Nice PPOR + 2 cheap IPs vs V.Nice endgame PPOR only and IPs later

Hi, really appreciate some advice please. Title kind of says it all. I have never owned an investment property. I live in Melb, wanting to buy in inner eastern suburbs near M1 for work. eg., Hawthorn East/Malvern East/Chaddy.

I currently own my 800k townhouse outright but have no other savings. I want to sell this house and buy the new one. Recent massive increase in salary to 450k pa. After talking to banks, I can comfortably service a loan of 2.6m at owner occupier and investment rates. So total 3.4 m (2.6+0.8) in property.

Option 1:
1. PPOR total price $2.3m
$1.4m derelict house on 600m2 land
$800k knockdown rebuild with metricon - Bordeaux
$100k stamp duty, misc costs

2. IP 550k, negatively geared.
3. IP 550k, negatively geared.
Maybe one IP being a small unit in leafy suburb whilst other being a house in outer fringe.

Option 2:
Single PPOR total price $3.4m
$1.9m derelict house on nearly 1000m2 land
$1.3m knockdown rebuild with metricon - La Pyrenee
$200k in stamp duty, misc costs
No IPs for the moment.
Would be probably 10 years before I could afford/service an IP? Depending on capital appreciation of PPOR and growth in equity. Maybe less.

On the surface, Option 1 makes the most financial sense. I get to negatively gear and reduce my tax burden on my significant income. However, I will have to pay CGT when I sell (hopefully the 50% disc still applies by then), as well as deal with significantly higher IP interest rates.

In 5-10 years time I know the wife will bug me to upgrade to a bigger/better house with a bigger land as our family grows.

Option 2 is the endgame PPOR. This is the house my family could live the rest of our lives in, and is the easiest choice.

Capital appreciation I would imagine would be similar between the 2 options, assuming say 10% pa.

So I guess it comes down to saving some tax eg., prob 15k per year vs being able to live in a significantly nicer house with bigger land and not having to go through the whole buy/KDR process all over again in 5-10 years. Wife can't contribute anything financially. She just looks pretty and takes care of the kids, which is fair enough.

Thoughts?? Thanks in advance.

 

Option 3 - rentvest
Buy end-game PPOR for $1.9m and rent it out
Use the rest for good quality IPs
in 10 years time, hopefully the cycle timing is in your favor sell some of the IPs and build your dream home, meanwhile your capital will be working harder for you with more in IPs.

Option 4
Similar to Option 3 but buy more IPs instead of spending 2.5 times the melbourne median on the future PPOR.
When you are ready, liquidate some IPs to pay for the PPOR

Both options rely on rentvesting. With rentvesting and the very low yields in the high end market, one will get to live in a much more fancy house than they'll be able to buy as a PPOR

Well done on the the high income, now make hay while the sun shines. Don't forget to have a good team on your side and diversify (be it buying in other states or investing in different asset classes).

 

Firstly, awesome income!

Secondly I'm thinking it's a bummer you don't have a huge loan for your current home - Best thing to do instead of paying it down would have been to stash the money for that asset in an offset account so instead of owning it outright, you'd own it with no interest but you can move the funds to the new PPOR. Anyway, that's hindsight.

You could move out of it, rentvest, pull equity up to 80%, (with the equity pull, buy IPs and shares), move back in within 6 years so it's still your PPOR for tax purposes, claim interest expenses etc as you rent it out.

But this will delay your next PPOR purchase though. May be a good thing or a bad thing.
My dilemma is I'm not sure how you can fund your next PPOR that tax effectively without selling the townhouse (under the understanding your only asset is your current home).

Thirdly, if you and your wife are really set on buying a PPOR that costs 2.4mill or more then go for it - but can I ask do you really need to/is it really what you want? Keep in mind it's not an income generating asset and you'll have to spend years paying it off and with that mortgage you could be tied to your work or a slave for money for a long time. Debt on a PPOR isn't tax deductible (unless somebody can think of ways to do it - substantially work from home or some other way). The stamp duty is a lot of money too, and you don't get that back.

With a "Paul Clitheroe" style hat on, I'd go for a PPOR I could happily live in, but I mightn't choose to spend 2.5 mill for it. (2.5 mill - 800k is still 1.7mill PPOR debt - which will take time to pay down). But it's really your call how you spend your money. Certainly, buy for the location - Good transport, easy city access, water views, whatever appeals to you.

If early retirement is the end game, I'd look to buy a somewhat more modest home (or even stay in the townhouse if the family is ok with it!). I would then go nuts buying IPs, shares (using tax deductible debt) and take the family on memorable holidays each year. Put money into super too. Re: IP asset type - try for houses, properties with land content - or inner ring terraces (though you might think they are too expensive as an IP). Look to buy not just in your own city as you'll hit land tax thresholds. The IPs and shares should help you and your family be financially free sooner.

Trusts could be explored - but speak to an accountant/lawyer on that aspect to see if it makes sense. To minimise tax, I'd ideally want to distribute earnings to your wife, and also your kids when they turn 18. It might also mean you can basically give homes to your kids when they become adults without needing to actually sell. But you'll have to get advice, explore your options and do the numbers on it to see if it stacks up.

In summary... with your income you can do a lot, yes, you could buy a new PPOR and have a huge debt on it but if I were you as an individual, I'd really look to minimise personal tax and I'd want to invest so I have early financial freedom. Perhaps if you can say, buy a 1.6mill home, that's good enough? Work because you enjoy it, not because you have to. Of course, there are many ways to skin a cat and if you really do want the 3 mill odd home, that's your perogative and that's totally ok.

Note: I have a PPOR that's worth over 2mill. (It's hard to put an exact dollar value on it as its a unique property). But we bought really well (end of 2015) and we upgraded from another home in the area. The trade up difference was only around 400k and that includes selling costs and stamp duty. I'm currently only paying interest on just over 200k since the rest is either paid off or there are funds in an offset against the loan. All manageable. I wouldn't want to have a huge non deductible mortgage over my head, even if the banks say I can borrow so much for it.

My 2 cents.

 

I like the option of:

1. Remain in town house given it sounds like your happy in this for now (do you have no mortgage on this, or is it just fully offset?)
2. Purchase future dream PPOR as investment property (this will give you your neg gearing benefits now)
3. Purchase quality IP assets in markets with good growth potential / cash flow now for wealth

When you move out of your townhouse into your new PPOR, maybe keep the townhouse as an IP? If the mortgage is offset rather than completely paid off you can begin to offset your new PPOR.

 

Firstly, congratulations on the pay rise. I could do with one of them myself.

Have you actually worked through the numbers for a negatively geared property?

Let's assume you buy a million dollars worth of IPs. The holding cost is 8% (mortgage, maintenance, insurance, agent's fees, void periods, etc.), yield is 3%, and they double in value over the next decade.

The gross loss would be 5% per year, halved to 2.5% by negative gearing, or $250K over ten years.

If you sold them, you'd have a million dollars in capital gains. Assuming 50% tax, and the 50% discount, you'd have a bill of another $250K.

So your total profit would be around $500K.

Now assume you put the extra million into your PPOR. You'd pay around $500K in interest over a decade (assuming 5% rates), you wouldn't be able to offset the costs against tax, but neither would you be liable for capital gains if and when you came to sell.

Assuming prices doubled, you'd again be looking at a $500K profit. (OK, that's ignoring maintenance costs, which might be another $100K over that time.)

You're swapping one tax break (negative gearing) for another (no capital gains liability on your primary residence), and I'm not convinced that it's going to make a lot of difference in the long run.

 

Id go for option 2 probably. Large tax free asset.
Structure the loan so you can quickly debt recycle into an investment property at owner occupied rates.

 

That's an unusually high income. Perhaps buy a house you like but limit the cost to a mil or less, and then save up for an investment. It's a good idea to limit your debt in case the income goes. Pay for an investment in cash and less to lose. At least save up a decent deposit for an IP.

 

Hi Hobart Chic. My thoughts on your comments in red. Note, I'm happy to hear why you have the thoughts you have.

That's an unusually high income. Perhaps buy a house you like but limit the cost to a mil or less, and then save up for an investment.
Sydney and Melbourne aren't like Hobart. While I think buying a PPOR for $2.4 mill or more isn't necessarily a great idea if they have 800k savings (to pay down won't be so quick unless they are very dedicated to it), my thoughts are that $1 mill is possibly on the low side. Then again, I'm from Sydney.

It's a good idea to limit your debt in case the income goes. If the debt is generating an income then I haven't really got too much problem with having a lot of debt. But on the other hand, a lot of non deductible debt not generating an income is harder for me to swallow. If the SHTF, (eg. the breadwinner has a heart attack) then the PPOR may need to be sold.

Pay for an investment in cash and less to lose. Disagree. Leverage is power. Plus any loan is tax deductible and with a really high income, that's what you want.

At least save up a decent deposit for an IP. Bad idea from a finance perspective. Better to buy the investments using debt (even 105% loan) and buy the PPOR with a deposit.

My 2 cents.

 

Sydney property. Pfft. An apartment in the city can cost more than $1 million.

 

Hi,
I stand by everything I said. I understand Sydney property is expensive. Perhaps my point is to keep debt and risk to a minimum. The thinking that nothing can go wrong with investing, particularly property, is a dangerous thing as the GFC showed only too well. We're far to complacent in Australia. That being said, it's not my money. I also said that I would save up a significant deposit if I was borrowing for an IP (you must have missed that).

 

Yep, I saw you said that. And I think people are better off not saving the deposit for IPs but instead draw those funds from equity. Borrowed funds are tax deductible.

 

I know why you would say that but it does not provide a buffer in the event life happens. At least with some equity a person has a bit of wriggle room. Equity only is a riskier, though you may find more rewardable, strategy.

 

Not sure I am following you.

For clarification. Say you have 500k.
2 scenarios.
1. 1m PPOR with 420k equity and 580k non deductible debt
Plus you buy a 400k IP where you paid 80k deposit from cash and took on 320k debt. Total debt 900k, total equity 500k

2. Or 1mill PPOR where you have 500k of equity sitting there. You split out 80k deposit from this to go towards a 400k IP.

Total borrowings are the same but now your tax deductible debt is 400k not 320k?

The buffer is really the same, just the amount that is tax deductible is different? And option 2 is actually potentially going to give you a bigger buffer over time because you'll get more tax back.

 

Thanks everyone.

To clarify, living in the current townhouse is not a viable mid term option because due to my recent new job I would need to commute 3 hours a day. Hence the new house/relocation.

I need to sell the townhouse to fund my new PPOR, and we have outgrown it, but more importantly, it is underperforming anyway with max 5% pa capital appreciation over the several years I have owned it. I would sell it in any case.

I want to live in the nice house that I will be building, not rent it out. That defeats the whole purpose. Not to mention renting out a house like that would give pretty poor rental yield.

My thinking is along the lines of what George said... either I have to sell all my IPs and pay CGT to fund my endgame PPOR or I can buy my endgame PPOR now. I mean the whole point in me getting multiple IPs is to works to me endgoal of living in a nice house in a nice suburb. If I can have that now, why not? I can always sell it for a tidy profit as well if the mortgage becomes too onerous. Capital appreciation similar. And later down the track I can still do IPs if I wanted to.

 

Sounds solid. I’ve recently embarked on a similar journey. 600sqm block (KDR). Only difference is I’m renting it out for 12 months while I decide on the design/builder etc.

If you don’t mind me asking why you thinking Metricon? Have you seen any end products etc.

 

I know Metricon have a mediocre reputation, but I was just blown away by their signature display homes compared to other volume builders. A piece of advice... don't take your family to the La Pyrenee 68 display home in Balwyn, Vic unless you can afford to build it. They decided that was the home they wanted to eventually live in and lost interest in any further display homes. Haven't seen anything remotely matching it from other volume builders. Since these are at the top end of their range I am hoping they will be more careful. I could go with small boutique builders but would probably pay a 10-20% premium. Happy to hear of recommendations for alternatives. Looking at a fully rendered/Hebel French provincial style double storey double garage 5 bdr plus study home of about 45-50 squares on the 600m2 land or 65-70+ squares on the 1000m2 land . Master bedroom must have massive WIR for all the wife's countless clothes/accessories.

 

There is guy called Dr Doom who posts on another forum. His blog is at: Living a FI

His take on how most people blow a salary of $400K (US dollars) by signing up to massive fixed costs such as a fancy PPOR and wonder all their life as to why they could not get ahead in spite of their massive salary.

I am not for a second suggesting that you are anything like the below description.

For what it’s worth, extracts from a couple of his posts from another forum:

So here's how things develop for most people. Nearly everyone reflexively builds habitual spending into their lives until they are trapped by a need for their current level of income and must therefore keep grinding it out at work. This produces a paycheck which, in turn, continues to (barely) fund the life they've architected for themselves. People are capable of spending outrageous sums of money, particularly on cars, houses (multiple houses! Or upgrading houses! Or remodeling houses!), and private schools. Thing is, these things generate obligatory monthly outflows: mortgages, leases, contractors, landscapers, tuition. And people convince themselves that those outflows are impossibleto put a stop to, for one reason or another.

How to blow through 400K/yr, a primer:
1. 105K/yr - taxes
2. 120K/yr - PITI + landscaping + house cleaners for 6000 sq. foot 2.5 mil home on 3 acres.
3. 80K/yr - premium private school for 2 children
4. 30K/yr -- Own 3 50K cars, rotate one of them out every 3 years, trade in the old model.

You are now locked into 295K of mandatory yearly spending and have "only" 105K left. This will go fast: clothes, food and drink, 15-20K of vacations, utilities, media and phone packages, club memberships, golf equipment, christmas spending, charitable giving, hosting parties, and the odd home renovation.

Worse, were you suddenly inclined to "cut back" on expenses, the only area you would consider touching is going to be in the 105K bucket. But no amount of trimming in that area is going to fix your biggest mandatory expenses. You've got to drastically change your lifestyle in order to increase your savings rate -- and at that point, you fear having your family hate you, losing social connections, and basically becoming a pariah in your circle.

 

Just putting it out there... You don't usually get negative gearing when you have good rental yields... LOTS of people buy their goal property then rent it out (negatively geared) whilst they live some where more affordable so they have lots of disposable income to invest with.

My two bobs... It depends on what is important to you and what you are willing to compromise on... Usually there is a trade off... Instant gratification of great home now, or slum it for a bit and throw money into investments.