I've hit the serviceability wall

[QueenBee]

Hi all

I would like to know how other investors (with numerous properties) get around this. My initial understanding was that as long as the properties were paying for themselves (postive cashflow) then serviceability shouldn't be an issue. I don't really know where I got that from - someone must have told me!

I have a PPOR (which is nearly freehold) and 3 investment properties. I have used the PPOR as security to buy the rentals with 100% finance. Initially, the bank wanted to throw money at me. All three rentals are owned by our LAQC.

My partner and myself are self employed and take wages and pay PAYE. But as you would know that owning a business has it's ups and downs and last year we didn't always pay ourselves first. Subsequently our wages were quite low, plus we also had another baby since first applying for our mortgages.

So I went to the bank and asked if we could have another $100k and they said no. The reason was that of serviceability. We were something like $800 short a month. But I said to them wouldn't that mean that everytime we bought another property our wages would have to increase. And I think that basically they said yes. They said even though the LAQC owns the properties we are still personally liable for them if they are all vacant at the same time, therefore the amount of the mortgages (around $1350) per month must be able to come out of our wages. I thought this was stupid.

I then decided to try a Broker. I went to Mike Pero mortgages. The woman basically said the same thing. I thought about it afterwards and thought hold on - you are not treating me as an investor, you are treating me as if I were Mum and Dad buying a house.

The computer programmes that they use to work out serviceability - are the same whether you are Mum and Dad or an investor.

So people with really big portfolio's - how do they do it? Surely their incomes don't have to go up every time they buy a house. And in fact they do don't they, because rent is part of your income. But then it's negatived out again because they say you are liable for all rent.

Am I missing the point somewhere! I can't seem to get them to understand my point. Am I talking Japanese?

Cheers, QB

[cube]

Hi QB,

There is some discussion on this elsewhere, but the basic issue is that the banks only take account of 75% or so of your rental income.

So, your perfectly cash positive property suddenly looks break even at best, and thats when its occuppied.

The ways those with large portfolios do it (Graeme, jump in if I'm wrong ), are

a. Patience - rent and equity will eventually rise (may take a few years in some places) to out-run the mortgage.

b. Paying off the mortgages as quickly as possible - the reverse of your solution to earn more is to owe less.

It is a good question, and one that stops quite a few new investors (us included ) in their tracks, just as they are getting keen!

Although the LAQC holds the title to the properties, if you read the small print, you'll find that you PPOR is used as security for the mortgages and you are personally responsible for the mortgages. The LAQC is really only useful (in IP terms) for redistributing tax benefits.

This hasn't helped, but hopefully things are clearer now.

cube

P.S. I'm not a property professional of any sort, so don't believe a word I say - check it out for yourself! All care, no responsibility!

[masteraccountants]

Hi,

The former poster's comments are correct. Banks don't just look at the deb-to-equity ratios, they also look at serviceability and they don't take into account all of the rental income. They assume a certain level of personal living expenses will apply, so they make their own calculations.

Your problem has been magnified by variable self-employed income. Banks like wage and salary earners on fixed incomes, even though business people's incomes can rise faster than wages and salaries.

Even when you satisfy the debt-to-equity ratios and serviceability criteria, you may bump up against the bank's global lending rules. Some only lend up to $750 000 to an individual customer.

That is why it's best to use a broker who knows all of these rules, and will structure loans with different banks so that you get the best deal from each bank. The banks pay the finance brokers - not you - so use them.

Chris

https://www.masteraccountants.co.nz

[kieran]

QueenBee,

Your problem is not a new one and whilst there is no simple 'quick fix' there is some good news for you...

First let me tell you a bit about how this problem affected me personally. In 1995 I was in a high paying job but realised that before long I would hit the 'serviceability' wall. Back then as an employee I could hardly ask my boss to increase my income to assist me to buy more properties!

But then I realised that the self employed investors I knew had a distinct advantage over the salaried/waged in respect of borrowing because when you are self employed you do have more control over your level of income. Lets face it if you are self employed and prepared to sacrifice more time (that you could spend doing 'lifestyle' things) then you can most likely increase your turnover/profit and hence your borrowing capacity. Unfortunately this is not a 'quick fix' as even if you instantly increase your profit the lenders will want hard evidence (ie financial accounts) and also a history of sustainability of such an increase (ie maybe 1-2 years!).

I started my own business in 1996 and started growing my income to the point where I could borrow much more than I ever could have if I had remained an employee. Of course I still got close to hitting the serviceability wall so I focused on my business and sought my clients advice of what extra value Icould add to them. They told me exactly what I could offer them and what they would be prepared to pay for such added value! So I started another business to meet that need, and then I repeated that process resulting in my building a Group of companies.

In the first few years of self employment I had to take a step backwards in terms of my borrowing capacity but eventually that had completely changed. Then the challenge is just to continue growing your profit by re-investing in your business/es whilst still growing your property portfolio. Over time rents increase too (on the properties you already own) which also assists with your serviceability of existing debt (from the lenders view).

I have found that business and property compliment each other perfectly because business generates cashflow relatively easily (it is harder to create large equity in a business) but property creates equity relatively easily (it is harder to create large cashflow from property) and of course business creates a tax liability (income) whilst that liability can be offset by tax losses created by property!

The good news for you is that you are already self employed so you have the basis to increase your income already!

The other potentially good news for you is that there are now plenty of 'no financials' mortgages available PROVIDING you have adequate equity to borrow against. With these products you don't even have to prove your income!

Alternatively if all else fails and a property opportunity is still worth pursuing even when paying a high interest rate (ie @14%!) then talk to your lawyer who may be able to lend you 'trustee funds' but will only lend you up to 66% of a Registered Valuation and usually only for 6 months or so. I have used lawyers funds on occassions and found them suitable for short term opportunities which I have subsequently refinanced through traditional lenders.

Hope this helps and rather than wish you have luck I wish you have focus and concerted effort!

[orion]

Hi Queen Bee,

Yes, I agree with what the others have all said. Each of us has our own strategy to overcome this common problem with the banks. For me, I used income from wraps several years ago, lease-options is more applicable today for creating extra cash-flow from real estate. I agree with Kieran though, in your case if you are already good at business which most people find difficult, work out ways of increasing your cash flow from that, so the banks are happier. As Kieran says, sometimes it's a time issue and if rents do increase, this will help your servicability, but it can be slow waiting for that to happen. If you want to make it happen quicker, you need to ask yourself how you can increase your current income in the quickest time. I don't know of an instant fix, but will let you know if I think of one.

Regards
Greame Fowler

[QueenBee]

Hi all

Thanks for all that info. I am making an effort this financial year to increase my income. When I first started my business, I was always worried about paying the bills on time and paying myself and my partner last. We basically got the dregs left over. This year, I've set up automatic payments to pay ourselves first every week, no fail, and the bills gets paid by the dregs. It's actually worked out quite well really, and I'm managing to pay my bills. I've also managed to cut back on some things that I didn't think were essential.

I've recently joined OZONE Barter and have been able to update software and get some new brochures printed off only using Barter dollars. I probably wouldn't have been able to buy these things with money from the business.

My properties have about $130k equity in them now and I only bought the properties just over a year ago, so I'm pleased with that, but they probably won't go up much until the next boom.

I've looked at up-selling in my business, so hopefully that will take off in the near future too.

Thanks for all the info. It's hard to find a good Broker though. There are so many out there, I don't know who to choose.

QB :

[fudosan]

Many property gurus tell us that you can buy several properties a year. I wonder how they actually do it, or maybe they are just selling us dreams -- expensive dreams.

[orion]

Hi Fudostan,

You actually can buy many properties a year, but it depends on how you do it. For QB, it may be best to focus on business. For someone that wants to do it solely from property - when you are more experienced you can sell contracts on, do quick cash deals, renovations etc. Just by knowing the market well and working these strategies and having good experience, it is quite possible to easily make $20,000 - $30,000 extra a month, which the banks take into consideration for income. Also by buying well below market value, then refinancing properties for 80% of valuation a few months later, or doing minor repairs and getting them valued earlier, you can draw out most if not all of the equity that was used. This is when it comes back to servicability once more and you need the extra income either from business or from other property strategies. If you are more of a beginner in property trading and investment, it's not impossible - but certainly more difficult, and has more risk associated with it.

Regards
Graeme Fowler

[drelly]

Hi QB,

Just an aside here... be very wary of barter schemes.

I used to be a member of Bartercard and although I know the charges in Ozone are a lot less, the concept of barter money, no matter what the scheme has a fatal flaw.... tax. You can't pay it with barter money!

So... if you earn $1000 in barter money, you then have to find the $333 (33% tax) in cash to pay the IRD... worse, you then have to find the 12.5% GST in cash when you go to spend it! (if you can!)

I have seen businesses run into the ground through using barter and still not realise the problem with it.

[QueenBee]

Thanks good point. Do I have to declare it. Will I get in the poo? How will IRD know?

Cheers, QB

[masteraccountants]

Cheers QB,

IRD know about Bartercard and similar organizations, and they can check on their records of members.

And if you don't declare your total income, IRD have some nasty penalties for tax evasion. So it pays to record all of your income. You are supposed to pay GST on your barter transactions, as the previous poster informed you. So make sure that you use up your credits.

Mind you, you can use some of your Bartercard credits to purchase a house. Contact your barter organization to see if they have the same arrangement with most banks.

Try to use the credits one way or another, as you can claim GST on purchases/inputs but have to pay GST on income/outputs.

Sorry to be a party pooper.

Chris

https://www.masteraccountants.co.nz

[drelly]

^^ What he said...

If anything, I'd say that the IRD would be likely to target barter members for the odd audit as records of barter money cashflow are so easy for them to check. They can demand records from Ozone itself.

[Guest]

The banking expression for the problem is "rental reliant". The wise men above are correct in that you either have to add value through improvement, wait for inflation or increase your income.Banks certainly scale rent by 75% but some like the BNZ increase scaling to 60% on the third purchase. I see all your properties are financed with one Bank. Whilst this may be initially convienient you place yourself in a position whereby if you want to sell one property you will need to get the Bank consent to release as all assets are tied together (crosscollateralisation). This may mean updating your accounts and having them all revalued.Extra expense in other words. As our friendly Mtge Broker Kieran will confirm the ageold strategy is "divide and rule". Ie raise the 20% deposit against one asset and use it as the deposit for a 80% geared purchase financed with another Bank.That way when you want to sell you can do so as you wish without recourse and the Bank having to review your financial position. Some Brokers suggest using different entities and blind trusts (use a corporate trustee) to hide effective ownership.(although youre still personally liable) They then exploit these structures by not disclosing them when they apply for funding for a new property. A little naughty but if they are self servicing and APs and rent aren't on your own bank statements..........

[kieran]

Yes, Mars has rightly pointed out the divide and rule concept I use and promote and I also promote FULL disclosure to all financial institutions.
Non-disclosure is a serious offence (Fraud - ie get caught and go directly to jail - Do not pass go and do not collect $200!) and yes that means you must disclose all of your interests etc in all trusts if you are personally a trustee, beneficiary or liable for the debts of that trust.

[Guest]

Aha, an honest broker,good on ya, quite right too. Using a document for pecuinary advantage is fraud. It happens though.Sometimes people use brokers deliberately to avoid full disclosure of contingent liability.The danger for the Broker is not really prosecution for fraud but the Bank refusing to deal with them again.