48 - Making Money Lazy

Up until lately we’ve been on a roll: a few years back the equity loan was approved against our family home—putting that “lazy money” to work for us, and we were approved for and built our first two investment properties using the bank’s money.

But things are tight these days in the banking and credit sector and, with only one income, our ability to service additional loans is viewed as risky by the big lenders. Which of course sucks because we have a sizeable “rainy day” fund, the wife is in a well-paid job, and we have a very strong history of paying our bills on time and saving.

In other words, we still have income coming in but no option (currently) to invest it in additional properties without tying up our own funds. Our mortgage broker said “no” :’(

This situation leads to the holding pattern which is Plan B: reducing interest payable on the investment property loans. In other words, we’ve started stashing our spare cash in the offset accounts attached to the interest-only investment loans. This cash is therefore fluid—it can be withdrawn at any moment—and, because we’re using the offset accounts instead of paying down the loan as principal and interest (or paying into redraw), interest on the full loan amount remains deductible if and when we do withdrawn cash in the future.

While I’d prefer to be building our property portfolio (the median house price moves forever upwards) using the bank’s money and tax-deductible debt to achieve long-term growth, at least we’re saving interest. In fact this is the exact strategy we adopted with our PPOR—but of course, interest on that debt was not not tax-deductible and there were different variables at work there.

The biggest problem I have now is our money could be working harder. Although it could be said we’re retiring debt (sort of), this is good debt and I don’t want to retire it… I want to use our money to borrow other people’s money so it can be put to work for us! Interest rates are low and likely to stay that way for the near-term and if we could buy again now, at today’s median house price or just below, we could achieve cheap capital growth over the next few years.

We’ll review things again in six month intervals—both serviceability but also capital growth of our existing investment properties, which may allow us to leverage that equity to fund a larger deposit for IP #3. But that’s not how I’d prefer to do 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 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

What 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

40 – Short Valuation

It’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

35 - Subprime Equity Loans

Gemma 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

32 - Preparing for the Second Build

It’s been a little quiet here but for good reason: I’ve been back to work after a few years as a stay-at-home dad. In other words, Gemma is on maternity leave following the birth of our second child and her paid leave recently ran out.

Now if you’re a bank or lender, you’d probably worry about loan serviceability with neither of us working, two dependent children, a PPOR loan, and an investment loan to repay. According to our mortgage broker, Nathan, women on maternity leave statistically don’t always go back to work. So to keep things ticking over I’m back to the bad ol’ 9-5.

Of course serviceability only matters if we were to apply for another loan. The existing loans are already in place (and being repaid) so the banks don’t care what we get up to.

And that point naturally leads to the announcement that we’re looking at a second investment build. Having now been back at work full time for a few months, we may even be eligible to borrow again sooner rather than later, which is great.

As with the first IP, we’ve got unused or “lazy” equity in our PPOR. What that means is the value of our family home is worth more than what we owe the bank, thanks in part to appreciating property prices and the fact we’ve gone to great lengths to pay down the loan and thereby save on interest charges. That equity can now be used to fund the deposit and costs on an investment property through a line of credit secured against our family home.

Rounding up, we used around $70k of this equity to cover the 10% deposit and other costs for IP #1, meaning we didn’t pay lender’s mortgage insurance on the 90% main loan. I’ve got a pessimistic spreadsheet showing me, worst case, how much it costs to hold this property with tenants in place and that works out to around $4k/year for the first few years; I’m meanwhile looking at the actuals and so far the costs versus incoming rent are more or less balancing out. Open Corp suggests holding costs are typically around $50-60/week.

Of course with Gemma not working this year (IP #1 is in her name) we’ll have to defer any tax benefits so it’s hard to get a true picture of holding costs.

Nonetheless, with the IP#1 build behind us, tenants installed, and actual holding cost data now available, I’m feeling comfortable about repeating the process.

Because the first build with Open Corp was so smooth and because I’m working full-time and have little time to spare researching the market, area, and property, I’m planning on going through Open Corp again despite the costs. At the moment we’re looking at a build in Melbourne and Mortgage Choice tells me we should be able to borrow what we need. I’m planning on using the same team, with state-specific replacements for certain roles of course (e.g. settlement).

I’ll note my intention at this stage is not to own a dozen properties, as some firms may suggest. I’ll do what we can afford to do and can do comfortably. Open Corp suggests five or six properties may generate the cash flow and create the equity needed to live comfortably in retirement but even that will come in time as the equity in IP#1 (and IP#2) grows and becomes accessible.

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

25 – Insurance for Landlords

As we move progressively closer to the “launch” of our first investment property, our handler at Open Wealth noted we should start looking at insurance options. I seem to write a lot about insurance!

For our family home, we have building insurance because the bank requires it and this is the same for an investment property, of course. Although the building itself is a depreciating asset, it’s what allows us to generate revenue on the land (an appreciating asset) and would be expensive to repair or rebuild in the event of fire, flood, impact from space debris (!), etc, etc.

We also have contents insurance to cover the things inside the house like the furniture, clothing, pots and pans, and the TV. Notably, our insurance company classifies window and floor coverings under the banner of contents insurance.

As landlords we have a few more things to consider, such as malicious damage by a tenant and lost rental income for reasons like the tenant not paying rent. We also need public liability insurance to cover things like a tenant injuring himself because he tripped over a crack in our driveway, for example. In general, these things come under the heading of “landlord insurance”.

When I initially started comparing insurance products, I assumed we’d need standard building (and possibly contents) cover and then bolt on a landlord insurance product through the same insurer or another insurer. I was surprised to find that many insurers selling landlord insurance already bundle building and landlord under the heading of Landlord Insurance, and typically include public liability insurance as part of that offering. These products also tend to cover window and floor coverings too—either through the building component of the policy or through a modest contents component.

As usual, the pricing and inclusions for insurance from the various providers varies widely. I’ve received quotes ranging in cost from $600 to nearly $2000 for our 4x2 single storey IP. Some insurers will include removal of rubbish and motor burnout while others do not. Some insurers include theft by a tenant while others list it as optional. Most insurers will deduct the bond from any claim payment for themselves—but not all. Some insurers will insure you only if the property is managed by a licensed property manager and has a fixed term lease in place—i.e. not a periodic lease; others offer flexibility on these points. The only way to get to the point of a like for like comparison is to read the (lengthy—and boring) product disclosure statements for each product you may be considering. Needless to say, the last few evenings at our house have been painfully dry!

I’ve also investigated having a broker recommend a suitable insurance product and thus far Queensland Insurance Services has supplied me with a few quotes after I submitted a fact finder document to them.

One nice feature offered by some insurers like Allianz and CGU is the option to pay monthly, instead of annually, at no extra cost. Normally I’d prefer the convenience (and cost savings) of paying annually for personal bills but when it comes to an investment property I’m thinking more about cashflow—especially in these early days when the property will be negatively geared.

In terms of paying for running costs like these, we’ve got a few options. The easiest would be to have the property manager deduct the payment amount from rents collected and then make the payment on our behalf. I haven’t set this up yet but likely will once I’ve got a grip on it all. An alternative would be to pay costs from the line of credit account we have associated with this property—and into which rental income and tax variations are paid.

I’m still in the process of exploring insurance companies in Queensland. As we’re insured through GIO in Western Australia, I’d hoped to insure this property in Queensland with them as well to obtain a multi-policy discount. Unfortunately GIO don’t offer insurance in Queensland—despite the fact their parent company, Suncorp—does. Which is frustrating.

Mortgage Choice referred me to Allianz and they’ve come back with a strong quote; I’d initially written them off because their online quote system told me they don’t insure for flood but the rep I spoke to following the Mortgage Choice referral was able to add flood cover. I’ve also had a look at RACQ but they don’t offer landlord insurance.

Suncorp seems to be very similar to GIO here but they are a little pricey. I’ve also looked at Commbank, Terri Sheer (owned by Suncorp—also a little expensive but recommended to me by our newly-appointed property manager, who gets a $22 kickback if we sign up), CGU (very cheap but offering a strong insurance product as far as I can tell), and QBE.

As I do with all of my insurance purchases, I’ll increase the basic excess to at least $1000. I’m not sure if this is a wise move or not for the small cost savings. That’s the unfortunate thing about tenants: they’re largely outside of your control in your house (er, investment property)!

One final aspect to consider when selecting an insurer is how likely they’ll be to pay a claim. This will likely come down to experience and anecdotal evidence from jaded (or maybe the odd happy) customers who post about their experience online.

Insurance, despite being awkward and boring, is one of those things required to manage risk. You pay the premium in the hope you’ll never need to make a claim.

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

16 – Base Stage Invoice

In my last post I mentioned the slab for our first investment property had been poured and we were now at the ‘base stage complete’ milestone. I also wrote that it was time to pay the base stage invoice of $22k to the builder. Our mortgage broker forwarded a copy of the invoice for signing to authorise payment by the bank (from our main loan).

That would have been great as I’d prefer not to pay anything more than I have to from our line of credit due to its higher interest.

Naturally, things didn’t work out as intended. The bank asked that we pay this first invoice in full as part of our contribution so we had to pay the full amount from the LOC.

Again, not a biggie as it’s there for a reason but it’s amazing how random this process seems—would it not be sensible to expect the bank to provide some sort of payment plan or schedule so we can know what we’ll need to pay and when? Cash flow isn’t a problem thanks to the LOC but I can only imagine it would be for some customers. We had seven days to pay this invoice and I got the invoice paid across two payments with a day to spare, thanks to the bank stuffing around.

Open Wealth mentioned late payments are taken into account should they need to pay the build guarantee or rental guarantee and that’s apart from the fact I do not like being late with payments.

Hopefully the next one will go more smoothly.

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

14 - Progress Update: Plans Approved

We received a quick note from Open Wealth today noting the builder has confirmed building plans and permits have been approved. The start date for construction—preparation for the slab pour—is next Monday!

I’m certainly ready to see this house built so we can get tenants in and start recouping costs. The holding costs have been minimal to date but now that we’ve settled on the land we’re accruing interest on the mortgage for that component and our first interest payment of nearly $700 came due just this week. That amount is paid from our line of credit and capitalised as interest during construction so it’s no problem from a cash flow perspective—and was budgeted for—it’s just a bit scary seeing it all start to happen for real now.

In contrast to our new build, Gemma’s father recently popped into town (they live south of Perth) with the intention of buying a second residence to accommodate them when they come up. They located an existing house in one day, put in an offer that equals the asking price, and settlement is due in the next few weeks. In effect, they’ll be able to move in soon and the time between their offer being accepted and move in day will be less than a month (if everything goes smoothly).

Two of the reasons why Open Wealth advocates building over buying is to take advantage of depreciation as a non-cash tax benefit and to avoid paying stamp duty on the building component of the purchase (i.e. the house). With a new build, we’ll pay GST to the builder (10%) and while the depreciation will be a substantial bonus, we’ll be accruing interest for many months before the house is tenant ready (again, assuming the build goes smoothly). I haven’t done my figures to determine which is the most cost-effective route but I imagine it would be close.

Note building new also brings builder’s and structural warranties, greater tenant appeal, of course, and potentially a greater valuation so you can leverage the equity and do it all again.

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

11 - Bank Deals

Here we go again! I recently posted about the improved deal I got on our house insurance just by phoning up and asking for a better price. Almost to prove my point, I called up the lender who holds the mortgage on our PPOR, asked for a better rate, and they were able to pretty much instantly knock off .05% (pending new paperwork to sign).

Not a vast improvement but nothing to sneeze at either—that works out to about $50/year for every $100,000 owing (.0005 x 100,000). Since this is the mortgage for our PPOR, we can’t tax deduct expenses like mortgage interest so every bit less we have to pay back is more money to us instead of the bank.

It’s worth noting we’re already on a discounted rate by virtue of having both our PPOR mortgage and IP LOC together under the one umbrella product.

The bank wasn’t, unfortunately, able or willing to improve the rate applicable to our equity loan but did suggest we could convert that loan to a fully-fledged home loan to achieve a better rate. Interesting concept but I’m not clear on the tax implications—i.e. the debt may be considered non-deductible.

We’re on a variable rate loan product and intend to stay there. I briefly considered fixing some or all of the loan before the most recent rate cut but was obviously glad I didn’t as interest rates dropped .25%. Some pundits in the media are predicting a second rate cut this year.

Michael Beresford at Open Wealth recently published a brief but informative “Wealth Workout of the Day” video on the subject of variable vs fixed and some of the implications you may not have considered, such as pulling equity out of your property. Here’s the video.

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

3 - First Steps

There are so many subtle decisions and parallel steps in the property buying process it’s hard to know where to start in describing how we went from A to B. I suppose I’ll start at the very beginning, following our decision residential property investment was the thing for us.

Selecting an Investment Advisor

I’ve written about our “A-Team” previously so won’t reiterate the contents of that post here. Suffice to say we knew we’d need to decide on an individual or company to assist us to select a market, suburb, and property. I considered the risks too high to attempt this on my own, the first time around. You might do this yourself, someone might do it for you at no cost to you, or you might pay someone to provide this service (such as a broker).

I met with a few property investment companies and ultimately decided to move forward with Open Wealth Creation. We aligned to the Open Wealth methodology because it made sense and the Open Wealth team provided a large quantity of quality educational materials at no charge (a reminder, this blog is not an advertisement or referral for any of the entities I mention in these posts).

As we evaluated Open Wealth, I was also interacting with Joyce Property (based in Perth) but I opted not to move forward with them because they also promote and sell apartments; I don’t believe apartments are a good residential investment and I believe if you’re spruiking apartments you’re not working in the interest of those who are investing with your firm. Notably, Joyce does not charge a fee for their services, whereas Open Wealth do charge a fee. Joyce are obviously a very experienced organisation (I met with Graham Joyce and he oozes professional history). 

My wife and I also met with a representative from Investmark and I attended a seminar and had a follow up meeting with IPG but neither were up to the task I set them and seemingly just wanted to shift stock onto naive investors. Their eyes widened when we first explained how much useable equity we had but neither one followed up with me, despite prompting, when I asked them to back up their claims. The free IPG seminar was more or less promising and it seemed like what they were selling was based on good research. At the end of the day, both felt very slippery, verging on dodgy.

Finally, I met with Nicheliving a few times (primarily for their mortgage brokering services but initially for their house and land packages). They’re obviously big in WA but were really pushing us towards NRAS properties and their approach seemed somewhat thick. I knew pretty quickly I wanted to be building in Queensland (Brisbane) but it was worth the discussion with Nicheliving. Nicheliving are a one stop shop, which might be a good thing (or might not!). Their advertising also shows a dude holding wads of cash so it seemed like they target the get rich quick crowd which is not what I’m about.

Getting Money

In parallel with the discussions I was having with these advisors and property development firms, I initiated contact with our current bank and with the mortgage broker we used when purchasing our PPOR.

Although I didn’t intend to send the investment property mortgage to the bank that holds the mortgage over our PPOR, I needed to understand how much equity we had in our family home and, secondarily, how much they thought we could borrow. This turned out to be a good move as the bank was able to very quickly order a full valuation at no charge to me and it turned out to be a very positive engagement in terms of learning how to to converse successfully with the bank. Importantly, because the bank ordered the valuation directly, I was able to get a copy (I wasn’t able to get a copy when our mortgage broker requested a second valuation—which also went through the bank…). 

I wasn’t as impressed with the bank’s view about our loan serviceability—and in turn how much they would lend us; this was due primarily to the fact we’re a single-income family. Nonetheless, the home loan specialist I dealt with was immensely useful in helping me to understand the value of our family home and how we might go about refinancing its corresponding mortgage and optionally financing the investment property purchase. The specialist was also able to share the valuation report with me and it was helpful to see how the valuer saw our property (interestingly, we have a four bedroom house—as per the plans I supplied to him—but he recorded and valued the property as a three bedroom house with a study…).

I didn’t want the bank which has our PPOR mortgage to also hold our IP mortgage because I didn’t want to cross-securitise the loans. I highlighted this when I spoke to our bank and was reassured it wouldn’t be a problem but I’ve read a single lender holding both mortgages will always ensure they come out best in the event of any problems. Yes, we might have secured a lower interest rate and it would have been convenient having everything in one place but I’d only consider a single bank scenario if we eventually get to the world of private banking.

Following that initial conversation with the bank I also got in touch with a mortgage broker. Broker’s are often recommended and, as mentioned, we’d had success with a broker when mortgaging our PPOR (we used Mortgage Choice). You can do your homework and check out products from each of the banks on your own but why bother when using a mortgage broker doesn’t cost you anything and they’re already familiar with countless loan products? The broker I dealt with reassured me Mortgage Choice is paid the same commission for all of the products they recommend, removing the opportunity for the broker to recommend one product above another that will earn them more money; of course I’m not sure how true that is.

Our broker told me he has a few investment properties himself and I think finding people who understand investment property is really important because they’ll have a better appreciation of the path you’re following. As some of our requirements were different to your mortgage broker’s average client requirements (more on that in a moment), I wanted to structure our loans differently than what the broker first had in mind. At the end of the day the broker was able to find the products we needed, submit the applications (he walked through every line on the application forms with me), and secure an interest rate on the main loan that is 0.02% better than what that bank would have offered had I gone to them directly.

With my wife being a doctor, it turned out she was also eligible for a partial LMI waiver (this is one of the interesting requirement I mentioned earlier). Essentially, some lenders will offer members of specific professions an LMI waiver on the basis that they present a lower risk as borrowers. Search for LMI discount or see here for examples—you may be surprised what you find. I certainly wish I’d known about this offer/wish it existed when we purchased our PPOR as we had some major cash flow problems for a little while when we first had to sort out stamp duty and then LMI (and then retaining walls)!

Both of the brokers I was dealing with (Mortgage Choice and Nicheliving) were across the major lenders offering LMI waivers (initially CBA and Westpac but now ANZ and possibly Macquarie and St Georges) and we ended up being able to borrow 90% of the IP costs without incurring LMI. Note the 10% balance was paid from the line of credit secured against the equity in our PPOR but we could have done an 80/20 split if necessary. You can take the latter approach too if you don’t qualify for an LMI waiver but don’t want to pay LMI and have sufficient equity.

Mortgage Choice submitted applications for the main IP loan and the line of credit with our existing lender. Both lenders performed their respective valuations, the first on the property we were buying and the second on our home.

After all was said and (nearly*) done, our unconditional finance approvals came through without a hitch. People get all bent out of shape about finance but I don’t let it phase me—in this case I’d done my homework and knew what to expect. In other words, I wasn’t asking for more than any reasonable person in our situation might need and the numbers were simple and made sense. I was also confident our team would get us through. Might be different next time around though!

* Land settlement is due in the next few weeks. When settlement occurs, the solicitor will meet with the bank and land developer to ensure monies are dispersed appropriately and all of the legals are taken care of.

Land and Builder (etc)

Following an initial phone consultation with Open Wealth and a bit more back and forth, the first thing we needed to do with them was have our name added to a waiting list for a property in the area (the development) they were recommending.

After looking over the property details and the house specifications, we had to sign an “Exclusive Hold Agreement”, which essentially allowed us to deliberate further, and undertake additional due diligence, while the property could not be offered to anyone else. The hold agreement also required payment of a $1,000 refundable deposit. If we chose to back out, the deposit would be refunded in full. This deposit was payable to Open Wealth and is ultimately part of their 2% fee.

With the land contracts submitted, we then had to pay a $2,000 refundable holding deposit to the land developer. This deposit is essentially part of what would be a typical 10% land deposit—there is no further deposit to pay for the land and the balance of the land price and costs are paid at land settlement. The land contracts included the Contract for House and Residential Land (REIQ) and Terms of Contract for House and Residential Land (REIQ), as well as special annexures.

Note we had no opportunity throughout this process to submit an “offer” as such and when I enquired about negotiating on price, I was told the prices are essentially non-negotiable. This is something I want to find out more about if we repeat the process again with Open Wealth.

Next, we had to pay the balance of the Open Wealth “Development Management Agreement Fee” (their fee) within seven days following unconditional approval. This fee is 2% plus GST of the total land and construction price and is tax deductible.

Finally (FINALLY!) we had the 5% builder’s deposit to pay; we were given the option of paying this before settlement so the builder could make a start before we actually owned the land (due to an arrangement between the land developer and the builder negotiated by Open Wealth). We had the option to pay this after settlement.

Note I would have paid all of these costs from our line of credit in order to tax deduct the interest but unfortunately the LOC wasn’t yet available when I paid the $1k and $2k deposits. I may still be able to claim something for these but it gets tricky as I paid both of these initial deposits from our personal transaction account and that gets messy in the eyes of the ATO; will let the accountant sort that one out come tax time! [Update: on advice from our accountant, I “refunded” the $3k to our personal account, in two separate transactions, from our LOC.]

In summary, these were our upfront costs and the timing of relevant milestones:

September

• Exclusive Hold Agreement signed and returned.

October

• Open Wealth deposit: $1,000 (of the total Development Management Fee) to Open Wealth. Refundable.
• Land contracts signed by us and returned.

November

• Land developer deposit: $2,000 (of the land price) to the land developer. Refundable. Payable once land sale contracts submitted
• Unconditional finance approval received. 
• Development Management Agreement Fee: 2% plus GST (minus $1,000 paid initially) of the land and construction costs to Open Wealth. Tax deductible.
• Construction contracts signed by us and returned.

December

• Builder’s deposit: 5% of the construction price to the builder. Tax deductible.

[Update: March

• Land settlement]

Reading and Learning

As all of these events unfolded, I was busily reading everything I could get my hands on. I’ve started a bibliography which I’ll publish soon in case you want to follow what I’ve read. Education is obviously a time consuming (and at times tiresome) activity but I feel it’s important to understand the principles of property investment inside and out—especially as I lack the repeated experiences myself.

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. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,
Michael

1 - The A-Team

When it comes to property investing, one snippet of advice I hear repeated is to assemble your own, personal A-Team. Your team may look slightly different to ours but most A-Teams will typically include a tax account (ideally with significant experience in property investment), a mortgage broker, a solicitor or conveyancer, one or more lenders, a property manager, and one or more real estate agents, buyer’s agents, etc. You may optionally pull in or need to liaise with a financial adviser, an insurance broker, and potentially land developers, builders, and councils if you’re building new.

This is the team we ended up with as we purchased our first investment property. I’ve listed team members in rough order of importance (to my mind).

A very quick note: I do not receive any incentive to mention these companies and individuals, i.e. this is not an advertisement.

Accountant

I consider myself a numbers guy so you can imagine the accountant is going to be important to me. A good accountant will help you understand why you need to do things in a certain way to maximise your tax benefits and stay clear of any trouble with the ATO.

On recommendation from Open Wealth (see below), we’ve ended up with WSC Group and I can’t speak highly enough of them. Their customer service is above and beyond and Rainer Lamb, in particular, has been instrumental in my own learning, helping us to ensure our ownership and financial structures were correct. The introductory materials provided a detailed overview of how they recommend buying investment property and they specialise in investment property. It’s remarkably clear to me they know what they’re doing.

Interestingly, WSC are based in the Eastern states and we of course live in Perth. I was a little reluctant to leave behind our local accountant but they were not meeting my needs despite being available face-to-face. The WSC accountants do travel interstate and, as mentioned, Rainer in particular has been expedient and accurate in responding to my many, many questions via email. David Shaw, CEO has also been running some webinars of late and came over to Perth for a talk about retirement planning so they’re very engaged with their clients from the top down.

We’ll rely on WSC in the near future to prepare PAYG variations, do our tax returns, of course, and apply depreciation schedules for building and fittings. Basically, their job is to squeeze out every last dollar in tax savings as this first property will be negatively geared initially.

Mortgage Broker

You can shop around to find a good lender but why bother when using a mortgage broker doesn’t cost anything? We used Mortgage Choice when buying our family home before the GFC and although I initiated a conversation directly with our current lender (which proved immensely valuable) I knew we’d likely get a better outcome through a broker. There are a few reasons for saying this: a) I didn’t want to cross-collateralise the investment property loan against our family home b) an impartial broker will almost certainly get you a good product with a good rate from a reputable lender.

We set up a line of credit and a separate main loan for this property so there were a lot of moving parts and paperwork. I knew how I wanted to structure the loans from the get go so had to be fairly direct with Mortgage Choice on that front to get what I wanted but we got there in the end.

It was a mortgage broker who also put me on to the idea that certain low-risk professionals with high-income and/or stable careers (such as my wife—a doctor) may have access to special offerings from the banks when it comes home loans. For example, we could borrow up to 90% of the property value before lender’s mortgage insurance kicked would be required (this doesn’t really matter as we used a split loan structure—a line of credit and the main loan—so LMI shouldn’t be payable even if you don’t have a fancy job title… I’ll go into this more in a subsequent post).

Note mortgage brokers get paid a commission from the lender and don’t charge you a fee. I’m told the commissions Mortgage Choice is paid are consistent across lenders so it should be guaranteed you’ll get the right product for you rather than the product that will achieve the highest commission for the broker. Mortgage Choice told me this so how true it is I can’t say.

For many people getting finance approved is hard and awkward. We originally tried to finance our family home through Wizard Home Loans who eventually came back to us, late into the finance period while the block of land was under offer, to say they couldn’t help us (for whatever reasons—I can’t remember why). We then turned to Mortgage Choice who got us sorted with a bank before the finance deadline. As very naive first home buyers we didn’t have a clue this processes is officially painful but it all worked out in the end. This time around, once finance approvals were all in place, the various members of our team called to congratulate us and my response (not uttered) was pretty much “duh”. In other words, I knew we could achieve the financing we needed, I was confident our mortgage broker would get us there, and guess what? It all worked as it should have.

Buyer’s Agent/Project Manager

This one is optional but may help you find a better buy. You can do the legwork yourself if you’re comfortable doing so to decide which suburb you’ll buy in and which property you’ll buy but if you’re a first-timer (as we are) you might get it wrong—or not do as well as you could have. It depends on your risk appetite and individual circumstances. Some of these companies will charge a fee (percentage-based) while others won’t charge you but get paid commissions (which may or may not be fully disclosed to you) from the land developer and builder.

We elected to go with a company called Open Wealth Creation for many reasons, one of which is the quality of the educational materials they provide at no charge (Cameron McLelland’s book My Four-Year-Old The Property Investor, his booklet The Ultimate Mini Property Investors Guide, and the Wealth WODs (Workout of the Day) he and colleague Al Lewison publish most days in video format). I like that Open Wealth aren’t pushing a get rich scheme but give you a reasonable, sound process (which is fully explained in the materials and backed up by common sense). Open Wealth do charge a significant fee (2% plus GST) but for that you get two things: a) an unbiased recommendation where to buy and b) a project management wrapper around the entire process of buying a block of land, constructing a new house on that land, and renting it out. If you’re time-poor they can pretty much do it all for you, if you want, but I’m choosing to be as involved as I can and have bought in predominantly for the research and experience on offer.

Some readers may scoff at the idea of paying for this service but to me, as a first-time investor, it’s worthwhile. The materials have explained the approach, with which I am comfortable, and, unlike other firms, I’m aligned to the process and believe we’ll do better in the short-term and long-term than had we attempted to do this ourselves.

Notably this is one place to be wary of unscrupulous sharks. Open Wealth will have proven themselves to me only when the build is complete and we have a tenant but they seem—so far—like one of the few legitimate companies I’ve come across. There are all sorts of sales people out there trying to unload their stock (rather than the best property) and make a commission. Be very careful to understand the financial motivations of those you deal with and push them hard to ensure what you’re being told actually makes sense. I initiated conversations with several other companies during the selection process which eventually led us to Open Wealth and as soon as I pushed these companies on really basic matters they backed away and went quiet. It was really weird but I guess they want a pushover who’s just going to open their wallet and make it easy.

Brokers or buyers advocates I’m not familiar with but they may help you find something suitable. I have heard brokers tend to push existing real estate that’s closer to the CBD, rather than new builds in the outer ring suburbs. It’s worth understanding the benefits of building new and buying more low-cost properties over fewer expensive properties.

The Bank

Interesting things, banks. They’re big (even the small ones), operate in isolation from each other (apart from overarching legislation), and are an integral part in property investment. Although we went through a mortgage broker, I started my enquiries with our current bank and the holder of the mortgage over our PPOR. I wanted to give them the opportunity to come up with a good offering even though I didn’t want to cross-securitise an investment property and our PPOR and I therefore new it was unlikely we’d give them our business for the main IP loan.

After assessing our circumstances, a free valuation on our family home was ordered. Knowing the bank value of our home was helpful in understanding how much equity we had in the property and therefore our LVR and what we can do over the next year or two in terms of investments.

The mobile lending specialist was a great help to me in understanding what options were available to us through our current bank and was able to answer many of the questions I had as we progressed with the purchase.

If nothing else, it felt like I had insider access to the bank!

Solicitor/Conveyancer

In WA I’d refer to a conveyancer for settlement but because we bought in Queensland we’re dealing with a solicitor. Again, on recommendation from Open Wealth, we went with Blaak & Associates. A solicitor will ensure contracts are in order and ultimately work with the vendor and your lender to ensure settlement goes according to plan. Being from WA I’m not familiar with the settlement process in Queensland. For that matter I’m not particularly familiar with the process in WA! Nor do I wish to be! Conveyancing and settlement is, quite frankly, a chore I’m more than happy to pay someone to do. And the costs are really minimal—a few thousand dollars at most—and are, I believe, tax deductible (or contribute to the cost base of the property at the very least).

A solicitor can also prepare your will, which is something we’re sorting out for the first time as we move ahead. Notably, I’m using the DIY couples will kit from Australia Post… for now, anyway.

Property Manager

I’ll leave this as a placeholder to revisit once our IP is built and we’ve got a property manager on board.

Financial Advisor

For some readers, a financial advisor will be very important. For us, I know we’re forging ahead with property—pretty much exclusively—and I’ve defined our own financial goals and strategy for the short-term, medium-term, and long-term. I could pay a financial advisor to help here but for now I feel it would be wasted money (they do charge a fee). WSC Group do provide financial advice if you’re looking. WSC offer a financial planning service through a company they own called Jigsaw Financial Planning.

Insurance Broker

This listing is at the bottom as it isn’t directly related to property investment. It should probably be higher up in our case. By insurance I’m referring to life insurance, total and permanent disability (TPD), and salary continuance insurance (SCI) or income protection insurance. Although they overlap to some extent they’re all different and can be bought differently. If you’re employed and receive superannuation, you’ll likely find your super company offers basic life and SCI insurance. If you still hold super but aren’t working (like me) then double-check; in my case, I’m not insured.

Admittedly, insurance bores me to tears. More importantly, we’ve considered it too expensive to worry about to date. But with mounting debts and children—and being a single-income family—it’s something we need to consider. Once again, WSC is helping us here and we’re in the early stages of getting a solution in place that will keep us financially safe if something bad happens. I have found the premiums can be adjusted in relation to the amount of cover and, more interestingly, we can pay for some of those premiums using a partial rollover from our existing super funds. I’m not clear how this works but apparently it was introduced with recent (June 2014) legislative changes.

Odds and Ends

Other roles you may need to call on include:

• A justice of the peace to witness mortgage documents (thank you Queensland!)
• Your employer
• Your superannuation fund
• Your credit card companies
• Your car and personal loan financier
• Etc, etc…

I don’t want to suggest you need to have all of these team members in place from day one. We built this team gradually when the need arose and I hope we can reuse team members again in the future without making any changes to the line up. You may need fewer people or have the option to rely on one or two key players to facilitate multiple functions. The communication lines can get a bit complicated (and that’s one area where I’ve already seen tremendous value in Open Wealth as the central hub around which the other functions operate).

I’ll update this list when and as needed.

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. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,

Michael

Setting the Scene

I’ve previously mentioned property investment and that’s what I’m here writing about (or will be soon once the formalities are out of the way). So before we get started in earnest allow me to explain why we felt the need to invest. As always, I’ll go into specifics in future posts—I promise.

Our pathway through life has been, to date, very much what most people would expect: grow up, go to school (university), get a good job (refer to Robert Kiyoasaki’s excellent Rich Dad Poor Dad book for more on this mantra). You might follow that with work hard, retire, die.

In my case, I opted to start my tertiary education in the arts to lay the groundwork for future specialisation so I studied English Literature and Art History. I followed that with a Masters in Information Technology.

My wife followed a similar path, starting out in veterinary studies before shiftingd over to medicine.

I did alright, academically, in my undergraduate degree and did very well in my Masters degree. The wife did very well throughout. I landed in a pretty good job out of university and my wife entered the public health system to complete her training.

Our incomes grew rapidly as we progressed from junior positions in the first few years of our respective careers and we soon focused on buying a block of land and building a house. We saved enough for a deposit on the land and took on a mortgage worth a lot of money (not quite three quarters of a million dollars at the time—2006—but close enough to make me uncomfortable) for the purchase costs and the build. Interest rates were higher then and bounced around a lot but we were protected by naivety, our double income, and a thrifty nature.

We went to work. We paid our mortgage (which cost over $4,000 a month in the early days). We saved a bit where could, using high-interest savings accounts—and paying tax on the interest of course. We were scared to spend and saved hard to establish a buffer or rainy day account.

At one point, the CIO I was working under suggested to me the best thing we could do with our saving was reduce the interest costs on our mortgage by pushing our spare cash into the included redraw facility. If you’re not familiar with redraw, it works very much like an offset account: any money you put in reduces the principal on which you pay interest. Whereas an offset account is a separate transaction account, a redraw account is basically your mortgage account. The cash you push in can just as easily be pulled back out again. It’s not quite as flexible as an offset account but redraw didn’t attract any fees in our case.

Important note: there are significant downsides to redraw if you ever want to turn the property into an investment property—against which  you would likely want to claim tax deductions. The ATO considers payments into redraw as payments which reduce how much interest you can claim. So watch out for redraw and prefer an offset account instead which doesn’t have the same problem.

From this simple idea was born our financial strategy: manually move cash into the redraw account when it was available, thereby reducing interest costs. This approach would save us hundreds of thousands of dollars and result in the mortgage being paid off early. Oh and there would be no tax to pay (if our cash was instead held in a high-interest savings account or other investment vehicle we would pay tax on the earnings).

Meanwhile, the equity in our home was increasing. It’s now 2014, we’ve owned the block of land since mid-2006 and been in the house since mid-2008. As we worked at our jobs, the property market—and the property cycle—kept working in our favour too, ensuring the value of our house was aligned to the median house price and comparable recent sales in our area.

In round numbers, let’s say we’ve been living in the house for five years; in that time, the equity in the house has increased by over $400k. Of course there’s inflation to contend with and we spent close to $100k on very necessary post-construction activities like pouring a very long driveway (we’re on a rear block), building a deck and pergola, fencing, tiling, painting, carpets, blinds, built in vac, etc, etc.

Equity, locked up in a family home is like almost-free money. That’s simplistic, of course, because to access that “money” really and truly you’d need to sell the house and crystalise the gain which most people probably won’t want to do if they’re living in that house. But—and very importantly—the banks will loan money against that equity using a line of credit or an equity loan. You’ll pay interest just like any other bank loan but you can effectively do whatever you want to with that money such as use it to pay for a deposit on an investment property (or buy stocks or go on a holiday or whatever—but ask an accountant about the idea of mixing the purpose of the loan before you do anything other than attempt to generate money). A line of credit can be established for smaller amounts but can go quite high too—the bank site I’m looking at as I write suggests $750k and up.

At this point, we have a problem. We’ve got a plan to pay off our mortgage in ten years or less (by paying less interest, basically) and we’ve got increasing equity in our home. That’s good problem to have, I suppose! It also sounds like lazy money to me: money—or rather other people’s money (the bank’s)—that could be working for me to make more money (so I don’t have to) but that hasn’t been put to good use.

Following an initial conversation directly with our bank I realised we could be approved for an investment property mortgage and could effect the transaction with no money from our own pocket. Really. Nothing. We couldn’t get a 105% or 110% loan because they aren’t offered by the mainstream lenders post GFC but by combining a line of credit with an investment home loan we could cover all of the purchase costs and we’d avoid paying mortgage lender’s insurance.

Rental income would cover a significant majority of the ongoing costs and tax deductions would take us up near 95%, leaving only a small difference for us to pay. By my (pessimistic) calculations that works out to $4,000 or less a year.

The property will therefore be “negatively geared” but the plan is for it to become neutrally or positively geared in the years to come meaning it makes money (“net cashflow positive”) and costs me nothing in the long-term. All the while the equity in this first property is growing and can be used for other investments.

So we’ve redefined our financial strategy—I plan to dedicate a future post that topic. In short we’ve now outgrown what was a simplistic and great plan (put it all in redraw!) and are now thinking long-term and bigger picture (through retirement and on to death). I’ve done a lot of reading over the last six months and spoken to brokers, accountants, other investors, lenders, and solicitors to understand the moving parts when it comes to property investment. I have a lot more learning to do however!

I’ll write more about risk in the future as well but the way I see it property is in a sweet spot between shares and savings accounts. Understand the risks and they seem rather manageable for the long-term returns you hear about. [Update: see my post Risky Business? for my views in this area.]

A side note: I earned ten thousand dollars one summer as a young man planning bus routes for the school board in my area. Another long story but that money was invested in a handful of tech stocks around 1998/99—just before the tech bubble burst, if you’ll recall! I watched some of the five or six stocks I held soar magnificently in value but was mentored to hold for the long term and I neglected my instinct to sell and cash in the gains. The bubble burst soon enough and my $10k became almost worthless in a short matter of time. In retrospect, I probably bought when prices were already high so the correction left me hanging in the wind. In the next decade that money would have come in terribly handy for immigration to Australia, getting married, studying as an international student, and buying our first home. Of course by that time it was long gone. It’s easy to call stocks a gamble but there are reasons why I have no interest in stocks (to list some of those reasons quickly: market mentality, lack of control or direction over the investment, lack of time and interest to understand company fundamentals, and so on).

Super would be fine and dandy—apart from the fact any contributions are locked away until you reach your preservation age (55 in my case) and the canned investment options are built around securities (and property and cash). Self-managed super would be great, especially when it comes to property investment, but then the ATO won’t allow you to buy a block of land and improve it (build) and building new is what maximises your depreciation benefits.

Other options we considered were to simply save our income. This is simple and surely it’s safe, right? The bank guarantees your savings but it won’t protect your savings from inflation (which is roughly 3% a year on average). Most importantly, your money isn’t working hard enough, even if it is keeping pace with inflation. With interest rates so low, high-interest savings accounts are still quite boring in terms of their returns and term deposits, etc aren’t much better as far as I know.

So we’re starting with property. It costs very little to build an asset base that will grow in value over time and allow us to save tax. Our strategy, if you can’t tell, is very much buy and hold—forever.

Hopefully that gives you some context for the stories and tales that follow. Our situation is unique in that it is our own but in dollars and cents I think you’ll find we’re not all that different from you or your friends and neighbours. There are no secrets and no magic tricks. Yes, there are tricksters and sharks who will attempt to lead you astray and while they may not steal from you, you may not get what you expect in return for payment. There are alternative strategies and approaches you’ll come across, of course. And there is plenty to learn: the financial aspects are fascinating and then of course there’s the tax office and different state laws and functions to consider. As a simple person, however, I don’t believe this stuff is beyond my grasp… but I’ll keep you posted either way!

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. I'm learning too and expect to make many, many mistakes along the way.

Enjoy,
Michael