Investment strategy

How to have a billion dollars property portfolio in 6 months.

Well not quite, but as you can sense the sarcasm in the title, I am not a fan of these get rich quick property schemes. In my opinion, all these schemes are good for are selling books and seminar tickets. I can’t believe there are still people out there promoting this sort of scam, I mean schemes. Remember Henry Kaye? If you don’t know who Henry Kaye is, just Google Henry Kaye.

When I was in Sydney last year at a homeowner expo, I watched a short presentation giving by this lady (I had no idea who she was) who apparently is a successful property investor and author, she was there to plug her book and seminars. The message of the presentation was that everyone can be a property millionaire, and to do that you just have to borrow more and more and then of course the value of your property will go up. Therefore, you borrow more against the growth in your property to buy another and so forth. She made it so easy,you buy your first property at 90%, then after 6 months revalue, borrow against the increased value to buy another one, then revalue again after six to twelve months and buy again. It just sounds so easy.

Yes you can be rich by investing in property, but it’s not as easy and risk free as it was made out to be. Moreover, not everyone can be a property millionaire as claimed at the seminars.

There are a few basic flaws with this high geared method, the first and most obvious is cash flow. Almost 99% of investment properties these days are negatively geared, which means you need to have the cash flow to cover the interest payments. Let do an example. Say you bought an investment property for $350K, base on this strategy you would borrow about 105% (by using the equity you got in another property – that’s the whole idea) or $367,500 interest only. Now let assume the following:

Current interest rate is 8.5%
Rental yield is generously 4% net (after all expenses).
Depreciation is 2.5% of the building, estimated to be worth $150K (this is an example only, the actually figures will depend on how old the property and what’s depreciable)
Your personal tax rate is 30%
So let do the maths:
Interest costs: $367,500 x 8.5% = $31,237.5
Depreciation expenses: $150,000 x2.5% = $3,750
Net rental return: $367,500 x 4% = $14,700
Tax loss =$14,700 (rental) - $31,237.5(interest) - $3,750 (depreciation expense) = $20,287.5
At 30% tax rate, you’ll get a tax benefit of $20,287.5 x 0.3 = $6086.25

Therefore, the real cost of holding this property is: $14,700 - $31,237.5 + $6086.25 = -$10,451.25 pa.

Remember depreciation is a non cash item, meaning it’s not a real expense to you but for tax purposes you can expense depreciation to reduce your taxes.

As you can see, on average, to hold an investment property at $350K, you will need at least $10K net income per year. Say you decided to follow this strategy and now have 2 investment properties plus your own home. You will need at least $20K spare, this is a very simple assumption, in reality the more negatively geared property you have, the less tax effective it is because your tax rate reduces, negative gearing works best when you’re on the highest tax rate. Basically, the higher the tax rate the more you’ll get back from the taxman when negative gearing.

Say your income is $80K, you would net approximately $60K. Assuming that you have a loan against the house you live in for $300K, your repayments is estimated at about $28K pa based on 8.5% over 30 years.

And let also assume that you are very wise with your money, and you managed to live on $1K a month or $12K pa.

Lets sum it all up:
Your net income: $60K
Less:
- Living expenses $12,000
- Home loan repayments $28,000
- Holding costs for 2 investment property $20,000
Total $60,000

Surplus: 0, that means if you have two investments properties, you will be stretched right to the your limits financially, therefore you can’t afford it.

As you can see, on an average income of $80K, you can’t afford to have 2 average investment properties. According to these numbers, you can’t even afford to hold one! How are you going to service 4, 5 negatively geared properties? The maths just doesn’t work. You can’t afford it and the bank won’t give you the money either! Obviously, it all depend on how much income you got, and if you’re a couple both earning decent incomes, then your servicing power would be better but it’s cleared that not everybody can be a property millionaire, it’s a gimmick to sell books and seminar tickets!

What about other flaws? The assumption that you can get a loan that easily is another flaw. You won’t! Banks will not lend you 90% if you can’t afford the loan. Mortgage insurance companies won’t approve your insurance if they know that you’re highly geared and borrowed well over your head.
And then there are other issues like the assumption that the property market will be up 20% in six months, it won’t! You may be lucky and found a hidden gem, but it’s unlikely. In one of the articles I read in a finance magazine, the author was claiming she bought her first house at 90% and then six months later revalued and borrow against the increase in value to buy an investment property, then she revalued again to buy another one. I find this hard to believe, in most cases banks will not revalue your property after just six months, In my experience even after 12 months you won’t find much increase in valuations to make a difference anyway.

And then there is the issue of your property sitting there untenanted for months, therefore no income. What about interest rate going up, although I personally believe we’re at the peak of the interest rate cycle, the strategy promote maximum gearing leaving you with no margin at all for a rainy day, therefore a 0.25% increase could literally tip you over the edge. What about all the fees you would have to pay?, mortgage insurance, stamp duty, bank application fees, valuations fees, accountant fees and more fees.

Therefore, in summary, unless you’re lucky or very skilled to be earning a bucket load of money, average people like us on average income will not be able to hold a large property portfolio. Forget these gimmicks and do the number before you jump into a buying spree, stay far far away from the property seminars where everything just sounds so good and so easy. Investing is all about numbers, there are no trick or magic spells, no hidden truth just pure numbers.

cheers,