Posts Tagged ‘equity is king’
I want to add a little bit more to my previous blog on whether to go for capital growth or equity as your property investment strategy? Before I go on I will say that this is my opinion and the right strategy for you will depend on a number of things. Particularly early in your wealthdevelopment you are going to need good cashflow - if you don’t have this from your job or Business then you will need this from your properties.
Timewarp to 2002 – triggers to me starting investing
I had read Andrew King and Lisa Didson’s best-selling book The Complete Guide to Residential property Investment in New Zealand, and Dolf de Roos and Jan Somers’ book Building Wealth Through Investment Property. I went as a guest of a friend’s parent to a couple of APIA, listened to property investment accounting guru Mark Withers talk on tax savings from property investment, and since I was a young corporate solicitor in what was then the top law firm in New Zealand I was on the top tax rate. Some family and family friends were investing in property, I had helped my grandmother for years drive to collect rents from tenants and be her assistant property manager, so I knew it was time to invest myself. Having been to fund manager, sharebroker and property investment seminars the presenters were saying that only between 1 and 8% of people retire rich, most are dead or dead broke (and obviously statistics get a little bit distorted or mis-interpreted a fair bit to sell a story sometimes).
So I had enough positive affirmation to make the decision to buy property. I am delighted with all of the above that helped inspire to get me into property.
So I started looking in the property presses of Auckland, various papers, using websites and agents.
My $200,000 mistake (my case study)
Back in 2002 when I started my own direct property investing, I made a mistake. At the time I didn’t think so, but hindsight is a wonderful thing.
I had narrowed my selection down to two properties - one in the lower decile suburb of Manurewa and one in the exclusive subrub of Remuera:
1) a 3 bedroom house on just over 800sqm in Manurewa, to be auctioned with agent’s estimated price and vendor’s RV of ~$152K, rental appraisal $260/wk, owner occupied, that would benefit from a minor cosmetic renovation; or
2) a 2 bedroom unit in Remuera with less than 300sqm land, list price $250K sale by negotiation, rental appraisal $275/wk; owner occupied by an elderly couple in need a cosmetic renovation.
Options:
Manurewa house: After talking with the respective agents and attending the Manurewa house auction where I was the only non agent there, I made a bid at the auciton at the nice low price of $125K. This did not meet the vendor’s reserve so the auction was canned. The vendor’s reserve and requirement was in fact $140K as he needed to clear his Mortgage of $133K and play to relocate to Australia $6K and of course $1K legal fees. So $140K I was told would definately buy it. The property would cost $7K to renovate with professional assistance or $2.5K if I did it myself and with friends. The rental then would be $280/wk giving a 10% yield.
Remuera unit: I was told the vendor wasn’t very negotiable at all, the agent not revealing the vendors reasons to sell, apart from time to move on to a new place. They said $250K would buy it. The property would take $10K to renovate professionally or taking out the bits I could do $6K. The rental then would be $300 per week giving a 6% yield.
Which property would you choose?
Well I choose property 1 the Manurewa property - being very attracted to the yield. Cashflow is King right! I got myself a pre-tax positive property and thought I was very clever.
After my renovation the property was valued at a Massive $160K up from the $150K if I hadn’t touched it. In mid 2005 I still owned it and it was valued at just $175K.
Guess what the Remuera property was worth…
It sold two months after that registered date at $470,000. All it needed was paint, carpets and a new benchtop, so even if the asking (list) price was paid, $10K for renovating this small-medium sized unit, it still went up over $200,000. Allowing for the tax rebate this property was after-tax Cashflow positive.
Tired of my assigned property managers sadly hating their job managing South Auckland properties I had 7 property managers in this time, and rent arrears so I terminated their contract. I managed the property myself for a while and got bored of turning up to collect rent arrears and finding their 5 children aged from 2-9 years of age unattended. I asked the 9 year old where’s Mum, where’s Dad – I got told at the pub! Sadly after won of these big day’s out Jake the Muss put his fist through the mother face fracturing her skull. This didn’t help my rent arrears and I saw blood on the walls of my rapidly deteriorating home.
I rang Tenancy Services wanting to get an immediate eviction – but to no avail. They were not 3 weeks behind in rent! I had had enough and was pretty disappointed with project and managing it myself was rather stressful – so I changed my mind as I wanted to keep this property forever, and I sold it.
Look at my foregone equity – taking into account the nearly $150/wk after tax positive cashflow I made (interest rates were sub 7%), reno costs, but subtracting the lost rent and damage to the property that they couldn’t pay (they split up) I made less than $20K on this property. The Remuera property would have made more than $200K after allowing for the costs of reno and cashflow
So I cost myself $200,000 by going for the positive cashflow property.
Equity is King.
I now know what my Granny and parents know – that cashflow is nice, and is needed when you are starting out building a portfolio. But whenever you get a choice – choose equity.
Remember that when you have an equity portfolio you can choose to change to a cashflow portfolio (or even putting the money in the bank!), but try changing from a cashflow to equity portfolio straght away. You will not be able to do it as you will not have much equity and hit debt sevice walls with the bank straight away.
Conclusion
I conclude that not everything you are taught is right. Just because other investors do it does not make it right. Cashflow is very important and you must be able to meet your debt obligations. However once that is achieved then Equity is King.
Some readers may not like my message as I am directly seeking that they question their own cashflow strategy – however I want to say there are other strategies out there and I guess if I can help a couple of people reading this blog not blow many hundreds of thousands of dollars in lost equity as I did, my job is done.