Listener questions – I bought a dud property, can we recover? (Ep.138)

 
 

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In this week’s episode, Dave, Cate and Pete take you through:

  1. A question from our listener. In this week’s episode we dive into a question received from one of our listeners who was concerned that he may have made an investment mistake and purchased the wrong property. The key question as posed by the listener was “is this a situation we can even recover from?”. In this interesting and insightful case study, the trio unpack the listener’s scenario and discuss possible options for his next steps.
  2. Analysingthe investment. The trio apply a critical eye to the property in question and they also assess the other properties owned by the listener to determine the future growth prospects, projected outgoings and anticipated rental yield.
  3. Why did the property seem like a good investment? The bells and whistles attached to a property may make it appear to be a good investment that will likely attract tenants. But often these shiny elements can catch your eye and blind you to what’s important, like the land to asset ratio, which is the primary driver of capital growth. These bells and whistles can also be a drainer on your cash flow and yield in the long-term. The trio discuss some clever marketing tricks that can deceive investors into going down the wrong path.   
  4. Peeling back the onion and working on long-term goals. Where many investors trip on their property portfolio journey, is failing to think about their lifestyle goals and long-term home. For most people, getting into the dream home is one of the big rocks that you want to fit in the jar, and this may mean selling one or a number of investment properties to achieve this goal. The trio discuss planning for your home and how this fits into your portfolio strategy, including retirement planning.  
  5. Running the numbers. A key component of any investment decision, whether it’s to buy or sell, is to get a clear idea on the different paths you can take and whether you can make that step now. This involves doing the maths and modelling scenarios to make an informed decision. The trio crunch the numbers in this listener scenario – can they get into their long-term home now? Or soon? 
  6. Making peace with selling at a loss. Many property owners will need to consider selling a property, whether due to upgrading, offloading a poor performing asset or as part of a debt retirement strategy. With the large in and out costs associated with property transactions, this decision can be an emotional challenge, particularly where a property is sold at a loss. The decision to sell a property should be a serious consideration, if it makes financial sense when considering your long-term goals and opportunity cost. 

Resources

Show notes

  • The question 
  • I’m writing to you to offer my situation as a case study for a future podcast episode if you feel there’s some value to your listeners. I’d also appreciate your honest opinion if this is a situation we can even recover from. 
  • In October 2019, my wife and I put down a 10% deposit for an investment property – from what we would realise later on was a spruiker. After getting educated, we now know this was a mistake. It settled in November 2021 and we are not sure if we should hold or sell. 
  • If we hold, cashflow would be positive by around $6k per year (because of depreciation) but with limited growth prospects. If we sold, we could put the capital towards a higher quality investment, but we will suffer an equity loss of $50k after deducing costs of buying and selling. We will be left with $147k from what was an initial deposit loan (from refinancing our Principle Place of Residence) of $197k. 
  • Below are some facts that could be relevant. 
  • My wife and I are turning 39 years old with combined income of $230,000 before super. 
  • Our annual surplus cashflow is only $30,000 if we sell, or $36,000 if we to hold. This can increase to $40,000 (or $46,000) once our son finishes childcare in 2 years and $60,000 when my wife goes back to full time work in 8 years. 
  • Combined super balance = $380,000. 
  • PPOR is a unit in Camberwell, but also not a great financial asset as it is 1 in 18 in the block, and we are facing the main road. It has had minimal growth – purchased 2016 for $590,000 and refinanced with valuation of $630,000 in June 2021. 
  • We have another investment property, which we believe we got right. It’s a villa in Maidstone, Victoria purchased October 2020 for $600,000 and revalued at $677,000 in June 2021. 
  • The property in question 
  • Location – It’s not in the CBD, about 10km on a busy road. 
  • Dwelling – It’s a high-rise apartment, one of 250 dwellings in the building. 
  • Style – 2 bed, 2 bath, 1 car apartment. 
  • Size – 65sqm internal, 8 sqm external. 
  • Outgoings (estimate) – $4000/year body corp, $1200/ year council, $700/ year water. 
  • Question whether a sellers premium was factored in there and rental guarantees.  
  • The depreciation is stronger because it’s brand new. 
  • The land to asset ratio was particularly low and the desirability of a really busy road, we would question. 
  • There are similar properties available, not only in the same building but also in the area. The property has no scarcity, which is why we believe it will not perform. 
  • Is this a position from which you could recover from? 
  • The long-term prospects for this property – no high hopes.  
  • Lost opportunity is the big key question – invest in something that will perform better long-term.  
  • The listeners are relatively young and looking for an increase in income in the future. You get past that and see that it was a blip in their lives.  
  • The Camberwell property hasn’t performed well according to the bank valuation. But it’s now been 5 years, the performance of that might get better. This may not have been a mistake. 
  • Why was this property so attractive? 
  • It was seductive because of the amenity – there would be a carwash, squash court, driving range simulator, wine bar, concierge, gym, movie theatre, community park and BBQ (but surprisingly no swimming pool). All these things depreciate and become costly to run and repair. The overheads become greater as a percentage of the proeprty, while the value of the proeprty is reducing. The yield is positive, but only because of depreciation, which will reduce over time and you’ll get the greatest yield percentage when it’s newest. But as it gets older, the property dates, the rental yield will reduce as well. 
  • Overall, the sooner they can get out of it and minimise the opportunity cost, the better. 
  • You think great enticements for people to live there and thinking that it’s a good investment. It’s more like a car, which is rapidly reducing in value after it’s been used. 
  • It’s the dirt that’s going up in value and there’s very little dirt. 
  • If they are being offered through the apartment block, in the end you are paying for it. The owner of the apartment is paying through it via the body corporate. If they need refurbishment, the owners pay for it again. 
  • How does this fit into their property plan? 
  • People usually want to set themselves up for the family home at some point. So, we like to peel back the onion and ask questions about that. What are their longer-term plans? Sometimes people are in a rush to set themselves up, and they trip and fall, because they haven’t done the research. 
  • Are your wife and you happy in your current PPOR unit in Camberwell long term? EG through to retirement? 
  • We plan to move out mid-2022 because we need space for our son. Whether we rent or buy is still a question (we are unsure what we can afford with either option), however we’d like to stay within the same location (ideally within the school catchment of Auburn South Primary and within walking distance or short drive to Anderson Park. 
  • We will hold Camberwell and rent it out. 
  • When people are stretching themselves and making poor decisions – it’s often because they haven’t sorted out what they will do around the home. Before they made this purchase and the Maidstone one, they needed to clarify what their longer-term plans from home perspective and investor perspective. 
  • What is their debt retirement strategy – do they want to collect capital growth properties and do something when they retire or are they wanting strong yield properties to retire the debt, so they don’t have to sell down any assets. How much do you want to retire on, how much is coming from property activity, downsizing or right sizing, asset diversification? 
  • The question to answer here is – Are you better to get the home today or wait for 8 years time when cash flow is stronger (when wife returns to work full time)? 
  • They are unknowns, but this is what you need to consider and go through the numbers on. What does it look like if you do it today vs what will it look like in the future. But what are the risks if you can’t achieve that (eg: because you purchase more investment properties along the way)? 
  • And what does your long-term home look like in an ideal world including location, dwelling make-up, land size, price range and timeframe? 
  • Boroondara is a beautiful place to live (I’m sure you’ll agree) and ideally we’d like to stay in the area 
  • This one is a good balance of space and being low maintenance. Ticks all the boxes, except for the $1.44m price tag it sold at auction for last Saturday 27th November – https://www.realestate.com.au/sold/property-house-vic-hawthorn+east-137731734 
  • As is often the case, when people want to purchase a long-term home, they are aware of what is happening in the market and looking for properties that will tick the boxes.  
  • This is a signal that there is a strong pull to buy that home. Can someone hold back scratching that itch for 7 to 10 years? Often it means selling one or a number of investment properties that they have purchased. 
  • What is your debt balance on Camberwell and Maidstone? 
    • Camberwell $630k + Maidstone $677k + Ivanhoe $552k = $1,859m x 80% 
    • LVR @ 80% = $1,487,200 
    • Debt  
      • Maidstone $135k (against home) + $541,600 = $676,600 (Paid $600K) 
      • Ivanhoe $197,000 (against home) + Ivanhoe $441,600 = $638k 
      • Camberwell $172k (100% offset) 
    • Total debt – $1,487,200 
    • Total Offset $244k 
  • Next step, go through the maths and the modelling – can they get into that home today? Not whether they should, but is it possible? They cannot get into their home without selling both investment properties – Camberwell and Ivanhoe 
  • They are about $30K short of purchasing their long-term home, but this could be covered by LMI.  
    • Sell Camberwell and Ivanhoe 
    • Left with Maidstone – $677k x 80% = $541,600 
    • Sell $1.18m ($1.050m after selling costs) 
    • Debt paid off $638k Ivanhoe, $172k Camberwell ($810k in total) + Maidstone paid down $136k ($677k to $541k) + left over cash of $104 + cash offset existing of $244k = $348k cash left over 
    • $1.44m x 80% = $1.115m loan  
    • 20% = $290k cash 
    • Plus stamps and cost @ 6% = $86,400 
    • ($376,400) 
  • The benefit of making this move today, is they could move into their long-term home, and slowly get into the position where they can invest again, and purely focus on investments for the rest of their life. 
  • But there will be an emotional challenge of selling two properties at once. Someone who has been focused on making financial decisions to set up their family for a good life would be loathe to do, which is totally understandable. But when you peel back the onion, and remove emotion, that should be a serious consideration. 
  • Selling at a loss 
  • It’s always hard to face the prospect of selling at a loss, but it’s about getting it right in the beginning. 
  • It’s one, it’s not multiple. We know people that have gotten excited about off the plans and purchased a handful. 
  • When you’re looking at stylised pictures and diorama – it can be deceptive. The address was quoted as a quiet street address which doesn’t exist and the pictures made it look leafy and cute. It did not say that it’s on a huge road. If it had the address that it has now and looked in the pictures that it currently does now, I don’t think that they would have been excited by this. 
  • The projected outgoings cannot be guaranteed by the developers. As the property dates and needs more maintenance OR code changes and you have to replace cladding. Sometimes the developers will undercook what the projected outgoings are.  
  • Zoning – you need to understand this, if it has shops underneath and it’s commercial, you’ll get points taken away for this one.  

Gold Nuggets

David Johnston – The Property Planner’s Golden nugget: this is a great example of what we write property plans for. This is a very common situation, someone has gone down an investment pathway but not clear on their home buying pathway. It’s why we map out the home buying pathway, most people prioritise the home, it’s the big rock. If you don’t plan for it and have investments fitting around it, you’ll probably get in trouble. Peeling back the onion – the bigger issue is that you’ll sell the Ivanhoe property, but when will you buy the home? Do you sell two properties now and buy the home or wait 10 or 12 years, where the home may get further away from you and become unaffordable or you may need to sell both investments anyway. There’s no certainty around that, but these are the types of questions that many are grappling with but don’t know how to work through it.

Cate Bakos – The Property Buyer’s Golden nugget: I want to thank the listener for such a great question and prompted an interesting episode. As an investment decision, I don’t recommend buying a high-rise off the plan.

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