The Mathematics of an IP

[hannah]

Guys…

I now have decided to buy a rental property. I personally do not have my own place so the idea is to buy a rental property (my first IP) and rent my self out as well.

Last night I have seen a place for the second time (Avondale Heights). It’s a solid house. My future father in law is a Master Builder and he gave it an ok as long as the construction goes. This is a very new house. Was built in year 2000. It has got 4 bedroom and 2 WCs. One internal garage and plenty of off street parking.

These are the financials:

The current tenants are paying $500/ week.
I have a deposit of $56000.
I have got a pre approve loan from Superbank upto $340k.

I am intending to form an LAQC to get the tax benefit from the government.

Now my question is what should be my offer to the vendor to buy this property. I think 7-8% yield is expectable. Really what I am trying to get is how you would evaluate this investment to work for you.

I do understand that if this property makes loss when I will eventually sale and if I make profit, I have to pay IRD the tax benefit I have received however I would rather like to get money form Mr. IRD ow and pay them back later.

I would really like to learn this simple mathematics so that I can create an Excel spreadsheet for me.

Looking forward to hearing from you all.

Kind regards

[drelly]

Hi Hannah,

Your approach is valid and often used in commercial property valuation. However, when buying someone's home, the emphasis for the vendor has nothing to do with returns (as they haven't been getting any) and all to do with perceived value.

What I'm saying is that this is a great way to set a price for the maximum that you are prepared to pay but the wrong way to approach a negotiation with a vendor.

What if you go in with a fair offer of $325k (based on 8% yield) but he was happy to accept $295k? You've cut your own throat!

When putting in offers, consider things like market values in the area, the vendor's situation and the condition of the market. I'm sure others will offer other things to consider as well.

By the way, it's important to establish WHY you're buying this property. If you bought for $325k, your borrowing at 7.6% means interest repayments of $393 per week. You have made the property CF+ve with your deposit but without the deposit, you'd be CF-ve. Is there some good capital gain to be made? Can you add value? If not, what's encouraging you to buy THIS property?

[Josko]

Hi hannah,

In addition, I think your approach to the tax benefits of investing may be misaligned to your intention.

If you purchase a +ve property as in the example provided, then an LAQC is not any benefit to you.

After your due diligence which includes doing what drelly indicated, you should start with the property advertised price.

Then apply the basic IP calculations to deduce if it is worth perusing and what is the maximum you are happy to pay for the property to achieve your rate of return.

Because you have a large deposit you should also consider the opportunity cost of such an amount i.e. could you be doing other things with the money that would give you a better return.

[hannah]

Because you have a large deposit you should also consider the opportunity cost of such an amount i.e. could you be doing other things with the money that would give you a better return.

Very well said and precisely my intention. I understand that with my full deposit I can make this purchase as a +CF however that is not the intention. An IP will either become +CF or -CF depending on the mortgage payment and the mortgage payment depends on the interest rate and the initial deposit. So LAQC is very much a vehicle if I pay less deposit and borrow more from the bank to make it a -CF.

I am just seeking if anyone has got a spreadsheet which they use to evaluate an IP. There could be some factors I may not be aware of.

I understand most of you have already have at least one IP if not more where as I am just starting and trying to learn from this forum as much as possible.

The asking price for the property is $388K. However apparently there had not been any offer on this property during last 6 months.

Does anyone one have got a spreadsheet which will calculate Return on Capital illustrating the advantages of gearing on a purchase of a let property. Surely I can build one for myself however if there is already one available, I would not mind to lay my hands on.

[drelly]

I personally prefer to use a calculator.

When considering the tax advantages of using an LAQC, work out how long you'll be benefiting by making a paper loss through depreciation (that's the only way my CF+ properties lose money). Also consider the issues with transferring the property to a trust later if that is your intention. The sudden growth in my properties' values has left me with an LAQC that will be difficult to transfer to my family trust.

[Fritz]

Re: The Mathematics of an IP

Guys…
The current tenants are paying $500/ week.
I have a deposit of $56000.
I have got a pre approve loan from Superbank upto $340k.

Hannah,

here are the basics:

Purchase Price $340,000.00 What you pay
Deposit $56,000.00 Your money

Mortgage $284,000.00 Other Peoples money (the bank)
Interest Rate IO 7.60%

Rent per week $500.00
Revenue: $26,000.00

Interest $21,584.00

Vacancy weeks: 2
Amount: $1,000.00

Insurance $450.00
Rates $1,100.00
R&M $600.00
Management 9.00%
Mgm. Amount $2,250.00

Operational
Surplus: $20,600.00
or EBIT
Earnings before
Interest and Tax

Gross Surplus: $-(984.00) (After interest)
per week $-(18.92) MINUS YOU PAY/ PLUS YOU RECEIVE


Ratios:
NET Return on cash basis on money invested -1.76%
NET Return on purchase price before tax -0.29%
GROSS YIELD (pretty meaningless, guide only) 7.65%

What does this tell you? How does your investment compare/benchmark to money in the bank or another investment or another IP ?

What would happen if you get it for 300K?

Is this a good investment in your eyes losing $19 EVERY WEEK with 56K OF YOUR OWN MONEY in it ?

Let us have your thoughts.

Also, check out Freezing Hot who has done this and bought his first IP:

http://propertytalk.co.nz/postt2946.html

Send me a pm and I am happy to give you that little excell sheet for free.

Having fun yet ?

Fritz.

PS: Andrew from Rentmaster has agreed to host this spreadsheet on his site and make it available for free for all PT members, simply click this link http://www.rentmaster.co.nz/pt/fritzquickcalc.xls to download it.

[Josko]

Hi hannah,

I have Fritz's spreadsheet at home, very good detail, not sure if it will give you the detail on what figures will make it tax effective, could give you a good start.

I am sure Fritz won’t mind me passing it on, at work at present, PM me or Fritz with your email address that accepts attachments.

Regards, Josko

[Josko]

Oh..i see Fritz is on to it, cool.

Good luck...

[Josko]

Also consider the issues with transferring the property to a trust later if that is your intention. The sudden growth in my properties' values has left me with an LAQC that will be difficult to transfer to my family trust.

drelly, I envisaged one of the benefits of having a LAQC or company structure initially was that the transfer into a trust in the future was merely a process of transferring the shares from your personal name to the trust?

Cheers,

[drelly]

The issue is that only $27,000 a year can be gifted to a trust. So if you have equity of $270,000 in an LAQC, it will take 10 years to get this transferred to your trust. The longer you leave it, the more equity there is and so on...

[Julian]

I'm no expert on trusts but this is what I have picked up:

You generally sell to the trust, exchanging property (or shares in a property company for debt). You then set your gifting in place gifting $27k straight away ($54k for couples) and a similar amount every anniversary thereafter until the gifting is complete. If you have $800k to gift, and there is only one of you this will take 33 years. Debentures can be used to protect the gifting process. And you can draw from the trust for personal expenses to further erode the debt the trust has to you. You can nullify the effect of the interest obligation the trust has on the debt by utilising the Marshall clause. When selling to a trust you are obliged to sell at fair market value, but without actually selling something to a third party it can be difficult to determine what exactly fair market value is. To avoid being bitten at a later date by the IRD you can utilise a "Sliding Value Clause" which allows the IRD to adjust the value of the sale if it deems you under-represented the value. The beauty of this is that it negates the IRD's ability to impose penalties.

Food for thought hopefully, but as always get professional advice.

Julian

[SimpleSimon]

[quote="hannah"]

Does anyone one have got a spreadsheet which will calculate Return on Capital illustrating the advantages of gearing on a purchase of a let property. Surely I can build one for myself however if there is already one available, I would not mind to lay my hands on.

I was in the process of puting together such a spreadsheet some months ago when I stumbled upon one here. There's a free download but I ended up paying the $49.95 for the full version and have used it extensively since then. Given the amount of time it probably would have taken me to finish creating my own version I decided that this seemed good value for money.

Cheers

Simon

[muppet]

Hi Hannah

Why not buy it in the Trusts name? Then you don't have to gift anything.

All our properties(7) are owned by our Trust and we live in one of them and pay rent (at market rates) to the trust.

We had, only in the beginning, gift one property to the trust and in the days of doom and gloom it only took two years to gift. If we had to gift all our properties now it would take nearly 20 years.

We also have a LAQC which allows me to get a tax refund.

Regards

[hannah]

I was in the process of puting together such a spreadsheet some months ago when I stumbled upon one here. There's a free download but I ended up paying the $49.95 for the full version and have used it extensively since then. Given the amount of time it probably would have taken me to finish creating my own version I decided that this seemed good value for money.

I sent a mail to that link and they added me to a mailing list however no free software arrived as yet ..

[hannah]

Why not buy it in the Trusts name? Then you don't have to gift anything.

So muppet are you saying that I should buy this first IP in the name of an LAQC to take the tax benefit and then any future property in the name of a Family Trust. Can we please have a dialogue in this issue on this forum?

Regards