High growth + low yield versus a balanced approach - the detailed figures show which is best

Discussion in 'Investment Strategy' started by Orion, 9th Jul, 2018.

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  1. Orion

    Orion Well-Known Member

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    Some time back I was trying to determine the best property selection strategy. I did some very detailed figures to show which was best. It was a few years ago, so you'd need to increase the buying figures, but it was basically trying to compare two types of property strategies

    Assumptions:
    • High income, 30% savings rate
    • 80% LVR max, 7% interest rate
    • Buy as often as one can whilst maintaining cash flow buffer

    Two property types
    1. Scenario 1A - Outer Suburban style house, $380k purchase price, 15 years old, 5% yield, 6% growth
    2. Scenario 1B - Inner Suburban style house, $600k purchase price, 40+ years old, 3% yield, 8% growth

    Today you might have to go with say 500k & 780k.

    Have a guess at which one will out perform over a period of 15-20 years before you look :)

    I'd love if anyone can show me where I'm wrong here. One strategy is clearly better than the other, in terms of high capital growth and much less stress.
     

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  2. Marcus Yuuu

    Marcus Yuuu Well-Known Member

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    interesting...could you share spreadsheet pls?
     
  3. Anthony Brew

    Anthony Brew Well-Known Member

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    Interesting that in the end result you have lower net worth yet massively higher cash flow. I wonder how it would look to sell down some of the other one so that they both end up at the same LVR and see how the cash flow looks since you would be reducing debt by about 4m while keeping your equity the same.
     
  4. CDaly

    CDaly Member

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    I think the one with the lowest net worth (scenario B), unless I have misunderstood, I read that the cash flow is negative? as in negative $93k, compared to scenario A which is $6k profit...
     
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  5. TMNT

    TMNT Well-Known Member

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    although your end result might not be different,

    assuming what growth there will be in 20 years time is pretty dangerous

    will your conclusion change if in 20 yrs the growth % was identical?
     
  6. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Are you assuming the rents will increase with CPI?
    Is this the case, especially for the current environment.
    Also if you are assuming rents are a fixed % of the value, then I have found this is not the case as if values grow by say 10% rents may grow only by 2%
     
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  7. aufm

    aufm Member

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    Awesome spreadsheet (i'm a bit of an Excel nerd myself)!

    Not sure what it'll do to the final numbers, but there is no more depreciation allowed on established houses from May 2017.

    I think practically, especially given the current climate, the real struggle will be getting more finance after the $2 million mark? The brokers on here will have a far better idea, but banks will generally apply a discount to rental income, and the 200-300k PAYG can only be stretched so far?
     
  8. GetRIDof5CENTpiece

    GetRIDof5CENTpiece Well-Known Member

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    Tis is true
     
  9. Orion

    Orion Well-Known Member

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    No, if anything, lower growth would favour higher yield properties even more. The Australian market may then become more like the American market, where it's more about yield than growth.

    Yes - this was done pre-2017, so I didn't account for this. You'd need to look at higher yielding new townhouses or similar. Note, this scenario was using a 15 year old outer suburban house, which had already had most of it's depreciation. If it were a new build, the figures would be even more in favour of the cheaper, higher yield, new build.

    Also, as you point out, the spreadsheet doesn't account for credit availability. There is no way to predict this, but whatever it is would affect both scenarios about the same, so it was easier to ignore it. Less credit availability would just slow things down, but the gap between the two strategies would be similar.
     
  10. Orion

    Orion Well-Known Member

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    If by current environment, then I'd agree, but I think when one is trying to make a spreadsheet to project out 20 years you have to use a long term value rather than something that is true for the next few years.

    Happy to reduce the CPI to 2% and run it again.

    In fact, happy to change any assumptions and run it again, assuming I can find the original Excel :)
     
  11. Orion

    Orion Well-Known Member

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    Alright, I just read up on the depreciation changes.

    From what I've read, depreciation of the building is still allowed, which is the biggest part of it, yes?

    If anything it seems they've fixed the loophole of people overvaluing plant and fittings because in most established properties most than 5 years old they should be worth almost nothing anyway (with some exceptions such as reno'd places - which are still included with receipts, right?).
     
  12. aufm

    aufm Member

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    Yes, my bad, I glossed over it when it was first announced and thought it also included the building. According to the ATO website for any buildings constructed after 1985, the building itself can still be depreciated.
     
  13. Beano

    Beano Well-Known Member

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    Once you concentrate on a cf+ portfolio that makes money then there is no $2m loan barrier or even the need for salary/wages to assist your cashflow (even when drawing $100k or $200k from the net rents) take my word for it!
     
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  14. Big Will

    Big Will Well-Known Member

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    I get the concept and there are always variables and I would agree a balanced is better overall - however if you are getting cash from elsewhere than growth will win. Eventually growth will out perform the yield in terms of rental dollars received and obviously growth.

    There are some minor assumption changes I would make to the spreadsheet however with the 40 year old home you could renovate which would improve cashflow without destroying to much equity. However the biggest variable would be purchasing a house because lets be honest if you were getting 3% yield on an apartment you are likely doing something wrong... So with a house in the inner areas (especially 40 years ago) you would likely be able to subdivide - I purchase a house that would be ~40 years old that is yields 3.1% (so pretty much the same as your example) however this house is on over 1,600m2 land. So whilst the cost of land appreciates the most building costs typically don't increase at the same rate so in say today it costs 250k in 10 years time using CPI of 3% would be roughly 338k to build however the land that using 250k to keep it simple growing at 8% would be ~555k so what would of been originally been a 500k purchase for a 50/50 land/build ratio (LBR) is now 893k but or 61/39 LBR (this also assumes the house hasn't depreciated in the 10 years).

    For us once we develop the 1,600m2 block (it already easily allows 3 block maybe 4) it would be a play for cashflow but at present it is a capital play.

    However overall I am agreeing with you on the principals but there are way to may variables and scenarios that everyone can talk about. However you typically hear of people who have made money from property through growth over yield but if you go to aggressive on growth and don't have the income to support it then it will all fall over. However if you go to far on yield there is other risks like property value going backwards, higher maintenance, longer letting period etc.
     
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  15. Orion

    Orion Well-Known Member

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    Regarding the 'cash from elsewhere' comment, these scenarios assumed a $200k income with a 30% savings rate. I did this to learn which one would be better even on a high salary (i.e. it would favour the growth strategy). Even for someone earning $200k, it the balanced strategy won.

    Yes - absolutely - and this is what I think the biggest potential for these 'big blocks' are, if you can subdivide 10, 15, 20 years down the track, and you can't really factor that into a spreadsheet, so I kept it a simple buy and hold strategy for both.

    I would say the potential to increase yield through renovation would be somewhat similar between a 15 year old suburban house and a 40 year old inner house. (but again, did not include this).
     
  16. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    You may need to increase the rental growth on the lower yielding property.
     
  17. Orion

    Orion Well-Known Member

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    Thanks for the feedback. Do you think it's good to assume a CPI increase, or stick with a % of the property value?
     
  18. John_BridgeToBricks

    John_BridgeToBricks Buyer's Agent Business Member

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    I think CPI plus 1.5-2%.
     
  19. Big Will

    Big Will Well-Known Member

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    Trying to understand this...

    House worth 100k yielding 5% = 5k p.a.

    House worth 200k yielding 5% = 10k

    How would the growth of rental change as either your yield % goes up/down normally depending on the asset value - yes sometimes the market goes backwards so the % yield would increase and other times the value of the asset would increase so the yield would decrease. However we are talking averages as an assumption.

    Otherwise should the 200k asset be now worth 6% yield... if so why? And why not the growth property also get an extra % on either growth or yield.
     
  20. Beano

    Beano Well-Known Member

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    It not always a clear choice between high yield lower growth as the holding portfolio becomes a lot larger so the total growth (in $$$) can end up higher (due to larger portfolio)
     
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