How to invest in property with no out of pocket expense
Saving up for a deposit is a memory fresh in your mind. Months of Mi Goreng noodles, a night in while your friends are out on the town, wearing underwear with holes in them because you can’t justify buying new ones or letting your fringe grow too long before you hack at it yourself instead of paying a professional.
Maybe you moved back with your mum—you and your partner squeezed around your childhood dining table or cuddled up watching TV with your stepdad who just doesn’t know how to reserve conversation for the ad breaks.
Saving for a deposit took sacrifice, and now you’re in your own place there is no way you are going through that again in order to start your property portfolio.
You like your life of little luxuries. Weekend brunch and coffee, Friday lunch out with colleagues. The occasional movie, new nail polish or a schooner after work.
Now what if it was possible to save for a deposit without having to give all that up?
If you own your own home you could get into the investment property market with no upfront cost and for less than a coffee a week in maintenance.
So how does it work? Here is a break down on how three people have gone about it.
How does using my current home to finance an investment property work?
There is a huge amount of unused equity sitting in banks across Canberra.
Equity is the gap between how much you owe on your property and how much your property is worth. If your property is worth $500k and you still owe $400k then you have $100k in equity. Equity is accumulated in two ways, the paying down of your debt and the appreciation of your property in value.
Unused equity is monetary value that is just sitting there, not earning you any extra money. What a waste.
According to data released by Corelogic, property values in Canberra have increased by an average of 3.8% per annum each year for the five years leading to January 2019. On a $400,000 property that’s an increase in equity of $30,000 over two years assuming you are making interest-only repayments on your loan. On a loan that’s paying off the principal also? You’re looking at even more, so depending on how long you have owned your home and how aggressively you are paying down the loan, you could potentially have more than enough equity to leverage against to invest in the next property.
Depending on the amount of equity you have in your residence, as well as your total household income, banks may in fact loan 100% of the purchase price of an investment property plus all the associated costs, which means no out of pocket expenses to get in to the investment market.
The amount of equity you need to purchase an investment property is highly subjective and is based on three things: how much you’re borrowing, how much the investment property is worth and how much equity you have.
Once you’re in the investment market with no out of pocket contribution, you can maintain that investment for the price of a cup of coffee per week. You may even end up cash flow positive, with extra money in your pocket each week depending on where you buy and what your overall returns are. Canberra ranks third of all capital cities when it comes to total gross return so investors in Canberra often experience the best cash flow.
Ben and Joanna*
Ben and Joanna bought their first home in 2011 for $400,000. Having paid a 5% deposit, $20 stamp duty thanks to the First home owner’s concession and the $10,000 First home owners grant, they ended up with a $380,000 loan for their $400,000 property.
They have been paying making Principle and Interest repayments for the past four years, which has reduced their debt to $346,000. In that time the value of their home has increased to $479,000 (an average of 3.7% p.a.) so they have $133,000 in equity, which they used to help buy an investment property.
Joanna is a teacher with an income of $80,000. Ben works in communications and earns $55,000 a year. Their combined total income is $135,000.
A year ago the couple bought a one bedroom $365,000 unit in the Inner South, taking out a loan of $380,000 to cover the costs as well as the mortgage. Their interest rate is 4.5% although current interest rates are lower.
They’ve received $18,720 in rental payments over the past 52 weeks and the costs (loan interest, strata, rates, insurance, bank fees etc.) have come to $24,200. However when they lodged their tax return they were also able to claim depreciation of $9,453 bringing their total deductible income to $14,933. This was one of reasons they chose to buy in a new development—depreciation is higher for newer buildings and they knew they’d get more cash back.
The deductable loss got split evenly between them. As he earns less, Ben’s refund of the investment property expenses was more—$2,687. Joanna’s refund was $2,575 bringing their total refund to $5,262. The left them with total loss of $218 for the year or $2.10 each per week.
Ben and Joanna are pretty fortunate. They have a decent combined income and no kids. $2.10 each per week is not a stretch. The story is a lot different if you’re on your own, right?
Wrong. Let us introduce you to Stacey.
Stacey was pretty fortunate. She was able to stay at home while saving up for a deposit and bought her own apartment in Belconnen for $250,000 back in 2003. Between her savings, the First home owners grant, the stamp duty concessions and a generous gift from her parents she now owns a $320,000 unit and has only $175,000 left on her loan, giving her a good chunk of equity. She works in real estate and earns $85,000 per year.
In 2017 Stacey bought in to Southport Stage 2, which had residents moving in early 2018. The one bedroom apartment cost $240,900 and she took out a loan for $250,000 to cover all the costs so that she didn’t need to outlay anything initially. The rental income for the property she purchased is $280 per week.
When she adds up all of the projected expenses, which for a new property are pretty easy to predict, and the depreciation and factors that into her tax, she’ll be receiving a refund of $1545, making her investment cash flow positive. Instead of waiting for the end of the financial year to claim the money, she’ll be going to her employer, informing them of her predicted deductions and they will lessen the amount of tax they take out of her pay each week, putting and extra $19.28 into her pocket each week. She won’t get the lump sum goodness at the end of the financial year, but it will pay for her movie tickets each week.
What do you get for your $4 per week?
While an investment property that is cash flow positive like Stacey’s is ideal, why would you invest in something that costs you $4 per week? It may just be a cup of coffee but you like your cup of coffee and need a pretty good reason to bring your own on a Tuesday morning (because no one in their right mind would bring their own on a Monday).
Well, while you’re forking out the cost of a box of chocolates per week, your property is not just sitting there. On average home values increase by 3.8% in Canberra per annum each year—so on a $300k property your net worth is increasing by about $9000 a year. If it increased by that much each year for the next 10 years you’re looking at an extra $90,000 added to your net wealth.
How do you do it?
Investing in property, building up a portfolio, is not out of reach, and it is simple to get started.
The first step to property investment is to seek advice from a mortgage broker, like those at Clarity Financial Group. The information we’ve given in this article is specific to three people. A mortgage broker will go through your circumstances—your income and current equity—to determine how much you can borrow and on what conditions. They can then help you choose a property that meets your needs. The best thing is it doesn’t cost you anything. You can meet with them for free.
Mark Edlund, Managing Director of Clarity Financial Group says, “We’re the buyer’s advocate, and really the only one they have. The real estate agents are after the best deal for the vendor; the banks are trying to sell you a product that makes their shareholders the biggest return. Solicitors are there to provide advice on the contract and conveyance, but that’s it. We’re the only ones there for you from the moment you start thinking about buying a house, explaining the purchase process, doing all the calculations and stepping you through to settlement and beyond.”
A good mortgage broker will be around for the entire course of home ownership, whether you’re going back when/if the terms of your loan change, or you’ve decided to tackle renovations. They’ll also get in touch if they see better lending options put on the table. Because their success is based on your success, you can be confident they’re acting in your best interest.
So there you have it, a simple guide to getting started in property investment. No noodles required. If you aren’t convinced, check back in a few weeks’ time when we look at what makes property such a great investment.
*Names have been changed for privacy reasons. Case study data collected 2017