How to make easy money from property...

A: Buy one...

The basic maths makes it a no brainer:

Just perusing this article today which had the following facts embedded in it:

1. Annual change in dwelling values over last 10 years = 5.3% (Australia 8 capitals)
2. Rental yield for houses in Sydney is a modest 3.3% (4.3% for units)

Given the yield of 3.3% is below the borrowing cost, and there are other non-cash deductions, these properties would also attract Negative Gearing benefits, around another 0.3% equivalent in return. See below for a calculation.

So, if I was to buy a Sydney property for $1M (close to the median, makes my math easy), then I would get the following in a "typical" year:

Total return on investment = 5.3% CG + 3.3% yield + 0.3% NG = circa 8.9%. That's tax free remember as your cash flow is underwater.

On an 80% LVR loan, you would borrow $800K at 4.5% (conservative) = $36K interest only.
Rent at a 3.3% yield on $1M = $33K, so a cash flow loss of $3K.
Add depreciation of about $50K and other costs of another $20K (strata, land tax etc) for a total tax deduction of circa $70K, taxed at the marginal rate of around 40% gives you that 0.3% NG benefit. i.e. $28K tax back.

How about the return on your investment (ROI)?

Well, you put in $200K cash as deposit and get a Net ROI of 8.9% (on $1M) = $89K pa. That's a 45% Internal Rate of Return (IRR). Not bad going!! Of course, that only improves over time as rents compound and valuations compound, but the interest is fixed on the initial borrowing amount which is depreciating in "real" terms over time.

You're making almost $100K Net and getting paid cash to do it. Your net cash flow is actually positive after that NG tax return. What was $23K cash outlaid ($3K rent vs interest + $20K other cash costs), becomes $5K in your pocket after deductions ($28K cash back)...

Gotta love this property gig!!

Who said property was unaffordable, they're PAYING you to do it! And that's on a 3.3% yielding Sydney $1M mansion.

Cheers,
Michael

 

Sounds easy doesn't it

 

I don't know Sydney that well but I picked a 1M suburb (meidan price for houses).

In 2006 Strathfield South median price was $624,000 and in 2009 it was $660,000 (gain of less than $40,000) if you included your interest and buy costs you still wouldn't of made money.

Yes if you bought in 2009 and sold in 2011 the median was $799,000 so you would of gained $139,000 in 2 years (less costs).

It isn't a simple buy and you will make money, you can end up losing a lot if you are unable to service that period e.g. 2006-2009.

 

Responses from the two Bigs!

Nice... I agree, the biggest problem with property is the amount of leverage employed and the risk to servicability if interest rates were to spike. But that can be mitigated via diversification, conservative LVRs and fixing.

Its not without risk, that's for sure. But what is also clear is that the fundamentals of the asset class over a decent horizon mean there's real money to be made in property. Buy and hold may be boring, but its profitable...

My current weighted LVR is around 50% which protects my servicability and improves my SANF.

Cheers,
Michael

 

How do you take into account inflation?

If annual price increase of dwellings is 5.3% and inflation is say 2.5%, wouldn't the real increase in value of your asset only be 2.8%?

 

Very interesting Michael - you don't need a lot of capital gain for it to come together nicely.

 

Depreciation expense, as far as i am aware is 2% of construction cost and only applies to buildings built after mid 80's. I would suggest this would mean a depreciation expense probably far less than $50k and probably closer to $5k.

 

Yep, but again the true IRR should be the basis for calculating the inflation adjusted return. You're only "investing" $200K but making $94K out of it annually after tax. That's an internal rate of return of 45%. If you take 2% off for inflation, you're still netting 43% IRR pa!

 

I just used what my actual depreciation is on the units I built in Mona Vale. They're worth about $1M each and have a $50K pa depreciation schedule on each one. I was a bit conservative in the "other" costs area to compensate. But you're right, its an indicative model only.

However, even if you drop depreciation to zero and assume that $23K is the total NG deduction for actual cashflow losses and that you therefore only get $6K back, you still get a total return of $69K ($86K - $23K + $6K).
That's still a net after tax ROI of 6.9% ($69K / $1M) and an IRR of 35% (or 33% inflation adjusted)

Depreciation helps from a non cash flow deduction perspective, but its NOT the main game.

And, remember, this is the AVERAGE returns over a long period. The recent returns in Sydney have far exceeded this conservative model. This is what you should expect in an average year if you invest through the cycle. If you're a "picker" and can pick your entry points to beat the average then this is the least you should expect.

Cheers,
Michael

 

And Depreciation is only calculated on the cost of the building. Not inclusive of the Land Value portion of your $1mill purchase cost. $650k land portion, 350k building portion. Depreciation Calcs on $350k.

 

Also not to rain on your parade but low interest rates, whilst here for quite a while yet, are not the norm throughout the property cycle.
What happens to your calc on 7.5% rates?

 

Like I said, I used my actual depreciation schedule for my units that cost me $450K each to build. There's all those internal fittings as well as the building itself which frontend loaded my depreciation schedule. It will taper off shortly, but has helped in the early years whilst rents increased and the cash flows caught up. They've been doing 15% pa in capital gains lately anyway so far exceeding the long run average. My yield on original "purchase" price is a lot higher than the current nominal yield on valuation. Personally, I am CF+ on them, but this is meant to be an "average" not a "specific" example, which is why I showed the depreciation is immaterial.

Cheers,
Michael

 

Yes Michael. You posted while I was typing.

 

Going home now so I will pick up again tomorrow, but even 7.5% is still less than 8.6% so nets a solid return. At that rate, you'd have a lot bigger cash flow loss as a NG deduction so negative gearing will come into play a lot more at higher interest rates. In short, at 7.5% you're still making 1.1% nominal gain.

The impact of NG is that the difference between the rental yield and interest rate comes back to you at 40% odd via tax. So, you'd get another 1.7% (7.5% - 3.3% yield x 40%) on top of that as the NG benefit as well as whatever the other costs add up to besides the rent differential. So, 1.1% becomes 2.8% plus a bit more for costs. Still, even a lousy 2.8% is still a $28K return on your $1M asset or 14% IRR on your $200K deposit (12% inflation adjusted). Much better than cash in the bank and THAT's at 7.5% interest rates.

Cheers,
Michael

 

I think you forgot to mention "Past performance is not a guarantee of future results"

 

Where can anyone get a mansion in Sydney for a Mil? All I'm hearing is holes in the ground going for that much in Sydney .

 

Great to see you here, MichaelW. You must have a perpetual grin on your face at the moment with Sydney going crazy like this and your development appreciating nicely thank you very much!

Makes all of the struggles you went through while you were developing so worth while!

Glad it all worked out so well for you - you deserved to be successful!

Regards Jason.

ps 1. I think we need a Mona Vale update thread over here!!!

ps 2. Anyone arguing the toss with MichaelW needs to go and read his Mona Vale thread on SS - its a gem!

 

Makes sense.

Ran then numbers on my modest portfolio
Property Values $2,100,000
Deposit $935,000 (56%LVR)
Yield 4.0%
growth 5.3%

Return is 6.8% (taking into account inflation and no negative gearing)
ROI is 15%

No where near the 45% in the example given BUT would be much better is LVR was 20%

Yup, gotta love the property gig

 

Michael
I understand your concept and agree with you.
However, I think at this stage of the (Sydney) 'market' if someone is relying on capital gains to make the investment work - they need their head checked.

Im not sure what is going to happen with Australian property. Up, down, sideways - or most likely a combination. However, relying on CG to pay for the investments is a risk I wouldn't be comfortable with - of coarse others will be different.

At present interest rates a low. We can all agree on that.
If interest rates move, to say 8% its an additional $28,000 the investor (in your first example) needs to find. Over $2,000/pm. Not an easy request.

8% may not be seen in the next 12months, but we are not in this game for the short term. Its a long ride.

Yes - in theory and on paper it works out brilliantly. However, in reality, its not always this easy.

Blacky

 

I would love Mona Vale update please, absolutely great project, got to love the big $ made here.

However, I don't buy the 10 year rule at all, you still need to get the timing right and buy when the market is rising early stages.

As Blacky said imagine an investor buying at close to peak (now), ridiculously low yields at 95% LVR. No different from those buying close to peak anywhere in Oz, they will be holding property for years on very low yields, rates, maintenance bills and perhaps interest rates back to 8%, negatively geared, hurting.

Mar