I’m Gen Y and I earn a big income, but I have no deposit saved. I’m looking to invest with my parents, who need to move their assets from growth-poor Bendigo
I earn approximately $140k per year, although it can increase with overtime rates, and I currently pay $1,500 rent per month. I have spare cash flow of $4,000 per month, which I currently put towards a personal flying loan debt that I have with my parents of approximately $100k, which was an equity access loan on their home.
We have been thinking of buying a property as a joint venture that I could live in while also renting out a room to a work colleague for approximately $1,000 per month – in a price range of up to $900k in Melbourne. My parents would also contribute $1,000 per month to the mortgage, which would allow me to continue to repay $2,500 per month to my flying loan with my parents. We would be interested in potentially developing that property in a few years' time and building townhouses or similar.
I suppose we are in a situation where they have access to a deposit, but I have the spare income to service the loan. They have access to approximately $250k equity in their current home, which would keep their LVR at 80%.
We feel that the joint venture house would be a very strong long-term growth buy, along the lines of a blue-chip suburb delivering the highest growth possible. It would be a foundation property of sorts that could then be refinanced, and we would invest separately using this joint venture home as our foundation.
My parents are currently in their early to mid 50s and would most likely lean towards cash ﬂ ow investments, whereas I am currently 23 and would be focusing solely on growth properties, potentially utilising the tax benefits of negative gearing as well.
My goal as a property investor is to buy and hold the highest capital growth properties I can for the long term, and look towards a rent/invest strategy after the joint venture property with my parents. I’m not afraid of diversification in a portfolio all over Australia and potentially internationally. I would ideally like to have a sizeable portfolio which would allow me to live off equity gains and provide financial security for my future.
Thank you for your help!
I really like this question and I’m encouraged to see that both Zac and his parents are thinking of ways to secure their financial future. I actually get questions about this type of scenario quite often, where the parents want to help their kids and the kids are excited to get on the property ladder.
In this case, we have Zac, who is still in his early 20s, being very proactive about wanting to take his first step onto the property ladder. This is admirable, and if he has a clear strategy he will manoeuvre himself into a fantastic position to create wealth from real estate in the next decade or two.
Joining forces with family members to get on the property ladder is a common way to start buying real estate. At the beginning of my investing career, I actually did a few joint ventures myself.
The challenge is that, along the way, sometimes business and pleasure get mixed – and it’s really important to understand that there are some pretty serious risks to this type of partnership that need to be discussed.
To run through these risks and show Zac and his parents the options available to them, I’m going to structure this game plan as Option 1 and Option 2. Option 1 is Zac’s plan as he’s proposed, and Option 2 is an alternative I’m putting forward.
Option 1: Zac’s plan
Zac earns a high income, pays cheap rent, and has loads of spare cash ﬂ ow. His mum and dad are in a position to lend him $100,000 to buy a property worth up to $900,000.
So far so good. However, there are many things about this proposal that concern me.
There are many risks involved – and I see most of those risks applying to the parents more than to Zac himself.
As parents, we all want to be able to help our kids, which is admirable. But you don’t want to do anything that could risk you sacrificing your own retirement down the track, in order to help your kids right now. In all likelihood, they won’t be able to support you in retirement.
If you happen to have money left over when you die, the kids can have it then. But until such point in time, any financial help you offer them should work in your favour as well!
The first big risk and big problem I can see with Zac’s plan is that this is an expensive house he wants to buy. The loan for a $900,000 property with a $100,000 deposit and an interest rate of 5% is going to cost $40,000 per year just in mortgage interest repayments alone.
That’s a really huge amount of money, and we haven’t even factored in council rates, water, insurance, repairs and other sundry expenses.
Repairs to a house of this size can be fairly expensive as well. There are hot water systems that break down and need replacing, along with big gardens to maintain. There’s likely to be more than one bathroom, which means potential plumbing repairs.
Now, I know that Zac is earning $140,000 a year and he says he can save $5,000 per month – but still, I’m a huge advocate of running through the what ifs.
What are the ‘what ifs’?
What if Zac loses his job? How are he and his parents going to find $40,000 per year to pay the mortgage if he’s out of money?
What if Zac’s overtime dries up or he changes jobs and earns a lower salary?
What if his parents retire and can no longer contribute any money towards the running costs of the property?
What if the friend he finds to live with him turns out to be a terrible housemate and he decides to kick him out?
What if Zac defaults on the loan? As a joint venture, will his parents have their name attached to the property title or loan? Will Zac’s potential defaults impact on their financial position and/or credit score?
If any of these scenarios eventuates (and these are just the first few that I’ve thought of – there are many, many more), this will have the potential to put Zac’s mum and dad under a lot of financial stress, because they have put their own home at risk in the process of getting their son into a property.
"Having this extra income is a smart strategy as it essentially means he has someone else helping him to pay down the mortgage"
Reality check: buying a $900,000 home
It’s great that Zac is planning to rent out a room to a colleague for $1,000 per month. Having this extra income is a smart strategy as it essentially means he has someone else helping him to pay down the mortgage.
But there are several things that need to be considered here. The first is, will he declare the income to the taxman?
It would help his borrowing power with the banks if he does declare the rental income. But most people don’t declare this income as they don’t want to pay income tax on it, so it doesn’t count towards their serviceability.
At this point I want to touch on the loan itself. In life, we have to accept that there are two sides to the coin: what we want to achieve, and what we are actually capable of achieving.
I asked my mortgage broker to run some numbers based on the figures Zac provided; they are estimates only and I did make some assumptions:
• Income: $140k salary per annum
• Rent: $1,500 per month
• No credit cards or personal loans (and I need to stress this as any credit cards would impact)
• Loan to his parents of $100k
Based on these figures, if Zac was to purchase a property to live in on his own, the bad news for him is that even with a $100,000 deposit provided by his parents, he could only borrow around $600,000 for his PPOR, even with a paying tenant. This is far short of the $900,000 home he desires.
If Zac were to purchase an investment property instead of this expensive blue-chip property, assuming he is receiving $400 per week in rent, then his borrowing power would increase to $700,000.
From what Zac has told us, his mum and dad will have access to around $250,000 in equity. He is asking them to contribute a $100,000 deposit to the joint venture. When you factor
in buying costs, that could add up to more than the initial $100,000 that his parents are contributing.
And what do they get in return – a part share in a property that their son lives in, and a whole lot of financial risk? That doesn’t seem fair to me.
Furthermore, I don’t think Zac realises what he’s potentially missing out on – because here is another huge consideration that should factored in: access to the First Home Owner Grant.
If Zac and his parents partner up, what is the ownership structure going to be? Will they be putting both Zac’s name and his parents’ name on the mortgage and title?
If that is the plan, then this will impact on Zac’s ability to get the First Home Owner Grant if he chooses to buy something brand new. Because his parents are not first home buyers and they are going into the property together, this negates Zac’s ability to get the grant – on this property, and on any other homes in the future.
The Victorian State Government has recently announced a number of changes in relation to this grant, which could save Zac tens of thousands of dollars. Homes up to $600,000 are free of stamp duty for first home buyers from 1 July 2017, while big discounts will be offered on homes priced from $600,001 up to $750,000.
In my view, it makes far more sense for Zac to create a strategy that allows him to take advantage of these grants (see Option 2).
I’m also not sure that Zac has considered the fact that he’s going to have to make a lot of sacrifices to his lifestyle to get this loan.
From our earlier calculations, the interest repayments only will amount to $40,000 per year, or $3,333 per month. Add in the principal loan repayments, council rates, water rates, insurance, termite and pest inspections (if the property is established), and all the other potential repairs and maintenance that go with owning a home, and this figure could easily reach $4,500–$5,000 per month.
Although Zac’s roommate will contribute $1,000 per month, Zac’s own contribution to his accommodation will jump from $1,500 per month to $3,500 plus.
Option 2 JOINT VENTURE INVESTMENT
Zac has quite an aggressive strategy around wanting to buy a blue-chip property. This shows that he’s doing his research, which is great. I also like that he’s thinking outside the square in regard to buying as a joint venture – this is a strategy that can really work, especially if the parents become part-owners as well. This helps to grow their wealth and move their kids’ financial position forward, and furthermore, it’s a great strategy for succession planning.
I’m passionate about education and I believe it’s really important to teach kids about financial literacy and how to manage money. What better way to do it than with mum and dad as a safety net? This really aligns with my philosophy of doing everything we can to teach kids about financial literacy.
However, where I take a stand is that I don’t believe we should ever sacrifice mum and dad in the process.
The scenario that Zac has put forward is inherently risky, and the majority of the risk is weighted towards mum and dad. After all, they have the potential to lose their $100,000–$150,000 deposit and their own home in the process.
So, what if we change the rules of the game slightly? What if we create some sort of joint venture agreement, whereby mum and dads’ ownership is equal to their son’s? They should be entitled to some of the capital growth over time, when it comes time to sell, as they are investing the seed money.
This brings us to Option 2. The aim of Option 2 is simple: don’t spend $900,000, and instead aim to invest in an affordable owner-occupier property for Zac in the first instance.
My suggestion is this: Zac and his parents should embark on two completely separate purchases.
Property no. 1: Zac’s PPOR
I did a little research and found that in the suburb of Hawthorn in Melbourne, you can buy a two-bedroom apartment for around $500,000, and in Richmond you can buy a one-bedroom for around $420,000. They’re close to lifestyle amenities, the city and transport, and are in central and growing locations.
These properties would be more affordable to maintain and a far lower risk for all parties involved.
If Zac’s friend or colleague is interested in renting a room for $1,000 a month, and this proceeds, then that will well and truly lower the risk involved all round.
The mortgage on a property purchase of $500,000, for example, would be around $2,000 per month
(principal and interest, at 5%, based on a $400,000 loan).
If Zac has someone renting for $1,000, then he only has to manage $1,000 in mortgage repayments on his own each month. He’s currently paying $1,500 in rent, so his monthly obligation will actually go down – although that $500 can be used to pay council rates, insurance, etc.
By following this strategy Zac is already saving at least $2,000 per month compared to Option 1 – money that can be ploughed into paying down his new mortgage.
TREAT INVESTING AS A BUSINESS
It’s fantastic to have the intention to give your kids a helping hand, but you shouldn’t be prepared to hand over a lot of money without thinking through every aspect of the arrangement. When things turn bad – and I’ve seen it happen – it can put a lot of strain and stress on the family.
You can’t sacrifice family for the sake of getting rich. You just can’t take that risk; it’s fraught with danger.
That doesn’t mean you should walk away from joint ventures altogether – but it does mean you need to go in with your eyes wide open, knowing this is now a business decision.
When you get involved in a joint venture with someone, whether it’s your son or someone else entirely, you’re going into business together. This means you have to be responsive – and you’ve got to start with the worst-case scenario in mind so you can plan your exit strategies for if and when things go bad.
Ask questions like:
• What is the ownership arrangement – 50/50, or another split?
• Who is providing the deposit?
• Who will pay for the monthly mortgage shortfall and other expenses?
• What happens when an unexpected repair crops up?How long do you intend to keep the property?
• In five years’ time, if the property has grown in value, who decides whether to sell?
• If the financial position of Zac or his parents changes, what happens to the property?
"Together with his parents, Zac purchases an investment property. This is a true joint venture with his mum and dad"
In this case, because Zac would have a lot of savings capacity, I think he should borrow the deposit from his mum and dad. He can pay them back at an interest rate of 5%. This is fair and teaches kids about the realities of borrowing money – it doesn’t come for free in the real world! This is how we teach our kids money management; if we just hand them the money, they’ll never learn to respect it or appreciate it.
As a completely separate purchase to Zac’s PPOR, he and his parents can become joint venture partners by investing in another property.
Property no. 2: Joint venture investment
Let’s say Zac purchases a PPOR (a one-bedroom apartment) as previously suggested in an inner-city suburb of Richmond, for around $420,000.
He borrows 90%, or $380,000, and borrows the funds from his parents for the deposit. The mortgage on this at 5% interest would be $1,750 per month, which is only $250 more than his rent right now.
Then, together with his parents, Zac purchases an investment property. This is a true joint venture with his mum and dad: the ownership is structured as 50/50, with his parents stumping up the deposit and Zac providing the borrowing power to get the loan. Any ongoing property expenses are also split 50/50, and at the end all profits are split in half (after paying back the bank and mum and dad for their deposit, of course).
This creates a win-win: without the deposit, Zac wouldn’t have been able to buy the property in the first place, so under this arrangement everyone wins.
Zac’s borrowing power (if he receives $400 per week in rent) would be roughly $500,000 for an investment.
Wealth creation in action
In this scenario, Zac now owns two properties: his own home and a 50/50 joint venture investment with his parents.
He could work hard to pay his parents back for the deposit they’ve lent him for his PPOR purchase – based on his current salary, he could achieve this within a couple of years – or, alternatively, they could come to an arrangement whereby, in a few years’ time, after Zac’s PPOR has experienced capital growth, he could refinance the property to pay back mum and dad. He will then own this property 100%, while mum and dad get their equity back and have the peace of mind of knowing that they have helped their son as well.
The best thing about this strategy is that, because both mum and dad and Zac are partners in a joint venture investment, they’re all growing their portfolio, and they’re all on a path towards creating wealth.
This gives Zac and his parents plenty of scope to help Zac get into his first home as well as purchasing an investment property; pay back his parents within a couple of years for his PPOR deposit; and stay on track towards buying another property in a couple of years’ time – all while reducing his and his parents’ risk.
Depending on their plans, in a few years’ time when they’ve had some growth, they can revalue the investment property and Zac can either buy his parents out, or they can decide to continue managing the investment together as a joint venture.
Either way, everyone involved is moving forward financially by following this option. Zac’s parents are not going backwards by giving him the deposit. And along the way, he learns how to be fully accountable.
At the end of the day, if both Zac and his parents had an education that allowed them to create their own investment strategy
and look at all parts of the equation, they would be able
to quickly identify the risk they were potentially exposing themselves to.
Furthermore, they could structure their future purchases in a strategic, disciplined and low-risk way that a) would not put them under financial stress, b) would give them the growth they were looking for, and c) would make it a win-win for both parties.
In my view, this is the solution to the age-old question: how do we help our children without putting ourselves at risk?
The end result
• Zac has two properties growing in value: one his own home, one a joint venture with his parents.
• This strategy lowers his own risk in case he loses his job, as his financial obligations are lower each month.
• It also lowers the risk to his parents as they’re not financially tied to a property that costs$400,000 plus per month in interest repayments.
• This strategy gives Zac more leverage to springboard from to grow his portfolio.
• Everyone is moving their wealth forward.
is a bestselling author and managing director of Real Wealth Australia.
Important disclaimer: No person should rely on the contents of this article without first obtaining advice from a qualiﬁ ed professional. The article is provided for general information only and the author is not engaged to render professional advice or services through this article.
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