NGs impact on prices and your exit strategy

I think we should be careful in describing this. Its not an increase in CGT. Its a reduction in the CGT concession from 50% to 25% . yes, the net effect is that you pay more CGT in the event of triggering a CGT event ( making a profit ) but its not an increase, technically

Likely, yes.

But really, we are already there. Even without NG changes or CGT changes, sensitised assessment rates, HEMs and IO quotas have resulted in an environment that basically rewards those who reduce debt and punishes ( or at least seriously challenges) those who do not reduce debt . It's a simplistic way to look at it, but its basically the way it is now.

So yield is already more important than ever before, even if just for P&I management. Plenty of PC members have shared their experiences of P&I shock already , and we are only 18 months into the IO quota. We still have 2-3 years of mass IO to P&I migration to come - at least ...... so barring a reversal or significant relaxation of those regulations, yield will simply have to become more and more sought after as more and more people migrate to P&I and face 50-60% higher repayments

 

Thanks for the link

 

There’s alternative conclusions to draw from the importance of yield debate;

- Borrowing power for yield investors has been smashed more than anyone else. Why? Yield investors relied on yield to produce borrowing power dividends to build larger portfolios. Today the additional impact of an additional 1% yield is MULTIPLE times lower than in 2014. Yield was the rocket under borrowing powers then and allowed borrowing power recycling to occur. No longer. Now it’s a relatively simple addition of about 55k to borrowing power per 10k in rental.

What this means is there’s increasing scarcity in ones borrowing power.

So how should one use it?

Dividend reinvestment via property strategies is a great ‘safe’ way to hedge bets. It protects against downside well as the return profile is via yield. It also factors into the consideration that property is likely to do poorer over time than in the past. Nonetheless, there’s not many who’ve followed this path to strong wealth accumulation. Most suggest you get wealthy from growth assets. Also, property itself may be the wrong asset class to pursue this strategy.

That’s one strategy and conclusion to draw. It has its merits, but isn’t without flaws.

Another is; it’s more important than ever to have assets that grow over time. That is, quality of assets. Of course, in an environment where borrowing capacities are contained over the long run, this becomes increasingly difficult too. It also helps add weight to removing poorer quality assets from the portfolio and replacing them with better ones.

Not certain what’s right or not, but I think these are considerations for investors when considering yield or growth today.

 

This is not because of yield It's because existing debt is now assessed at a sensitised P&I rate and we use HEMs instead of the Poverty Index

I disagree. Two policies - "actuals" and HPI living expenses - were the real rocket under borrowing power. Their removal has had a far more significant impact on borrowing power being reduced than yield ever had on increasing borrowing power

Lets look at a scenario. Couple with 2 dependents go to their bank or broker in the pre APRA era looking to borrow more $$$$. They advise their bank or broker that they owe $1Million at 4.5% IO already . The IO period is 5 years. Their rental yield is 3% so they generate 30K in rental income, of which the bank uses 24K (80%) as income for servicing

Existing/OFI debt is assessed at the "actual" rate of 4.5% and living expenses are assessed using the Henderson Poverty Index. So their debt is considered to be costing them 45K per annum and their living expenses are considered to be @ 36K per annum

But today, in the post APRA era , their debt is assessed using a sensitised assessment rate of at least 7% P&I and their living costs are assessed using HEM's (at best) or by auditing months of transaction statements (at worst) to see what they spend on uber eats and deliveroo and coffee and so on and so forth... So their debt is now deemed to be costing them at least @ 87K per annum and their living expenses are deemed to be @48K or greater per annum.

So repayments are deemed to be 42K more per annum, and living expenses are deemed to be at least 12K per annum dearer - for a total of 54K . Thats 54K less income available on the servicing calc.... and thats net. And I would point out that this is the best case scenario, as living expenses are increasingly subject to extreme scrutiny and may well be applied at far more than the HEM's bare minimum.



Now lets look at the role yield played pre APRA, versus now.

If the borrowers had a 3% yield in the pre APRA era, they were generating 30K per annum, of which 24K was accepted as income for servicing by lenders

If they had a 6% yield today and are generating 60K per annum, 48K would be accepted as income for servicing by lenders

So they'd have an extra 24K of income available for servicing from the rental side of things, but they would have 54K less available from the sensitised assessment rates and HEMs.... so i would argue that strong yields didnt supercharge borrowing capacity in the pre APRA era anywhere near as much as "actuals" and HPI did . Which means that all you ever needed to do to achieve an increase to borrowing power in the pre APRA era was to either refinance to a lower rate or wait for a reduction in rates, which happened quite regularly regularly and in an almost uninterrupted fashion ( except for a couple of "inconvenient" but short lived 12 or 18 month periods) between the late 80's and 2015 when APRA stepped in. Yield didnt see borrowing power expand from 3.5x income to 15-20 x income across 25(ish) years . Actuals did.


The real value of yield is in its long term debt reduction capabilities. Paying down debt without selling means you are retaining income ( which will hopefully grow over time) and every time you get rid of $1 , that's $1 not being assessed at 7% P&I

 

To be fair, until recently this wasnt even on most investors radar. Most investors could get all the money they wanted, harvest equity relatively easily , refinance if required, and hold IO indefinitely. And so could just about everyone else. So if they could hang on for 7-10 years ( or thereabouts ) and catch a cycle, they could make easy speculative gains. They never had to consider holding under P&I conditions, or being told they couldn't refinance , or being stuck at a borrowing ceiling for years and years. And if they did reach a ceiling, all they needed was a rate cut and a lender who used "actuals" and problem solved. Voila! So it would really only be fair to compare the wealth outcomes of the two approaches after allowing for 25 years of data from the post APRA era to be compared to the 25 years pre APRA

Its especially unfair when you really dissect the growth claims as well. I mean, consider how few pre APRA investors ever got past 2 or 3 properties..... where are all these wealthy resi investors anyway, retired from growth alone? Shouldnt there be hundreds of thousands of them walking the streets in bliss by now, financially independent 25 years after the greatest credit boom in human history drove prices up up up up up up up.....?

yes...most do suggest this - but as I said above - ATO data tells us very few ever get there. What exactly does the ATO data tell us after 25+ years of uninterrupted credit growth where purchasing power went from 3.5x income to 15-20 x income? That 3 or 4% of investors ever got past 2 or 3 properties.... ?

Getting wealthy from resi property from growth alone has been achieved by only a very small minority, it seems

So my point is... if that's how it went in an era where a rising tide of credit lifted all boats, how well will that work in an era where the credit tide is no longer rising, but is actually going out? .

 

Great explanation on lending standards @euro73.

What I meant was that yield was the key investment metric required to squeeze out the loose lending standards that you mentioned.

An average single borrower only has a couple thousand a month in surplus income. In your examples above, a 3% yield would soak up ‘surplus’ net income quite quickly - it’s basically be gone with 1mill in debt. Change that to 6% and you have a situation where yield properties and actual repayments would actually increase your borrowing power! That is, the more you buy the greater your borrowing power would be.

Borrowers used this to develop larger yield based portfolios with slower growth rates. The thinking was: more quantity and a larger portfolio would do. The return profile felt safer given yield is more certain (albeit with big finance risks)

Nowadays though, yield doesn’t have the ‘larger’ portfolio impact other than the standard rental income factor of around 5.5 per dollar earned. That doesn’t mean it’s still not immensely valuable, just that it doesn’t extrapolate (as) much anymore in terms of higher borrowing amounts.

In general terms though, your right, capacities are contained so investing strategies should adjust.

 

But nit available to the next investor buyer. So the offload value could be well impacted.