Determine Your Strategy

Transcription

1 STEP 1D 1 Determine Your Strategy Your Property Strategy 4. Maximise multiple streams of passive income 1. Buy in high capital growth suburbs Your Property Strategy 3. Add value to the property 2. Buy property at fair market price or below There are 3 primary renovation strategies: 1 Renovate & Reside 2 Renovate & Sell 3 Renovate & Rent STEP 1D DETERMINE YOUR STRATEGY 1 OF 19

2 Renovate & Reside The Renovate & Reside strategy is for people who buy an unrenovated property and renovate it, whilst living in the property as their primary place of residence (PPOR). Under Australian law, you re only allowed to have 1 PPOR per person, per defacto or married couple at any time. You can sell your PPOR once renovated and do the same thing again however you re limited to how many times you can do that. In my experience, you can do 1 or 2 PPOR projects every 3 to 5 years without too much backlash from the Australian Taxation Office (ATO). Please speak to your property accountant further about whether this will suit your circumstances. Any renovation profits made under the buy, renovate and reside strategy are totally tax free in Australia. Renovate & Sell The Renovate & Sell strategy is for those people who buy an investment property with the sole intention of renovating and selling for a profit, immediately on completion. This is property flipping in the truest sense. People who are tight on cash flow tend to opt for this strategy however it s important to recognise that a lot of your profit is lost (that you never get back) when you make the decision to sell. Profit is eroded by having to pay any bank fees associated with paying out your mortgage early, property styling, marketing costs, agents commission and capital gains tax. People who thought they would buy, renovate and sell normally change their minds once they see this and elect to do the buy, renovate and rent strategy instead. Renovate & Rent The Renovate & Rent strategy is for those people who buy an investment property, renovate it and rent the property out on completion. A rental tenant is put into the property who pays the bulk of your mortgage costs moving forward. People in this category typically re-finance at a future point in time, tapping into any available equity to fund further property purchases that help you build a property portfolio for STEP 1D DETERMINE YOUR STRATEGY 2 OF 19

3 longer term wealth accumulation. If cash flow is tight, it s likely you won t be able to do another project immediately. You may need to wait months, a year or possibly more until you get more capital growth on your property. Once you have more equity in the property, you can re-finance and use that equity as the deposit for your next project. Renovating to rent is a highly lucrative strategy due to a triple dipping profit effect. You not only (1) manufacture equity by doing the cosmetic renovation, you get (2) a higher rent due to the cosmetic renovation and (3) you hold the property for long term capital growth. Very few property investment strategies give you multiple chunks of profit. Understand The Property Cycle It s important to understand that the property market runs in property cycles therefore your renovation strategy can change depending on what the property market is doing see Property Investment Cycle Chart on page 10. See Step 1D - Property Market Cycle for more detailed information. When the property market is booming, the Renovate & Sell strategy is harder to achieve, You ll find it more difficult to buy an unrenovated property at the price you need to, due to intense buyer competition. Conversely, when the market is flat, having less buyers in the market means you can buy at the price you need to, making the Renovate & Sell strategy, then easier to achieve. The Renovate & Rent strategy is considered by many as the strongest performing renovation strategy of all and universally works well, at any time of the property cycle. It allows you to build a property portfolio, leveraging long term capital growth, in combination with any equity you ve created doing a cosmetic renovation. Property investing is not risk free. If so, everyone would be doing it, however you can minimise the risks through calculated decisions. Property values can shift, negatively or positively, due to the unpredictability of property markets, their cycles and economic influences within Australia and globally. It is ideal to hold all of your investment properties for the long term (10-year minimum) and whilst there is a real possibility that your property may drop in value in soft markets, you should re-cover that loss and more, when the property cycle moves and the market booms again. Your property value will be up and down (a bit like a rollercoaster) depending on where you are in the property cycle. As long as that rollercoaster is trending in an upwards direction over time, that s ok. You need to be comfortable with this as it s a fundamental part of being a property investor. STEP 1D DETERMINE YOUR STRATEGY 3 OF 19

4 Lock Down Your Strategy To lock down your property investing strategy and determine where and what type of renovation(s) you ll do, you ll need to look at 5 key parameters: PARAMETER A Property Market Cycle What stage the property market cycle is in PARAMETER B Your Current Position How much money you currently have PARAMETER C Your Renovation Type Cosmetic or Structural Renovation PARAMETER D Your Renovation Strategy To Reside, Sell or Rent PARAMETER E Your Renovation Location Inner City, Metro, Outer Metro or Regional Areas PARAMETER F Your Long Term Financial Projections Forecasting if renovations will achieve your financial goals Parameter A Property Market Cycle Please refer to detailed course notes, titled Property Market Cycle, for further explanation. STEP 1D DETERMINE YOUR STRATEGY 4 OF 19

5 Parameter B Your Current Position By now, you should know what your net worth is, sometimes referred to as equity. If any of this equity involves 1 or more properties with a mortgage, the banks won t allow you to use all of your available equity to buy more property. They ll never lend you the full amount, in case house prices drop. They don t want security over a property that is worth less than what the customer actually owes. What the banks will lend you against is called Available. Banks typically lend 80% of a property s value minus the debts you owe on any properties you re holding collectively. When you buy a property, you ll contribute 20% deposit as a general rule of thumb. It s possible to borrow more than 80% (up to 100% of the property value) by taking out an insurance policy called Lenders Mortgage Insurance (LMI) at the time of your bank finance application. LMI is calculated as a percentage of your loan amount and the fee will vary depending on what deposit you put in against your loan amount. This is called Loan To Value Ratio (LVR) which is basically the % of deposit you put in, relative to your loan amount. The less deposit you put in, the higher the LVR which increases your LMI Fee. LMI is a positive for renovators who are starting out with limited equity. It allows you to purchase a property with a significantly smaller deposit. Lenders mortgage insurance fees are a hefty cost (around 4% of your loan amount) which can be amortised into the life of your loan. LMI gives you the ability to accumulate more properties in a faster period of time. Some banks won t allow you to build the cost of LMI into your loan and may make you pay this upfront. STEP 1D DETERMINE YOUR STRATEGY 5 OF 19

6 Below is Net and Available as a hypothetical example. Example Net $400,000 Property Value less $200,000 Mortgage Owing = $200,000 Net Available $400,000 Property Value less $80,000 (20% Bank Security) less $200,000 Mortgage Owing = $120,000 Available On the above hypothetical, your net equity is $200,000 ($400,000 - $200,000) and your available equity is $120,000 ($320,000 - $200,000). The banks will lend you against available equity only, in this case $120,000 not the $200,000. As a simple, general rule of thumb, if you multiply your available equity x 4, it s typically representative of what the banks will lend you as your maximum purchase price for another investment property. For example: if you have $120,000 in available equity, the bank will typically lend you around $480,000 to buy another property, provided you can satisfy all their other lending criteria (like your ability to pay back the loan, etc). Please note also, that banks change their rules all the time, so this general rule of thumb could change at anytime, depending on the economy and finance regulators such as APRA (Australian Prudential Regulation Authority). AVAILABLE EQUITY X4 TYPICAL BANK LENDING CAPACITY STEP 1D DETERMINE YOUR STRATEGY 6 OF 19

7 Before you can work out your strategy, you need to work out what your available equity is right now, in order for you to leverage that equity to fund your first or next property deal. And obviously, if any of your equity is non-property related like cash or shares, you don t need to take that 20% buffer away from those assets. Available Calculator Calculate all of your assests and liabilities BUT minus a 20% bank buffer for any property assets. Exclude tangible items like furniture and jewellery. This should give you an available equity amount. 1 Assests (Address) 2 Current Property Value 3 20% Bank Security (2) X 20% Available Property (2) - (3) Liabilities Debt Total Other Significant Assets (Excluding cars, jewellry & household contents) Cash in Bank Shares Other: Other: Total Assets (A) Total Liabilities (B) Total Assets (A) Total Liabilities (B) Available (A) - (B) (Total Assets minus Total Liabilities) NOTE: If you have a credit card but have no debt owing on the card, many finance lenders will count your available card limit as a liability into your available equity equation. Available Calculator Download in the Resources Section of Step 1A STEP 1D DETERMINE YOUR STRATEGY 7 OF 19

8 Parameter C Determining Your Reno Type Your available equity will by default, determine whether you re a cosmetic or a structural renovator. Please use the guide below to determine what type of project you should be doing, based on your available equity. <$500K >$500K Cosmetic Renovations Structural Renovations Or Multiple Cosmetic Renovations If you have $500,000 or less, you financially cannot afford to do structural renovations. Why? Structural renovations are more suited to inner city locations or suburbs with higher property values thereby requiring a higher deposit with higher project and construction costs, tied up for longer periods of time. If you have less than $500,000 available equity, you re a cosmetic renovator. It s that simple. STEP 1D DETERMINE YOUR STRATEGY 8 OF 19

9 As your equity builds over time, you may then make the decision to transition from cosmetics to structurals, however many of my students always stay in the cosmetic space due to their ability to get in and out of these projects quickly, with less risk. This is a smart move, particularly if you adopt a cookie cutter template mentality to your projects where you re replicating the same look and feel, project after project, for time, cost and process efficiencies. With a structural renovation, you re re-inventing the wheel on every project as no two structural renovations are ever the same. There is also a lot of merit in having multiple cosmetic reno projects on the go rather than 1 long structural reno project. Remember you need the capacity to: (1) buy the property (2) cash flow the renovation without putting yourself into financial stress. Parameter D Determining Your Reno Strategy As the market nears the end of the boom and is even entering the slow down period, this may be the time where you consider selling a property (to release equity and free up cash flow) or you can elect to keep the property through the slump, slow down period however you need to be prepared that your property values may decrease during this period. When the property cycle transitions back around to the recovery period, your properties should rise again and you ll get your next spurt of capital growth. It s important to know that the strategy you employ will be dependent on where your suburbs are sitting in the property cycle process. STEP 1D DETERMINE YOUR STRATEGY 9 OF 19

10 When the market is going through a recovery or boom phase, your ability to buy, renovate and sell will be more difficult. You may find it difficult to buy an unrenovated property at the price you need to, due to intense hysteria and buyer competition in the market place. When the market is going through the recovery and boom phase, an easier strategy (in most suburbs) is to do the Renovate & Rent strategy. This is also particularly favourable for gaining capital growth whilst undergoing these 2 phases. Property Investment Cycle Seller s Market High Confidence More Buyers Than Sellers Intense Media Interest Low Rental Yields Affordability Crisis Housing Oversupply Shortage Of Tradespeople Property Prices Increase Rapidly Prices Rising Housing Levels Tightening Boom Recovery Hold or Sell Sell Property Investment Cycle Buy Slow Down Slump Rising Interest Rates Construction Prices Dropping Unemployment Is High Tradespeople Readily Available Property Prices Fall Low Rental Vacancies High Rental Vacancies Rentals Increase More Sellers Than Buyers No Confidence Buyer s Market STEP 1D DETERMINE YOUR STRATEGY 10 OF 19

11 Let s assume you re going to be a cosmetic renovator. You now need to determine whether you re going to live in, rent or sell your project. Remember you have 3 options here: 1 Buy. Renovate & Reside (Owner Occupier) 2 Renovate & Sell (Property Flipper) 3 Renovate & Rent (Asset Accumulator) The advantages and disadvantages of each strategy are listed below: Strategy Advantages Option 1 Renovate To RESIDE Option 2 Renovate To SELL Option 3 Renovate To RENT No capital gains tax applicable. No time pressures to complete. No costs to rent elsewhere. Lower project costs (no selling fees, styling or agents commission, etc.). Immediate cash flow when property settles. No worries with the property dropping in value due to market fluctuations. Greatly reduced risk of being too highly leveraged. Build wealth through long term capital growth. Tenant pays bulk (if not all) of ongoing mortgage costs through rent payments. Negative gearing tax benefits for any out of pocket expenses. Achieve a rental premium above normal market rents. Typically attract a better quality tenant on longer lease terms. STEP 1D DETERMINE YOUR STRATEGY 11 OF 19

12 Option 1 Renovate To RESIDE Strategy Disadvantages Option 2 Renovate To SELL Option 3 Renovate To RENT Live in construction zone mess for some period of time. Can only do 1 or 2 properties in this fashion every 3 to 5 years (typically) therefore limited. High capital gains tax (up to 45 cents for every dollar of profit earnt, if selling property within 12 months of purchase). No long-term capital growth on the property. Can t access 20% of your equity due to the bank keeping a 20% security buffer. High sale costs (agents commission, marketing, property styling, etc). Finance break fees may be payable for early payout of mortgage. Long sales & settlement time (typically 3 months) whilst incurring holding costs. Risk of not getting a buyer at your desired price thereby losing all of the sale and marketing costs. Your available equity will play a part in whether you live in your property, sell or rent it on completion however there is no right or wrong answer. It s what you feel most comfortable with. Saying that, I do personally believe option 1 (owner occupier) or option 3 (asset accumulator) are the best strategies. Option 2 (property flipper) isn t favourable due to the large amount of profit that is lost when you make the decision to sell. Use the chart following to point you in the direction of your strategy, taking your available equity into account. STEP 1D DETERMINE YOUR STRATEGY 12 OF 19

13 Position Chart Less than $500K More than $350K More than $500K COSMETIC RENOVATION STRUCTURAL RENOVATION MULTIPLE COSMETIC RENOVATIONS $70K - $150K Regional & RESIDE $150K + Outer Metro & RESIDE $200K + Metro & RESIDE $350K+ Small Structurals Metro & RESIDE $750K + Large Structurals Inner City & RESIDE $500K + Metro Or Outer Metro & RENT & SELL & SELL & RENT & SELL & SELL & RENT & RENT & RENT & RENT If choosing this option, expect the properties to be severely negative geared (ie. rent does not cover the mortgage) however high capital growth potential exists. STEP 1D DETERMINE YOUR STRATEGY 13 OF 19

14 Parameter E Your Renovation Location Your level of available equity will dictate which suburbs you do your cosmetic renovations in, in conjunction with what your bank will lend you (based on their lending criteria). Cosmetic renovations work best when you re buying an unrenovated property for $550,000 or less. Properties even lower in value, around the $300,000 - $400,000 mark, seem to be the absolute sweet spot for cosmetics. You can however purchase above this price range but only if higher property values exist in your suburb. Cosmetic renovations in most states, typically work best in the outer metropolitan ring, approximately 20km to 75kms from a major CBD area where you have a good chance of buying property within those price ranges. In the metropolitan ring, which is 10kms to 20kms out from a major CBD, cosmetics start to become more difficult to achieve financially. This is because property prices are typically higher in these suburbs making it more difficult to pick up a property for under $550,000. When you buy over $550,000, the figures become more difficult to achieve. Of course, some suburbs are exceptions. For regional areas, cosmetics work well too however you typically want to remain within 15kms of a major regional hub. Please do not buy an unrenovated house in a small country town. For students in smaller states such as South Australia, Tasmania and the Northern Territory, the above rules do not apply. You can target cosmetic renovations anywhere from 3kms out from your main CBD infrastructure. The chart on the following page illustrates where cosmetics work best in most states of Australia. STEP 1D DETERMINE YOUR STRATEGY 14 OF 19

15 Strategic Location Chart Inner City Large Structural Immediate CBD 0-3km No Go Zone 3-10km 10-20km km Metro Small Structural Outer Metro Cosmetic Regional Cosmetic + Structural 200km+ STEP 1D DETERMINE YOUR STRATEGY 15 OF 19

16 This chart will also be helpful to finalise your strategy: Available Creative Deals Cosmetic Renovations Structural Renovations No To Low Range Under $70,000 Co-ownership Joint Venture Property Syndicate Low To Mid Range $70,000 - $150,000 Regional Low To Mid Range $100,000 - $350,000 Metro Outer Metro Regional Mid Range $350,000 - $500,000 Metro Outer Metro Metro Mid To Upper Range $500,000 - $1,000,000 Metro Outer Metro Inner City Metro Upper Range $1,000,000+ Metro Outer Metro Inner City Metro STEP 1D DETERMINE YOUR STRATEGY 16 OF 19

17 Paramater F Your Long Term Financial Projections By now, you should know what your financial goals are but will cosmetic renovations alone, get you to where you need to be financially? Use my Renovate To Rent Strategy Calculator to try and map out what your financial situation will look like in the next 10-year period. It will be too difficult to map out any longer time period past this. This template is an editable calculator that you can change in any way you like. For example, you might only want to do 1 cosmetic reno, every 2 years. Just adjust it to whatever suits you best. Please note that my Renovate To Rent Strategy Calculator is technically just a tentative roadmap to help you try and forecast what your equity position could look like within a 10-year period, with a strategy in place that you actually implement. This chart cannot take into account market fluctuations that may detract from your end goal. Renovating For Profit cannot be held responsible in any way if you re unable to achieve this as it is dependent on your current equity levels, your personal finances and circumstances into the future and to a larger extent, market conditions and price fluctuations. STEP 1D DETERMINE YOUR STRATEGY 17 OF 19

18 Renovate To Rent Strategy Calculator Enter your portfolio start date 01/07/2012 Property Purchase & Renovation Financials Capital Growth By Year Cumulative Portfolio Based on Property Revalue Increase of % post renovation Assumption based on 5% Value & Starting Property Value Bank Lend % Mortgage Required Deposit Required Project Cost % Project Cost $ Total Cost Outlay Total Property Costs Property Revalue $ Net Project Profit Year 1 Value Year 2 Value Year 3 Value Jul 2012 Jul 2013 Jul 2014 Portfolio Value Bank Lend % Lend $ Less Debt Owing Available Property 1 40, ,000 90% 178,200 19, ,947 56, , ,262 16, , , ,016 July ,825 90% 237, ,200 59,243 Property 2 59, ,877 90% 231,189 25, ,933 73, , ,977 21, , ,276 July ,292 90% 557, , ,974 Property 3 147, ,900 80% 172,720 43, ,487 79, , ,977 21, ,977 July ,269 80% 714, , ,506 Property 4 132, ,000 80% 283,200 70, , , , ,226 35, July ,387,159 80% 1,109, , ,418 Property 5 244, ,000 80% 324,000 81, , , , ,945 40, July ,970,462 80% 1,576,369 1,189, ,060 Property 6 387, ,000 80% 356,000 89, , , , ,705 44, July ,633,690 80% 2,106,952 1,545, ,642 Property 7 561,642 80% July ,765,374 80% 2,212,299 1,545, ,990 Property 8 666,990 80% July ,903,643 80% 2,322,914 1,545, ,605 Property 9 777,605 80% July ,048,825 80% 2,439,060 1,545, ,751 Property ,751 80% July ,201,266 80% 2,561,013 1,545,309 1,015,704 1,545,309 2,199,620 2,379, , , , ,269 Renovate To Rent Strategy Calculator Download in the Resources Section of Step 1D STEP 1D DETERMINE YOUR STRATEGY 18 OF 19

19 Tips For Setting Your Strategy For anyone with less than $70,000 in available equity, you re not in a financial position to do a cosmetic renovation project just yet (unless you partner with someone else who can contribute time and funds). In the meantime, look at doing alternate deals such as joint ventures or property syndicates. Once you have enough of your own money, do not do these types of deals with others. As a single property owner, you have absolute control over your property asset. When you own property with others, that control is diminished that can put you somewhat, at risk. Building a property portfolio is essential for wealth accumulation. Long term capital growth is what builds your wealth. Ideally, try to build a portfolio of either break even or postive cash flow properties where you re not forking out a lot, or any of your own money, each month. This is much more achievable when you get increased rental returns as a result of your cosmetic renovation. Understand that building a property portfolio does take time. It s not an overnight event. Most people never reach more than 2 properties in their lifetime so be realistic. Even buying 1 property every couple of years is totally fine. You ll still be streets ahead of most Australians! Lastly, there s a possible chance that through this strategy process, you ll discover that renovating isn t for you or not going to get you to your financial goals fast enough. Better to recognise that now than half way through a reno! STEP 1D DETERMINE YOUR STRATEGY 19 OF 19