Investing strategy - Risk, cash flow, buying the next property.

[sbw]

I would like to hear about people's different investing strategies.

I am looking at buying a third rental property - my strategy is to never sell and eventually build a big property portfolio that I can retire on from a passive income (a long way to go yet!).

I only have two properties now (live in one, and rent out the other).

If mortgage rates where to rise to say 8-10% and my tenants moved out, I could still quite easily cover the mortgage and all expenses for both properties. The current rental property is cash flow positive and doesn't require any top-up from my own salary.

If I was to buy a third property... (property c) which I now have the equity in the other two properties to do and are looking in to (hence my reasoning for asking a question)... I could cover the mortgage and expenses if it was empty, as long as my other rental property was tenanted.

However - say I couldn't find tenants for both rental properties and interest rates rise to 8-10%, I 'could' cover all the expenses and mortgage.... but only just! - I'd be scrapping the bones of my bum to live.

The third property would be cash flow positive (part of my buying criteria), so as soon as one of the two rental properties were tenanted I would be right again.

I guess I have to consider the chances that two properties will be left empty at the same time between tenancies, and any major R&M that needs to be considered. The other thing I'm considering is putting in place say a $5k cash fund for rental contingency only (before buying a third property - although it is tempting to use this now and reduce the mortgage).

I'm pretty sure I won't be the only person out there with this problem... I know several people using this forum will have >3 rental properties and to those people I ask, when you are buying a property to expand your portfolio do you consider the worst case scenario of having all your properties empty at the same time and interest rates rising?

The other option is to wait... yes I'm the first to admit I don't have much patience... reduce current debt so that the properties become more cash flow positive and then there is greater cash flow to cover other mortgage payments. However, there are certainly some good deals out there I am picking up on at the moment. (n.b. I am more interested in cash flow than any capital gain - if in 30 years I am mortgage free I will stay have my rents as cash flow and a passive income to live off!)

I would appreciate other people's thoughts towards this topic and any ideas or suggestions on moving forward.

I am also interested to hear if maybe a different strategy of buy, do up, sell is maybe a better strategy to take to start off with, in order to build a solid equity foundation to then invest with??

Go the All Blacks!

[charlotte30]

Dear SBW

Keep buying cashflow positive properties. Do not focus too much on potential vacancies as this will hold you back from buying more. Just deal with vacancies as they happen. It is highlighly unlikely that you will ever have all properties untenanted at the same time (even after earthquakes). To deal with the worst case scenario I keep a Line of Credit for sanf and this works well. Regarding a different strategy buy, do up and build on the backyard.
Charlotte30

[Tan]

I understand where you are coming from.
Once I got past the point that I could cover the mortgage payment with my wages I found it scary, and still do! But I had to get over it or stay the same since wages don't rise enough.

With residential, a month vacancy is very rare, and for more than 1 to be in that situation is not something I add to my worry list. I always have some access to money somewhere just in case.

Buying rentals in good rental areas (near schools, buses, multiple employers etc) helps, the first one I bought has never been vacant for more than 1 day and tenants stay years. The worst one which is on my PPOR section out of town has about 3 weeks vacancy every 2 years or so.

Also, buy in several suburbs in case something happens to one (ie large employer closes, or earthquake or tsunami if you want to get dramatic).

[sbw]

Thanks Tan,

Some good points there thank you. I knew I wouldn't be the only person that has come across this issue - if you have 3 properties costing you about $250-350 in mortgage repayments and expenses each month, your own salary can only go so far.

[NovInvestor]

Hi Sbw

I bought 4 rental properties in a year and never thought about not being able to pay the mortgage.

All i was interested was the gross yield i was getting, ie doing my numbers.

If interest rates go to 8%-10%? I didn't worry or give much thought about that either, as by the time interest rates go that high, inflation will be through the roof, and so will property prices. At that point I can just sell one of the properties, cash in the equity, and cashflow comes from the reduced mortgage.

PS: I always leverage to more than 100% of each property, ie banks pays for all, and I put in nothing.

Once you condition your mind to see the $ just as a number, your stress level goes down significantly!

[sbw]

Thanks NovInvestor - again some good points. I guess it is really an analysis of risk and 'what ifs'.

Completely agree that it is always a numbers game, and cashflow is what I am after.

If you don't mind me asking how did you buy 4 in a year? Did you have a big stack of equity to start from day 1. Or did you add value to each to re-finance the next. If you were to re-finance - did you buy under value do up and revalue each property in 3 months?

I guess the next step is to go through the numbers again and get out and put some offers in!

[NovInvestor]

Yes I am fortunate to have a bit of equity to start with, but, all my purchases were 20% or more below After-Renovation-Value.

So if I started with 1 at a time, it just takes a bit longer to refinance and get 4.

add value to each to re-finance the next is a must, otherwise equity will run out very quick!

did you buy under value do up and revalue each property in 3 months? - yes, 6 month at the start, now 3 month is very doable, only problem is finding the right deal.

[spaceman]

When I started out, I was concerned about the whole what if my rentals are empty for too long or there is some large repair/maintenance bill.

My answer was to use LOC/revolving mortgages ..... I paid in extra money to use as a slush fund in case of lack of income or large surprise bills....... Earlier on my slush fund was large and I guess as I got more confident it got smaller.

Since 2007 when my slush fund was at an all-time low, I've been building it up again ...... now to be honest it's a bit larger than I want it to be and the extra cash is burning a hole in my pocket.

Each time I've refinanced or changed banks, I've made it clear that part of the deal includes preserving the slush fund when lenders haven't wanted to do this they simply didn't get my business ....... right now that's making it harder to borrow more but I'm happier waiting and keeping my large slush fund rather than buying again and paring it back........ tempting though as there seems to be some good deals out there right now.

Cheers
Spaceman

[drelly]

Buy good quality property (or do it up so it's in good shape when you rent it).
Don't buy anything that doesn't cover all expenses unless you have a plan to change that in the short term.
Don't buy crappy properties in crappy areas because the cashflow looks good.
Don't put any old tenant in because you're scared of vacancies.
A month vacant is better than a bad tenant.
Don't stay highly leveraged forever - houses of cards do collapse. See Terry Serepisos for further details. There was an article in this month's property magazine about a successful property investor with $3m equity who rented his family home and drove a leased Ferrari. He says he lives for the day. Well, good on him... but he was 80% leveraged. If the market goes the wrong way while you're that highly geared, it doesn't matter how much equity you have.

[sbw]

Thanks Drelly - I know most of that stuff - and have put it into practice but it's always good to be reinforced.

Yes I read that same article in this months PI magazine - He had 10mill or property and 3mill equity.

I liked his idea about renting himself though - it sort of made sense... The article said he paid $2,500 per week to live in a $6,000,000 house. My calc put weekly mortgage repayments on a $6mill house (assuming 20%) at $6,600. Guess it depends if you want the comfort of living in your own home and doing what ever you want (knocking out a wall here and there).

a bit off topic sorry guys.

[Re@der]

Agree with previous points but restate that if you limit yourself to mortgages that you can pay if you have no tenants in any property, this sets a natural limit to how much you can borrow and puts an extreme brake on growth of your portfolio. Where as a more sensible brake would be perhaps a percentage of your total income. ie of total income of job and rents no more than 80% should be used for paying interest. I do not do this myself so do not know what this number is but it could be part of a reasonable risk mitigation strategy.

[Wayne]

Agree with previous points but restate that if you limit yourself to mortgages that you can pay if you have no tenants in any property, this sets a natural limit to how much you can borrow and puts an extreme brake on growth of your portfolio. Where as a more sensible brake would be perhaps a percentage of your total income. ie of total income of job and rents no more than 80% should be used for paying interest. I do not do this myself so do not know what this number is but it could be part of a reasonable risk mitigation strategy.

The banks do don't they? They assume you will not have 100% occupancy across the portfolio and adjust the imcome side accordingly.

[DaveW]

yes the banks work with 75 or 80pc of rent to factor in vacancies, maintenance.

I started off by renting the house i lived in and sublet the other rooms so i was practically living rent free. I then bought 4 rental houses in west akld and completed a 2 week reno on each and tenanted. 6 months later i refinanced to buy 3 more no money down and repeated the reno work, and finally repeated with another 2. I never had any vacancies as tenants loved the renovated properties and I always added equity after i bought. This was all about 15 years ago but same simple rules apply today.

[Kerry Christian]

Never buy on Gross yield


Use only NET Yield