Passive Income From Real Estate.

Hi everyone

It's been a goal of mine to use property as a means of generating passive income (mainly through rent).

I recently bought a property which is positively geared (only just) and i've got a P+I repayment schedule going. From my income at my job alone, I roughly earn about 67k before tax.

I plan on buying more property as soon as I can.

How should I structure this exercise so that I can start enjoying the passive income from rent as well as buy more property?

 

Well, where is your next deposit coming from?

who do you know or read about that lives off property rents? How do they do it and what do they own?

 

My view is that property should be used for growth and shares for passive income.

If one wants say $60,000 passive income from property and uses a net yield of say 2% (rent - expenses), then one would require $3M portfolio of IPs, all debt free.

Out of that $60,000, one still needs to pay income tax.

If one wants say $60,000 passive income from shares and uses a dividend yield of say 4%, then one would require $1.5M portfolio of shares, all debt free.

Out of that $60,000, one still needs to pay income tax but dividend imputation reduces that expense.

Shares are better for passive income and a lot less work to manage IMHO.

 

Curious.... what’s the net yield

 

^^^^ Exactly this! Residential property in Australia offers pitiful cashflow for plain old buy and hold investors. Longer term capital growth, however, is a different story.

Perhaps value-adding strategies might be a good play for you? I.e. do a cosmetic renovation, re-value it, then do equity-release-re-finance to unlock the increased value as deposit/down payment for the next property purchase. Not only this but the newly renovated property will likely rent for higher than what it would have, if unrenovated. So the extra cash flow will help pay for the interest you'll pay, on the fresh equity-released portion you'll use as down payment on Property #2.

Just do not cross collateralise the mortgages on both together.

Where I've observed this tactic be really lucrative (but never done it myself!) is:

- Buying a 2/1/1 house unrenovated in an area/market where 3/1/1 is the norm, and buying it below market value. And in particular; in an area where 2/1/1 sells for a LOT less than 3/1/1
- Ensuring you buy the 2/1/1 that has a LARGE lounge room and/or kitchen, and importantly a separate dining room that already has its own window installed
- Doing a LIGHT *read: modest budget* cosmetic that does the 'standard' stuff (floors walls re paint, light bathroom tile paint, and light kitchen - think Cherie Barber quick cosmetic reno style); but includes the wildcard of converting the dining area into a bedroom. Since the dining window is pre-existing, most councils won't require a DA to install the internal wall/door that sections the dining room off and turns it into bedroom #3. This conversion is as cheap as $2K for new wall door and paint. A built in wardrobe adds another $1k.

I've seen someone do this in Ballarat and the rough numbers they mentioned to me (if I remember this correctly, this was a few years ago...); was something like $225K purchase price + $10k purchase costs for the 2/1/1 House. Then 6 weeks of mortgage interest for the rehab for another $1K or so (6 week vacant reno project time) then I think it was $20K reno/rehab budget which included a yard trim back/tidy up, and of course the 3rd bed conversion. So all in up front for: ~$256K.

Investor leased it out right away for full 3/1/1 rent-rate; and 3 months later had it re-valued as a 3/1/1 for $315K. Meaning he could extract 80% of that value-increase amount ($315K - $256K = $59k value add so 80% of that = equity release of $47K) which he could then use as going towards deposit on nect property purchase.

The only alternative to small-scale reno or value add I can think of; would be USA residential buy and hold investment because in some markets there, residential property is actually a cash-flow asset class more than a capital-growth asset class as it is in australia. But of course this strategy relies on a fair whack of capital up front and (more importantly) a fair whack of learning and due diligence up front before you can commence.

 

I have done such renos.

I have found that the money spent typically increases the value, at least by the cost of the reno (but not always).

I have found that the rent does increase post reno and normally covers the additional interest charges (typically with something left over).

For all the effort undertaking the reno and all the risk one exposes oneself to (imagine doing a reno in Melbourne in February/March this year), this approach doesn't produce a lot of extra passive income.

If one is after passive income, go for shares. There is little to no work, the net yield is a lot better than property, there are tax advantages with dividend imputation (Aussies shares), ...

Yes, there is price volatility (even with the COVID crash, shares are now to breakeven this calendar year) but the OP is not after growth; they are after passive income. I don't believe property will "cut the mustard".

 

And less likely for the Govt to leave the rules and taxation around shares/stocks alone. Property and housing is a political issue and revenue source. The Govt and OSR can't resist sticking their beaks in all the time.

 

Well said.

Just like to add developing property can be lucrative Strategy, 3/4 unit development sites

Either hold all, sell the lot or sell a couple to create income stream.

Its all dependent on the numbers, whichever makes sense

 

Thanks for all your responses, i appreciate it.

The rent from the tenant basically pays all the outgoings associated with holding the place leaving me with $1000 at the end of the year (pitiful lol).

Since this is the case all of the income I get from job can be saved as normal. How should I go about buying another property? And does anyone know any good areas?

 

Could be worse..... could be negatively geared like most property investors

 

I was listening to a podcast by Michael Yardney today where he was saying that the old ‘Living off equity/living off income’ strategies (which I think he used to promote) are dead. Low yields mean you need to command too large an asset base (as mentioned above), and attaining lending for such a asset base is pretty hard these days for the average borrower.

Not sure what strategy he is promoting instead now though?!

 

Writing was on the wall for this 5 years ago. I was going to try the LOE strategy but became clear it wasn’t going to work the old way.

I started selling down and transitioning into shares. Oz shares provide decent income + franking credits and zero expenses.

 

Yes, and sadly he is right, his been around the block a few times and a successful property investor. Also search what mortgage brokers have to say on this, will give you an idea on the playing field today

What worked 20 years ago wont work today you will hit the wall at maybe 3 Properties Due to restrictions in lending criteria.


Prior to APRA you could borrow 12 x your salary or combined salary, however today its only 5 x salary. The average yields are about 3% gross

Why investors will need to look at strategies to increase cashflow.

I am not saying to throw in the towel, but you will need to be creative and a very good broker to help you mitigate this so you can continue buying
Alternatively buy when serviceability allows, caveat you may be looking at a much longer time frame


A change of structure can help

 

It is a contrarian view and it will take years to know for sure, but I think LOE will actually make a comeback.

In an economy awash in freshly minted central bank funny money, there isn't any yield anywhere, and the whole economy is based on paper equity valuations.

I actually think that it will dawn on banks that they need to rely on equity if they want to continue lending (they are money shops after all), and in doing so, they will reduce their reliance on yield, and increase their reliance on equity. This is an about turn from the standards we saw from 2017 to today.

The hint was in the recent changes to the legal liabilities that will lead to a relaxation of lending standards in Australia.

In a zero interest rate world where yield doesn't mean anything, equity will be the only game in town.

 

A very wise plan..... those nasty tenants

Seriously though there is a place for both but its about cash flow and not everyone holds all properties, some trade

LOE is a dead duck, I know a couple of investors on PC who tried this, one ended up having to sell their family home the other went back to work

 

Hey John do you know anyone who successfully LOE?
Lots of talk about it but........???

To LOE u also need to be able to refinance to access equity, this needs to be timed, buffers already in place prior to goodbye day job.....not everyone can do this. Dependent on market etc

Unless you have 10 year buffers. Not sure many investors would have this???

Personally I do not feel comfortable LOE?? Its smoke and mirrors. True financial freedom is income

 

I hear you, but what if we have negative interest rates (we are pretty close now)?. Is equity back on then?

 

right
But you still need a healthy sizeable diversified portfolio to do this
If you have this then u should be able to LOR

 

I totally agree. But we live in the financial twilight zone. I am not saying it is rational, but I am saying that if banks want to keep lending, and if they simultaneously want high property prices to make sure their lending book doesn't implode, they will have to prioritize equity. Once they do that LOE is a natural consequence.

To answer your question more directly, it can only happen once the LVR is low enough irrespective of the yield.

 

What!!!

People lose income and are termed investors?

What idiots!!!