Multiple cheap properties vs. one expensive property

I've only recently started investing in property, and have been trying to understand the pros and cons of cashflow vs capital gains. On property chat the majority of people seem to recommend buying as close to the CBD as you can afford (at least on the Brisbane related posts). I wanted to get some more opinions on this topic, within the investment strategy forum instead of where to buy. My main goal is to become financially independent, but not get myself into potential mortgage stress situations doing it.

I currently own 1 property, a 3 bed house about 20kms from Brisbane CBD. I'm looking to make my next purchase somewhere over the next 6 months or so. I'm weighing up these two options (figures are rough estimates only).

Option 1: Buy a house in the 500K range 10 - 13kms from Brisbane CBD.
With an LVR of 90 I'd be out of pocket about $10,500 each year
I'd have upfront costs of approx $76,000

Option 2: Buy 2 houses, both less than 25kms from CBD, both around 300K each.
Thinking one property around 330K and the other around 270K
With an LVR of 90 I'd be out of pocket about $6,500 each year.
I'd have upfront costs of approx $80,000

So the upfront costs are approximately the same, while for cashflow I'd be +$4,000 better off with option 2 (which would cover the capital cost difference in the first year).

I'm leaning toward option 2 as for option 1 my holding costs would be approx $200/week, while option 2 is $125/week. $75/week difference isn't much, but if property prices stay flat for years it would become significant. Furthermore if property prices stayed flat I'd build up equity quicker with option 2, around $800/year.

The main argument for option 1 would be a greater potential for higher capital gains, however looking at % of annual growth rather than $ I'm seeing that there isn't much difference between inner, middle and outer ring suburbs (in general).
Inner Brisbane suburbs do seem to be slightly higher with % compounded annual growth (looking at realestate.com.au data), however there's also lots of outer suburbs with equal % growth.

The last point is that I don't want to get myself into a situation where I'm stuck working to service the loans. I have no plan on quitting work anytime soon, but still don't want to be in that situation.

 

Hi @trp35

We have done a blog on this same topic previously, feel free to check out.

It came about from our own experiences and in building our own portfolio.

 

If you were to purchase two cheap houses it might be better doing it in two different markets, ie different cities, buying 2 houses in the same area just means twice the gain or twice the losses at the same time.

 

In your out of pocket expenses have you considered things like insurance, council rates, maintenance and other ongoing holding costs? What about future capital growth?

There isn't a direct correlation between these costs and property value or rental income.

I suspect in the example given, the $500k property may well be the better deal when you look at all the figures.

 

I am considering that, but I'm also considering two different LGA's within greater Brisbane, which would still be better diversification than 1 property alone.

I've considered all of those costs except for maintenance as that's far too difficult to estimate. I also haven't considered future capital growth due to it being very unpredictable

 

Hi @trp35 , it is great that you are planning ahead, the main thing to consider is to find a balance between capital growth and rental yield.

as you indicated that you are looking at long term hold, then it comes to the question of how much will the portfolio cost you to hold long term ( how long is long term, say 10 yrs)?, apparently the less it costs the better.

re the option 1 vs option 2, there are also " maxing opportunities" & " minimising risks", with 2 IPs, you have 50% more opportunity to have some capital growth than only 1 IP, i.e. with 2 IPs, if one does not grow, the other might has chance to grow. but with 1 IP, if it does not grow, it does not. if there is a down turn, you have 50% less opportunity to loss money.

and when it comes to rental, 2 IPs, again, have 50 % less chance of both been vacant, thus more stable rental income.

also when it comes to time to sell, with 2 IPs, you could sell them at different time ( one at a time) to reduce tax. but with 1 IP, you could only sell it once ( you might be hit with a larger tax bill)

 

I see yield as a trap in real estate here in inner east Melbourne. It is easier to buy and does not affect your cash flow as much but Capital gains is usually a lot worse (High gross yield over 3% are usually apartments or units)

 

That’s because Melbourne has already had massive growth and yield doesn’t follow. Growth generally follows yield, western Sydney is a good example. Great yields 5 years ago followed by massive growth. If you were to chase yield there now you would be buying non investment grade properties (apartments etc). Many suburbs in Melbourne are similar. Yield play in Brisbane is different as it hasn’t had the growth yet so you can get 5 or even 6% yield in investment grade properties (houses, small unit blocks).

 

I thought we were talking about maybe 5 x $200k properties verses one $1m property from the title of the thread.

I have always gone for cheap properties. At the start, I had no other option, as we were broke, but even the more recent purchases, I've still bought cheapies. You usually get a better yield, which means that you can service more debt (important nowadays). If you buy in a City, you will find that a rising tide lifts all boats, so, using Sydney as an example, if Sydney itself goes up in value, it will flow to all suburbs. It might not flow evenly. Some will grow more than others, but they will all grow. You need a crystal ball to know which areas will do the best. Somebody mentioned Western Sydney earlier in the thread, and that particular area is a good example. During each boom, prices have doubled, even though it is a long way from the centre of Sydney. This latest boom it was the first to move and I believe has done better than some of the traditionally better performing suburbs.

If you need, or want to sell, you don't have to sell everything all at once. If you've got only one expensive property and you find yourself in trouble, you may have to sell it at the worst possible time, whereas if you have a number of cheaper properties scattered about, you can select which one you will sell. Or, if you want to sell the lot, you can split the sales into different financial years, which means less CGT.

Look up the history behind the following posters. You may have to go back to the SS forum in the investor stories to find them.
Handyandy
Karina
Brenda Irwin

 

Article here from Canada suggests tightening of bank lending may push buyers to lower priced housing, pushing up prices

'Cracks Are Starting To Show' In Canada's Borrowing Binge

 

I was reading some info a few days ago ,and they seem to be going crazy with taxes ,
a new "schools" tax in Vancouver for homes valued over $4 mill and a new speculation tax on empty properties or used for less than 6 months a year , they were also taxing residents that live there but derived there income in other areas outside of B.C, but at a slightly lower rate .
Even in the U.K, anyone that now buys a second home has to pay a higher tax, and interest from IPs cannot be be used to lower their tax bill from rental income.

 

That's not exactly unique to Canada. I believe it's affordability that's driven many of the extreme growth locations over the last year or two. Take a look at Melbourne's outer West.

 

Not a fan of chasing capital gains right now while interest rates are at a low and due to go higher.

For example a house that costs about 1.5% per year to hold (e.g. 4.0% financing, 1% costs and 3.5% yield) will cost 15% of the purchase price after 10 years, assuming its constant. This is definitely not a good thing if interest rates go up and pressure is applied to capital value. 1.5% net holding cost may quickly become 2%, 2.5%, etc.. and if a major renovation is required, this will blow out more.

After 10 years, assuming a house costs 1.5% per year to hold, and assuming standard inflation at 2.5% per year, you will need a house to appreciate more than 50% just to pay for your costs! In your situation the $500 000 house will have to be worth at least $750 000 in 2028 just to break even! Keep in mind I assumed holding costs of $7500 (1.5%) where-as your holding costs are about 40% higher!

Also remember if your holding costs and/or cost of money - the interest rate - goes up, your break even number goes up dramatically.



I am biased towards finding good cash flow properties where you are paid to hold the property rather than paying out of pocket. Ideally the cash flow property will be undervalued by the market at the time you buy it, and after some time holding it, it would sell on the market at a yield lower than what you bought it at, thats how I personally would invest..

 

If there was not much growth in the last 5 years with all the Chinese money coming in, loose lending standards and record low interest rates then when will it get "the growth"

 

You forgot interest only. Over the next 20 years

 

My last post was a bit confusing, so here is some quick math:

Assume 100% of property is "funded" or at a cost of opportunity of 4%, interest rate is also 4%, assume inflation 2.5% p.a. over 10 years. Assume no major reno or unexpected expense occurs over 10 years. Notice I'm assuming the cost of holding is still $10 500 at 100% LVR, your case it is at 90% LVR.

Purchase: $500 000
Stamps/legal: 5% of price
Cost of holding: 2.1% p.a. , ($10 500 divided by $500 000), also assume adjusts fairly consistently with inflation

Effective purchase price at year 2028: $640 000
Cost of holding up until that point: 21% of purchase - this assumes cost of holding is consistent with inflation
Cost of stamps: 5% of purchase

640 000 * 1.26 = $806 400

... Thats a big number, to break even at ... And this is assuming interest rates remain flat for 10 years.

Its not all problems, obviously there are tax "advantages" to being negatively geared. But this is a minor benefit, and will be quickly cancelled out if a big expense comes along to eat into your profit.

 

What do you consider a "good cashflow ..IE the net yield"?

 

For the residential market in Aussie capital cities I don't think you will find good cash flow.. I think good cash flow is a minimum 0% net cash position assuming 105% of the price is financed (or 1.4% net cashflow on purchase price at 70% LVR), but not factoring in vacancies/amortised renovation & maintenance costs etc, for the sake of simplicity.

The pros would be having an offset you can pump money into for a guaranteed % return, as well as a chance to get a buffer ready for the likely chance that cost of money will go up.

For example a $1m property with 4% cost of money would need to have a net yield of at least $42 000, of course you won't find that in the residential market in most capital cities now, as that would mean rents in excess of $850 per week.

Assuming you do find properties that are cash positive in these times - that is, with interest rates likely to be going upwards, not downwards, and hence cost of owning to rise - you'd also want them to have other things that give them upside or potential capital growth when the demand side of the market picks up again.

 

Hi Chabs - I haven't reconciled against your last post but I agree that it has never made sense to buy with a 3.5% yield. The capital gains in Sydney for example have made this look like a good strategy but it was always speculative.