The next properties
For investors, the fastest way to get a deposit for the next property is not to save again – but to use equity in their home or other properties as it becomes available.
This could require waiting and hoping for the market to increase in value, doing a renovation or paying down the loan.
Here is how it works.
Home equity is the amount left over when you take away what is owed on a home loan from the current value of the property. With our investor’s two $250,000 apartments, the revaluation is likely $350,000 today ($700,000 in total) – to be conservative.
In this situation, our investor initially paid $50,000 in a deposit for each home – meaning her loan was $200,000 per property ($400,000 in total).
Even without paying any additional funds into paying off the homes, she has turned her $100,000 worth of deposits (two x $50,000) into a total of $300,000 because she has, in theory, gained an extra $200,000 from the re-valuations. This means the portfolio would be worth $700,000. The debt remaining would be $400,000.
In this situation, it would be possible for the investor to pull equity out of these properties to cover more deposits plus costs. This approach could be used multiple times to ramp up a portfolio above the 10-property mark, provided they don’t hit a “serviceability wall” where the bank will no longer lend.
Mortgage Choice’s 2017 Investor Survey found 22.2 per cent of investors borrowed the full purchase price of an investment property using the equity in their current home as security and another 29.6 per cent borrowed some of the purchase prices with this method.
Based on this data, more than half of Australian property investors rely on equity to build their portfolio.
If our example investor decided to buy a $500,000 investment property using her equity – she could push her portfolio up to home number three. Her portfolio value at this point would be $1.2 million.
But if our investor sold her portfolio at this point – she wouldn’t walk away with $1.2 million. In fact, she is far from a “property millionaire” and would be unlikely to even walk away with $300,000 – the equity plus initial deposits.
When capital gains tax and selling costs are considered, this can quickly erode the leftover value. Add to this costs incurred by holding the property – including any shortfalls between the rent and mortgage repayments, improvements to the property, insurances and other outgoings, and it doesn’t look as attractive as the initial one-off figure.
Many investors would not be selling at this point – in fact, many are willing to lose money in the short term, by paying more to hold an investment property than it makes in rent, in the hopes of future gains.
The 2016 PIPA Annual Investor Sentiment Survey found 64 per cent of respondents had bought for “long-term” growth. The growth of 10 per cent on our example portfolio would be an additional $120,000 in equity.
If this growth didn’t occur, they could be losing money due to the holding costs.
And if values fell, it is entirely possible these investors could end up with mortgages costing more than the properties are worth.
reposted from domain.com.au