Question: My wife and I bought our first house about five years ago when I was 19. It was a three bedroom house and land package in Tarneit, in Melbourne’s west. A few months ago we decided to upsize and purchased a much bigger house for $425,000 in the same suburb. We used $40,000 in equity (it is valued at about $330k) to pay the deposit, deciding to keep the old house as an investment.
We have since rented it out for $270 a week, making it negatively geared by about $600 per month. This is a problem because I believe that having positive cash flow properties would be the best way to grow our portfolio. Should I sell the investment property and start afresh or hold onto it and wait for capital growth to get us more equity?
Answer: Firstly, congratulations on purchasing your very first home so young. You must be the envy of your friends.
Without knowing the exact investment property and its location, I would say your decision should come down to the level of risk you are looking to take on and the timeframe in which you want to achieve financial independence.
At your age, you have time up your sleeve if you want to take the ‘slow and steady wins the race’ approach – usually the low risk option of ensuring you have manageable levels of debt and can plan for the next phase of your lives, such as having children. It’s these new additions to the household that typically impact on your income and lifestyle.
People looking to sell to buy elsewhere often fail to take into account the true cost of this strategy. If you calculate the entry costs of stamp duty – lenders fees, mortgage insurance and a host of other things – then add the interest paid over the time that the property was held and finally add the selling costs of agents and marketing fees, all of a sudden your costs for selling the property could be upward of 15% of its value.
When you sell to chase cash flow, you’ve got to also keep in mind your buying costs on a new property. If you assume they will be an additional 5% of your purchasing price it will mean you’d need a huge short-term cash flow gain to justify selling your current property.
Generally speaking, if you can source a property delivering higher yields – to the point of being cash flow positive – it will have less of an impact on your household spending. However, if you are taking a long term view, you can’t purchase just for cash flow. Capital growth is necessary, since equity is useful for making further purchases.
If you’re looking at the 15-20 year picture, your decision should ultimately come down to whether you expect your current property to outperform in capital growth. A growth in value will eventually result in greater rental income.
- Answer provided by Ben Kingsley, Empower Wealth