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In this week’s episode, Dave, Cate and Pete take you through:
Introducing Tom and Linda
In this case study we introduce Tom and Linda and share with you how we unpacked their property conundrum so they could make a successful decision for their next property purchase.
Tom and Linda are a couple in their late 30’s with two children under 4 years old, living in one of Australia’s major capital cities.
They wanted assistance with working through the various pros and cons on how to best achieve their long term financial and lifestyle goals and what was the right balance for them. In terms of their Next Purchase, they weren’t sure whether they should start building their investment portfolio OR purchase a holiday home as they are satisfied that they are living in their long-term home.
- Employment income – total $345K
- Tom Income is $190K full time
- Linda income is $155K full time
- Kids – 2 children under 4 years old (18 months old and 3.5 years old)
- Living expenses – $95,000 p/a ($7,900k p/m)
- Paying for full time childcare and nanny – as don’t have family support in looking after the kids. This will reduce as the first, and then the second starts primary school in 2 and 4 years time.
- It will increase again in 2030 and 2032 – sending the children to private high school
- Possible changes in the short-mid term
- Review work balance when children start primary school
- Linda would like to do a company director’s course
- Surplus cash flow p/m – $5,512
- Home – Living in one of Australia’s major capital cities – inner-north suburb
- Property value – $2,350,000
- Debt – just under $1.2M monthly P&I repayments of $4,743 p/m (part fixed and part variable)
- Total Available funds – $180,000
- Super – $444,000
- Credit card – paid off monthly
- They were reasonably neutral to risk, and both rated themselves ‘3 Balanced’
- Their comments were: ‘“We have a lot of equity built up in current home and relatively high paying salaries, so comfortable with taking on some more debt to buy an investment property or a holiday house”
- Likely improve the family home by adding an additional bathroom – currently they only have one bathroom and a powder room
- Potential holiday home purchase OR may decide it’s better to keep renting AirBNB for holidays
- Both want to keep progressing their career, continuing to have roles that are challenging, interesting, meaningful
- Flexibility to cut back on work in the future, or make professional decisions that are not entirely based on salary
- Potential to live and work overseas for a period in the medium-term
- Flexibility to retire early if they wanted to
- Enjoy having surplus income for entertaining, good food, wine, etc
- At least one overseas trip per year. Want ability to travel/holiday regularly
- Next Property Decision – Want to buy a holiday house or investment property with long term goals in mind and unable to decide which pathway.
- Property Strategy – Given how important property purchase decisions are, they want to ensure they have the right strategy and expert-driven advice to support that decision making.
- Their preferred property pathway:
|Decision||Property Type||Purchase Year||Purchase Price in todays dollars||Financial Return|
|Purchase||Holiday Home||2027||$800,000||Capital Growth|
Financial and Money Goals
- Financial security and education – Want to provide long-term financial security for the children and to send them to private high school in 2030.
- Money goals
|Existing Surplus Cash Flow||$5,512|
|Money Goal – Surplus Cash Flow||$1,500 – $3,000|
|Existing total Available Funds||$180,000|
|Money Goal – Available Funds||$70,000 – $180,000|
- Flexibility stage of life goal
|Annual Rental Income Goal||$150,000|
Scenario One – holiday home purchase at $800,000
- Hits their target price point for a holiday house.
- Allows them to enhance their lifestyle by securing the holiday house now.
- Achieves their Surplus Cash Flow and Available Funds Money Goals.
- Loan Structure
Security – New Purchase $800,000 + PPOR $2,350,000 = $3,150,000
Total Security $3,150,000 x 80% = $2,520,000
Existing – PPOR Home Loan $1,192,700
New – Purchase Loan $640,000
Equity Release Loan $98,000
Total LVR – 61%
- Cash contribution – $110,000
- Secured against PPOR – $98,000
- Secured against PPOR LVR – 12.25%
- Holiday Home Loan – $640,000
- Holiday Home LVR – 80%
- Total LVR for Holiday Home – 92.25% Loan to Value Ratio
- Total lending – $738,000
- Surplus Cash Flow Money Goal Achieved – $1,500 per month, assuming a principal and interest repayment of $3,012 per month at 2.75%. This outcome is right on their Money Goal, although given their level of debt and the fact they will be holding two non-income producing properties, we think they should try to aim for $2,000 and above per month until incomes rise.
- Available Funds Money Goal Achieved – $70,000 is right on their Available Funds goal of $70,000.
- They do not need to purchase another lifestyle property as they will have the family home and holiday home, and every subsequent decision can be investment focused.
- Their initial goal was to purchase a holiday home in 2027 for $800,000 in today’s dollars and this achieves that goal, which enables them to enhance their lifestyle now.
- Their overall debt levels are far lower in this scenario.
- Should the holiday home win out as their Next Purchase, they enhance the likelihood that they will purchase a property that they genuinely enjoy spending time in, ensuring family holidays don’t get overtaken by the desire for rental income.
- They will have reduced cash flow following this purchase compared to the investment purchase scenario, as they will have two properties producing no income.
- All debt will be non-deductible.
- This pathway is purely a lifestyle grab.
- Their Available Funds outcome is also inferior in this scenario as they are required to contribute $110,000 funds towards the purchase in order to achieve their minimum Surplus Cash Flow goal of $1,500 per month.
- Delaying the investment purchase, and as a result the building of passive income and wealth, which may push their retirement, reduce the quality of their retirement and impact their ability to travel or work less while the kids are at school.
- It may be better to budget a generous amount every year for holidays, than to purchase a holiday house, as Tom and Linda have noted in their Property Plan questions responses.
Scenario 2 – Purchase two investment properties for $1,800,000
- Achieves above their Surplus Cash Flow goal at $2,500 pm and Available Funds Money Goal as they do not need to contribute any cash whilst also showing how they can achieve the level of investment of $1,800,000 that they noted they would like, to get into the investment market over their next two investment properties, all whilst keeping their LVR under 80%.
- Loan Structure
- Security – New Purchases $1,800,000 + PPOR $2,350,000 = $4,150,000
- Total Security $4,150,000 x 80% = $3,320,000
- Existing – PPOR Home Loan $1,192,700
- New Purchase Loan $1,440,000
- New – Equity Release Loan $468,000
- Total LVR – 75%
- Cash contribution to purchase – $0
- Secured against PPOR – $468,000
- Secured against PPOR LVR – 26% of the new purchase(s)
- Investment Property Loans – $1,440,000
- Investment Property LVR – 80%
- Overall LVR – 106% Loan to Value Ratio
- Total lending – $1,908,000
- Surplus Cash Flow Money Goal Achieved – $2,516 per month assuming 2.50% yield, 4% interest only loans and 1.50% holding costs which is above their Money Goal of $1,500pm, and we would prefer to see they keep at least $2,000 pm as surplus cash flow anyway.
- Available Funds Money Goal Achieved – $180,000, they don’t need to contribute anything to the purchase which means they keep their full buffer of $180,000 which is our preference to help them manage risk, and is will above their stated Money Goal for their Available Funds of $70,000.
- Counter-intuitively, their financial position via their Money Goals of Surplus Cash Flow and Available Funds outcomes are far stronger in this scenario despite the much greater outlay.
- This means they will have greater funds to reduce their non-deductible debt through the use of an Offset account, which will have a compounding effect on the principal reduction of their mortgage.
- This is also likely to leave them in the financial position where they feel the most comfortable given the income they would derive from the two investment properties.
- They are accessing equity in their PPOR property to ensure they do not have to contribute any cash to this purchase, therefore their loan for the investment purchase will be fully tax deductible, which will help to reduce their tax payable.
- They could own properties in two or three states providing them with some diversification and protect against different property cycles and state based economic success.
- All things being equal, a high value property or two should provide for a greater level of capital growth than a holiday home over their lifetime creating the opportunity for them build greater net wealth and retirement income.
- Buying two properties sooner, in the long run is likely to set them up financially due to the extra time for compound growth and debt reduction, although it presents more risk in the short to mid term.
- Given they have some lofty rental income goals for retirement at age 55 and with $150,000 income from property, this pathway will put them well on the way to achieving that sooner.
- In our view the first purchase should be in the $1,000,000 to $1,200,000 range, which will be more growth focused, and a reduced yield, but this provides they with more compound growth over the longer term.
- Keeping $170,000 in Available Funds also provides the opportunity to bring forward adding the extra bathroom sooner than later to provide a nod towards the lifestyle pathway and getting some lifestyle return in the near term.
- Finally, this approach is in line with what they were thinking also with regards to their next purchase being an investment.
- They are prioritising their financial position over their lifestyle and this decision may come to frustrate them over the years as they commit to paying multiple loans and it may be more difficult to find the balance they have made clear they want with focusing on enjoying their lifestyle.
- To the above, buying an investment property now will make it difficult for them to purchase the holiday home for potentially another 5 to 10 or ever, due to their debt levels, cash flow needed and the likely continued increase in cost of the future holiday home.
Purchasing the two investment properties may be achievable sooner, however, will absorb a lot of the equity they have and their cash flow, which may mean the holiday home purchase is pushed back. The sooner these two investments are purchased, the longer they will have to set themselves up to purchase a Holiday Home if that is the path they choose.
- Moved ahead with Scenario 2, but just the first investment.
- It will be difficult to achieve all their goals include having a holiday house in a coastal region, debt free at retirement or sooner, $150,000 in rental income, overseas work and reducing employment while the kids are school.
- These goals will require some careful consideration as it is less likely all will be achievable and there some compromise will likely ensue.
- They do not want a mixed focus resulting in a holiday house that they do not enjoy spending time in and is a poor investment choice to boot which was a consideration.
- They decided upon a price point of $1m after various discussion regarding the pros and cons of the starting price point between $1m and $1.2m.
- They wanted to use a Buyers Agent and they worked with one of our preferred partners whom we receive no kickbacks from
- Purchased for $975,000 using an A grade Buyers Agent service within 6 weeks of delivering the property plan.
Overall, it feels that their instinct for much of their pathway forward was quite good, and we trust the Property Plan has reinforced some of their considerations and filled in some of the gaps to provide they with the confidence and education to be empowered to make the right decision for their ‘Next Purchase’