Property Planning Case Study #1 – What’s our next move? Renovate our home and invest, sell the home and upgrade, or upgrade and convert the home into an investment (Ep.143)

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

  1. Meet Neil and Amy – the conundrum. This case study revolves around clients Neil and Amy (names have been changed), a professional middle-aged couple who live in one of Australia’s major capital cities. Their goal is to achieve a good quality standard of living, both now and into the future. Neil and Amy were stuck on deciding their next move. Do they:  
    1. Sell the existing home and buy a new home; or  
    2. Keep the existing home as an investment and purchase a new home; or  
    3. Keep the existing home, undertake renovations, and purchase an investment? 
  2. Unpacking their goals and financial overview. The trio discuss Amy and Neil’s lifestyle and investment goals, their financial circumstances, the level of funds they have to play with for their next decision and Dave explains how he navigated them through their money goals and he asked questions such as; what available funds did they want up their sleave after the purchase?, and how much can they save each month with their surplus cash flow? Setting smart ‘Money Goals’ is a foundational element of effective Property Planning. Money goals are the limit that allows you their clients to rest comfortably at night and these goals are linked heavily to a particular client’s appetite for Risk. 
  3. Getting on the same page – risk profile analysis. Neil and Amy both shared a conservative attitude toward risk, however with different approaches on how best to manage their risk. Attitude towards risk is a significant piece of the property strategy puzzle. Inaction or delaying decisions between couples is typically due to the inability of the couple to get on the same page. The trio share how to bridge the divide that holds couples back from making successful decisions. 
  4. Reviewing the existing home. If you are thinking about retaining the current PPOR, there are important questions to ask yourself. If your plan is to turn it into an accidental investment property – have you considered whether the property has investment grade qualities, and are you able to optimise your tax deductions? Or if you think you would be happy living in it for the long-term – are you happy with the location and does the dwelling suit your future needs? Or does it need some work? Being honest about your property is critical to seeing clearly.
  5. Modelling the scenarios. The trio unpack the pros and cons of the three scenarios that were presented to Neil and Amy for their next decision and each outlines their preferred scenario. Scenario 1 – purchase the long-term home for $1,600,000 and sell the existing home. Scenario 2 – Purchase the long-term home for $1,300,000 using equity in the existing property which is retained as an investment. Scenario 3 – Keep living in the current home and purchase an investment for $800,000. Which would you pick?  
  6. The importance of revising your plan. Sometimes the best laid plans get thrown overboard when there is an unexpected spanner in the works. This is why risk management is critical, via your mortgage strategies, available funds buffer and surplus cash flow. We’re often great at thinking about the worst that could happen and having a plan for that. But risk management is also about giving yourself the ability to say yes to the exciting opportunities that come your way. This could range from acquisition opportunities within a business, taking the opportunity to buy a great asset, being able to take time off work to study, extra parental leave, going on holidays or taking a secondment, (to name a few). 

Resources

Show notes

  • Meet Neil and Amy 
  • Neil and Amy (names have been changed) professional a middle-aged couple who live in one of Australia’s major capital cities and have risk profiles which were both 2- Conservative (1 being Very Conservative, 2 Conservative, 3 being Balanced, 4 aggressive, and 5 being Very Aggressive) 
  • They owned a principal place of residence worth $690,000 and had debt of $389,000 and wanted assistance to working through the various pros and cons of whether to: 
    • Sell the existing home and buy a new home; or 
    • Keep the existing home as an investment and purchase a new home; or 
    • Keep the existing home, undertake renovations, and make an investment 
  • Their goals 
  • Amy and Neil are a couple in their late thirties who came to Property Planning Australia to give themselves the best chance at achieving a good quality standard  of living, both now and in the future. 
  • They want to know that that they’ve made informed decisions that are in their best interests in the short and (to the extend that it’s possible to predict) the long term. 
  • Financial overview 
  • Combined, the couple earn over $200,000 per annum. 
  • They spend $5,000 typically on living expenses each month, so they are quite good with their money management. 
  • Giving them a monthly surplus cash flow of $6,000 with no children, and no plans for children in the future. 
  • They hold approximately $250,000 in savings. 
  • This combination of factors gave Neil and Amy great flexibility with their situation. 
  • Neil and Amy set their money goals 
  • After their next purchase, a target of $50,000 available funds buffer was preferred 
  • With a surplus cash flow goal of $1,500 per month. 
  • Neil and Amy are willing to be stretched on their cash flow, as long as they can retain $50,000 in Available funds. 
  • Setting smart ‘Money Goals’ is a foundational element of effective Property Planning. Money goals are the limit that allows you to rest comfortably at night and are linked heavily to your appetite for Risk. 
  • Getting on the same page – risk profile analysis 
  • Neil and Amy both shared a conservative attitude toward risk.  
  • However, they had different approaches on how best to manage their risk –  
    • Neil would prefer to prioritise paying off their home as quickly as possible’. 
    • Amy prefers to take a larger risk now to increase their wealth, so that they have more safety in the longer-term if things go wrong. 
  • Another interesting factor – one was more comfortable to stay in the current home and the other preferred to upgrade. So, there was a different perspective there as well.  
  • Taking too much (or too little) risk may lead to discomfort for either party, which can lead to a stressful property decision, negatively impact relationships and can open up the potential for a mistake in Property Strategy or Money Management. 
  • The risk profile step, which underpins the decisions made whether to do or not to do something – we call this getting two people on the one page. It can be a difficult task to navigate if they don’t talk openly. Sometimes people can’t articulate what they feel. It’s important to get both parties to see the other’s point of view – what are you scared of? Is this not how you want to build wealth? Is it a question of timing. Inaction between couples is typically because they haven’t tackled this risk profile element.  
  • Tying it all in – risks, five top values, lifestyle and investment goals. Going through the process of getting this out, discussing and then tying the decisions back to those aspects, makes it easier to come to a decision when it’s also backed up with numbers and facts.  
  • A lot of people are uncertain whether their existing properties are good, bad or indifferent assets.  
  • Sometimes it’s not all about the quality of the asset, it’s also about the tax position.  
  • Assets 
  • PPOR – From an assets perspective, Neil and Amy currently own their principal place of residence in Brisbane, within 10km of the Central Business District.  
    • The property was valued at $690,000 at the time their scenario was being analysed. 
    • At the time of the refinance, the value was $830,000. 
  • Debt  – Their existing mortgage balance was $390,000. 
  • Equity – 80% of their Property value is $552,000, minus their existing debt of $390,000 gives them $162,000 worth of usable equity in the property. 
  • And $250,000 in savings.  
  • The key question – Are we happy with the home? 
  • Lifestyle vs investment conundrum – do they focus on achieving their long-term home and/or start building their investment portfolio and how to go about it.  
  • They would like rental income of $75,000 per year to be achieved by the time they retire.   
  • This would entail purchasing 2-3 quality assets that will generate an appropriate amount of rental income, and also bolster their portfolio value through sustained capital growth. 
  • At an assumed rental yield of 3.5%, Amy and Neil require an additional $2,142,000 in investment properties. 
  • Reviewing the existing home 
  • Long story short our analysis was as follows: 
    • The suburb and property location (eg micro location in the suburb and the street quality) was Above average for the capital city.
    • The Dwelling rating was Average, however this rating would be bolstered with the improvements Neil and Amy are considering. 
  • One member of the couple was thinking it was feasible to stay in the property, provided that they did some improvements, which could cost $150,000-$200,000 
  • These renovations included – 
    • A new deck within next 1.5 years 
    • Bathroom and kitchen within 5-6 years 
    • Veranda within 7 years 
  • Scenario 1 – Long-term home purchase for $1,600,000 @ 80% LVR + Sell Existing home 
  • Why 
    • Top end price point that should allow them to purchase a property that could be their long-term home.  
    • Would provide Neil and Amy greater ability to purchase a quality dwelling in the location of their choice. 
    • Achieves both their Surplus Cash Flow and Available Funds Money Goals. 
    • The Available Funds outcome is double their goal which was important given the level of debt they’ll be taking on and their conservative risk profiles.  
  • How 
    • Existing Property sale proceeds – $280,000 
    • Cash contribution – $416,000 
    • Total LVR – 80% LVR 
    • Total lending – $1,280,000 
  • Outcome 
    • Surplus Cash Flow Money Goal Achieved – $1,615 per month (goal was $1,500) based on a cost of $6,729 for the purchase (3% P&I repayment, 1% holding costs) 
    • Available Funds Money Goal Achieved – $105,000 is more than double their Available Funds goal of $50,000 and provides a strong buffer post purchase. 
  • Scenario 2 – Long-term home purchase for $1,300,000 @ 80% using equity in existing property which is retained as an investment 
  • Why 
    • Best achievable price point that meets their Money Goals while retaining their existing property as an investment and keeping the LVR to 80% across both properties.  
    • Achieves both their Surplus Cash Flow and Available Funds Money Goals.  
  • How 
    • Loan Structure 
    • Security – New Home $1,300,000 + PPOR $690,000 = $1,990,000 
    • Total Security $1,990,000 x 80% = $1,592,000 
    • New Home Loan $1,040,000 
    • Equity Release for Home $162,000 
    • PPOR Investment Loan $390,000 
    • No LMI – securing borrowing above 80% against your PPOR property 
    • Cash contribution – $176,000 
    • Home Loan (secured against new purchase) – $1,040,000  
    • Investment Loan (secured against new purchase) – LVR – 80% 
    • Equity Release Loan (secured against PPOR) – $162,000 
    • Equity Release Loan – LVR – 12.5% of new purchase value  
    • Total LVR – 92.5% LVR 
    • Total lending – $1,202,000 
  • Outcome 
    • Surplus Cash Flow Money Goal Achieved – $2,485 per month (goal $1,500) based on a cost of $6,150 for the purchase (3% P&I repayment, 1% holding costs). 
    • Available Funds Money Goal Achieved – $65,000 is greater than your Available Funds goal of $50,000 and provides a strong buffer post purchase. 
  • Scenario 3 – Investment Purchase – $800,000 – 106% LVR 
  • Why 
    • High growth asset that could support Amy and Neil later in life either through rental income or sale proceeds. 
    • Achieves their Surplus Cash Flow Money Goal. 
    • Continue living in their existing property and ensure funds for renovation are kept, but contribute some saving towards paying down the home loan so they can optimise tax deductions (see next point).  
    • Borrow full purchase price plus costs mostly via existing equity, therefore no cash contribution. 
  • How 
    • Loan Structure @ 80% across both properties 
    • Security – New Investment $800,000 + PPOR $690,000 = $1,490,000 
    • Total Security $1,490,000 x 80% = $1,192,000 
    • New Investment Loan $640,000 
    • Equity Release for Investment $208,000 
    • PPOR Home Loan $344,000 
    • Cash contribution to purchase – $0 
    • Cash contribution to PPOR home loan – $46,000 
    • Investment Loan (secured against new purchase) – Amount – $640,000  
    • Investment Loan (secured against new purchase) – LVR – 80% 
    • Investment Equity Release Loan – Amount – $208,000 
    • Equity Release Loan – LVR – 26% of new purchase value to cover shortfall of 20% plus costs. 
    • Total LVR – 106% LVR 
    • Total lending – $848,000 
  • Outcome 
    • Surplus Cash Flow Money Goal Achieved – $4,852 per month (goal was $1,500) based on a cost of $1,148 for the purchase (3% rental yield, 4% I/O rate, 1.4% p.a. holding costs). 
    • Available Funds Money Goal Achieved – $195,000 is significantly greater than Neil and Amy’s Available Funds goal of $50,000, and almost allows them to retain but achieves having $200,000, which is the top end range of their home renovation costs plus any savings between now and completing the renovations. 
    • The purchase of the property would involve borrowing up to 80% against the investment and funding the remaining 20% plus costs from an equity release of up to $208,000 plus additional lending of $640,000 if they purchased for the full $800k. 
    • This scenario requires the Neil and Amy to be satisfied that they can improve their existing property in Brisbane, to turn it into their long-term home, with them already being satisfied with the location.  
    • This is a big consideration – if something is not quite right, people are good at deluding themselves that it’s for the best. You get one crack at paving your pathway  through life – if there is a burning desire to upgrade, that itch won’t go away. Be really critical and honest with yourselves. 
  • Crunching the numbers 
  • Most consumers don’t have the capability to crunch these numbers – this takes time and experience. How do you quadralate available funds goal, with surplus cash flow goal, with borrowing capacity and loan to value ratio, to come up with the best scenarios.  
  • The reality is that each time, it’s different based on the individuals involved. Everyone’s financial situation is different, lifestyle goals, stage of life and family is different.  
  • Revising your plan 
  • Things change and you need to be able to pivot and have some flex and not feel under pressure.  
  • This is why setting money goals and having buffers are critical to risk management.  
  • We are great at thinking of all the bad things that can happen, but sometimes there are good things that come along that throw a spanner in the works. Provision for things in life that can be great – going for holidays, taking time off work to study.  
  • Have the ability to say yes to the exciting opportunities that come up.  
  • The next purchase is the most important – the further you look into the future, it becomes more fuzzy.  
  • The happy ending 
  • There is always a happy ending, because people end up making the decision that is right for them and that they are comfortable with.  
  • Neil and Amy went for scenario 3 – live in the home they currently have and purchase an investment.  

Gold Nuggets

David Johnston – The Property Planner’s Golden nugget: the power of having financial metrics that determine the price point of your next property. They should be suited to your personal situation and risk profile and the next purchase fits within those. With good mortgage strategy, it allows you to do things to have the surplus cash flow your after, available funds buffer and make a purchase that suits you rather than just fits a borrowing capacity.

Cate Bakos – The Property Buyer’s Golden nugget: accidental investing – so many of us look at our cherished home and can’t stand the thought of selling it or get emotional about renting it out to tenants, where there is wear and tear. Before you worry about who is taking over your home, be pragmatic about whether it has investment grade attributes or whether it was a really great home for you and it’s ready for the next family.

Market Updates

  1. Market conditions changing as more stock comes online. With Easter just around the corner, greater stock on the market is giving buyers more choice and the rate of pass-ins continues to shine a spotlight on slightly eased conditions for buyers. The last weekend of February saw the highest number of auctions ever, since CoreLogic first started recording this data. With a number of public holidays drawing near, we can expect the lead up to April to be just as busy. We’ve seen significant shifts in the market, but you’ll have to tune in to next week’s episode to get the full picture.   

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