Structure for an increased portfolio
Published on 28/05/2011
There is more than one way to service a loan, says an agent and investor.
Considering how many Australians seem to be obsessed with property ownership, you'd think the country was awash with real estate moguls. Yet most Australians own or pay off only one property — usually their home — in their lifetime.
For all the giddy dinner-party talk, only one in 10 taxpayers is a negatively geared landlord thanks in part to a tax system that supports property investors. And only 1 per cent of the population own three or more investment properties.
What stops many people from buying more real estate isn't just a lack of money in the bank but loan serviceability.
Many lenders now assess your current and future debts at 2 per cent above the prevailing interest rate — and that means digging deep into personal cash flows to repay investment loans.
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Buyer's advocate Melissa Opie says investors tend to stick with owning one investment property because they don't structure loans properly and fear too much debt.
Ms Opie, the director of Flemington-based real estate agency Keyhole Property Investments, argues that to build a portfolio, investors should use interest-only loans and squeeze as much equity as possible from properties so they can continually reinvest.
She is not alone: many investors prefer interest-only loans. They cost less in repayments each month, offer improved tax deductibility and give more flexibility.
You can choose to repay the principal and the interest with this type of loan and, at a later date, redraw all your equity to fund another purchase.
With a principal-and-interest loan, the lender owns the minimum principal part of your redraw facility and reduces the loan limit daily.
The downside of interest-only loans is that if property markets go down or plateau, investors with them are more likely to get burnt. You are betting that a future capital gain will cover the high cost of your interest bill and the principal cost, which you have not paid down by even a few dollars. There are other hurdles to building this type of portfolio, too, such as state government land tax.
Dr Terry Burke, the professor of housing studies at Swinburne University, says high land tax is an issue that hits investors hard. "It stops them from owning multiple properties," he says.
In Victoria, land tax on income-producing residential properties with a land value of between $250,000 and $600,000 kicks in at $275 a year plus 0.2 per cent of every dollar of the valuation that exceeds $250,000. For properties worth $600,000 or more, tax rates go up again. But by buying apartments, which attract a lower rate of land tax than houses, and investing interstate, you can reduce exposure. When you own properties around Australia, you can access tax-free thresholds in every state.
One of the big themes in investment thinking since the end of the property boom has been: Forget about capital gain for now and focus on being cash-flow positive. Ms Opie takes a different line and advocates a financing strategy called the "kitty-loan system".
The system uses three loans to buy a property. The first is for the deposit (and is secured using equity in your home). The second is for the balance of the purchase and is secured against the new property. The third is the kitty loan, which is a draw-down facility secured against existing equity you set up to fund the cash shortfall until the investment becomes cash-flow positive.
Ms Opie claims this way of arranging loans allows you to build up equity without having to cut your personal spending.
She recommends buying within a two to 12-kilometre radius of the city centre. "I never buy right in the city itself," she says. "You get better capital growth in the inner city and you attract the type of tenant who is prepared to pay for the lifestyle."