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Help..beginner at work, need some help with thought processes

Discussion in 'Introductions' started by chowmein, 28th Oct, 2015.

  1. chowmein

    chowmein Member

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    I stumbled across PC a few months ago, after it was recommended by another person and I have since been following avidly.

    I would really appreciate some advice as I am a real novice. Pardon the silly questions,
    Here is my story:

    we are in our mid 30s with 3 young kids. we have a PPOR valued at 750-800K which we owe 300K ( but have decent offset). we have 1IP that is positively geared and we are looking to expand our portfolio.

    we gravitate towards more conservative investing given that we are still on 1+ income and there is some but limited fat in the budget.

    My question is:
    we are considering taking equity out of the PPOR to invest and would like to get back on the property train. However, having done the sums, we are somewhat confused. Even if there is 4-5% CG and 5% yields, whereby the property is NG, wouldn;t we be better off paying off our PPOR before investing further? If not, it seems that we are just paying money to the bank (ie not paying more off our PPOR, but paying more to service the NG investment loan).

    The only way i can think of negating this is to buy a neutrally geared property (being a villa/unit/townhouse) for the time being until we have paid off the PPOR.

    Is this thinking correct? What are we missing?

    any thoughts on this is much appreciated, thank you
     
  2. Befuddled

    Befuddled Well-Known Member

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    Welcome.

    Assuming 5% yield, 105% borrowing for the next IP and 4.5% interest rates, you're looking at being out of pocket by around 0.5-1% without accounting for depreciation. Subtract that from the 4-5% CG and you would still come out ahead.

    If you wait until fully paying off the PPOR before buying the next IP, that could take another 5-10yrs. By the time you're ready to go again the same IP could easily have increased in value by 30-50% (assuming 4-5% year-on-year CG). On top of that, you would likely have to take equity out of your now fully-paid-off home to buy, meaning you'd STILL be slightly negatively geared.

    Assuming constant yield, interest rates and CG, the difference between the 2 scenarios is you lose out on a number of years of CG on the IP at the saving of a bit of initial cash flow. Huge difference
     
    Last edited: 29th Oct, 2015
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  3. jpcashflow

    jpcashflow Well-Known Member Business Member

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    In regards to the above comment, you need to take into account what if your property was not tenanted for some time, can you afford the repayments? Also if you bought a investment property and kept it for 5 years plus what maintenance would you need to do?

    When investing, I dont just look at the basic numbers, look at all the possibilities.
     
  4. bob shovel

    bob shovel Well-Known Member

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    Why not look for higher yields plus better short term growth. Doesn't need to be a unit or town house, follow the numbers

    You have heaps of equity to play with. Keep reading and find a good broker.
     
  5. chowmein

    chowmein Member

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    Thank you everyone for your replies thus far.

    Assuming 5% yield, 105% borrowing for the next IP and 4.5% interest rates, you're looking at being out of pocket by around 0.5-1% without accounting for depreciation. Subtract that from the 4-5% CG and you would still come out ahead.

    Yes you are correct.

    jpcashflow, post: 91798, member: 646"]In regards to the above comment, you need to take into account what if your property was not tenanted for some time, can you afford the repayments? Also if you bought a investment property and kept it for 5 years plus what maintenance would you need to do?

    When investing, I dont just look at the basic numbers, look at all the possibilities.[/QUOTE]

    Indeed, hence my concern and also choosing the right property in the right area becomes paramount. This also pushes us towards a newer build townhouse/unit equivalent to reduce overheads.


    That would mean picking the market which we are trying to do. Yes, we are in search of that and doing lots more reading. Any help to accelerate this would be helpful,
     
  6. Steven Ryan

    Steven Ryan Mortgage Broker Business Plus Member

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    On the paying off PPOR before investing question...

    As @Befuddled mentioned, there is an opportunity cost.

    But lets look at another important factor. LEVERAGE.

    Paying down your PPOR loan produces a dollar-for-dollar return, saving you whatever your interest rate is on each dollar paid down (or put in offset).

    Investing with your PPOR equity allows you to leverage, and effectively multiply your return on each dollar by 5-10x depending on whether you're borrowing 80-90%.

    Example (assuming 5% interest rate to keep numbers easy):
    • Pay $100,000 off PPOR, save $5,000pa.
    • Use $100,000 as 20% deposit on a property and you now have a $500,000 asset (the interest on which is tax deductible).
    Lets say that new $500,000 property increases in value 3% in year 1. That's a $15,000 return. Sure beats saving $5,000. What if it increases 5% instead? That's a $25,000 return. Sure beats saving $5,000.

    (Yes, there may be holding costs depending on the rental return, but they will typically be a fraction of the overall increase in value)

    Fast forward a few years and lets say that property is now worth $600,000. You're up $100,000 and, if income allows, you can draw out $80,000 and use it to buy another property worth $400,000. Now you have an extra $1 million in property working for you. Your PPOR loan hasn't been paid down at all but now if you see 5% growth across your investments, you will be up $50,000. Sure beats saving...you get the idea.

    Lets fast forward another 10 years and imagine you haven't drawn out more equity to buy more property (though I would). Your $1 milion of property has done well and is worth $2mil. You're up $1 millon and have a cashflow positive portfolio as rents have increased in line with inflation over the decade. Sure beats saving ~$50,000 ;)

    Obviously, this isn't for everyone but it's incredibly easy to overlook the enormous power of compounding and leverage.
     
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  7. Big Will

    Big Will Well-Known Member

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    You are missing the key factor of leverage.

    Lets keep the numbers simple - $100,000 is what you have in the offset and the rate you use is 4.5% p.a and you are able to save $1,000 per month (12k p.a.)

    In a year you save 4,500 in interest + 12k = $16,500

    Now lets say you buy a house for $500,000 and used the $100,000 as deposit (excluding all fees) and the house grows at 5% (I would be looking for 7% growth which is $35,000).

    The house will gain @5% - $25,000 however you now have to pay extra loans of $500,000 (100k on PPOR & 400k on IP) - $22,500 so net $2,500 + 500 p/m (6k) = 8.5k but you also have extra income of $400 pw (20,800) - $29,300.

    Note I have not included fees, duties or NG benefits in the calcs above.

    So would you rather 16.5k or 29.3k in a year? The later does come with more risk though.
     
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  8. Big Will

    Big Will Well-Known Member

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    really should of written what he said lol
     
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  9. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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    Consider also that you can borrow to pay expenses. Search for 'debt recycling'
     
  10. Befuddled

    Befuddled Well-Known Member

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    What the previous posts said. Maximise your asset base but factor in risk and make sure you don't overextend yourself.
     
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  11. chowmein

    chowmein Member

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    Thank you all for your comments and calculations that makes it easy to understand. Definitely makes sense now.

    Another question moving forwards: I have been looking at re.com.au for yield and capital growth. However, I am having a hard time finding high yielding areas (5-7% as some have mentioned in a capital city) together with 5% or more CG that lots of people talk about?

    Is this accurate or is there a better website to access this information for accurate info?



    Do you mean paying of the interest etc from the equity obtained from PPOR? I will have to look into this. thank you
     
  12. Terry_w

    Terry_w Solicitor, Finance Broker, CTA Business Member

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