Purchasing an Investment Property

Discussion in 'Investment Strategy' started by Ben John1, 2nd Apr, 2018.

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  1. Ben John1

    Ben John1 Well-Known Member

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    Hi all, I am new here and seeking your input.

    I have recently cleared my debt on PPOR, it is a unit worth 450k. Recently I receive an inheritance of 300k and thinking to buy an investment property worth 600k.

    Just wondering the most effective way to get it done. Should use the 300k for 50% deposit and borrow the remaining, or use the equity from my PPOR? any inputs will be much appreciated. Regards, Ben.
     
  2. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    Hi Ben
    Great position to be in.
    It's better to use equity from your owner occupier property, utilise your borrowing capacity, and keep control of the $300k cash by parking in an offset account. Once the $300k is spent you will only be able to access it by either going to the bank and asking for an equity top up or by selling the property.
     
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  3. Anthony Brew

    Anthony Brew Well-Known Member

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    Use equity. Always use equity.

    Lets say you put in 300k into the property. After X years the property doubled in value. You now have 900k equity for a value of 1.2m.
    The rental income will probably be around 4% gross and 2.8% net after holding costs (you may not realise that the costs of holding a property are around 1/3rd of the total rental income).
    So then say you want to take out 300k of this and invest it into shares to produce a higher cash return (generally at expense of lower growth) because you want a passive income not having all your equity but no actual income from it. You may have major problems getting this cash. If you are retired the bank wont let you withdraw the equity. End of story. If you lost your job for a while, same problem. Maybe you want to use the money to go on a holiday or buy a fancier car, but now the interest on the money you pull out is not tax deductible. Or say you want to buy another investment property and together they have negative cash flow and you need a buffer to pay for this negative cash flow while waiting for the rental income to rise to pay for all holding costs, you may not be able to get equity to use for this. Many problems.

    Keep your cash and borrow the entire cost of the investment, and keep your cash in an offset (or 2 years of expenses in offset and the rest in income producing shares).

    General strategy is - use borrowed money for investing in property, put cash into income producing index funds for anything beyond what you will need in the near future (eg 2 years of expenses)

    Sux that I did not know this when I bought my first property.
     
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  4. Todd

    Todd Well-Known Member

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    Welcome Ben.
    I agree totally with above, but also:
    - educate yourself on property investing by reading some books. Do a book search on this site and there is a thread with all the best books. $100 on books could make/save you a fortune by helping you to avoid mistakes.
    - set your goals- what is it you want to achieve from property investing and in what time frame?
    - understand cashflow of property investing (the books)
    - get a good mortgage broker so you have an indication of budget and so your finance is structured properly for the long term
    - research, read heaps of threads on this site.use the search tool.
    - don't go to any property advisor (or spruiker) that tries to sell you anything. Run a mile if they do. Get independent advice or educate yourself or find an experienced mentor who has done it successfully.
    - don't rush into it, there is always somewhere when it's the right time of the cycle to buy at any given time.
    - think outside your State. Most first time investors buy close to where they live and it's just lucky if it's the right time to buy in that location.
     
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  5. Ben John1

    Ben John1 Well-Known Member

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    Thank you Sana, Mona and Anthony. I am a newbie on investment property and I still try to get my head around this.

    If I use the equity from my PPOR, is that mean I borrow 600k from the bank, and put the 300k on offset, which mean I pay interest only for 300k.

    Compare to putting the 300k into 50% deposit, and borrow 300k which means the cash stuck in the property, Is that the case?

    So is flexibility is the main advantage of using the equity rather than deposit by cash?
     
  6. Ben John1

    Ben John1 Well-Known Member

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    Hi Todd, yes agree with you. I find the propertychat very helpful and rich with wisdom :)
     
  7. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    1. Borrow against PPOR.... these funds will be used toward the deposit of the IP. eg. You need ball park 25% of the IP as purchase costs, being $150k .... this is just hypothetical. Better to access as much equity as possible, because depending on your overall borrowing, it may be hard to go back and draw down remaining equity down the track.

    2. Borrow 80% against IP being $480k. Overall, IP will be 105% financed

    This is high level. Depending on your income and your goals, best to look at the big picture and see what potential you have with expanding your portfolio beyond IP1.

    Advantage of using equity is detailed well in Anthony's post above. You want to keep control of your cash for non tax deductible expenses such as travelling, car etc or living expenses in the event you need the money. If it's tied into equity, and you need the cash, what options will you have?

    If you really need to use the cash based on your borrowing capacity, then that's another story.
     
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  8. Anthony Brew

    Anthony Brew Well-Known Member

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    Your 450k property, if you can extract 80% equity, means you can borrow 360k to use as deposits on investment property. This could be a deposit for maybe 1.5m worth of property (depending on your serviceability). After the same X years that it took to double, you would then be left with a profit of 1.5m instead of 600k.
    The main difficulty with 1.5m of property all bought at around the same time (as opposed to say one property every 2-4 years which many can only do) is that the total negative cash flow each month would be a fair bit higher as you have not had time for the rents to rise to help covering holding costs.
    But with your 300k in cash, you could use this as a massive buffer to make up for this hole in your cash flow over the next 10 years while rents steadily rise enough for the properties to pay for the repayments themselves.
    The main risk in leverage (ie borrowing a lot of money) is that if you have some problem and you are unable to pay for the cost of holding the property each month, you are forced to sell, generally at the worst possible time after property prices have (temporarily) dropped because that is the time that the economy tends to be at its worst, and you miss the profitable ride from bottum up to the next peak during the next property growth cycle.
    If you can have a 300k buffer then you have virtually eliminated the risk with your investment while allowing you to acquire much more assets which will grow more.

    In vague terms you can call it 'flexibility' or say it 'gives you options', but in more specific terms it allows you to acquire more income producing assets which will provide you with much greater wealth.
     
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  9. Ben John1

    Ben John1 Well-Known Member

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    Many thanks Anthony, just my curiosity is renting a high value property is more difficult than lower one as tenant is expected to pay more?

    I would guess the rental yield will be lower as well but that’s when the 300k comes into play. Besides I’ll be expecting capital growth more than yield.

    Just wondering assuming in the worst scenario I somehow can’t repay the loan after using the buffer 300k, the bank will sell the IP and if it does not cover the loan, will they sell my PPOR?

    Just having cleared my debt, I am bit nervous to borrow in such big amount with little experience in IP. Probably I need to se an accountant to make sure the numbers are add up if I want to go this path. Any accountant recommendation in vic?
     
  10. Anthony Brew

    Anthony Brew Well-Known Member

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    I was not referring to a single 1.5m property. More like 3 x 500k. You then get 3 rental incomes to cover most of the expenses.
    Each would still be negative cash flow if they were purchased in the major cities, but less negative cash flow than a single 1.5m property.

    Regarding what happens if you use all the buffer - 300k is a massive buffer and the plan would be to not use much of it.
    Lets say you are 10k/yr negative for each of 3 x 500k properties, and then (assuming you are working) get around 1/3 back in tax deductions for negative gearing, then it would be about 20k negative in the first year. If it takes 10 years for the rents to rise until it supports itself, you would expect the total cost to be around 20k + 18k + 16k + ... + 4 + 2 = 110,000 total over 10 years until the rents cover loan repayments going forward without the need of any more of your cash.
    These are rough numbers, and rents could stagnate for a few years before bouncing back in-line, but if you bought in multiple cities you would lower the chance of all rents stagnating at the same time, plus you have another almost 200k extra if it takes a bit longer, and it would be unlikely that you should need a large amount of it.

    Your fear of debt means you have some reading to do. Not all debt is bad. There are 3 types of debt.
    bad debt - for things that go down in value (eg loan for car, boat, holiday).
    tolerable debt - for your home. goes up in value but does not produce income.
    income producing debt - debt for investment that goes up in value and produces an income.

    Borrowing for income producing assets is actually a good thing (provided you borrow sensibly and don't over leverage), because if you choose a reasonably well located property, the return (value increase plus rental income) should be quite a bit more than the loan repayments, so the more debt you can use (sensibly), the more profit you can generate.

    You sound quite green, and should get your hands on some books before you make any moves with your money. Books on both property and shares.

    In any case, I was in your position and sunk a huge amount of cash into my first property and I hope you have more sense than I did and keep it as a buffer and borrow for your investments and instead put the cash into an offset so your interest repayments remain the same as if you had actually paid it down, but you actually have access to that cash for more profitable strategies and lower risk.

    Edit: by the way I am not trying to convince you to buy 1.5m worth of property, I am just trying to illustrate that by keeping your cash as cash, you will have access to more and superior strategies for creating wealth.
     
    Last edited: 2nd Apr, 2018
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  11. Greyghost

    Greyghost Well-Known Member

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    Should have used the 300k to pay into offset your PPR, then redraw it to purchase the Investment property. Too late now.
    Buy investment property @ 80% LVR and put the balance of funds into offset on the IP until you work out what to do with them.
     
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  12. Eric Wu

    Eric Wu Well-Known Member Business Member

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    excellent advice @Anthony Brew.

    Hi @Ben John1, welcome to PC, there are great advice above, often cash is hard to get, preserve it as much as you can, cash is KING in any circumstance, it allows time for you to get back on your feet in case things go wrong ( risk mitigation).
     
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  13. Ben John1

    Ben John1 Well-Known Member

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    Thank you all for your sounds advice. Indeed I need to broaden my knowledge before jumping in. Much appreciated.
     
  14. hobartchic

    hobartchic Well-Known Member

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    I would give yourself twelve months at least after a major grief before making big decisions if you can. Certainly give yourself some time to read about the pros and cons of what you want to do and talk to trusted advisors who have done well with their money about what they did. Does not mean you tell them you had a windfall either.
     
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  15. Ben John1

    Ben John1 Well-Known Member

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    Propertychat is very addictive to be honest :)

    I read through some posts about Cross Collateralisation. Just want to know more if I use my PPOR's equity to purchase IP does it mean it cross collateralised somehow as the bank will then take my PPOR title again?

    Thank you.
     
  16. hobartchic

    hobartchic Well-Known Member

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    Yes. If your IP loan can't be paid off you risk your home (which is paid off).
     
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  17. Property Twins

    Property Twins Mortgage Brokers & Buyers Agents Business Member

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    If you keep the equity loan secured against the PPOR, and have a separate loan for the IP itself, then no.

    If you have one loan for the IP ie 105% of $600k, and also have PPOR as security for it, then it will be crossed.
     
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  18. Eric Wu

    Eric Wu Well-Known Member Business Member

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    @Ben John1, here are the very basic concept of Cross Collateralisation and non Cross Collateralisation.

    hope it helps
     

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