Turning your PPOR into an Investment!

Recently I wrote an article about the comparison of Renting vs Buying. That article was for the initial choice between buying a house compared to renting a place to live and investing the assumed extra cash flow that comes with it. A question was asked of us recently on the benefit of moving out of your PPOR and renting a place, while renting out your PPOR in the meantime.

I remember reading an article a couple years ago about the benefit of purchasing a place that you want to live in some time in the future, basically the typical 4 bedroom suburban home to raise a family in, while you are single and young, live where you want to. The benefits seemed to make sense and this is exactly the situation I was asked about. I now seem to find myself in the same situation. I have been living in my PPOR for the last two and a half years but I am relatively far from the city, not close to many of my friends and not in the most desirable area to live in.

The decision to move out has already been made in my mind; I feel for me at this time, it is a better lifestyle choice. Since I have already balanced the emotional side of the decision, I now just had to convince myself of the financial benefits. I was able to develop a fairly routine spreadsheet to show the financial implications of making such a decision.

Basically, I would be able to rent out the property for $400 per week and to rent out a place that I would like, I would be able to find a property for $250 a week. Already it is easy to see a benefit of $150 per week. However it is important to note there is a lot of additional expenses that will need to be covered when you become a landlord. Landlord insurance is required to ensure your tenants do not take you to the cleaners, contents insurance is also a good thing to have when you are renting. Property management fees will also need to be taken into consideration.

After taking all of the above into consideration, I found out that I would be approximately $100 per month better off if I moved out of my PPOR and rented it out. It should be noted that I did not take into account the tax implications of turning my PPOR into an investment. I realise you would be able to deduct a fair bit due to having the investment property, but this would most likely be offset by the added income due to the rental returns. So in the end, I did not take into account the tax implications, it would have made the spreadsheet a lot more complicated, and I do not believe it would have added anything extra.

If you would like a free copy of this spreadsheet, please click this link Spreadsheets

I have also read about the benefits of exchanging the title of the property into a trust to be able to fully deduct the interest repayments with your tax return; however I have not looked into this in great detail and unfortunately cannot provide any extra information. However if you have paid down the principal significantly (in which case there is minimal interest to claim), then it may not be worth it. As stamp duty will have to be paid when you transfer the title to a trust.

2 Houses Are Better Than 1

One of the first things I noticed when looking to get a loan was just how much interest you ended up paying over the life of the whole loan. To purchase a $400,000 property on a 30 year loan would end up costing you around $1,000,000 (assuming interest rate of 7.00%). So you are effectively paying two and a half times the value of the property.

This didn't seem too appealing so I looked at the best way to reduce the amount paid in interest. The most efficient way I could determine was to reduce the loan period, which means increasing your repayments. To purchase a $400,000 property on a 15 year loan, it would only cost you approximately $650,000. Saving you $350,000! This is almost enough to buy the same property again. I then wanted to figure out other ways to be able to escape this need to pay such a high amount in interest repayments.

Unfortunately, to pay off a property quicker, you need to increase the repayment amount. In the example above, the 30 year repayment was $2,660 and the 15 year repayment was $3,600. So where would you come up with the extra $1,000? Then I remembered sitting with my group of friends and talking about investing in property.

I have talked in another post about the benefits of purchasing a property with someone else, where simply the increase in repayments by using the combined incomes, significantly reduces the loan term and effectively reduces the interest paid. But now I am contemplating something different. Let's say two people purchase a house together and use their combined incomes to pay off the property ASAP. Then the same two people buy a second house, again paying it down ASAP. So at the end of the day, each person has a house each.

There would be a lot of complications between what is an equivalent house for each to own and there may be some issues between the two if one believed the other got the better end of the deal, but avoiding all the emotional aspects, and looking at the pure financial side of things:

Using the following inputs:
- Each person has a monthly saving of $3,000
- Initial cost of a house is $300,000
- Capital Appreciation of 2% Per Annum
- Interest Rate of 7.00% Per Annum

Situation 1 - Each Individual buys their own property

Using this formula in excel - NPER( ) - the repayment period will be 151 months for each person, so a total individual cost of $453,000.

TOTAL COST - $906,000
TOTAL PERIOD - 14 Years 7 Months

Situation 2 - They buy 2 properties together, one after each other

So the total repayment is now $6,000 per month.

1st House will take 60 months to pay off. A total cost of $360,000

To obtain an equivalent house for the 2nd property, assuming the capital appreciation of 2% per annum, the house price of the second house would now be $331,200.00 (after 5 years)

2nd House will take 67 months to pay off. A total cost of $402,000

TOTAL COST - $762,000
TOTAL PERIOD - 10 Years 7 Months

So as you can see in Situation 2, the total cost is $144,000 cheaper than Situation 1. And also the total period of being in a loan is 4 years less, with both people at the end of the day essentially obtaining the same thing.

Keep in mind, this is a very simplified example, and there is a lot I have not taken into account. Firstly, if you do buy a property together, you will only be able to use one FHBG and stamp duty exemption or whatever else your government offers you. Also there is the option of, for instance, say you both purchased a 2 bedroom property, then in Situation 1, each person would have a spare room which they could perhaps rent out for extra repayments, whereas this does not occur in Situation 2, until the second house is bought. It is also important to note the preferred option is typically dependent on the capital appreciation of the property, using a low rate (as I used 2.00%) will generally have Situation 2 preferred, but a higher rate (over 5.00%) will generally have Situation 1 as the better alternative financially.

I have developed a spreadsheet which takes all the above into account and allows for a fairly accurate comparison between the two different methods.

If you would like a free copy of this spreadsheet, please click this link Spreadsheets

The Internet vs The Spruiker

Photo courtesy of Alex E. Proimos

The internet is a great place. It contains a wealth of information and all you need to do is put in a little bit of effort to find what you need or want. The number of people spruiking highly-priced educational courses never ceases to amaze me. These people claim to be rich from whatever field they are in but are out there trying to get you to buy their course which promises to make you rich. It shouldn’t cost thousands of dollars to learn about an investment idea that is freely available on the internet.

Now don’t get me wrong, a number of them are genuinely good at what they do and are simply passing on what they have learnt, with a significant fee attached to have that privilege. However, the majority of these so called ‘gurus’ are nothing more than con men and women, trying to profit from everyday people.

I believe that the key to becoming financially free or at least financially comfortable is to ‘give it a go’. This may sound quite simple but you won’t gain anything from not doing anything. You need to take a few risks, get involved in a number of different sectors and the most important thing, learn from your mistakes. I believe mistakes are much more valuable than successes. Now this may sound a bit hypocritical based on what I have written above but there is a difference to getting involved in new things and wasting thousands of dollars on rubbish ‘get-rich-quick’ schemes.

But I digress. As I was saying, the internet contains copious amounts of information and a lot of it is free. So whether you’re just starting out in the investment game or have been investing for years, there is always new and better ways to do things. The best thing you can do to reach your goal is to keep learning. Use the free information that the internet offers. Have a crack at different investment options that come your way (of course only after weighing up all the pros and cons) and learn from them.

The most important thing, however, is to be positive. Not many people become rich by being negative and pessimistic. You will all have come across the friend, colleague or family member who instantly rejects the new idea or investment that you have just told them about. It is this attitude that stops them from trying anything different. It’s this ‘sheep’ mentality that will keep them employed but always chasing their tale. Whether it is trying to keep their job or trying to keep the bank happy.

If you don’t want to be like most other people, work 9-5 and only start enjoying your life when you’re way over the hill, then you need to do something different.

The fact that you’re reading this blog already shows you’re on the right path.

Check out these posts on investing:

Creating Investing

Importance of Keeping a Budget

Advantages of Using Finance

Nobody ever likes going into debt, but when you are buying a house, it is almost an inevitable outcome. But just because you are going into debt, does not necessarily mean it is a bad thing. Now of course with the average house price in Australia being around $300,000 (just an estimation), it would take someone too long to be able to save that much money up to buy a property outright. Even if you were able to save, not just earn but save, $1,000 a week, it would still take you 300 weeks, almost 6 years of saving up. Now that would take some serious dedication.

The solution to this dilemma is to go into debt, so that means you only have to save up for a portion of the time, and able to live in your dream home right away. So by saving up a 10% deposit ($30,000) you can use the bank's money to purchase your house.

But apart from buying your house to live in, purchasing an investment property it is also a great benefit to be able to use finance. Look at the following two examples, where Example A will not use finance, and Example B will use finance.

Example A - $100,000 saved up for a property, 8% Net Yield, 3% Capital Appreciation - Property Bought Outright

After 5 Years -

Property Value = $100,000 x 1.03^5 = $116,000
Rent Return = $100,000 x 0.08 x 5 = $40,000
TOTAL VALUE = $116,000 + $40,000 = $156,000

Example B - $100,000 saved up, 20% deposit for $500,000 property, 6% Net Yield (Yields tend to become lower percentages with higher value property). 3% Capital Appreciation. 7% Loan Interest Rate

Property Value = $500,000 x 1.03^5 = $580,000
Rent Return = $500,000 x 0.06 x 5 = $150,000
Existing Loan = $400,000
Interest Repayments = $400,000 x 0.07 x 5 = $140,000
TOTAL VALUE = $580,000 + $150,000 - $400,000 - $140,000 = $190,000

Example A - Value = $156,000

Example B - Value = $190,000

So as you can see from the above simple examples, using finance has increased the value of the investment in Example B by almost 22% compared to Example A. Doing similar calculations for over 10 years, you will an increase in value of 36% towards using finance.

Please note I have been very simplistic in these calculations, I assumed an interest only loan, and assumed the rent received for each property did not change over the 5 years. Also note the above examples are simply examples and are not based on any properties in particular.

One important issue you need to be careful with, is if your property does reduce in value over time, using finance will magnify the lost return, and you always run into the risk of having negative equity in a property. That means that the loan value is more than the property value. Which is always something to avoid because you never know when your circumstances might change and you might be forced to sell up a property.

Provided you are prudent with your initial property search, and you perform your own due dilligence and ensure you purchase a property in a good solid area that is not over valued, then you can see that going into debt is not always a bad thing, and by using leverage you will be able to receive a much greater return.

If you have any questions or comments feel free to email us at streamlineinvesting@gmail.com

Disclosure: The article is not to be taken as investment advice and the views expressed are opinions only.  Readers should seek advice from someone who claims to be qualified before considering allocating capital in any investment.

Should you pay off your Mortgage or Invest?

A lot of people talk up the benefit of having a mortgage in investment property, so you can deduct all of the interest from your income and effectively save yourself when you pay your money to the tax collector. But the way I saw it was that instead of paying money to the tax man, you were just paying the money to the bank in the form of more interest repayments? So my initial thought is to just pay down your mortgage as quickly as possible.

Now you should note that I am only talking about for investment properties, where the interest paid is tax deductible. A PPOR should have the mortgage paid down as quickly as possible to avoid paying a lot in interest over the years.

After looking into it further, I thought I should actually calculate if I was better off paying down the mortgage for an investment property, or instead of paying down the mortgage, investing the saved money elsewhere. Looking at it fairly simply, I first did some hand calculations pretty much as follows.

There is an existing loan of $300,000 at the start, with 7% interest rate, the interest only repayments become $1,750 per month. Saying now you have an extra $2,000 per month in savings, choosing to either pay down the mortgage amount, or invest it elsewhere. Other assumptions include a $120,000 gross salary (after superannuation) and an investment return of 15% gross for the other investment option. Also assuming this is an investment property returning $1,500 per month in rent.

CALCULATIONS

Paying Down Mortgage - After 1 Year

Monthly repayments of $3,750 on a $300,000 loan at 7.00% interest rate

Principal after 12 months = $256,625.00 (using spreadsheet calculations)

Total Rent Earned = $1,500 x 12 = $18,000.00

Interest Paid on Loan = $19,625.00 (using spreadsheet calculations)

Taxable Income = $120,000 + $18,000 - $19,625.00 = $118,375.00

Tax Paid = $31,745.00 (using Australian 2012/13 Tax Tables)

Net Income = $120,000 + $18,000 - $19,625 - $31,745 = $86,630

Plus bonus of reduced Principal = $300,000 - $256,625 = $43,375

TOTAL VALUE = $86,630 + $43,375 = $130,005

Investing Elsewhere after 1 Year

Principal after 12 months = $300,000 (no principal paid down)

Interest Paid = $1,750 x 12 = $21,000.00

Interest Earned on Savings = $3,574.00 (using spreadsheet calculations)

Rent Earned = $1,500 x 12 = $18,000

Taxable Income = $120,000 - $21,000 + $3,574 + $18,000 = $120,574

Tax Paid = $32,560.00 (using Australian 2012/13 Tax Tables)

Net Income = $120,000 + $18,000 - $21,000 - $32,560 = $84,440

Plus amount in investments = $45,010 (using spreadsheet calculations)

TOTAL VALUE = $84,440 + $45,010 = $129,450

As you can see from the bolded values above, there is a benefit to paying down a mortgage in this instance, this is also assuming a 15% return from a different investment, which is of course a very impressive return.

I developed a spreadsheet to be able to calculate a number of different scenarios and by using different variables. The spreadsheet also acts over a 10 year period so you can see a longer term approach. It should be noted that inputing the above variables into the spreadsheet, after 10 years, paying down the mortgage is still a better option. Typically, the higher the interest rate, the better it is to pay down the mortgage, however this is a general statement and it depends on a number of investments.

But looking at the spreadsheet, it shows that paying down a mortgage can actually be a very good place to invest your extra money. This means that while you are looking for a suitable investment, it is a good idea to just park the money into an offset account attached to the loan and pay down the mortgage and reduce the interest paid, until you find a suitable investment which can provide you the required return.

Also please note I have only talked about the purely finance benefits of investing or paying down a mortgage, there is always emotional conditions to consider. For example I myself just prefer to be debt free and to be honest always loathe it when I owe someone money, and owing the bank is no different. So this is just another reason why I typically choose to pay down the mortgage as fast as possible.

If you would like a free copy of this spreadsheet, please click this link Spreadsheets 

Investing in Mining Properties

Recently someone asked me about investing in mining properties. Mining properties are very interesting and provide a very unique investing option for any avid investor. The main reason for mining properties being so unique is that the rental yields are extremely high. Look below for a typical example that you can find in a mining town.

Mining Property in Moranbah, QLD

Moranbah is a town in QLD, where a friend of mine actually went to go work, when he showed me the properties in the town, that is when I initially found it interesting to see if mining towns actually provided a good investment for myself. Firstly here are some details on the town of Moranbah:

• Population of just over 7,000 people
• 200km West of Mackay
• 1000km North West of Brisbane

Basically, it is a small country town, not near anything of any note. And yet there is a 3 bedroom fibro home that is selling for $700,000? This is higher than most suburbs in Sydney, and a similar town that did not have a mine would see the property only sell for around $200,000 if you are lucky. 

But look at the rent the mining company is paying for this property, $2,000 per week! Just for comparison sakes, you can get a 5 bedroom house in Vaucluse overlooking Sydney Harbour - LINK

So here you get a gross rental yield of almost 15%, higher than probably anywhere in Australia, and comparable with the returns you can see in the US at the moment. So what is the deal? Well the big draw back with a mining property is the capital gains, or should I say, the lack thereof. There is no capital gains to be associated with this type of property, as soon as the mine has finished up, the town will go back to what it was before, with the property value reducing back down to approximately $200,000. Assuming the mine operates for another 10 more years, well that would be an 11% drop in capital appreciation every year for 10 years. 

This is where the big issue is, as soon as the mine is done, your house is done too. Whereas purchasing a traditional property, at least you would hope to see steady capital gains in your property in the long term. This is the advantage with a typical property, the oppurtunity of capital gains, whereas a mining property has next to zero potential for capital gains.

It should also be noted that I do not believe if you purchase a property in the mines, you can rent it out for a year or two, and then sell it for what you paid for it initially. It is typically public knowledge how long the mine will be around for, so as you get closer to this mine closure date, the value of the property will slowly decrease until the mine eventually closes. Of course you may get lucky and be able to sell the property to someone who has not completed their due dilligence and does not realise how long the mine will be there for, and be able to convince them based on the high rental yields. 

So when looking at these properties, you need to think to yourself, are you satisifed with the high cash flow despite the negative capital gains on the property? I guess I was curious to see if it was worth it, so naturally I developed a spreadsheet to test out and compare the two scenarios.

By inputing a couple different variables, I was able to compare investing in a mining property based on investing in a mining property. The results from my calculations were as I expected, although the mining property was better in the short term (first couple of years), the traditional property became a much more profitable option. So for me anyway, it seems that investing in traditional property is more lucrative for making money, simply due to the potential for capital gains. 

If you would like a free copy of this spreadsheet, please click this link Spreadsheets 


If you have any other questions or comments, feel free to email us at StreamlineInvesting@gmail.com


Disclosure: The article is not to be taken as investment advice and the views expressed are opinions only.  Readers should seek advice from someone who claims to be qualified before considering allocating capital in any investment.