Cash Deposit vs Existing Equity for first deposit

[Annett]

First of all greetings to you all and thanks ever so much for the many hours of enthralling reading.

A bit of background about myself and family (I have pages of the stuff but I'm sure I can still get my point across without complicating things too much):
-We live in Wellington
-My partner and I are in our late 30's with two young children.
-I am the one out of the two of us that enjoys property and wants to make and investment out of it. My partner is interested but not as keen to commit as much time as I am to pursue IP.
-We have no IP's yet,
-Have been on an enjoyable and somewhat challenging learning curve since February re IP

-My partner and I still have a mortgage on our lifestyle home of around $43,000 which will take around 2 years to be repaid everything remaining the same. The mortgage has been on a BNZ rapid repay for the last 4 years since we purchased it and our debt is being reduced according to what we have budgeted.
We have around 90% equity sitting in this home, in my thinking doing nothing.

-Thus the idea to use the equity to leverage into IP's.

-I would consider us to be conservative-slightly moderate risk takers when it comes to investing, especially with large amounts of money involved in a property transaction.

-We do not have other investments, cash etc with which to leverage.

-We have a family trust set up and a newly formed (empty) LAQC.

-Our property goals are in 15 years time to replace our current income (in todays dollars) and build equity

strategy for this:
to purchase long term "buy and holds" and increase value where possible a bit further down the line, with things such as adding carport,garage,room etc. Nothing too adventurous/expensive.

-purchase positive cashflow properties before depreciation claims, use P&I, once personal mortgage repaid. (sounds wonderful and very easy to type into the computer)


I started out thinking that I would use the equity in our house to use as the 20% deposit to purchase our IP's.

I have run through many analyses trying to jiggle this and that and the only close solution has been to provide a debt free/cash deposit of around 20%-25%. and put me on the happy track to P&I happiness, and positive cashflow before depreciation.

Now of course the problem arises - we don't have a cash deposit to set the first one going.

I of course want to purchase now or in the near future, and can see the following acceptable options:

1) Buy at well below market value to provide the invisible deposit to produce the positive cashflow
2) Repay the current home mortgage of $43,000 (2years) and take another (2 years) to save $40,000 for a deposit. That is 4 years away.
3) Increase our income to achieve 2) faster.

I have looked at selling our house to free up cash equity and buying another home for a lessor amount. The financial cost I estimated would run close to $20,000. Real estate fees $15,000 just to start and then shifting costs, conveyancing for selling and purchasing, trustee documentation, as the house is in the trust. So, I didn't really think that this made to much sense to make and instant loss of $20,000.

I have looked at IP analyses on properties ranging from listing prices $180,000 - $220,000 taking into account 100% leverage, interest only over 20 years, claiming deprecation on buildings and chattels(just the normal IRD stuff allowable), no account for property management expenses and squeezing the purchasing price down to ridiculously low prices, and maybe I have came across making $10 a week at the most, then decreasing to -ve figures after about 5 years due to depreciation claim reducing significantly.

What I have picked up from general reading over the forum is that investors that do have mortgages still remaining on their homes have already invested in IP's. For those readers out there who are in this situation what did you do before you bought your first IP? did you use the equity in your home as the deposit for your IP's? if so how have things worked out for you? if not, what did you do?

If someone is in the same or similar situation as me and has managed to make sense of things please come out of the closet and let me know what you think?

Looking forward to hearing from you,
till next time,
Annett

[orion]

Hi Annett, just realised it was you!
Congratulations on your first post, well done.
See what others have to say, seems to me like you are on the right track anyway. I'll be back in a week, just going away to Australia this morning.

Regards
Graeme Fowler

[Gerrard]

Hi Annett, a couple of things leap out at me:

1) You see yourselves as conservative-slightly moderate risk takers
2) You (probably) have a good income to pay off your current mortgage at the rate you are

Based on that, you could look at buying in good "safe" location where the yeild might be lower (than otherwise possible) but you'll have a good property where you can attract good tenants and it should make for a relatively low risk and low hassle investment.

In areas like Newlands and (some of) Lower Hutt you should be able to get 7% - 8% return. This means you may be neutral to slightly negatively geared, but once your own home is paid off you will be able to pay off the investment property at a fast rate.

There are risks with leveraging the equity in your own home, but it it more tax efficient (i.e. ability to claim tax deduction on 100% of borrowing rather then 80%). I don't understand the full risks here so perhaps a few of the beanies could make comment?

So, that's one idea to get your thinking started. Good luck!
Gerrard

[orbital]

I am in a similar position,
married, in early thirties, living in Auckland, have just gone to one income with baby on the way, about 90% equity in the house "doing nothing" with a mortgage of $80k, which is looking like being paid off in about 5 years. And not looking to move/downgrade.

Savings, about $10k in shares.
Also conservative moderate risk takers.

And also in the dilema pay off mortage then save for a depoist on a IP ..long way away, or use equity as a deposit.

I've been through much the same analysis as you Annett, but I still find it hard to get my head around the fact of still having personal debt (mortgage) while borrowing more (yes very conservative here) for a IP.

So have the posters here done as Gerrard has suggested and leverage the equity in the home for tax efficency, and at what point do they say " maybe I'll clear all debt off the family home and have that totally debt free instead of leveraging it some more for that extra IP"
Or do they in fact not clear that and continue to use the equity as a easy form of leverage and finance?

Regards

[Gatekeeper]

I can only speak for what I'd do.

If I had debt at this point I would be working hard to get rid of it. I don't think its a good time to get in to PI at this point in the cycle. Too many "ifs" at the moment if you are conservative (like me). Better to cut back debt and beat the raising interest rates and tuck away equity for future use.

Try an investment in energy or commodities, or hang out for higher interest rates, they are sure to come. I'm investing in my own homes energy efficiency. I reckon the return on this will grow significantly in the next few years as energy costs soar.
Saving a dollar can be as good as earning a dollar, and a lot more passive

Good luck and wise investing.

[Gerrard]

Hi Orbital - A big question to think about from the start is whether property is the right investment for you?

I didn't really think about it when I first started (only 18 months ago so I haven't had a lot of experience yet). There are lots of other investments out there, but property has probably been one of the more high profile ones lately.

I still haven't looked much at other kinds of investments because I can see how property fits with my goals right now, but I do plan to diversify in the future.

I still owe about 45% of the value of my house, but have leveraged it to purchase investment properties. I consider my own home as one thing and investments as another. I'm paying off the home loan from my salary while the tenants are paying off the investment properties. So from that angle taking on extra debt doesn't worry me at all.

I have been looking for other ways to reduce my homeloan, but I still consider this a separate activitiey from my long term investment properties.

As for timing getting into the market, I think any time is a good time, so long as you can find the investment that suits your goals.

I don't see any evidence of a major crash coming up, so if values aren't going to change much in the next few years, then what is the point in waiting? You just end up kicking yourself for being 2 years behind where you could have been.

Gerrard

[Marcus]

Welcome to PT orbital and Annett.

First off Annett,

1) Buy at well below market value to provide the invisible deposit to produce the positive cashflow
2) Repay the current home mortgage of $43,000 (2years) and take another (2 years) to save $40,000 for a deposit. That is 4 years away.
3) Increase our income to achieve 2) faster.

1) sounds to me like the better option to consider.
Your own home could be used as security and you could borrow 100% of Purchase price (perhaps more for adding value to the purchase).
Purchasing well below RV is not an easy task at present but not by any means impossible.

Another option could be to refinance your home loan and approach another lender with cash to act as a deposit (and temporary loan to your new IP company if you choose) on your first IP. If you are able to find a property that is perhaps under value and or needing a tickle up to raise its value enough, you may be able to then refinance that IP and pull your deposit to either repay to your home loan or use as a deposit on the next IP (Disposable income permitting).

Gatekeeper raises a valid point that now may not be the best time to be getting in to the IP business. That point however, may well be investor specific. You appear to have some sound ideas on investing.

Whether prices will go up, down or :arrow: over the next few years is anyone’s guess. However, the sooner you purchase, the sooner someone else starts paying your IP's Mtg for you
If you buy & prices go nowhere for the next 6yrs you have had the principle reducing for that period (thank you tenant). You may have even decided to expand your portfolio even further in that time….. who knows!?

I have often heard it quoted that the most important factor in investing is time.
Once it is spent it cannot be reclaimed. Between now and when you start investing, you may miss many learning opportunities.

At the end of the day, as always, the ball is in your court.

Kind regards,
Marcus.

[janesco]

Hi Annett

Welcome aboard. This is a fun game with lots of people to play with.

I can only tell you what I did. i'm no Guru though.

I had about 10K left on my mortgage. Sounds cool but the house was only valued at 130K.

I sorted out my limits with the bank and went shopping.. I have to say there was a certain amount of luck involved but I read everything I could get my hands on and had the basic concept in mind.

I found a place that had two separate houses on it ( a three bedroom and a two bedroom) that had been turned in at auction. I never buy at auctions ... too chicken.

I purchased this property and immediately had it valued. ie on the same day I took possession. The very nicevaluer added $94K to the price I had paid for it. To assist him I had done some homework and had an idea of the values of similar properties that had sold. My valuer found this very helpful... Actually I don't think he liked it.

Any way there you go it now has it's own equity.

I then went out using this extra equity and purchased three properties that were cash flow positive. They all combine together to pay for them selves. I stole this idea from Brad Sugars and his wagon wheel approach.

I have subsequently finished paying for my meagre mortgage and have adopted the attitute that I am just another tennant so I pay rent as well. This will help me gain further equity to continue playing the game. Actually I'm about to start buying again.

My ambition is to be as successful as Orion (HA HA).

The bottom line for me was do your home work... Talk to everyone who is into property Don't panic.... Don't rush..

Hope some of this helps

Allan S

[Nobleone]

debt free on your PPOR

Hi All,

I love reading these posts...

Just last week I had a meeting with my finacial advisor and he asked me what my short term goals were now that I was investiong in IP's.

One thing I mentioned was to eliminate all debt on my PPOR for the security factor because that's what my dad had always taught me.

OK time for a complete change of basic training...

he did a rough calculation based on my PPOR being worth $300,000 showing that if I used the 80% the bank would loan me I therefore had $240,000 to use as 20% deposits on IP's.

therefore I now had the purchasing power to buy IP's with a total value of $1.2milllion.

Which he pointed out if they were all cash flow positive would easily cover the cost of the 80% mortagage on my PPOR and also provide me with an after tax income of around $60,000 per annum.

he showed that even debt can be good for your long term wealth.

These are just rough calcualtions and I know that there are probably some maths geniuses on the forum that will take it apart... But at the end of the day paying off your PPOR may not be the best idea.

Cheers, Barry

[hawkeye]

Hi Annett,

We're in Wellington too. Have two small children and one on the way and we are both leaving the corporate world at the end of the year to live on the income from our Investment Properties (75K before tax per annum) It's not retirement because they can take considerable time but it is freedom from salary slavery. We can live our present lifestyle and very slowly eat into our capital or work occasionally when it suits to keep the capital intact.

This was achieved by using the equity in our own home on Mt Victoria and buying a number of Investment Properties. We were lucky enough to start this strategy almost three years ago so we have reaped a considerable capital gain on the Banks money. It can be very scary when you look at your mortgages and see how much you owe so you have to do what feels right for you.

The strategy worked for us but it is a different time in the cycle now.

Good luck with whatever you try.

One piece of advise I'd offer is to make sure you do thorough due diligence on each property you invest in and get your overall structure right before you start.

Regards, Hawkeye

[Belinda]

Hi All

Very interesting reading. I'm a first-timer here, have quite recently purchased my first IP (6+ months ago) but have been surveying the lay of the IP-land for the last couple of years now.

My advice is take every property on its own merits and be clear what the purpose of that purchase is i.e capital gains, income generating or whatever. Read, read and read some more. There are fabulous books out there.

I don't have a problem with leveraging, seems to make a lot of sense to me, but you do have to be confortable with your own decisions. One thing I have learnt in all of this is that at the end of the day you shoulder the risk, an everyone has a different opinion. Goodluck Annett

Belinda

[Annett]

Thank you to all of you for replying and sharing your experiences and ideas. You've been most generous and your ideas have been very helpful to me and I hope to others in a similar situation.

By all means I don't wish to end the conversation, so keep it coming if you want to take part.

I just wanted to make contact before the time lag got to long and to show my appreciation.

Its neat to see real people "out there, doing it, and sharing it"

till we chat again.

Annett

[tamara]

Hi Hawkeye

As I am an expat I am always interested in what strategies people utilise when purchasing IP in the country they live in. So if you dont mind could you answer a few questions.

When you made your purchases what type of gearing did your properties have?

Did you refinance your PPOR to find the deposit or cross collateralise?


Thanks

Tamara

[janesco]

Hi Tamara

I thinkmy message was pretty self explanatory.
I just used the equity in my PPOR. Then immediately had the investment properties revalued. I used the new equity to continue playing the game.


No need for refinancing.

Allan S

[Glenn]

Great stuff there from everyone.
One thing is clear we are all different in the way we go about our investing. Yet the funny thing is everyone is correct.
The economy changes all the time. Like interest rates or rates of return.
Generally over the long term for most of the time factors transpire to always make it hard to get started. So at any one point in time looking at the figures only make no sense.
The first IP should really be regarded as a building block or stepping stone. You can not expect to get very much if any cash rewards from it for some time. What you will get is a mechanism to build equity on.
Generally since I have been in the game the interest rates have moved around from 7% to 15%. So in some years when the interest rates have been 15% I have been able to buy properties with 14 to 15% rate of return. Generally every property I have purchased has appeared to put me backwards for two years. Then after this period it all seemed to suddenly look wonderful.

Glenn