Pay in full vs loan for investment

Hi all,

I am still wondering, if I can afford to buy a 500k property in full, why would I go through the whole hog of getting a loan for the same property?

My aim is to make more money over time btw.

Thanks a million!

 

You could use that $500K for a property out right.
You could use that $500K for 20% deposit on 5 x $500k properties (ignoring fees for a moment).

$500k property goes up 10% one year = $50K
$2.5M property goes up 10% one year = $250K

$500K property gives you all the rent bar 30% for expenses at say $500 per week = $18K per year
$2.5M property gives you all the rent bar 30% for expenses at say 5x $500 per week minus $80k loan payments = $11k per year.

So you earn $7k less per year for the opportunity of earning 5x the growth.

 

As @D.T. says, buying buying outright you are not applying any leverage into the equation.

 

Hey D.T,

Thanks for laying it out. So overall it means that I have my hands on more property using the same amount of money. This gives me a chance to build more equity over the same period of time. But I would be taking much more time to pay them all off eventually. So the money I am getting for rent for 4 properties goes straight into the properties. Would I only see a profit when they're all played off?

 

Because:
1. You may not qualify for finance in the future
2. You may need some or all of your money for private expenses at some point in the future
3. Your tax situation may change
4. Structuring opportunities
5. spouse strategies with offset accounts
etc

 

Thank you TerryW for your your reply. So it sounds like the loan buys the person 'time' for many excellent investments. However, there is still the issue of making sure the properties stay rented out to pay for all of them and for me to keep my job for regular cash flow until they're all paid off.

My question now is, would I only see financial benefits after the properties have been paid off? I.e if I sell 1 or 2, or after 30 years?

Thanks!

 

You can have your cake and eat it too.

Borrow 80% of the value of the property, on an IO basis, and place cash in an offset account. You will not pay any interest on the loan.

Benefits
- You stop working. No longer qualify for finance, but you could buy another property with the cash in your offset account.

- Private expenses say you need to use $200,000 for a medial emergency, then you would be able to claim $10,000 per year as a tax deduction (at 5%).

- Structure. Say you decided to invest in shares and wanted to use a discretionary trust to do so you could lend $400,000 to the trust as an interest free loan and personally claim $20,000 per year as a tax deduction while the trust builds up income. Diverting income to the trust will allow for great tax savings.

- spouse. Say you find a spouse and he or she is not working. You could get her to buy a house with you lending the cash to do so on an interest free basis. You have just saved your family a heap of tax.

 

Hi Terry_w,

Thank you for that eye opener. I will probably get a loan then. Well I will just start with first IP and I'll see how that goes.

 

This gives me a chance to build more equity over the same period of time. Would I only see a profit when they're all played off?[/QUOTE]

Not likely. Firstly your equity will increase exponentially over time by leveraging your $500K into five properties. Over time the rents will increase and the value of your loans will decrease. This can be because you pay off some of the principle and with inflation devaluing the amount outstanding. In both of these cases the yield will slowly increase, ie the amount of cash flow you receive from rent exceeding outgoings.

 

Hi D.T.

I've been asking myself this question as well.

Does it mean borrowing to buy properties will always be a better idea (due to the leverage) with the assumption CG will happen over time? But here we are basing our decision on an assumption/speculation. If the CG doesn't happen, we lost.

Also in your previous post you didn't take into consideration the costs of the 4 purchases (stamp duty etc.). With this taken into account, would the balance change?

I believe in your example above you assumed rental yield of 5% and loan interest of 4%. But what if the figure change, say we buy a property with high land component and potentially higher CG, but the rental yield is 3.8% and the loan interest is 4.9% (which is I believe close to the current bank loans)?

I would appreciate very much your comments.

 

Not really because you can't borrow for stamp duty any way. And it'd be the same amount in both scenarios.

It was really just to demonstrate that leverage is better than without. Everyone's circumstances are different and strategies / time frames are different. Can't really account for every possible permutation.

In general, I think investors should assess what their goals are and also what they can afford to spend each month on property-shortfall and buy the best CG-chance option they can within that. Remember no one has a crystal ball - whats performed well before mightn't necessarily perform again.

 

Based on the questions you are asking, I'd recommend finding a good broker who caters for investors and invests her/himself as well.

Reason I say this is because, its about an investing mindset more than anything. And you want the broker to help with your investment journey, not just the first property.

 

What he said ^

 

Investing in property is actually more about finance than it is property. i.e. what makes property great is the amount you can leverage. If you had $500k and no plans to borrow then you will find better asset classes to invest in than property - shares for example.

 

Hi Beelzebub,

Yes that makes a lot of sense.

cheers

 

Make sure you also understand how the bank serviceability calculators work and take this into account when determining your strategy. Naturally income is a big consideration.

Generally:
- a minimum amount of living expenses is assumed
- assumption when assessing property debt is that you are paying 7.25% interest
- lenders only consider 80% of rental income

A broker can correct on the specifics.

If spare income from your PAYG income is tight, make sure you look at high-yield investment properties in the 6%+ range. It will help with serviceability when buying multiple properties.

Also watch out for strata fees that can significantly decrease your net yield and cashflow.

Depreciation can help cashflow if the properties are relatively new or have had extensive renovations.