Longterm strategy-Buying large land with depreciated house vs New town house

Discussion in 'Investment Strategy' started by radioactive, 8th Jul, 2018.

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  1. radioactive

    radioactive Well-Known Member

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    Hello forum members,

    I think most of the members here prefer to a depreciated house with larger land component considering land holds value while a new house would depreciate faster and loose money.However, konrad bobilak of investor prime recommends that a brand new town house makes more sense in building a long term portfolio of multiple properties.
    I would appreciate if you can share your views and experience on the same.



    Cheers
     
  2. thatbum

    thatbum Well-Known Member

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    Had a quick skim. Looks like rubbish to me.

    His main slide has depreciation and yield but no recognition of higher typical growth on the land?

    Pass.
     
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  3. radioactive

    radioactive Well-Known Member

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    I guess his trying to say that new townhouses help to build a multi property portfolio ,so that you have better cashflows and thus higher ROI overall.
     
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  4. thatbum

    thatbum Well-Known Member

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    Except that's rarely true at all, unless its some very specific scenario where a person is limited by serviceability and not at all by deposits/equity.

    Even then there's way better cashflow plays obviously.
     
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  5. Marg4000

    Marg4000 Well-Known Member

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    Search the forums.

    A previous poster (@Rixter ?) did extremely well selectively targeting the townhouse sector of the market, building an impressive portfolio.
    Marg
     
  6. Anthony Brew

    Anthony Brew Well-Known Member

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    You better watch out with guys like this who tell you half the story so that the downsides are not mentioned and therefore you can not see them if you did not know them before listening. There is someone on this forum who does the same thing.

    So lets go through the other side that these people don't tell you.

    1. The numbers.

    So say you have 2 x 600k properties in the same suburb, one new with smaller land and one older with bigger land.

    1. New property : 225k house value + 375k land value
    2. Older property : 100k house value + 500k land value

    What happens when land prices have risen to double in the area?

    1. New property : 125k house value (dropped by 100k) + 750k land value (doubled) = 875k
    2. Older property : 75k house value (dropped by 25k) + 1,000k land value (doubled) = 1,075k

    The concepts are simple:
    1. Houses depreciate
    2. New houses depreciate much quicker and much more than established houses
    3. Land appreciates
    4. For the same purchase price, the more expensive the dwelling, the lower the land value

    Put that together and you end up with a massive loss of opportunity cost as per the numbers above.​


    2. Depreciation

    He said there is almost no depreciation as though it is a negative.
    What is depreciation? It is where the value of something you paid for goes DOWN. This is NOT a good thing.
    So the government (temporarily) gives you back 1/3 of this loss, who gives a rats ass?

    A. You have still lost the other 2/3rds that ain't coming back. How is making a loss and getting back 1/3rd of your loss a good thing?
    B. When you sell, you lose the other 1/3 anyway as it comes off your capital base for CGT calculations, so you actually don't even get to keep it - it is money borrowed temporarily.

    So when he says depreciation is much better, what this actually means is that the actual value of the building that you paid for in an older house as part of the purchase will not go down much more. Think about this for a moment. Why on EARTH would you want to own something that will lose more value just so that you can temporarily get back 1/3 of it? It's insanity, and peddled as an advantage to the uneducated.

    He never mentions any of this, just as the person on this forum selling his own brand new houses and dressing them up as a good investment never mentions it.​


    3. He does have one point worth considering

    In all of his half truths and leaving out information to hide it from you, he does have one point that may be worth considering.
    Firstly ignore the part about preferring a brand new property, that's complete rubbish. Lets look at the idea of buying smaller land vs bigger land (but both with established properties).

    2 houses each on 300sqm of land vs 1 house on 600sqm.
    You essentially have the same amount of land but double the income due to 2 properties. The total price will be higher and you have a higher proportion of the depreciating asset with 2 houses, but the income would make up for this.
    Eg (if both established houses in same suburb)
    2x 300sqm = 800k, income 36k less 30% costs = 25k, less 4.5% interest = 11k negative (for 2 properties)
    1x 600sqm = 500k, income 18k less 30% costs = 12.5k, less 4.5% interest = 10k negative (for 1 property)

    So you end up with a similar situation, similar cash flow, same total land, etc.
    The advantage that I see is that you can buy just one of the 300sq properties now so that the cash flow is more manageable, and you can buy another one when you have a bit more savings under your belt or when the rent has increased a bit. Smaller chunks are definitely easier to chew and can lower your risk, and lower CGT when selling in different years once retired. But as for a "better return", this does not compute.

    Any time someone tells you a brand new property is a good investment, you now have all the proof you need to know they are telling you half truths and it's time to just remove them from your life completely as a source of information.
     
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  7. aufm

    aufm Member

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    So I've been thinking about this at a high level for some time (trying to decide whether to H&L or buy existing property for the next IP), and your post has motivated me to finally put in some numbers (and sign up here on the forums!)

    I'm not a tax / accounting professional so may have made (one or more) glaring omissions (by all means please feel free to pick my analysis apart), however there appears to be some more bits to the story that needs to be taken into account:

    A. Marginal tax rate and the capital gains discount.
    B. Rental differential between new and old properties
    C. Investment returns on the additional cash flow generated by a new build.

    Using the same numbers as your example:

    1. New property : 225k house value + 375k land value
    2. Older property : 100k house value + 500k land value

    A. Marginal tax rate and the capital gains discount - For a person on the top marginal rate (45%+2% medicare levy), the annual tax benefit of the building's depreciation (assuming 2.5%/yr) works out to be:

    $225000 x 2.5% x 47% = $2643.75

    Assuming the property is held for more than 12 months, when the time comes to sell, the 50% CGT discount will apply to the add back, therefore the annual add back works out to be:

    $225000 x 2.5% x 50% = $2812.50

    At the top marginal rate, you are at most giving back $2812.50 x 47% = $1321.88 (and hopefully with some planning, you will not be at the top marginal rate at the time of sale)

    B. Rental differential - Logically a new property will rent for significantly more than an older one (within reason, tenants generally don't care about land size). Assuming property 1 rents at $480/wk and property 2 rents at $400/wk, there is an annual rent differential of $4160.

    Assuming 5% interest, both properties will still easily be cash flow negative after interest and expenses. This means income tax is not a consideration on the differential, and the new property will literally result in $4160 of cash flow per year.

    C. Investment returns - This is where things get very interesting, based on A and B above, the new property will have $2643.75 + $4160 = $6803.75 more cash flow per year than the older one.

    Let's assume this can be invested in the stock market for the average long term return of 7% per year.

    Comparison

    Over a ten year horizon, the new property would have the following positive cash flow over the older property:

    1. Depreciation tax benefit: $26437.50
    2. Rental difference: $41600
    3. Investment return (assuming same annual contribution and compounding at 7%): $32543

    For a total of $100580.50 less the add back of $28125 x the individual's marginal rate is at time of sale.

    Meanwhile, assuming land value doubles in the 10 years, the older property would have gained $125000 more in land value less half the individual's marginal rate is at time of sale.

    So it can be a bit of a wash which way to go (especially once you take into account more subjective variables, e.g. maintenance should be more on an older property, might also be longer gaps between tenancies as older property should be harder to rent).

    On a 'lifetime' (aka 40 year horizon), the newer property clearly becomes the better choice as the numbers are now:

    1. Depreciation tax benefit: $105750
    2. Rental difference: $166400
    3. Investment return (assuming same annual contribution and compounding at 7%): $1181066 (yes, over 40 years the opportunity cost of the lower cash flow from the older property is over a million dollars!)

    For a total of 1453216 less the add back of $112500 x the individual's marginal rate is at time of sale.

    Meanwhile, assuming land value doubles every 10 years, the older property would have gained $500000 more in land value less half the individual's marginal rate is at time of sale.

    Assuming the analysis above is in the right ball park, it should be possible to mathematically work out the 'break even' holding period (i suspect some where around the 15 year mark?) that would help with the decision between new vs old?
     
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  8. thatbum

    thatbum Well-Known Member

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    Nope because its not simply as mathematical as that. Too many assumptions and then calculations with assumptions on top of that.
     
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  9. Illusivedreams

    Illusivedreams Well-Known Member

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    I have done as. Well out of apartments as houses.

    I know. Many who have done better.

    Have a friend who bought 3 apartments is Liverpool in 2011 average was $180k valuations were recently averaging $400k over 100% appreciation

    Each decision is personal
     
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  10. Anthony Brew

    Anthony Brew Well-Known Member

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    aufm

    It's funny that your post contains exactly same points that the person on this forum that sells new property which he builds himself says.

    Some of the points that come up again and again from that person that also coincidentally came up in your post

    1. Assumption of top marginal tax rate to skew it
    And why for the love of god would someone with a top marginal rate buy cash flow property instead of a growth property. Just another one of the many ways to manipulate people using assumptions that make no sense to fit in with the half truths.

    2. Pointing out cash flow as a benefit of depreciation to avert the readers attention away from the massive amount lost growth it offsets

    3. Adding an assumption of investing positive cash flow into the stock market, despite you even making a post saying that you put "play money" into some LICs and said the returns over 1.5 years have not been particularly good yet the brand new properties you develop to sell have gone up in value over this short period, knowing full well that both property and shares move in cycles and using 1.5 years of data is no different to the rest of your continuing manipulation of data to sell your properties to unsuspecting people.

    Whether you post under a different username or not, the manipulation and half truths make it obvious who you are. Please post under your usual username in future so that I don't even see it since I've put you are on ignore.
     
    Last edited: 8th Jul, 2018
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  11. radioactive

    radioactive Well-Known Member

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    @Anthony Brew
    Thanks a lot.That was awesome!!
    Just one point here - may be we are neglecting the maintenance costs on old property?
     
  12. radioactive

    radioactive Well-Known Member

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    @Westminster

    If you don't mind, it would be fantastic to have your opinion on the post and comments.
     
  13. Westminster

    Westminster Tigress at Tiger Developments Business Member

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    Well my opinion on this is a bit of both worlds due to my strategy. I take old **** and turn it into new product. So I actively always have both in my portfolio but the old stuff is only bought for it's development potential.
    The maintenance on my older stock is higher but it's mainly due to the age of appliances in them - hot water systems, hot plates and such fail and need replacing. If they are built well then I tend not to have leaks etc. My old stock is generally quite old and things do tend to be built better. I would take a 1960s house over a 1980s/1990s house most days as they were build solid in the 60s.
     
  14. Anthony Brew

    Anthony Brew Well-Known Member

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    @radioactive
    I didn't say old, I said established. How much maintenance is there with a 10 year old house.
     
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  15. Orion

    Orion Well-Known Member

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    I think this video has a point.

    I've done the same analysis and found that the better cash flow (through both rental yield + better tax deductions + stamp duty savings) does allow you to own more gross assets at the end of a given period (not to mention the less stress of better cash flows and buffers).
     
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  16. aufm

    aufm Member

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    You are clearly quite passionate about this topic, though may I suggest approaching the discussion with such a strong prejudice is not particularly constructive.

    For the record I am not an alter ego for any other member of this forum, just another salaried rat in this great ole race; and certainly do not stand to gain by spruiking anything to anyone (whether you choose to believe a stranger on the internet is, of course, completely up to you)

    Back to the substantive discussion, I did actually make a significant mistake in the calculation for the 40 year time frame by multiplying the land values by 4, instead of doubling them 4 times. So based on the assumption that land value doubles every 10 years, the difference at 40 years is actually $2 million, which probably swings the pendulum back into the favour of the older property with larger land component.

    Given how close the outcomes are, (and perhaps to @thatbum 's point) the current modelling may be making too many simplistic assumptions, and there is still a fair bit of refinement to go before we can get to a conclusive outcome?

    Thinking about it from a policy point of view, surely a country with an increasing population would want to encourage the building of new houses (and this is evident in the amount of new estates popping up all over the place).

    So if purchasing a new house on smaller land is always financially worse than buying an older home with a larger land component, who are the people buying these new estates? Logically the market for new houses would be limited to owner occupiers with an overriding emotional desire to live in a 'brand new' home?
     
  17. thatbum

    thatbum Well-Known Member

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    Pretty much this I would imagine. I can see the attraction of wanting to live in a shiny new home, for what is probably a much cheaper price than trying to buy/build the same in an established suburb.

    Add in a large number of not-so-sophisticated mum and dad investors who get talked into buying H&L packages as their IP and don't really put much analysis or searching for other options out there.

    These are just my general opinions mind you, and I'm sure there's always exceptions to the rules out there somewhere.
     
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  18. Anthony Brew

    Anthony Brew Well-Known Member

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    If it really is a coincidence and you are not the same person despite overwhelmingly similar points being made, I apologise.

    Exactly correct!

    There is absolutely nothing wrong with purchasing a nice shiny new house going for comfort at the expense of $$$, and people do it every single day with new cars, new boats, new expensive watches, and upgrading every few years. They are happy to pay a high cost for comfort and luxury.
    And at the same time, I don't begrudge a developer getting a profit. They took the risk and they deserve a reward.

    My point is that a new property as an investment is atrocious and only peddled by people making the profit at the buyers expense.

    And if someone wanted an investment with higher cash flow to own more properties, it makes more sense owning 2 established 10 year old properties on half size lots, instead of 2 brand new properties on 1/6th sized lots as in the video posted.
     
  19. Orion

    Orion Well-Known Member

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  20. Orion

    Orion Well-Known Member

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    I bought/built a H&L package in Narre Warren for $225k in 2005 and it's now worth $620k... zero maint, great rents the whole time - wish I owned 10 of them. I would agree though, not a good idea to do now.

    In regards to something newer in an established inner area, I wonder the feasibility of buying say under 5 year old townhouses 2nd hand. You lose the stamp duty savings but still get the majority of the depreciation allowance. Obviously you'd want the most land % value as possible, so it would probably be a townhouse.
     
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