June 03, 2014
In order to understand how Mortgage Choice Ashgrove and Stafford's Property Investment Analysis (PIA) Service works, take a look at this case study.
For more information on what the PIA service is, click here.
Case Study: Max and Lotta Cash
Max and Lotta are a young couple with two kids. Lotta is 40 years old and earning $95k per year. Max is 42 years old and earning $65k per year. They own their own home valued at $650k and owe $200k.
- Purchasing an investment property for $450k
- Borrowing 100% of the value of the property plus costs using equity in their existing property.
- The real estate agent estimated that the target property will earn $420 per week in gross rental and they have factored in a 5% void period.
- The property is a new town house.
- The property has relatively low body corporate fees and relatively high depreciation available.
The loan structure:
- 100% value of the property loan, plus costs to purchase the property are also borrowed.
- Total loan amount of $477k.
- Repayments: Interest only at a variable interest rate of 5.5%PA of $2,186 per month.
How this impacts cash flow:
Max and Lotta will earn $420 per week in gross rental income from the property, and estimate that around 30% of this will go towards costs such as:
- real estate management levies,
- body corporate fees,
- rates and water etc.
After costs, they will be left with approximately $1,274 in extra income per month.
The monthly interest only loan repayment is $2186. This equates to a shortfall of around $912 per month, or $210 per week that Max and Lotta would need to cover in order to make their monthly repayments and hold the property.
Taxation benefits and impact:
- Buying the property in one name only:
Max and Lotta ask their Mortgage Broker to use a property cash flow forecasting tool to model their current position and their proposed purchase.
The Cash flow tool confirms that Lotta is currently paying $24,500 in tax which matches her tax return.
If she buys the property in her name only, the post purchase tax position is $16,300 after negative gearing and depreciation.
This results in Lotta receiving a tax credit of $8,200 in the first year ($680/month).
- Buying the property in both names:
This model indicates that the tax benefits are similar if they purchase the property in joint names. However, as they anticipate that Lotta’s income will increase more substantially than Max’s in the future, they decide to discuss their options further with their accountant, in order to determine which scenario will be best for their specific circumstances and future financial plans.
When they meet with the accountant, they will have detailed notes from their Mortgage Choice broker, and will be more prepared to discuss the pros and cons of purchasing in either Lotta’s name only, compared to putting the investment in joint names.
- Tax Variation forms:
Tax variation forms can be submitted with the tax office, in order to reduce the amount of tax taken each fortnight from your pay. In short, you get less of a lump sum tax return at the end of the year, as you get it back each in each pay instead. In this case, by reducing the amount of tax taken each month from Lotta’s pay, she brings home more in per pay packet each month, so her cash flow can be improved on a monthly basis. This helps to ensure that the monthly shortfall to hold the property can be covered.
- Holding costs:
The ‘holding cost’ of a property is how much out of pocket each week or month you will be just to keep the property. If you do not take into account the holding costs when acquiring a property, or make a very informed decision, you may be forced to sell a lot earlier than you anticipate. It is vital that you can afford to cover the holding costs of a property before you purchase it. The PIA software enables you to work these costs out, and make an informed decision.
Max and Lotta’s model indicates that the actual holding cost of the unit is $251 per month or $58 per week.
This is $1, 935 less than the interest required to service the loan.
According to the PIA software, the model estimates that the tenant renting the unit will be covering 65% of the full cost of holding the property and, after the tax benefits, Max and Lotta will contribute only 9% of the total holding cost.
Therefore, by borrowing the entire amount to buy the property, including costs, they minimise their cash investment and enables the Internal Rate of Return on the investment to be at a healthy 39% before tax and 63% after tax.
“Tweaking” the model:
Some of the assumptions in the model can be ‘tweaked’ to enable different scenarios to be analysed. This helps Max and Lotta determine how different factors influence the numbers which ultimately helps them decide what type of property to buy, and how much they are comfortable spending.
For examples, the following factors can be changed within a model:
- growth rates
- interest rates
- growth and yield assumptions
- holding costs
At the end of the P.I.A process provided by their Mortgage Choice broker, Max and Lotta end up with detailed notes (see attached example) to discuss with their accountant, and to help them make a very informed investment decision that is specifically based on their financial situation and future plans. It doesn’t get much more personalised than that.
For a copy of the actual report used to determine these figures, or for more information on this case study, please email Stuart at email@example.com
If you are interested in tweaking some numbers based on your own personal investment scenario’s and would like a Mortgage Choice broker to help you analyse it, please contact Stuart Pullar from Mortgage Choice Ashgrove today on 07 3366 9982, or email him directly at firstname.lastname@example.org