt reduction
• - $20k in cash in following 5 years. Leads to around $25k in debt increase (needs to be funded).
• - $13k positive result over 10 years, average return of $1.3k p.a.

Model:

I've used your own model in this, left all else unchanged (your assumptions) & simply swapped the debt arrangements to a realistic one.



Summary:

The above points are what APRA want borrowers to prepare for & be aware of. It is just an example applied to a very high yielding property investment.

Debt terms change & borrowers need to be aware of it.

It is why lenders like CBA have introduced IO / PI repayment calculators on their applications, why Macquarie are calling borrowers now to give them notice of changes ahead, why ANZ want brokers to input P&I repayment after 5 years into apps.

All borrowers, before making investment decisions, should be going in eyes wide open about what the debt they are taking on actually means & prepare for it.

In my view, this is the main way 'the game has changed' & what APRA have done.

The above is why debt should be repaid over time (as its the only way property turns positive yielding over time). Its the best way to manage risk over time. And that means all debt, not just owner occupier debt. The risks of debt are similar between the two.

Property is risky & debt isn't as simple as your current repayment. Borrowers should prepare for this & have their own risk management plans in place.

 

The game hasn't changed, but the strategies and tactics need to be changed/amended.

 

Once regulators come in hard and markets turn down theres very little investors can do. Property will start becoming less attractive and difficult investment class. FOMO will be replaced by Fear of not getting out...

The game hasnt changed, its more like GAME OVER.

 

The game is afoot

 

Oh, please! People are always going to buy houses and people are still going to invest in property. Just because things change won't change this.

I can buy a run down house on a splitter block in Perth. Renovate the front house and build a new house at the back. Split the block and sell both. I don't need ridiculous capital growth to make money from that scenario. Actually, I have already done this but not to sell. I am holding for the rental income.

 

Cash rate is at 1.5%, the game is certainly NOT over. Access to credit for most Australian's is readily available & cheap as its ever been. It can be far worse.

Having to repay debt over time is a reasonably prudent stability tool. Most countries don't have a proportion of IO lending that Aus do & many don't allow equity pulls. The financing (and tax) environment here is reasonably fluid and promotes risk taking.

Its mainly that the risks of debt are being spoken of and communicated more and more by regulators. Its just prudent for borrowers to be aware of what the debt they're actually taking on means.

 

Game on.