This article explores effective strategies for lending and financial decision-making in various contexts.
FAQs
FAQ - Strategy
Should I sell my property given it has underperformed?
If we are in an asset that has underperformed but has the possibility of reverting back to the mean in the future, selling property can often be a last resort due to the high transaction costs. If you have sufficient borrowing capacity and deposit, it’s best to proceed with that first.
Once we are restricted, then we should consider selling and reinvesting into a better-performing property
You can also lean on the research team for insight into the markets - refer to optional post-session activities section
For houses and townhouses we want data looking into the market to see if it won’t do well in the foreseeable future. If it’s not going to do badly, then the counterargument is that we would need to see a decent outperformance in redeploying capital when considering transaction costs. From our research, we see 90% of LGAs perform between the 5-7% mark over the long term so it might not do well now, but at a later point it will swing around. However this has to be balanced as weak markets may stay flat or declining for a very extended amount of time where opportunity cost can be large
However, if an asset is clearly an underperformer going forward, we should definitely sell the asset as there can be a huge opportunity cost in being in a poor-performing asset
Straightforward for obvious high-rise new apartments, but for low-rise units/apartments you would want some data backing it up with the incoming supply posing an issue
I’m thinking between purchasing the PPOR and continuing to invest, what should I do?
Let me pose two scenarios to you:
Scenario 1 - You have an investment portfolio that is producing the passive income you desire and you are financially secure knowing that you will be able to live the lifestyle you want. However, we don’t have the dream home and we’re working on that as a second goal
Scenario 2 - You have your dream home and it’s debt-free but we’re playing catch-up on investing. We’re not financially secure and we are unsure if we will have the passive income desired to live the lifestyle we want.
Which do you prefer?
(For majority of clients who will say scenario 1) While the PPOR is definitely a goal, when we talk to clients that are older, 10 out of 10 clients say they should have secured their financial security through income-producing assets instead of getting their PPOR first
Once we add the PPOR, the borrowing capacity blows up and it’s much harder to accumulate IPs after
A lot of them feel like they overcapitalised on their PPOR initially, and are struggling to meet their financial goals
That’s why we usually aim to invest first, and then we map to get your PPOR at a later stage and see what income we need to get there
When does it make sense to buy the PPOR first?
If you’re buying a home that you’re going to live in for at least ten years, the rental yields are high, it’s not a unit or apartment and the city has a diversified economy
You’re buying a home and you’re getting all the first-home benefits, you do the calculations on the return on investment including all the grants and it puts you in a better position than a perfectly positioned investment
Works if the grants get you in a higher priced property even if performance is lower
There are also the emotional aspects of owning your PPOR and we can’t put a dollar figure on that, and that needs to be weighed up on how much you value owning your own home
What are your thoughts on rentvesting?
When rentvesting, your borrowing capacity is used for productive assets that give income and growth. While your PPOR might grow, you’re limited to buying in areas near you instead of optimising for the areas with the highest potential for growth
Your borrowing capacity is also increased a lot because when banks assess serviceability, they take the actual amount of rent you pay but for PPOR loan repayments, they add a buffer (1-3% currently)
As a result, you have much more equity growth from investing first which helps you buy your PPOR later on
You also have the benefit of having ‘good debt’ which is tax deductible, rather than ‘bad debt’ on your PPOR
Rentvesting also takes advantage of the difference between yields in where you are living and where you are investing
Especially for people living in Melbourne or Sydney, you pay a very low yield to live in these cities while you invest and get a strong rental income from the investments
Allowing you to live in expensive places that would cost a lot more to buy and pay a mortgage on, and giving you the freedom to enjoy living in these places with flexibility
Can I make it a requirement to have something with development potential?
We can consider development potential in our search but there are tradeoffs when we do this
Firstly as this is an extra criteria, it can take a bit longer to find a suitable asset
We may need to stretch the price point higher to expand our search and also lower the yield, this is because we need to pay more for a larger land value (Would expect budget to increase by 200k and drop yield by 1%)
We may also need to consider that the property will likely be in a worse condition as the plan is to knock it down, so we may need more capital to complete renovations
The property also is priced on the potential and not its current value, so the prices often are higher than necessary
Development is quite an intentional strategy, so it can make sense to do if you plan it out, but we do need to keep mindful that it does cost money and does take time, it can feel like a second job when you need to manage town planners, council, and other professionals
Generally we see that it’s only for investors who know what they’re doing, otherwise, the return and effort might not be worth it, especially with construction costs at the moment
We typically see more value in just putting your money in another asset and getting a better return there without the effort and that’s why Arjun has built his extensive portfolio without any properties with development potential
From a feasibility point of view, you have to consider the value of your time, does it provide a better return on your hours than working somewhere else?
Can I make it a requirement to purchase something with a granny flat, or a duplex or triplex?
These assets lack owner-occupier buyers, surrounded by areas where investors continue to buy and sell
As a result, the growth is restricted as we’re buying and selling from a yield point of view rather than focusing on growth prospects
Lots of investors in Sydney and Melbourne are looking for a ‘high-yield’ and think that 4-5% yield is high and they need to purchase these assets to get it, when we can go to our higher yielding capitals and regions and get both the growth and the yield from a normal house
Also, show the cashflow difference per week from 5-7% and show how it isn’t that much post-tax, talking to the sacrifice of capital growth for it
A real example is Arjun buying a 7% yielding dual occupancy in Ipswich, QLD, even though it was in the same area of properties that saw a 30-40% increase in value, his only went up by about 15%, as it was valued by the yield rather than the owner occupier appeal
We don’t usually purchase granny flats, but for dual occupancy houses, duplexes, triplexes, etc. there is a time and place, as a passive asset it’s viable if cashflow is the focus
We sometimes purchase granny flat homes if they’re already there, but not very often though
We don’t build as councils aren’t all very accepting and then it can make the investment not viable if the plans don’t go through as you purchased for that sole purpose
We usually buy unit blocks in bulk and revalue them individually on a separate title
If there is a bulk title and we’re not sure if we can separate it, then have to be an extremely high CF
Usually, CG is similar to houses, because they’re small regional, low-density areas
Ideally, we want reno potential on these as well
Can usually take 6 months to source, we’ve only bought about 15 over the past 5 years, and already have a few clients who have been waiting for a while
Total criteria: unrenovated, multiple titles, bulk block, no more than four in total as it’s then not considered commercial (more costs for valuation, more time for finance needed, not as high LVR, higher rates and fees, lower loan terms), in our growth areas, plus reno upside, convincing vendor to sell cheaper in bulk, otherwise, you’re just compromising, price ranging from 600k-850k, sometimes even up to 1m
In summary, it is very hard to source and we will probably be searching for a long time, we need to hit all these criteria because there is a higher supply risk if something is built next door
This is why we typically go to commercial instead
Should I consider commercial properties?
Commercial is a great way to supercharge your portfolio to focus on cashflow. Once you have built a solid residential base of properties, we believe commercial takes your portfolio to the next level, where you can enjoy a strong passive income
Once you have a portfolio of a few residentials, this is typically when we see clients move to commercial to focus on building the passive income
If they ask for details:
Yields
The target is 5% - 6.5% net yield for a combination of a good industry and tenant type that we’re searching for
Net yield is a way to measure risk, above 7% is highly risky such as small offices in Melbourne CBD, you can get them for 200k-400k with 8-10% net yield, but high vacancy rates
Medical and retail are the safe bets, with good lease terms and tenants
Rental increases are typically 3-4%, they can be higher sometimes with CPI clauses
We only buy properties with a tenant already and a minimum 3-year lease
Pros
Long leases and little to no maintenance
The cost to manage is much cheaper as expenses are covered by the tenant
High cashflow
Cons
CG can be lower as value is attached to rental income (Think DCF rather than CMA in valuation)
Vacancies are typically 6-12 months, but it does vary quite a lot depending on the property/industry
You do get 2-4 months notice from the tenant though
Reletting fee is 1-1.5 months instead of 1-1.5 weeks for residential property
Much smaller market so REA and Domain charge a lot more due to advertising, much less exposure compared to residential property
Larger buffers are required, should keep 50k for each commercial property, accounting for roughly 4-6 months of vacancy, as the tenant needs to give 2-4 months' notice so this adds up to 6-10 months to find a new tenant
When can I access Super?
Not financial advice, but I believe if you can access it on the following
Under 60: you must have finished working and have no intention of working again
60-64: when you leave or stop working for an employer
65: you can access all your super, even if you’re still working
However please do double check this all with a financial planner for personalised advice
FAQ - Lending
Should I use a trust to extend my borrowing capacity?
I am not an accountant, so this is not formal advice but I can provide some insight into what I’ve seen with previous clients
I have seen some clients set up trusts and under certain criteria, the bank was able to preserve their borrowing capacity
The trust is required to be positive cashflow at the time when you want to expand your lending
The accountant has to sign off on a letter stating the trust is for investing purposes and is self-sustaining, with income covering all expenses
So when these criteria are met, the client can borrow in a second trust, and the bank will ignore the borrowings in the first trust and only look at what was in their personal name
Advantages
Allows you to exceed borrowing capacity limits from a personal name
Able to distribute to other family members who may be in a lower tax bracket
Asset protection if someone takes legal action against you
Disadvantages
A higher land tax which can be very expensive depending on the state and your land value
Expensive accounting fees, $2k-$3k to set up and $1k-$2k for ongoing tax returns
Borrowing capacity loophole that might not last forever, only a handful of banks allow this
This means that if policies change, you’re paying a lot more to hold it in a trust
This can stress household budgets, you need to make sure you can hold all the properties or it can derail your plan
Unable to negatively gear within the trust if you don’t have other income-producing assets within the trust
However, losses can be carried forward into the future
What we’ve typically seen is people buy a few in their personal name, and evaluate if they actually need more according to their plan, if they do then they consider going down this path
Fixed vs. variable interest rates
While I can’t give formal loan advice, there are advantages and disadvantages to both options
Fixed rates give you certainty around the repayments when budgeting and considering cash flow, in case of any rate rises
However, you do take on the risk of rates dropping
Also when building a portfolio, you limit yourself from refinancing to another bank that may provide a better offering in terms of rates but more importantly equity, as banks can vary largely in terms of valuations
There can also be limitations in terms of extra repayments when on a fixed rate, if you are considering paying more than the set amounts
This is why generally the flexibility of a variable rate is more advantageous for investors building their portfolio
Should I go Principal & Interest or Interest-Only for my loan?
While I am not qualified to formally recommend a loan type, here are some pros and cons that I’ve seen with investors
IO with a PPOR debt
Pros
Additional cashflow from the IO on the investment loan, used to offset the PPOR debt and get a savings on tax given interest isn’t tax deductible with PPOR debt
Greater buffer given higher cashflows
Cons
Higher interest rate paid on IO compared to P&I
Less serviceability with major banks
IO without PPOR debt
Pros
Better cashflow and therefore larger buffer
Better serviceability in the future when we need to stretch borrowing capacity with 2nd or 3rd-tier lenders
Could be a benefit of future tax planning savings if PPOR is purchased later down the line, money in offset on IO is used to have less PPOR debt in the future
Cons
Higher interest rate paid on IO compared to P&I
Lower serviceability with major banks
I have a joint loan but want to invest further individually, how will this affect me?
When loans are taken out with another individual party, these are considered joint and several liability loans
This means that each party will be individually responsible for the debt (in most cases, 100% of it), but lenders will only take into account half the rental income when assessing serviceability in the future which can impact your borrowing capacity should you wish to invest in another property outside of the joint purchase
There are some lenders who offer ‘Common debt reducer’ loans which take into account your actual share
These loans will require proof of self-supporting income for the share of liabilities for both parties such as loan statements, liabilities and assets, payslips, etc.
As of October 23, there are only three banks that do this so it severely limits your options
One alternative is to put the property in a trust with a corporate trustee, so that when the trust is self-sustaining, you can get a loan and the debt isn’t listed on their personal credit report
This allows a lot of lenders to exclude the debt
I’m a business owner and I’m paying myself a low income to reduce my tax, how will lenders assess me?
This is case by case, some lenders will consider the profit of the business, but some won’t and you will have to increase the income you pay yourself
You should speak to your broker about this as it depends on the type of business as well as the lender assessing you
I’m planning to relocate overseas, is this okay?
Generally, lenders will still lend up to 80% LVR, allowing you to do refinance cashouts and pre-approvals if you’re an Australian citizen or have a PR but working overseas
Typically you will need to be working for the company for 6-12 months depending on the lender, but if you are working at the same company and moving overseas that won’t require that amount of time
How does commercial lending work?
Banks usually give 70% LVR but there are cases where you can get 80% LVR with a 15-25 year loan term
Currently (2023), WBC offers cross-security against residential, allowing you to get residential rates for the whole deal
Borrowing capacity
It’s typical that when doing plans, the borrowing capacity spikes over the 6x DTI that we typically use as a measure
There are banks that offer loans with no major servicing requirements due to low doc and lease doc loans, but if we can’t get this then we can simply push out the purchase
If borrowing capacity is still available, mention that they should talk to their accountant and their lender as it may be beneficial to put the next residential purchases in trust to preserve borrowing capacity
I don’t have a pre approval, can we put it on hold for now?
As our searches take time, we usually start the search without pre-approval and apply for it at the same time
Usually, all we need is an indicative green light from your broker completing a preliminary assessment so we know we should be okay
We also have finance clauses to protect you in the contract
This allows us to speed up the process, as generally, banks work faster once they have a contract in front of them too
