How to improve servicability

[Gerrard]

Here's somethng to think about for the number geeks out there:

From talking to ASB a while back my understanding is that in calculating servicability for loans they will use the following numbers:
- 70% of rental income, thus allowing for expenses, vacancies, etc
- current prime lending rate (i.e. floating rate which is currently 8.75%)
- 25 year term
- repayments are calculated at P&I.

ASB is known as being conservative so other lenders may use different figures. For the sake of this example I did a quick calc about the yeilds we currently need to be getting (based on ASB's criteria) so as to not affect servicability.

For every $100,000 you borrow
P&I payments will be $9,975 a year at 8.75%
That means you need $14,250 of rental income per annum (70% of $14250 = $9975)
That is $274 a week in rent
Which is 14.25% yield

So currently, for your servicability to remain unaffected you need to be buying properties at 14.25% yield. Yes that's possible, but not common in the larger centres.

If you're buying at less than 14.25% yield then servicability is going downhill and at some stage the bank will not lend you any more money.

So what are the options to improve servicability / avoid this problem?
- find lenders who are less conservative?
- only buy high yielding properties?
- have masses of equity so the bank likes you more?
- the slow and steady route to property acquisition?

Any other suggestions?
Gerrard

[Roberto]

Well, the banks are relying on all your income incl day job to determine serviceability.

[Marcus]

So what are the options to improve serviceability / avoid this problem?
- find lenders who are less conservative?
- only buy high yielding properties?
- have masses of equity so the bank likes you more?
- the slow and steady route to property acquisition?

Any other suggestions?

I was 1 IP away from hitting the serviceability wall last year. I have since sold 1 due to its out of town location, and my lack of confidence in Auckland city rental projections. This still means I am now 2 IP's away from the same fate unless I have a change in strategy. The area I am focusing on this year will be how to generate more income. The two areas I am looking at are buy well/reno/sell, and business.

I must say that it is comforting to know that there are PT members here that are active in both arenas whose experience can be called upon in trying times.

Any business propositions out there???

Cheers,
Marcus.

[wealthspy]

Hi Gerrad,

OK so there are a number of vairables,

1.your personal income,

2.your rental income,(70%)

3.your debt to service

1. your personal income,

you could try working for more money , but most of the time thats no fun unless your in the 100k bracket which would be great on your DSR (debt service ratio)

Maybe you could look at other options, like No DOC loans, this is good if you are self employed and you can actually state how much you earn as an income, the key point here is because it is a no DOCuments loan you don't have to provide proof of income and lets say you just told them that you earned say 70k per year even if your only started in business.

NOTE: you will normally get charged an extra 1% for this type of loan.

2. your rental income

Charge more rent, fix the place up, do a renovation(calculate the figures) add an extra room, unit on the back i.e. home and income.

by asking more in rent this will add extra to your DSR.

3. your debt to service

ensure you have no personal debt before hand

buy below valuation.

OUTSIDE THE SQUARE: if it's on a large section subdivide, sell off extra land and reduce the the debt.

Have agreat Day!

Matthew Taylor
[email protected]

https://www.wealthspy.co.nz

[Gerrard]

Hey guys - good answers thanks.

[kolzee]

Hi Gerrard,

thanks for adding a very good post.

I think you've explained very well the major barrier for property investors to continue their expansion in portfolio.

It's interesting also that the other posters (no disrespect) have only been able to come up with changes in the factors which would be done as a matter of common sense regardless of servicability - eg increasing personal income, increasing rental income, buy below valuation, etc.

My question then is how does this change if you are paying interest only? I have repeated your calc below to show this for interest only based on an interest rate of 8.75%.

For every $100,000 you borrow
Interest payments will be $8,750 a year at 8.75%
That means you need $12,500 of rental income per annum (70% of $12,500 = $8,750)
That is $240 a week in rent
Which is 12.50% yield

Also, if you use the current fixed interest rate of 7.6% this yield is 10.9% (209/pw rent).

Also though, a key point in this calculation is that the yield is being based on the borrowing amount rather than the purchase price/capital value, which is what I and most people use to calculate the yield they refer to.

Am interested in your thoughts.

cheers

kolzee

[lissie]

OUTSIDE THE SQUARE: if it's on a large section subdivide, sell off extra land and reduce the the debt.

And get classified as a trader by IRD and made to pay CG on both that sale and any others you might make over your entire portfolio

[wealthspy]

Yes Lissie,

you may have to pay Tax, depending what your intentions are on the whole with your portfolio, if you keep the investments for long term.

- if you use a trading trust
-LAQC

which ever is the best option that your tax specialist can come up with.

maybe you might have a OUTSIDE THE SQUARE opinion?

my understanding that talking with my accountant, he metioned that if you sell 1 or 2 properties a year and as long as you have the right structure. you can defer CG tax.

in the end you will have to pay tax eventually, would it be worth it if your cashflow improved, and your debt reduced?

have a great day!

Matthew Taylor

[Gerrard]

Hi kolzee - I'm really interested to hear from those who have bought lots of property in a short time how they managed this.

I'm also keen to find out other banks' forumlas. I've been told that ASB is very conservative (which you can see from them using the floating rate, P&I etc), so I wonder who is "lose"? I guess that's the value a good broker brings.

Cheers
Gerrard

[kolzee]

I can only offer from my most recent experience with BNZ who advised that they used the same calculation (ie 70% of income) but on the fixed rate (which they raised just before purchase from 6.9% to 7.6%).

Unfortunately my gut feeling is that it's the type of thing that they are only really honest to you about once you hit 'the wall' of servicability. In my scepticism about banks' honesty, I am suspicious about just how honest they are while gaining your business....until you've hit their threshold....

I hope over time I'm proven wrong however!!!

[Wayne]

Westpac do 90% of rental income for me!

[Gerrard]

Hi Wayne, have you done something to gain their favour or is a general Westpac rule?

Cheers
Gerrard

[whitt]

So currently, for your servicability to remain unaffected you need to be buying properties at 14.25% yield. Yes that's possible, but not common in the larger centres.

If you're buying at less than 14.25% yield then servicability is going downhill and at some stage the bank will not lend you any more money.

Wow Gerrard I had a similar thought a few weeks ago and ran some serviceability calculations too. I came up with about the same figures 14% would be an ideal yield that would not affect servicing levels.
The reason I was looking into it was the fact. A lot of the seminar type followers have gone out and have maxed out serviceability levels to buy numerous properties. This on its own may not be bad but could be slightly flawed during a slump. If values do not increase much in years to come they will quickly run out of serviceability and find they have to wait quite a while.
As a side note some of these seminar followers have been purchasing in less than desirable areas. Which are slow to move in value until later in a property cycle (ripple effect) so they won't be able to benefit until well into any property boom.
I have been drawing up a strategy of investing which suits myself:

• Always be aware of current serviceability levels.
• Property values can raise and fall so knowing your levels you can be prepared.
• At the end of a property boom it is probably better to have a lower servicing level. That way if prices drop you are more protected.
• Try to buy wisely during any down turn in the market so as not to affect your servicing level. Buy creatively and try to achieve high yields eg. Buy a 2 Br and convert to a 3 Br.
• Buy in good areas which will see growth early as the next property cycle rolls around. That way you can be in a position to use your gains early and go hard into a boom. Being 1 step ahead of other investors who may have purchased last cycle in less desirable areas.
• As the property market picks up and we lead into the next boom raise servicing levels high. Buy up big as each property shows equity growth.
• As the boom is nearing an end consider dropping servicing level once again.
• Repeat process.

[fudosan]

Excellent discussion! I'm actually thinking of switching to high-yield apartments if there is a crash in Auckland's apartment market and I can pick up some good deals, and then use the buy-renovate-sell approach using another entity when the market picks up again in a couple of years. Any problem with my thinking?

[RentMaster]

I'm actually thinking of switching to high-yield apartments if there is a crash in Auckland's apartment market and I can pick up some good deals, and then use the buy-renovate-sell approach

I am not sure there is a lot of scope to renovate an apartment. You cant change the outside appearance without body corporate permission. You cant add another room on etc. You cant landscape the garden. All you can do is give it a coat of paint on the inside. That wont add a lot of value.