Optimal Leverage

Discussion in 'Real Estate' started by Norak Bastiat, 30th Sep, 2007.

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  1. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    Yes, you're right - I didn't see that. But at the same time, I wouldn't buy a property on a 3.5% yield.

    Yes, I agree which is why I'll no longer address him.
     
  2. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    Okay, so after I cooled down, I thought I'd use an actual calculator that we have for proposed property purchases. I put crc_error's figures in and gave the investor an average wage (50K p.a.). The property is rented for 50 weeks a year at $300 a week (5% yield).

    With all expenses including interest minus rent plus depreciation, the property costs the investor about $115 a week or about $5,980 a year.

    So let's take the net figures:

    House will make $30600 PA 10.2% NET ex interest
    Fund will make $16200 PA 13.5% NET ex interest

    Then when you apply the figures from the calculator (which is accurate by necessity, since it is used to provide figures to clients - and no, I will not give it to anyone, so don't ask) you get:

    House will make $24,620 NET
    Fund will make $9,720 NET

    Obviously the property figures will fluctuate, depending on depreciation and how many weeks rent you get and the managed fund figure would also be higher, because of tax deductions, but you get the idea. Wish I'd done it this way the first time.

    Mark
     
  3. shake-the-disease

    shake-the-disease Well-Known Member

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    Tax benefits for a property on a 3.5% yield are significant. That shouldn't be ignored in this comparison.
     
  4. coopranos

    coopranos Well-Known Member

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    I also wouldnt touch that yield unless it was a development site. Nor would I completely exclude non-cash deductions from my calculations. Nor would I skew interest rates by a total of about 1% to make my calculations look nicer. Nor would I pull expenses from my hiney. Nor would I ignore issues such as control and value-add potential.
    The fact is both vehicles are valuable, and using either is a million times better than using neither. I do not ignore the higher % gains of equities, the increasing ease of getting higher leverage, and the better income potential in shares/managed funds.
    In reality, the argument is really about as valid as arguing whether your hand is better than your foot - both are there to use for your own benefit. Probably the best use of time is not to argue which is better, but how best to utilise each under different circumstances.
     
  5. Mark Laszczuk

    Mark Laszczuk Well-Known Member

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    An excellent point. I couldn't agree more. I personally use both property and shares and the majority of our clients do as well. The ones that don't are in the process of using one to get into the other. Why can't I have my cake and eat it, too.

    Mark
     
  6. DaveA__

    DaveA__ Well-Known Member

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    This is a luxury that only one of you have.

    Mark has used his full name, consistantly reminds people of this work place and can not be ananymous at all. People will look at Marks post as a reflection upon himself and use this to make a choice if he can add value. For the 5k fee i sure hope he can.

    Isnt it funny that planners are usually into funds/shares while for his exception he seems to get drilled.

    Additionally, no one here has thought about diversification, nor risk factors. Additionally no one has mentioned all styles of products.

    The PPT 100% finance could blow Marks figures out of the water, however risk comes into it....
     
  7. crc_error

    crc_error The Rule of 72

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    Please read my model AGAIN CAREFULLY.

    A property in Melbourne Suburb of South Yarra: Growth 8.2% + 3.5% yield - 1.5% costs = 10.2% ROI
    http://www.domain.com.au/public/subu...arch#mapanchor


    I have counted RENT or YIELD as i called it.. No property is going to pay 5% in rent. Average is 3.5 to 4% If there is higher rent, then thats probably cause its a unit, and used to offset body corp. I have also deducted 1.5% in costs like insurance etc.
     
  8. coopranos

    coopranos Well-Known Member

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    Dont even bother, Mark!
     
  9. crc_error

    crc_error The Rule of 72

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    Mark, I think we are getting a little excited. I didn't use body corp in my example. That pdf I attached was not related to my model. Just illustrating how high some rates and body corp can actually be.

    I used a generic 1.5% PA COSTS which someone else mentioned earlier as bee n reasonable. That means $4500 PA.. yes $1300 of that could be rates, but there would be $3000 worth of other expenses, like tenant placement fee's (normally 1.5 weeks rent $350) agent management fee (usually 7% of rent collected $840) house insurance ($500), tenants insurance ($300), advertising ($300). The remaining $900 is for repairs, and/or body corp, cleaning and minor maintaince, lock replacement, tribunal fee's, 2 weeks a year vacency etc.

    If you ad in $1280 body corp, that would be ontop of the $4500.

    So please, re-read my model carefully again.
     
  10. crc_error

    crc_error The Rule of 72

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    I think your a bit optimistic assuming rent of 5% You certainly wont get that here in Melbourne.. and going by my PDF attachment for the gold coast property, they don't even assume such high rent and they also are a property investor association

    Since your not showing how you came to this figure, we can't break it down. I clearly showed my calculations step by step, so if there is something wrong when a step please point it out.
     
  11. crc_error

    crc_error The Rule of 72

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    Shares pay franking credits, so we can get a little to technical..

    So yes, those on higher tax brackets will benefit more from negatively geared property.

    I assume these tax deductions to offset maintaince of the property.. Every 7 years you will need to update the kitchen, bathroom, re-paint, new carpet, update blinds and fittings, hot water units, heaters etc... more costs which people don't notice up-front. Obviously not all need replacing at 7 years, but you get my drift of costs which come up at a later stage.

    The reason you get deprecation is to offset a item which is losing value..
     
  12. crc_error

    crc_error The Rule of 72

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    If your going to make accusations, please back them up with facts.

    Rent is good

    Property researcher Residex shows that Perth has Australia's lowest rental yield of 2.95% followed by Sydney (3.6%), Melbourne (3.8%), Brisbane (4.1%), Adelaide (4.3%), ACT (4.5%) and Hobart (4.5%).

    Sounds like you are making up the numbers.. My rent estimate of 3.5% to 4% still stands. I don't see anyone getting 5% PA
     
  13. shake-the-disease

    shake-the-disease Well-Known Member

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    South Yarra had a p.a. growth rate of 11.3% from '96 to '06 (source: Valuer General Victoria)

    South Yarra median house price rose 32.5% from June 06 to June 07 (Source: REIV)
     
  14. crc_error

    crc_error The Rule of 72

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  15. D&K

    D&K Well-Known Member

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    CRC, you have some good points regarding the costs of body corporate fees, etc, and renters have probably become better off cash-flow wise renting than buying as prices increase fast than rents, despite their complaints of rent rises. But you are not comparing apples with apples.

    If you own shares (or through a fund) you will get a dividend an franking credits that include the benefits of depreciation on facilites, plant and equipment. You need to consider depreciation on property too, and don't underestimate this. It is quite acheiveable to find a new or near new property that is negative geared, but after all costs and tax deductions will be positive cash flow even if rent is only at 3.5%. The cash flow isn't huge for the first few years but it keeps you covered until the rents pick up after 4 - 5 years. That's why I also have managed funds.

    As a second point, you are assuming that investors are seeking average returns. Would you refuse to buy into a managed fund because their return was higher than average! So why would property investors seek average performing properties?

    I don't normally disclose my own figures but, based on properties sold:

    1. Inner West Melbourne, older house, average 16% CG over 10 years, rent exceeded costs for last 5 years.

    2. Canberra, 50% in 20 months or 30%pa CG after costs including rental shortfall (... if only I'd bought more :rolleyes:) In fact these were secured against our house but if we'd put in 20%+ fees we'd still be looking at 250% on investment less CGT.

    Factor in depreciation and selecting an above average property and you might find out what Mark is on about.

    Cheers, D&K
     
  16. D&K

    D&K Well-Known Member

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    Hi Norak,

    Back to your original question. Yes, but only in part.

    The LOE also involves use of a managed fund to improve cash flow. You can keep increasing your capital and using it to buy more property, but there will come a point where banks (and other lenders) will look at you and say that you don't have the cash flow to support your properties, so "no" you can't borrow any more. Remember that they factor in increases in interest rates of 2% and occupancy rates of only 90% and most won't consider the tax deductions (reducing taxable income through deductions doesn't actually work for you in getting a loan). This is the problem with the process you have summarised, LOE is broader than that. To start you need more income that you can demonstrate to lenders (in my experience anyway).

    So the process is, very briefly, more like:
    a. invest in a managed fund until you have enough to buy an IP and continue with +ve cash flow (or -ve if you can manage it),
    b. take intermediate gains from the IP and invest in an income producing managed fund ... and margin up if you're happy with the risk,
    c. take future gains from the IP and/or managed fund to get another IP,
    d. take gains from the two IPs to invest in the fund for more cashflow,
    e. keep doing that for a while, balancing IPs and cash flow from the fund ...
    f. stop buying IPs but use the capital gains from a number of IPs to invest in an income producing fund,
    g. live off the income from the fund that was funded from the captial growth from the IPs (which you can continue to convert from IP equity to income fund investment and more income).

    There are risks in property going down in value, choose wisely. There are risks of shares going down also or companies failing (it's hard to buy the "index"), funds reduce this risk but again choose wisely.

    The thing you need to manage is amount of risk and leverage you are prepared to live with for both property and funds / the stock market, and balancing capital growth and income. One challenge is then to switch from a CG (wealth building) mode to an income mode without getting hit by excessive tax.

    LOE is about taking the best of both worlds, not just one. I hope this helps address your question. This thread seems to have got a bit off track along the way. ;)

    Dave
     
  17. crc_error

    crc_error The Rule of 72

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    Hi D&K,

    What you did is what property IS about. Don't get me wrong, I'm not AGAINST property investment, and don't say its bad to use it as a wealth creation vehicle. Sounds like you did make some good investment choices. I also made a good investment with a property investment in East Bentleigh..

    Yes depreciation does help to cover the early years of negtive gearing. But this is limited to your income. You can only buy so many properties, and have them negatively geared. So I would say the average person can have a few properties up their sleeve, but beyond that going down the managed funds route may be a better option.

    You mention about picking above average properties, well I stuck to averages so as the comparison is fair. I could also argue that picking winning stocks or above average managed funds. I have a ungeared fund in my portfolio which has averaged over the last 7 years 20%PA, with gearing, your return will be hugh.. Have a look at the 10 year average of the wholesale CFS australian geared share fund.. what about the CFS small companies fund.. its produced some amazing results..

    All I'm trying to highlight is another angle in property investing, and help people consider ALL the varations before making a decision on how to invest.. Not blanket accpting 'property makes 10% and I only put down 10% so I double my money each year'. when it doesn't.

    I'm not sure why Mark got so excited about this discussion.. it would seem he was taking this like I was attacking him personally, when all this was, was a healthy discussion. I would have been more impressed if Mark came back with a strong arguement with facts backed up with statistics, and not plucking figures like 5% yield out of the air, when clearly, the average property wont achieve this.

    Tom