What I learnt out of buying 7 properties

Not sure if it's been mentioned in a previously, but seems like I am receiving quite a few requests for pets from tenants. Had to decline one request because it's in a strata complex and a fairly new townhouse. Not too sure what the strata bylaws is for the complex in relation to pets and also didn't want it to become an issue later on with the neighbours.

 

If it's a standalone house I would normally review and approve. I think allowing pets actually incentivize the tenant to stay longer.

Strata complex I would tend to agree with you - the drawback of potential damage to the property and complaints about noise may outweigh the potential benefits. Was it a dog or cat that your tenant was requesting?

Cheers,
David

 

It was for a dog David and even though they've provided reassurances that the dog be placed outdoors, still the issue of keeping the peace with the neighbours in the complex.

But in saying that, did approve for a small dog for a house.

 

Wow, just found this thread - incredible source of knowledge for everyone no matter which stage of their journey, thanks for sharing @David Shih

 

17. Seventeenth Lesson - When should you build a Granny Flat?

In recent years Sydneysiders have fallen in love with a product called Granny Flats (GF) – especially when it has a good cashflow return to help support the mortgage repayment. Investors absolutely love a block which has the ability to build a granny flat in the back yard.

But is building a GF as good as what everyone thinks? We explore some upside and downside in this post so you can make the logical decision yourself on when would be the best time is to build the GF.

• The different phases of a property journey

To understand when is the best time to build a GF an investor must understand which of the phase he/she is currently in. The normal phases a property investor will go through are:
1. Acquisition Phase
2. Consolidation Phase
3. Retirement Phase

Acquisition Phase is when property investor, Bob, goes hard in acquiring properties to his/her portfolio. Usually in this phase as the number of properties increase so too are the level of mortgage/debt.

As Bob’s cash/serviceability runs out that’s when he moves into consolidation phase. During this phase Bob focuses on holding his portfolio for a long period of time so that rent essentially surpass all the outgoing expenses and starts to form passive income. Bob can also execute some value-add strategies to speed up the passive income/wealth process.

Lastly after the portfolio has had a good capital growth run, Bob may decide to sell down some, if not all of the assets to reap the reward and move into Retirement Phase.

During the Acquisition Phase and if Bob has a really aggressive risk appetite then he will (naturally) want to acquire as many properties as possible and in the shortest timeframe possible. In order to do this he’ll need to divert all his resources towards purchasing assets – this means both cash and borrowing capacity.

However if today Bob is an investor with a low risk appetite, who decides to purchase IP1 with a big backyard and due to his risk aversion nature, wants to make sure he maximizes the cashflow/yield of such IP before moving onto the next. To do so he wants to build a GF on IP1 to boost the rental return. Couple of implications on this approach:

1. This may limit his ability to purchase additional properties during acquisition phase
To do this he’ll need to divert either his cash or serviceability against building the GF. Let’s assume the two bed, vanilla GF cost him $120K. This will either have to come out from his cash or equity (which means less deposit for his next IPs), or if there’s no cash/equity then it’ll need to be a construction loan which impacts serviceability (less borrowing power moving forward), or most likely a combination of both.

Either way, by directing resources to GF instead of being able to purchase another 2 IPs after IP1, he may be confined to IP1 + GF only.

2. How much value does a GF add?
Once built, if Bob decides to get the place re-valued by the bank then the valuation returned will rarely reflect 100% of the GF value - on average they will only reflect about 60% of the GF value. In other words, you may only get an additional $72K capital value after spending $120K cost upfront.

3. Additional rental income is the icing here
Rental income should hopefully be good once rented out therefore speeding up the mortgage repayment process or at least helps holding IP1 more comfortably. It also means that Bob now has two streams of income coming from IP1 – and if one goes vacant, then the other leg will be available to support the mortgage repayment.

Personally point 1 and 2 should be enough to turn down most of the investors – as they can see the money is not working hardest for them by going down this approach.

Which is why a smart investor will look at acquiring IPs with potential to add GF, but hold out till acquisition phase is completed before looking at building out the GF as part of consolidation phase exercise to improve overall portfolio cashflow.

During consolidation it is all about holding onto the properties for as long as possible to maximize the CG potential (buy & hold) or execute different value-adds such as cosmetic renovations to improve CG/cashflow. To be able to buy & hold for long term, the portfolio needs to be robust enough to attest the time of interest rate fluctuations. GF is a great way to boost portfolio cashflow and would certainly make holding of the property portfolio easier.

Just another general note – not all suburbs are suitable for GFs so I would definitely recommend every investor to do their detailed due diligence and engage GF specialists for an assessment before pulling the trigger. GF in the wrong location may not have the demand and may not achieve the desired rental return intended.

Cheers,
David

(Above is written based on my personal experience/opinion and is general in nature. Please seek specific advice from qualified professionals)

 

Hi David
Definitely great information to know as we have just started on our first IP and plans to invest in more,it’s been nervous beginnings to say the least but the more we digest knowledge like yourself,we are getting more confident in knowing what to expect if you do your homework cheers

 

Love these posts

 

Spot on David, good post.

 

I disagree with holding out until acquisition phase is complete. Building a granny flat can help with further acquisition. It can also hamper acquisition if not executed correctly.

Eg. You have an IP in Sydney, if the place is worth $600k, the $120k used to build the granny flat can yield 20%, that increases your cashflow and puts you in a safer position to maintain your properties as opposed to being stretched.

Sure you can use the $120k to purchase another property, but then you're cashflow poor and may not have the ability to build a granny flat when you're done with acquisition.

By building the granny flat, your cashflow increases, which then allows you to borrow more money and you can extract the equity out to purchase the next property and repeat.

But the granny flat strategy doesn't apply to all properties as you said. For me, it doesn't make sense to build a granny flat for $120k in areas like Logan, where the purchase price $320k.

Building costs are the generally pretty similar regardless of area, but a granny flat in Chatswood would yield more than a granny flat in Mt Druitt, and people generally fail to understand that, they just look at "granny flat = cashflow".

One needs to understand rules and sequencing. Get that right, everything else falls into place. Its like trying to remodel an entire bathroom after you've spend money changing the toilet and replacing the shower screen, then deciding you want to change the tiles.

 

It hasn't been mentioned yet, but it is worth being aware that putting a granny flat on a property will usually impair the value of the primary property. When it comes to resale, GF's are attractive to investors, but less to owner occupiers.

 

Yes and some houses with GF's can be particularly attractive to investors purchasing via SMSF. Especially when the yields are similar to commercial property, but with less vacancy risk.

 

100% agree. People are happy to buy a house with a bonus granny if the price is the same as one without a granny flat. People aren't generally happy to buy house + granny flat where there is a premium (unless they are specifically looking for that).
Granny flat being a cashflow strategy should be considered for buy and hold, not quick release.

 

Thanks @neK I agree with you in principle and I think it'll be based on individual situation, risk appetite & strategy. I can only offer general advice in my article based on my personal experience.

I would also like to add it's important for investors to be mindful that lenders are now capping annual rental income - as an example to 6% gross rental yield. So if you build a GF
and improves the yield to say 15% gross the rental income for servicing only 6% gross yield will be used.

As a simple example:
- You bought a $300K IP renting at $350 a week - gross rental yield of 6%
- Chuck a $100K GF on it. Assuming valuation now comes back at $400K (house + GF) and rents at $600/week then gross rental yield is 7.8%.
- For servicing purposes however, you won't be able to use the annual rent of $600 x 52 weeks = $31,200. Instead it'll first be capped at 6% which means annual rent to be used for servicing is $24,000 (before any additional rental shading). So in essence almost 25% of the extra annual rent won't be qualified for servicing in this scenario.

As an alternative example:
- You bought a $600K IP renting at $400 a week - gross rental yield of 3.5%
- Chuck a $100K GF on it and val came back at $700K and rents at $700 a week - gross rental yield of 5.2%
- In this case as the gross rental yield is below 6% so it will help improve your servicing

So definitely be mindful of these scenarios and check with your broker before pulling the trigger as they can assess such impact to your serviceability.

Cheers,
David

 

Great point John - thanks for highlighting it!

Cheers,
David

 

Granny flats need very careful thought, people doing them in regionals may be throwing money down the drain unless they are in a good location and will be kept for a very long time, as the building can exceed the property value.

People were going nuts over GFs, but I think they would be better off doing a proper development.

You beat me too it, was writing this last night,

Needs a lot of thought.

 

Another great point - thanks dabbler
By all means GF are not silver bullet. To an extent I would treat it like building a new home - need to do thorough DD on cost/quality of build, location, demographics, rental demand and expected ROI etc.

I know you have bought and done a lot of research on regional areas. Do you have specific examples of GF built in regional where people have lost money or ones that just doesn't make sense?

Cheers,
David

 

Never knew that. How does that work that in practicality?
For example, i am asking the bank for a new loan for a new property.
I state I have $350 per week rental income from Property 1A and $250 per week rental income from Property 1B.
I could state the value to be $520k.
Would they actually run a valuation on that (If there is no cross collaterisation in place and the loan is of property 1A and 1B is held with a different lender ?

 

No, cause most of the people who were interested in the market and locals largely did not touch units as the market demand is largely for houses with large rooms and quarter acre blocks.

But now that the market is hot, people are doing it & some PMs encourage as they get 2 lots of fees, but the fact remains, when market is normal, most people want a home on quarter acre block and they prob wont want too share.

In some places, lets say your GF costs 120 too 150k, you could look for a whole other rental property in some places for that much, also the lenders wont like them, in larger regionals you prob need 240k now, but it will still be a good performer, land val not high, easier too sell and easier to secure loans with.

Once the new place with new GF gets old, and the market demand for homes and rentals normalises, then your left with a sub standard place that is not in demand, not liked by lenders and probably no longer easy too rent as it is old and prob can rent free standing house elsewhere for same.

I think they can suit some blocks and locations in Sydney and busier cities and locations, but you can face similar probs, but that may depend more on the block IMO. I see these dumps of places, all around the Bankstown LGA, with a GF stuffed in the back yard, all great for rent and while new, but can you imagine the loss if selling now ? But a clever design in a good spot with a modern house and GF that is well laid out, that could appeal too more people.

I mean if we walk up too a place, and it is appealing in many ways, that is always going too beat something that is full of compromises, poor layout & setup and position etc, add a daggy fibro dump, deadbeat neighbors etc, well, your income may look good right now, but I do not like sale time.....

Also, with regional towns, many people just do not know the areas, or whats going on.....in one, they spent last decade including a lot in last 3 years or so, selling off the housing commission stock, and what they do is buy random places in the new estates, so you might just buy your 600k or so place and have bubba and co next door. But people are doing it, playing roulette in a market that is hot ATM, but will soon cool both for rentals and home buyers.

Last boom many did same, built and chased rents, it turned off and many were exiting.

So, yeah, may need too be sure your going to hold long term. Know the location very well too.

PS you have to think why a lot of people may be moving to an inland regional for example, and it is not to downsize into these new Sydney style cramped box with no yard The locals def do not want dog boxes.

PS PS I was looking at a place that was on around 2 acres in town, I got beaten by a downsizer....an old guy and his wife, lot of people live on the land, they aint going into town to live in a box with no yard ! Sure you may be able to sell a bible in a foreign non Christian country, but you would better of with stock of the locals book too sell

Well, that is my philosophy.

 

Depending on the lender's risk appetite and location of the property, but I believe in almost all cases lender will organise valuation to arrive at their own estimated dwelling value as well as rental estimate rather than taking what you have stated at face value. And then they will use the lower value of the two (between what you stated vs what actual val came back at).

Cheers,
David

 

I don't fully understand this.
The bank would actually run a valuation on existing properties with existing loans (even when those properties aren't forming part of any security for the new loan that is being applied for) ?

Eg. For those who have multiple properties (say 5+) in say Logan, if they wanted to purchase an IP elsewhere, it would seem to be a very costly exercise to run valuations on 5+ properties when they aren't being used as security, but their details disclosed because its part of the loan process.