Ryan Crawford reveals how to time your next purchase to perfection, regardless of what the market is doing…
It’s a question that many investors ask a lot.
Some investors rely on the statistics to guide them on their next move. For them, the right time to buy their next investment property is determined by the movements of the broader markets.
However, the more reliable and important indicator you should pay closer attention to is your fi nancial capability. Why? Because there will almost always be lucrative investment opportunities to be found around the country – no matter how the macro markets are behaving. I believe the best time to buy your next property is as soon as you are ready. And by this, I mean financially ready.
Regardless of how the state or national markets are performing overall, there will always be pockets of growth and decent yields to be found in both urban and regional areas.
If you are ready – financially – to invest then consider taking action. If you wait for the broader market to bottom out on the assumption that you’ll secure the lowest price, it may result in valuable profit-making time being lost.
Further, waiting for the national market to reach its bottom before investing is a very diffi cult thing to pinpoint. Chances are, by the time you hear from the property economists and researchers that it’s reached its bottom, prices are already on the up and you’ve likely missed that golden window of opportunity.
One of my key recommendations to investors is: ‘don’t follow the pack’. There is no need to be at the mercy of the broader market. With the right advice, research and property selection, you’ll be well placed for success in any marketplace.
So, how do you know when you’re financially ready to invest again?
Ideally, you should aim to have at least 10% deposit available in either cash, equity or a mix of both. And if you intend to negatively gear your next investment, you also need to have the income available to cover the gap between the rental income you’ll receive from the new property and the interest payments on your new mortgage.
Also be sure to allow for a potential interest rate rise of at least 2% as a short term buffer to ensure you don’t get caught short when rates inevitably rise in the future.
Thirdly, you need to have a cash buffer available – these are emergency funds you can access in the event the property is vacant for any period, requires emergency maintenance etc. My rule of thumb for buffer funds is usually four weeks' rent.
Now, you’re probably thinking you won’t know what deposit you need or how much you’ll need to throw at the mortgage every month until you know what property you want to buy. This is how investors can run into trouble. It’s important to assess your financial capacity first, which will then dictate what you can afford – if, indeed, you can afford to invest again just yet!
Ideally, you should be reviewing your equity and income every six to 12 months to keep tabs on your position. This will allow you to act swiftly when the time is right, enabling you to grow your portfolio as quickly as possible.
Here are the steps you can take to determine whether or not you’re ready to invest again. I’ve used a real life example to help illustrate the process.
How to work out if you’re ready to invest again
Let’s assume you have one investment property – a flat in the inner city Sydney suburb of Surry Hills which you bought two years ago for $550,000. The rent you receive on the property is $2,310 per month and the average monthly holding costs of the property (interest payments, property management, rates, strata etc) are $2,600 per month. This means you’re having to top up the rent by $290 each month on average to service the mortgage and other costs associated with owning the property.
STEP 1: Calculate your equity position – do you have enough for a deposit?
Surry Hills has had good capital growth over the past two years, averaging 11% per annum. An independent valuer has valued the property at $694,500.
Let’s say you have an interest only loan so you haven’t paid down any principal during this time, only interest. This means you have generated equity in the property of $144,500, based on the valuation.
Unfortunately, this doesn’t mean you can now go to the bank and release the full $144,500!
Why? Because lenders will typically conduct their own valuations and given the conservative approach many lenders take, their valuations will likely come in below the valuation that was provided by your independent valuer or real estate agent. A lender will also want you to retain some equity, usually around 20%.
This means you may find that your original calculation of $144,500 equity has now reduced to, say, $100,000 based on the bank’s lower valuation and its need to retain some equity.
If you want your equity to act as a 20% deposit (to avoid LMI), then your budget for your next investment property is $500,000, which is the figure we will use in this example. It is possible to secure a loan with a 10% deposit, sometimes less, depending on your financial situation, but an LMI premium may be payable.
The alternatives to the equity release approach, if your existing property has not produced enough equity for a deposit, would be a cash deposit, or a mix of cash and equity. The fastest way to build a portfolio, however, is to invest in locations that you are confident will deliver decent capital growth, instant equity or ongoing cash flow to provide funds for further investment purchases.
STEP 2: Revise your budget – can you afford to be out of pocket?
If your portfolio is currently negatively geared, as a first step, you must work out how much more you can afford to be out of pocket each month. In this example, you are already making an average monthly cash loss of $290.
At this stage, you could be faced with one of two scenarios: The first is that you find you can safely afford to top up the holding costs of a second property by as much as $300 a month.
Based on a mortgage assumption of $100,000 deposit, interest only, 25 years, and a rate of 7% (factoring in a rate rise of 2%), the interest payments would be close to $2,300 a month. This means you can afford a property to the value of $500,000 which delivers monthly rent of $2,300 (assuming around $400 per month on top of this for additional property holding costs including rates, taxes and management).
The second option may be that you are unable to safely funnel further cash into a second investment property. This means you are not yet in a position to invest again until you have a larger deposit available, or your cash flow increases – unless you revise your strategy! If faced with this option, you may want to consider positively geared property which would enable you to invest again without needing to cough up extra cash each month.
A positively geared property is one that makes the investor a profit, after expenses, each month. It can be a great way to balance out the loss that’s generated from an existing negative property, while still benefitting from capital growth.
STEP 3: Talk to your mortgage broker
Now that you have a good grip on your financial circumstances, you can talk to your broker or shop around lenders to discuss loan products, rates and pre-approvals. Bear in mind that, if you’re happy to put down less deposit and pay LMI, you may be able to borrow more if you’re keen to purchase a better quality property. Your broker will discuss this with you.
What is critical here is that you only borrow what you can afford – you must make sure that you’ll be able to service the loan payments. This applies to both negative and positive investments. You must be confident that you’ll be able to service the loan should the rental market deteriorate and in the likely event interest rates rise.
STEP 4: Begin your property search!
Now that you’re clear about your budget and rental income requirements you can begin your property search with a very clear picture of what you need your next investment property to deliver.
Understanding these points allows you to go into the market with greater clarity and a clear picture of the type of investment property you’re looking for – one that best suits your situation and portfolio.
Ryan Crawford is group director, Crawford Property Group
This feature is from Your Investment Property Issue #88. Buy the copy to read more!