44 - Re-letting IP#1

For rentOur Brisbane tenants vacated the property in early September at the conclusion of their lease. No clear motivation for their departure was supplied to us by the property manager, apart from the girlfriend being pregnant. I wonder if the $5/month rent increase we applied when the lease was renewed/reworked was partly to blame but I suspect the tenancy simply ran its course. The local Griffin rental market is currently oversupplied and rents have fallen slightly.

The outgoing tenants willingly tidied up and addressed a handful of issues that required attention (a chipped kitchen tile, dog faeces in the back garden, some cleaning residue on the walls). Having the house empty was also a good opportunity for the builder to rectify a roofing defect and related ceiling damage from a recent water leak.

The property was not producing income during this vacancy period but my (admittedly pessimistic) budgeting plans anticipate a four-week annual vacancy period.

While home inspections were not widely attended before the last tenants vacated, interest picked up gradually from September. The property manager tells me the local rental market is oversupplied with new developments recently coming online and we eventually dropped the weekly rent from $415 initially to $410 and then to $405 as the weeks went by. Every $5 decrease translates into an additional loss for the investment of $260 per annum—less than I would have thought.

The “competition” (i.e. rentals exactly like or very similar to ours) were including a free week of rent and/or other incentives like six months of free gardening services. Our PM also suggested we could upgrade the realestate.com.au advertisement to feature/highlight our property but the rent decrease seemed the obvious way to go as it impacts the tenant’s bottom line.

We had a diverse range of applications through while the property was vacant:

  • An ideal first application came from a mum and dad couple with two older, pre-teen boys and no pets. Dad was working away but mum was not employed and is, presumably, a homemaker. Unfortunately the neighbour’s aggressive dog growling through the fence scared them off (a friend initially inspected the property on their behalf as they were all living North); one of the sons was reported as having a disability and being afraid of dogs.
  • We then received a second application from a mother with an older daughter, who herself has a 2yo and a newborn baby. They have a large breed dog, only 12 months old. It wasn’t clear whether mum was effectively planning to serve as guarantor for her daughter but they could service the rent payments between them. Kids and dogs don’t make for ideal tenants in my mind but that’s exactly the market we’re targeting with this style of property (4x2) in this location (outer-ring suburb). The pair were ready to go immediately on a six or twelve-month lease but, between my prompt reply to the real estate agent and their following up with the applicants, the applicants had accepted another property.
  • On the back of the second application falling through, we received a third application from a very young couple (late teens/early twenties) with no rental history and very little rental affordability (<30%). Although without kids, they too have an active dog. As our only option, we discussed the risks with the property manager who thought the affordability risks were high. Meanwhile, my wife and I were both thinking back to when we were the same age, with very little income, a cat (and eventually a dog); we stayed in our first rental for four years, paid the rent on time every week, kept the property clean, and caused no damage. The PM discussed having a parent join the application as a guarantor but this couple also found an alternative rental before anything further happened.

Between applications and twice-weekly home opens, the property manager was working to see what could be done about the dog next door. The ranger was called and inspected the situation but decided the neighbour’s property is adequately fenced and the dog could not be labelled ‘menacing’. The ranger did speak with the owners and it was agreed a barrier could be placed against the fence to prevent the dog from getting as close to the boundary. Our PM also spoke to the neighbour’s PM about the situation and was told the dog would be brought inside during home opens (and is friendly once it gets to know someone).

We finally received a fourth application for a couple with two kids under five and two dogs—an older large breed dog and a younger small dog. They were requesting a 12-month lease commencing within the coming days. We approved their application and an executed lease document soon came back. At last!

The property was physically vacant for six weeks—and someone likely kicked a hole in the letterbox during that time, just for good measure—but the new tenants are hopefully in and happy as of last Friday.

Given the length of time the property was vacant, I consulted my risk matrix for some hints as to what to do next—should the vacancy period continue. My mitigation and contingency strategies were minimal (‘review property manager’ and ‘review financial controls’) but, following this experience, I added ‘review market supply’, ‘offer incentives’ and ‘promote advertisement’. I also increased the Probability rating from Remote to Occasional. Fortunately, we’re not cash flow investors and have sufficient cash buffers to weather an extended vacancy.

Although I naively expected our first tenants to stay on for another year at least, I likely need to adjust my expectations to assume a tenant will stay somewhere between 6-12 months. A 12-month lease gives us some surety but also locks us in to a rental amount and the tenant, who may or may not be problematic.

In terms of lessons learnt, I created a Landlord’s Vacating Tenants Checklist. This checklist differs from the standard checklist which might be supplied to the outgoing tenant or used by the property manager during the exit inspection in that it lists the things I need to check and do to a) ensure the tenants have done the right thing and b) ensure the property manager has done the right thing. More about the checklist and b) soon.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

43 - Recapping the IP#2 land purchase

TortureWhat a roller coaster ride we’ve had “just” to buy a plot of land over the last six months! We’re nearly there now and I wanted to briefly highlight some of the issues we encountered in securing the block of land and finance. In summary, the land titles have registered and we’re finally approaching settlement.

If you’re interested in the details, I’ve linked to earlier posts below.

Step 1: Difficult finance pre-approval

We kicked off towards the end of 2015 when I asked our mortgage broker to look into finance pre-approval following my return to work several months prior. Although the wife was on maternity leave, I’d nonetheless been tinkering with the idea of a second investment build. The broker deemed our bank-appointed credit assessor to be unreasonably pernickety but finance was provisionally approved on the basis of servicing via my income alone.

I then needed to convince dear wife a second investment build is a good idea and gave Open Corp the okay to proceed once we reached agreement.

Step 2: Property selection do-over

All was looking rosy with the first property selected for us by Open Corp until the vendor mysteriously sat on the signed land contract for some weeks. It turned out we’d been gazumped by a large buyer who apparently bought out all remaining blocks in the release—including those blocks with unexecuted contracts.

By this point, our bank pre-approval was due to expire but Open Corp quickly found us a similar, alternate property in a neighbouring estate. It was slightly larger, with a correspondingly larger price tag. In the interest of time, we nominated Open Corp to purchase the property on our behalf.

Step 3: Short valuation

The Valex-appointed valuation company contracted by the bank to value this second block came back with an ill-considered short valuation. We were told by Open Corp and otherwise of the view the property value was in line with the contract price. Appeals to the valuer (Peter Jones from Lee Property) and the bank to review or reconsider a similar valuation that came in at cost for a similar property in the same estate fell on deaf ears. In brief, the valuer considered an inappropriate set of comparable properties and didn’t do his job. Unfortunately, there would be no getting around this and we’ll need to contribute the shortfall from our equity loan.

Step 4: Finance do-over

Throughout the valuation shenanigans, the contract I was on at work came to an abrupt end and left us as a no income, two kids (NITK—my acronym?) household—not all that appealing to a lender when it comes to their evaluation of a client’s ability to make loan repayments. The wife was still on maternity leave and, although she had a contract to resume work (and was actually on leave—maternity leave), the initial finance application was based on my income alone because our mortgage broker didn’t think her potential income would be considered. With my last pay stub showing the drop off in hours, it was difficult to prove to the bank we could afford this loan. For good measure, my overarching head contract also ran out!

Meanwhile, our deadline for finance approval with the land vendor was due to expire. A one-week extension was approved, provided the deposit was paid in full by the original due date. I wasn’t terribly comfortable paying the deposit until finance was unconditional but both Open Corp and our (independent) mortgage broker confirmed it was fully refundable.

Through a tip from another mortgage broker, I persuaded our broker to approach the bank about taking into account the wife’s signed work contract, commencing on her return to work from maternity leave and well before settlement. I’d been told the bank we were working with had recently softened their stance on maternity leave. Of course we first had to find the wife’s contract, which was buried in her work emails as an attachment she couldn’t access remotely. Her maternity leave had also been paid upfront so she had no recent pay slips.

The final hurdle was the build contract, signed by nomination, which the bank wouldn’t accept. A new contract was couriered out to us and signed in a hurry before being couriered back to be executed anew by the builder.

With the build contract sorted, the maternity leave strategy delivered and finance was finally approved.

Step 5: Deposits

Although the Open Corp land deposit is normally $2,000, our land contract stipulated the typical 5% deposit. As mentioned above, the extension required us to pay the balance before finance was unconditionally approved.

The builder’s deposit (5% of the build price) also came due just after finance approval and the balance of Open Corp’s fee was also payable.

It’s at this point—when significant amounts of money are moving out of the account—that it all starts to get real. Of course land titles haven’t yet registered and settlement hasn’t yet come about. Perhaps more importantly, in terms of getting a paying tenant through the doors, construction hasn’t yet started.

Step 6: Finance re-do over

A final twist to the finance saw our request for an LMI waiver come through shortly after signing the first loan documents, which necessitated the inconvenience having the loan documents signed again. We weren’t sure how this was going to play out before this point so it was a happy surprise, at least.

Step 7: Certified ID

As a final poke in the eye, I heard from Open Corp—two days before our anticipated settlement date—to say the solicitor needed a certified copy of our ID. On very short notice, the wife was fortunately able to find a Justice of the Peace at the hospital who could certify her ID… the head pharmacist, he was paged and materialised from a sterile room in a full biohazard suit to help her out!

Subject to the bank, settlement is scheduled this week.

Update (bonus Step 8!)

Wow, we’ll never cut a break with this one!

We settled on Thursday morning at midday but first had a call from our Eastern states solicitor at 7am to say the bank wanted a $25,000 owner contribution (the day before it was $0). That amount was not only more than I could transfer online given our daily transfer limit but it was also more than the bank’s first-line call centre rep could manage for us.

I asked to speak with the rep’s supervisor and, after going through some additional identification questions and a nuclear launch sequence involving call backs and temporary passcodes, I was able to make the transfer.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

42 - Tenant Churn

suitcaseThe property management firm (Century 21) managing our Brisbane property contacted us recently seeking our instructions regarding the renewal of the current 6-month lease, which runs out in the next few months.

It was noted the current rent is at the high end for the area, with a nearby estate also coming online—increasing rental supply. The agent reminded me the last (and first inspection since this lease began) was acceptable, and mentioned monies owed by the tenant are generally within tolerances.

The agent additionally mentioned a contractor reported two dogs at the property, one being a small puppy. Although I’d not formally rejected the tenant’s pet request, I hadn’t approved it either.

Despite being annoyed about the dogs—mainly the dishonesty of the matter, I proposed another six month lease at the same rate and approved the pet request as there seemed to be no option not to. I asked that our dissatisfaction about the dogs be conveyed to the tenants and requested the tenant raise any other issues now so they might be cleared up. It’s frustrating when the adults you lease a property to behave like three year-olds but if they’re paying the rent, that’s a good thing.

After all of that, the property manager came back with a response from the tenant and they won’t be renewing the lease. We haven’t been given a reason why but the agent was going to enquire.

Open Corp have noted a preference to lease to families due to the stability they offer as tenants (kids in school, general stability, other life pressures which preclude moving house, etc) but we approved the original trio of adult tenants as they had no kids, no pets, and were the first and only application we received. We also pretty much had to approve the application to secure the Open Corp 12-month rental guarantee at the original rent we desired.

Having the lease turn over means the property will need to be advertised and we’ll need to pay a new letting fee to the property manager. Of course there may also be a vacancy period. I’ve budgeted for both the costs of an annual letting fee and four week vacancy period. Although very much not preferable, I’m confident we have an adequate financial buffer to cover any gaps. Nonetheless, I also include long-term vacancy as a risk on my property investment risk register.

Admittedly, from the point we transitioned this property from acquisition and commissioning to tenancy, my expectations around the time a tenant will remain in place were likely too high. My only frame of reference for this was as tenants ourselves: we spent four years in the Adelaide house and a couple of years in a Perth rental. I hoped to get two years out of the original Brisbane lease but will adjust downwards future expectations on the back of this experience. Although I dislike the idea of churning tenants and the wear and tear a house takes in the process, as long as we have tenants in place to contribute rent towards the holding costs, I suppose I can’t care too much… everything else can be repaired! I’d be curious to know the average tenancy duration across different types of rentals in different areas…

It’s easy to trick yourself into believing being a landlord should be a set and forget exercise once the initial setup is complete. The books, magazines, and online resources (such as this blog) tend to focus on matters such as types of investment, types of property, location principles, ownership structures, financing, tax structures, and so on; the day-to-day landlording is typically glossed over by promoting the use of a property manager or improving the property to “manufacture wealth.”

The last twelve months have offered me an enormous experience as a newly-minted landlord but this role still feels very foreign to us and the mandatory, ad hoc decision making requirement when you least have the headspace to spare can honestly be a hassle. I’ll endeavour to write more about this aspect in future posts.

The property will be advertised about six weeks out from the end of the lease; it will be interesting to gauge the market and find out who we get next as tenants. I’ve intentionally remained very anonymous with these tenants but am rethinking our approach the next time around to experiment with a more personal approach (while keeping the PM in their role).

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

41 – Why bother reviewing your bank interest rate

I write constantly here about reviewing your interest rates (and insurance premiums, etc) but that’s because I’m constantly astounded by how willing large organisations are to take us all for a ride with very subtle interest rate movements and other fees.

I recently noticed the interest rate advertised online for our PPOR and line of credit were a little way from the actual interest rates we’ve been paying. I thought the interest rates on these products would keep pace with both RBA rate changes and changes to the original product but of course that’s not always the case with RBA rate and perhaps not so much the case regarding changes to the loan product.

So I contacted the bank and, after chatting with a representative from the retention department, the rate on our PPOR loan was reduced by .20% (they couldn’t move the LOC rate).

It’s worth noting the rate advertised online is for new loans and the rep I spoke with told me they can’t “match” that rate as our loan was established at a certain point in time when interest rates were likely higher (i.e. when the bank “bought” the money they lent to us). I was told we’d have to refinance to achieve the lower rate.

The rep also mentioned the interest rate isn’t adjusted automatically as the product itself changes and it’s best to review the interest rate every twelve months or so and give the bank a call if necessary—good advice.

So what does .20% actually mean to us in dollar terms, I wondered? Is it $10 per annum and hardly worth bothering about or is $1000 (or more) per annum? I don’t like to wonder these things, I like to know with certainty so I put together a spreadsheet to multiply a given daily interest rate (or part thereof) by a specified amount for a specific timeframe (i.e. 30 days, 1 year, 2 years, etc).

Working off a principal amount of $500,000 (let’s call that the national medium house price, roughly speaking), I was surprised at the results.

For example, let’s say I’m comparing two loan products with an interest rate of 4% and 4.5% p.a. respectively. How much does that extra 0.5% cost per year? From my table (below), intersect the 0.5% column and the 365 (days) row and you can see the answer is $2,500. That’s a lot of money to unburden yourself of every year for no benefit. If you’re capitalising that charge it’s also going to compound in the bank’s favour!

The table shows two sets of columns. The first set with the dark headings shows part percentages up to 1%; the right-most columns with the lighter shading show a range of current rates, increasing at 0.5% intervals.

Have a look and compare the rates on your loans and then talk to your bank—or refinance if you have to (talk to a mortgage broker).

Click the image to see a a full-size version of the table.

Interest Rate Table

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I’m not selling anything and I do not receive any form of commission or incentive payments for any companies or individuals I endorse. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

40 – Short Valuation

FruitIt’s just one problem after another with the finance application for the second investment property.

Most recently, the valuation ordered by the bank came back under the contract price (short), specifically citing a discrepancy between the construction price and comparable build costs of around $35k. Annoyingly, the replacement value (which might be used when nominating an insured amount, for example) is noted as being above the contract price.

Our mortgage broker asked me to take this up with Open Corp, who note several points when it comes to valuations:

  • No two valuers will value a property at the same price. The valuation comes down to the valuer’s experience, knowledge of the area, and subjective interpretation of comparable sales and the area’s price point. Of course, the valuer is attempting to (efficiently) compare houses on different streets, of different designs, built of different materials in different eras, and in a changing market—this isn’t apples and apples stuff.
  • The properties we buy from Open Corp are full turn-key house and land packages, constructed as investment properties (i.e. to house tenants). The internal finishes are of a high quality to attract tenants and because they’re often hard-wearing. The house is 100% complete and includes landscaping, fencing, washing line, letter box, etc. I previously questioned Michael Beresford from Open Corp on the cost difference between the standard house and land packages for sale on realestate.com.au and the properties in the same development being sold by Open Corp and he made the same point in the context of that conversation.

Open Corp supplied me with a valuation for a similar, smaller property in the same area which did come back at the contract price. As plan A, I asked Mortgage Choice to submit this alternate valuation to the bank, requesting it be substituted for the original. This would in part be a test of the mortgage broker’s relationship with the bank but would more likely come down to the individual personalities at the bank’s end—more subjectivity—and in conjunction with whatever risk algorithms they apply.

Perhaps not unsurprisingly, the bank was unwilling to accept the alternate valuation and our mortgage broker subsequently took up the matter with the original valuer and and their minder, Valex (the valuation panel through which valuations are ordered by lenders). I have no experience contesting a valuation but understand it’s often a difficult proposition. The finer points seem to hinge on the comparability of the ‘comparable sales’ cited in the valuation—in other words, suggesting our build is comparable but at the higher end of the spectrum. As anticipated, the valuer (Peter Jones from Lee Property) wouldn’t budge and was apparently quite direct with our mortgage broker on this point.

In the meantime, Mortgage Choice ordered an independent valuation through another lender, giving us the option to supply that valuation to the original lender or proceed with finance through the second lender. This valuation came back at the contract price but was also not accepted by the first bank. Interestingly, many of the comparable sales cited for this valuation were in the same development whereas the comparable sales in the original valuation were from further afield.

Our last option was to challenge the valuation with the bank directly but that was equally unsuccessful.

In order to secure any form of financing from this application, we made the decision to reduce the loan amount (aligning to the original valuation) with the difference contributed from our line of credit (at a slightly higher interest rate and with the added risk of the increased LOC balance being secured by our PPOR).

This would have done the trick if I had a current pay slip for the bank—which I don’t because I was unexpectedly stood down by the firm I was contracting for earlier in the year when their pipeline of work dried up. Of course the wife’s still on maternity leave and won’t be back to work for another few months and the bank won’t accept her signed contract in place of a pay slip. Of course this also makes applying for finance through another lender a tricky proposition.

What a saga.

Finance is due in four days, on Friday. Mortgage Choice have recommended we request a finance extension from the vendor until wifey is back to work. Open Corp have suggested this may be an option because the land titles haven’t yet registered—but will be dependent on a conversation with and the goodwill of the vendor.

If this plan works out, maybe enough time will have elapsed for the bank to order a new valuation. Ha!

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

39 – Gazumped

Tank Wheel ClampI’ve mentioned a few times on this blog how smoothly everything went with the first investment property. From land and build contracts, to finance, to construction, and tenanting it was one tick in the box after another. When we set about repeating the process with Open Corp, I expected an identical outcome, this time with the benefit of personal experience.

Through no fault of Open Corp’s, we’ve had a rocky start this time. Our finance pre-approval, with me only recently back to work and the wife on maternity leave, was heavily scrutinised by the bank and was finally approved in mid-December—valid for three months, including the Christmas holidays. Dear wife then took her time finally agreeing to the commitment before we gave Open Corp the green light.

More recently, with our pre-approval due to expire within a week, I received a call from Open Corp telling us a larger buyer had come in and offered to purchase all remaining blocks in the development we were to buy in to—including all blocks with non-executed contracts. We’d signed the contract but it hadn’t yet been fully executed (signed) by the vendor. I’m not sure if it applies in the fullest sense to this specific situation, but I think we were gazumped.

Open Corp were helpfully able to secure another, larger block for us in a neighbouring estate (at a higher cost due to the increased land size—with the difference to be rebated back to us). They also had our initial deposit refunded from the original land developer and applied to this new property. The stamp duty will be about a thousand dollars more because of the increased sale price but I’m comfortable with that seeing as how we’ll be getting an extra 48sqm at minimal cost.

Given the timelines for the finance pre-approval, we were able to nominate Open Corp to sign the land and build contracts on our behalf (the property is in Victoria) and the mortgage broker was able to submit our finance application on the last day of our pre-approval… still without an executed land contract.

Land contracts just aren’t working out for us this time around. It’s now been two weeks since the final finance application was submitted and we’re still waiting on the executed land contract. I have no idea what the hold up is this time and apparently neither do Open Corp but it’s all slightly concerning—especially coming from where we’ve been with the first block. Will the same thing happen with the unexecuted contract being sold to a bulk purchaser? Is whoever does the signing at the vendor’s end out of town? In other words, what’s going on?!?

[Update (6 April): the signed land contracts finally came back late last week, which of course starts the clock ticking for the finance approval…]

Meanwhile, the bank seems to be moving the application forward without this seemingly important document and have ordered a valuation on the property and requested a few extra pieces of documentation from us. I have no experience how flexible the major banks are with the deadlines for their pre-approvals and I’d be very curious to know what happens next if this purchase falls over on the land contract.

All of this is unnerving and frustrating but we’ve never had any major issues buying or securing finance for our PPOR or the first IP and I’m hoping this will come good. I know finance is often the biggest hurdle for many buyers and it was certainly a relief to move forward from the point of unconditional finance approval with the first IP.

Compounding matters, the bank (a different lender to the one we used for the first IP—to avoid cross-collateralising) has flagged a possible issue approving a 10% LMI discount for us. Certain professionals are eligible to pay a 10% deposit instead on the typical 20% deposit before LMI kicks in and the wife, being a doctor, falls into that category of professional. The only problem from the bank’s perspective is the fact she’s not working… or more precisely, as I’d describe it: she’s on leave (maternity leave)—and she is therefore still employed. Unfortunately she has no current pay stubs to prove that to the bank and we’re waiting on a letter from her employer in the hope the bank will accept that.

I hope we’ll have a better view of both the land contract and the finance situation this next (short) week but I won’t bet on it.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

38 - Surprise! Unexpected Changes

SurpriseI find the vast majority of mainstream real estate reporting in the media is either all or nothing: the market is going gangbusters or it’s the next worst thing since the Great Depression and all hope is lost (I’ve given up paying any attention to the news…). There’s no middle ground. Similarly, the property spruikers only share the positives and conveniently overlook the details when they do cite a one-off example of something gone wrong.

Although many of the posts on this blog have been relatively upbeat—in line with our experience to date, I strongly believe in reality, facts, and the accurate, fair reporting of our experience. On that note, today’s post is a recounting of what is likely to be the largest single “upset” (not to dramatize) so far along our property investing journey.

Earlier this month we had three tenants in the Brisbane property and over six months remaining of a 12-month lease; then, suddenly, we had one tenant plus an “unknown” (or rather, the girlfriend of the remaining original tenant) and a pet request for a middle-aged, large-breed dog. On Friday morning last week, a water leak in the metre box was also reported.

How quickly things change from a seemingly stable position to near chaos. Fortunately, the exemplary property management team at West Property is handling all of this for us but I won’t deny I’ve found it remarkable that tenants can simply walk away from a contractual agreement they’re legally obliged to uphold. If nothing else, this doesn’t make for a good lease reference for them and they may end up have to cover re-letting fees for us.

I’m not sure why two of the three roommates have left but I believe they were together as a couple and I assume they either now aren’t or have decided they needed more privacy. I suspected there may be some instability when we took on the trio (we very much expected to end up with a family—mum, dad, two kids, and a dog) but they were the first application after a few weeks of home opens and they were happy to pay the advertised weekly rent. I thought one of them might leave eventually but wasn’t expecting any changes in the first year. In my mind, you sign a lease for twelve months, go to the hassle of moving, and then you stay put for a few years—call me simple and old fashioned.

We were notified by the property manager the pair have now moved out and requested to be removed from the lease. We had the option of saying no to this request and they would be obliged to continue paying their share of the rent—regardless of whether they’re actually living there. Practically, that option may be difficult to enforce.

In their place, the girlfriend of the remaining tenant had moved in, I’m told, but she had neither applied nor was she approved by us to live at the property. The wording in the lease document is quite specific to this point and clearly notes no one else can live in the house without prior agreement by the landlord.

If this new couple are keen to stay on, can afford the rent, and seem to be acceptable, then we’re all for that. Ideally that means no break in rental income. Plus there’s less wear and tear on the house for them to move out and be replaced with new tenants. But who is this mystery woman? Does she have an income? Does she have any prior rental referrals (or a criminal history)? Does she smoke? If she’s not paying her way, can her partner afford the full rent on his income after paying only a third of the rent to date?

Technically, there are more questions to be answered if the girlfriend checks out. Do we amend the lease to include her or have the tenants sign a new, 12-month lease? Do we increase the rent now as part of the new lease or after six months via some kind of special conditions clause (which may be tricky to do in Queensland—I’m not sure)? If the couple opt for a 50/50 split, the original tenant will need to increase his bond contribution from 1/3rd to 50%—or 100% if he’s covering the lot.

The worst-case scenarios I can imagine are having the remaining tenant vacate (for whatever reason), leaving us with an empty house to re-let and the resulting loss of income, or—if he stays—having a gap in the rent payments from the departing couple while all of this is sorted out. If all else fails, we are still covered by the Open Corp rental guarantee but that does mean having to accept any tenants they pre-screen and put forward to us (which could be good or not so good). Without checking the finer points of our insurance policy, we may also be covered for loss of rent if the rental guarantee were not in place.

Here’s another good fact sheet if you’re interested: http://tenantsqld.org.au/wp-content/uploads/2009/12/You-Want-to-Leave-Nov-09-SD_NEW.pdf

On the dog front, I simply wasn’t mentally prepared to deal with this request so early into the original lease and the property manager has recommended we say no for now (which was a relief). Before today’s revelation, we had considered allowing the pet if the (original) tenants were willing to sign a new 12-month lease effective immediately—using this request as a trigger event to keep the tenants on for a longer period. That’s less of an issue now.

We also hadn’t yet decided whether there would have been a corresponding rent increase; we can’t increase the rent mid-lease in Queensland so even a token increase would likely be the way to go to a) ensure we achieve an increase within the 12-month period, b) condition the tenant that the rent will always increase at renewal time, and c) cover any issues related to the dog (i.e. damage) as we can’t charge a pet bond in Queensland.

Meanwhile, the water leak is still being investigated by the water company. At least it’s outside and I’m told it’s likely on the water company’s side or will otherwise fall to the builder to rectify.

A few weeks on, and after consulting with Open Corp and receiving a tenancy application from the girlfriend, we offered the couple a six-month lease to see how it works out. We also increased the rent by $5/week. The lease was accepted and signed and we shouldn’t have missed any rental payments (the outgoing tenants would have been required to continue paying their share of the original lease until it was terminated). It will be interesting to see if the relationship lasts and what bearing a breakup has on the remaining tenant’s affordability; it’s easy to say a married couple with kids would have been a more stable tenant option but who knows—with the frequency of divorce I’m not convinced marriage equates to tenant longevity.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

37 – A Few Reasons for Investing in Property

rcrIt’s been a hard couple of weeks here. With a bank pre-approval valid for only three months before the reams of documentation would need to be supplied anew, it was go-time for getting agreement from Gemma and setting the wheels in motion with Open Corp for the second investment property purchase. I thought Gemma remembered and understood the reasons for buying the first property—and how that logic extends to a second. As my external voice of reason, however, she was reluctant.

A refresher was in order. I spent a few evenings nagging Gemma to think it over. I drew a few simplistic diagrams on the kid’s chalkboard to reinforce the key points. I asked her to re-read the very readable Property Investing Mini Guide from Open Corp (which I’d helpfully underlined and annotated—because that’s how I roll).

Gemma wasn’t sure about the risks but couldn’t explain to me the basis for her reservations—her default financial strategy is to ‘put it in the bank’ and ignore the negative impact of inflation. Her preference was to take a wait and see approach with the first property, which isn’t a good move if house prices continue to climb and become less affordable. How long do we wait? This first year also won’t tell us much: since the first property is in her name and she’s on maternity leave, we won’t see many tax benefits this financial year.

I argued the experience of the first build went well and the process of buying and tenanting was an exceptionally solid result with Open Corp. We wouldn’t have a long-term view of success or failure for the better part of ten years or more (one property cycle) but doing nothing with our available equity would leave us behind as inflation eats away at out savings at a rate of ~3% a year.

What should be an emotionless decision was quickly becoming a very heated emotional debate between us.

In addition to my points above, I banged on about historical growth rates, leverage, and risk.

Historical Capital Growth

Looking back in time we see Australian house prices growing continuously since the 1970’s (and well beyond). Whatever happened (or started happening) back then—be it government forces, population and other demographic shifts, war, tax incentives, rising incomes, or other market forces—has tended to continue. That’s over forty years of generally positive data.

chart2

The past is not a guaranteed predictor of the future but it does provide some guidance. Of course you’ll also find arguments against property investment using similar data—see this article which proposes we’re in a housing price bubble.

Leverage

Buying a property seems expensive but it’s not. We pay the up-front transaction costs (indirectly through a line of credit) and borrow 100% of the cost of the property through a combination of the line of credit and a primary loan. In other words, we put in about $70k to invest $380k. That’s a powerful thing: by my very simple math, if we put in a dollar, the banks put in $5 and the interest costs are largely covered by the rental income, tax deductions, and depreciation. Yes, both the LOC loan and the primary loan are subject to interest rate increases and other legislative changes (e.g. negative gearing) and it’s always wise to take these variables into consideration when doing your sums.

Risk

I’ve written about risk before but the options are simple.

1. Do nothing and inflation calls the shots. Even in a term deposit or a high interest savings account, your position will probably decrease or remain flat (i.e. unproductive). Real estate can be considered as a hedge against inflation given the relationship between GDP growth and demand.

2. Invest in the share market and Ben Graham’s insane Mr. Market calls the shots—in other words, the share markets are unpredictable and crazy; unless you’re investing in the company itself and understand the industry and the internals of the company, you’re betting against the house—so to speak. Plus, you don’t have any control over how your investment is put to work.

3. Invest in real-estate. Land has a long-term history of appreciating in value and putting a house on it will ensure the costs involved in holding the land are manageable. In time, the rental income may cover those costs and provide an income stream. If everything else turns to pot, at least you can live in a house and capital increases are potentially accessible via equity loan.

These aren’t the only arguments to consider but they’re a good starting point and encompass many of the finer details. Here a few more points to consider:

  • Real-estate investment is relatively easy to understand
  • You have more control over your investment than you would as a stock investor
  • You can create value (e.g. by renovating)
  • As a long-term investment the impact of any initial mistakes are likely to be lessened over time
  • There’s less volatility in the real estate market than there is with the stock market
  • Bricks and mortar have a high tangible value (compare to investment in a start-up that may have a product idea but no product and no revenue stream)
  • Rental income provides a stable income
  • Housing will always be in demand as our population increases
  • You have many options for managing your investment (subdividing, doing your own maintenance work, using a property manager or doing it yourself)
  • Portfolio diversification
  • And so on

In the end, Gemma came around and the IP#2 wheels are turning. We signed the hold agreement with Open Corp, put down the $1k hold deposit and $2k land deposit when returning the land contracts.

Gemma did caveat her approval of this build: this second property would be our last for a little while. I’m fine with that as this purchase will come close to exhausting the small line of credit we took out for the first build, secured against our PPOR, and the banks may not be too willing to extend us a third loan given the fact I’ll be back on stay-at-home dad duties in the next few months. The general tightening of the financial lending market over the last few years doesn’t help much either on this front (I’m not quite sure how the 26 year-olds in the magazines amass 10 properties in such a short timeframe!).

On request, Open Corp came back to us with a 400sqm property in Victoria, an hour’s drive south of Melbourne. I’ll discuss the specifics—and recount the process to acquire and build, as I did with the first IP, in future posts.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

36 - On Goals

top-50-super-quotes-of-all-times-19-728I scared myself silly when we signed up for our first mortgage in 2006 to buy a block of land and cover the ensuing house construction. That mountain of debt looked insurmountable and, considering the higher interest rates at the time, the repayments felt like an invisible shackle binding us to the daily grind of working life. The system had us by the balls and would continue to hold on for the next thirty years—according to the bank’s timeline.

This mortgage was, in many ways, a necessity (of modern life, anyway) as it would fund the establishment of our family home and promote us from the status of mere tenants. As projected, we now have two young children and are proceeding to raise them in the house we built.

In the years preceding the build we rented, paying what felt like dead money to our landlords—around $125/week or so. After repaying a student loan to my mom and moving to Perth we had very little money to our names, despite the fact I’d been working full-time as a professional for two years. My infamous frugality comes to me honestly after several years of having to live on the cheap!

On deciding to buy the block, the savings we had put aside for a deposit were all but spent by the time the deposit (we borrowed 95%, from memory) and stamp duty were paid and then we had that fun little surprise of lender’s mortgage insurance to deal with.

It was around this time I casually voiced my apprehensions about all of this to a work colleague (the CIO where I was working at the time, Colin Macdonald). His simple advice to me—which I would readily pass on to anyone else in a similar position—was to repay the loan as quickly as possible.

The bank had us down for thirty years. Colin’s advice was to clear the loan in ten years.

Say what now?!

I broke out a spreadsheet and projected some numbers forward in time. At best, I thought we might be able to repay the principal amount by 2018 (so ten or eleven years). I played with the bank calculators and quickly realised we could save the value of the property itself in interest costs—hundreds of thousands of dollars—by making extra repayments. I was intrigued.

We had a basic home loan at the time with no offset facility. The bank did include a free redraw facility with this product, however. With the redraw setup, we could manually (electronically) transfer our savings into the mortgage and therefore save the associated interest costs that would otherwise be charged on that amount. Better yet, the redraw funds were fluid, meaning we could redraw, on demand, some or all of funds we put in if we needed that money (in an emergency, to fund a car purchase, for a holiday, or for any reason).

There is one caveat to note with redraw, which I only learned about more recently: the ATO considers funds contributed to redraw to have contributed to paying down the original debt. In brief, if you think you might rent out your property in the future, you’ll only be able to tax deduct costs associated with the loan amount you haven’t yet repaid (even if you redraw the surplus funds). Offset accounts may attract a small fee but are immune from the ATO, work in the same way as redraw, and are more convenient.

And so we set ourselves a goal, which would later become our very basic financial strategy: put it all into redraw. Rather than making interest at whatever low interest rate the bank would offer, we save the interest the bank would charge for some of the mortgage amount (whatever we could put in).

With me working as a contractor and the wife working long hours in a good job (that doesn’t pay terribly well) we continued to live as we had: simply. We didn’t spend excessively—we didn’t often have the opportunity to do so with the wife working 60-80 hours a week. Entertainment costs were out!

Instead of keeping our savings in a regular bank account, we kept them in the redraw account.

Slowly but surely the extra contributions started to add up with the added benefit of reversing the huge impact of compounding interest fees the bank would have otherwise been charging us. The Albert Einstein quote says it all: “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it.”

But today’s post isn’t about compound interest, it’s about goals—specifically the huge goal we set out to achieve nine or so years ago.

Admittedly I’ve been a little distracted by being back to work and the kids and I’d neglected for some time to update my spreadsheet that tracks the balance of our home mortgage and the offset account we now employ in place of redraw. I updated this spreadsheet recently and noticed what I first thought was an anomaly in the data: the negative amount highlighted red I normally show for the balance of our home loan minus the offset balance was no longer negative and it was no longer red: it was black and it was positive. The balance in our redraw account was more than what was owing on the mortgage.

I do keep an eye on our monthly repayments so I knew before this point we were heading in the right direction. In the last six months the monthly interest charge had plummeted steadily from a couple of hundred dollars to less than $10.00.

It then dawned on me: we’d met our goal. We’d met our goal a year early. Although the mortgage account was still open (and will remain so for a couple of specific reasons), we effectively have the option to repay the mortgage balance in full, if and when we choose to do so.

Back in 2006, this milestone was equivalent in my mind to being financially free. Today that’s not quite the case as our commitments—financial and life-related—have increased and of course there is a cost of living in groceries, petrol, clothing, and so on. I can say achieving this goal feels as good as I hoped it would back in 2006—perhaps all the more so because I neglected to watch as the odometer tick over.

This post is isn’t to boast, it’s to celebrate and inspire. From a very low base, ten years of hard work and time has allowed us to meet our single financial goal. Your goal(s) might be different depending on your circumstances: your timeline to repay your mortgage, depending on the value of your mortgage and your income, might be the same or it might be a shorter timeframe or a longer timeframe. You may also favour a better balance in life than what we’ve managed to achieve (I believe strongly in delayed gratification but I’m also nearing forty…). Nonetheless, set a goal and then plan to achieve it. The world can then be yours.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

35 - Subprime Equity Loans

abandoned-house-auburn-2008jpg-089b37cb6d68e85b_largeGemma and I watched Michael Moore’s documentary Capitalism: A Love Story the other night. In the film, Moore connects the sale of suspect equity loans in the US and the ensuing subprime housing collapse. I first read about all of this in The Big Short: Inside the Doomsday Machine by Michael Lewis and it was a fascinating recounting but given how we’ve structured our investment property loans I thought it’s important to distinguish between a subprime equity loan and an equity loan in Australia.

From what I understand (and the entire situation was designed to be incredibly complicated), bank deregulation in the US lead to the availability of cheap finance for people who couldn’t actually afford to make the repayments. Banks, politicians, capitalism—you know what a dangerous cocktail that is. The US financial system then created products which bundled up those loans and subsequently sold products which bet against the homeowners making their repayments (derivatives and collateralised debt obligations or CDOs). It was only a matter of time until the foreclosures started rolling in en-masse and a few people got rich while a lot of people lost a lot of money.

Banking regulations are much tighter in Australia but more importantly I wouldn’t take on a loan if I hadn’t myself assessed our ability to afford the repayments. In other words, the closest we got in Australia in recent times to a subprime situation was around 2006 and the banking regulators here put a stop to all of that pretty quickly (and of course what was happening in Australia was nothing like what was allowed to happen in the US). From recent experience, I can vouch for the bank’s rigour in assessing our credit situation—it’s only gotten harder to get credit in the last few years, especially with the 2015 changes implemented by the Australian Prudential Regulation Authority.

As always, there is lot of information circulation about what’s good and what’s bad from sources which are good and bad. It’s important to do your own research and make your own decisions before acting but don’t forget it’s equally important to do something so inflation doesn’t do it for you.

I suppose a disclaimer is also worth posting: I'm just a guy, I'm not an accountant, lawyer, solicitor, tax agent, mortgage broker, banker, financial adviser, insurance agent, land developer, builder, government agent, or anything else so I disclaim your application of anything I write here is to be applied at your own risk. What I write may be incorrect and you are best to seek your own professional advice (tax, legal, financial, and otherwise) before entering into contracts or spending your money. Your situation is unique to you and what I write here reflects my experience only. This content is not professional advice and is not tailored to your situation. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael