Episode 168 | Listener Q&A: How to buy your first investment property | Host Special

A question so good we dedicated an entire episode to it!
One of our dedicated listeners Lily, asked six questions around buying her first investment property. The questions were so relevant and important they warranted their own entire episode. We discuss how to assess, prepare and act on buying your first investment property, what you should be buying and how to know if you’re ready.
Questions:

1. Financially, what are some indicators you're ready to buy an investment property?  (Eg is there a rule of thumb for how much of your place of residence you should pay off first? And does that count money in an offset account?)

2. In terms of location - does the advantage of having local knowledge outweigh the risks of having all your eggs in one basket? (And if the advice is to diversify, does that mean look in a different suburb, or is it better to look in a completely different city? Diversifying makes sense in theory but buying in an unfamiliar city seems risky)

3. Is there any guidance around the value of an investment compared to the value of your place of residence, assuming you can service repayments? (eg would it be weird to have an investment property worth more than your place of residence, assuming you are happy living in a modest home?)

4. In terms of type of property, is it good to diversify from your first property or just to focus on a 'quality asset'? (Eg Our home is a townhouse - should we try hard to get a freestanding house for an investment property?)

5. What are some tips and considerations for structuring mortgages? (Eg we make currently make minimum repayments and keep any extra in an offset, just in case we want to buy or rent elsewhere and keep our current place as an investment property. However, it's looking more likely that this will be our 'forever home' and future property purchases would be investments - or if we didn't want to live here we'd be happy to sell it, rather than rent it out - would that change the strategy?)

6. What are the pros and cons of using the equity in your home as leverage?

RELEVANT EPISODES:
Episode 162 | Houses vs Apartments
Episode 161 | Listener Q&A: Building your own home, retiring on property & sustainable properties?
Episode 157 | 2021 predictions & 2020 review

HOST LINKS:
Looking for a Sydney Buyers Agent? www.gooddeeds.com.au
Work with Veronica: https://linktr.ee/veronicamorgan

Looking for a Mortgage Broker? www.wealthful.com.au
Work with Chris: hello@wealthful.com.au

Send in your questions to: questions@theelephantintheroom.com.au

EPISODE TRANSCRIPT:
Please note that this has been transcribed by half-human-half-robot, so brace yourself for typos and the odd bit of weirdness…
This episode was recorded in March, 2021.

Veronica Morgan: In this episode, we're answering one of our listener questions. It was such a good question. We decided to devote an entire episode to it, and we'll be covering how to go about buying your first investment property.

Veronica Morgan: Welcome to the elephant in the room. This is the podcast where we love to talk about the big things in property that never usually get talked about. I'm Veronica Morgan, real estate agent buyer's agent co-host of Foxtel's location, location, location, Australia, and author of auction ready.

Chris Bates: And I'm Chris Bates mortgage broker. Before we get started, I need to let you know that nothing we say on here can be taken as personal advice. We always recommend you engage in the services of a professional.

Veronica Morgan: Don't forget that you can access the transcript for this episode on the website, as well as download our free full forecast report, which experts can you trust to get it right? The elephant in the room.com did I use

Veronica Morgan: Our question is from Lily. She says, I'd be interested in an episode about buying your first investment property. Assuming you've already bought your first home. Now Lily had six specific questions. This is why it's a whole episode, really covering how to know that you're ready to buy an investment property through how to structure your borrowing, how to choose an asset and what pitfalls to avoid. So he goes with the first of those six questions financially, what are some indicators you're ready to buy an investment property? For example, is there a rule of thumb for how much, your first place of residence or the first property that you own how much of that you should have paid off first? And does that count money in an offset account?

Chris Bates: Thank you so much, Lily. When I got this email through with a question, I was like, this is such a well-crafted question in terms of there was so much thought put into it and it's really helps us delve deep into some of the things people are thinking about if they're considering their first investment property. So thanks for such a brilliant question. I guess the, the financial, what are the indicators, whether you're ready to buy an investment property? It's a really interesting question as well because I think often clients have gone way past those indicators. You know, they've looked years and years later and they're paid off their home and no one at the moment has got, you know, hundreds of thousands of dollars in savings, like so risk adverse and the indicators were actually maybe 10 years ago. And so for them they've gone way past it and they've wasted 10 years. It's time is our biggest asset in life. And so that's definitely too late, but I also say clients do too early, you know, they get a little bit of equity in their home. They've got the capacity and then they go leverage up to the Hills and I've definitely seen clients buy multiple properties. And you know, basically blow it all up because they had to sell their home or they've had to sell an asset or one of those properties has been a poor investment. So just thinking about,

Veronica Morgan: I was about to say in scenario, I've seen that many, many times where the minute you've got a skerrick of equity, they go and borrow and it's usually not enough to buy anything, any good. So the buy a piece of junk and then they do it all over again and over again and over again. So that's, but I've seen people do it the opposite way as well, where they've just the indicator was 10 years ago. I had one client. This has happened a couple of times actually, where I've had a client come to me. So, right. Well actually I don't need to borrow, someone's going to buy an investment property cash. I'm like, that's fantastic. You know, whether they've sold shares or had a business or whatever it was, it's like, that's fabulous, but you need to go and get some financial advice because you can, you know, divide that equity you can borrow. You can actually you know, get a new numerous assets in that scenario without actually costing you in terms of cashflow at all, you know, and depending on where you are in life and the risks that you do or don't want to take, I mean, quite shot, that's an ultimate risk aversion.

Chris Bates: Yup. A hundred percent. And that's one I'm we will cover is, you know, if you have got a capacity or borrowing capacity from the bank, or you can borrow money basically really you should be borrowing to buy investments and then putting your money in the offset, even if you're in that fortunate position. So I guess going back to sort of Lily's first question is what are some of the indicators I really liked to have a bit of a live chat here. And if you were a client Lily, I'd be sitting down and saying, okay, yeah, I know you bought your first home, but you know, what's going to happen with your life. You know, you're married, you're gonna have kids. Are you gonna want to move to a different city for work or for lifestyle? You know, the home you're in now, can that, can you renovate that?

Chris Bates: Would you be happy there? Do you love the area? Do you love the street? You know, would you overcapitalize if you did a renovation and so I think that real sort of life chat's really important because you know what you could, you know, big mistake. I say, you know, someone gets a home that they're happy with for five years. Most people just say five years, like it's a random number and then they'll go and bought an investment property. And what they're actually doing is shooting themselves in the foot because they know they're not happy in that property. It's potentially something they're gonna outgrow. And then they go and buy like another apartment they'd say, and they've got two properties, but then three or four years later, they had that child they're outgrowing the apartment and they want to house. And the only way to make that house happen is to not only sell the house they're in now, but also sell the investment property.

Chris Bates: They just purchased three years ago. And so I think that's a really important discussion is, is, is what, where are you going to live? Long-Term and if it isn't in your current property, my, you know, my brain automatically goes to thinking, well, should we be buying that as your investment property? Should you be buying your future home? You know, or should you be doing an upgrade earlier rather than just staying in, you know, the place you're in now, till you outgrow it, why don't you move into something that you can grow into? So that's probably the first thing that I think about. What about, about you Veronica?

Veronica Morgan: That's such a good point because you know, the amount of times that we have people come to us and they want upgrade their home, you know, they've had kids or they're, they're doing really well in their career and it's, it's time to sort of move to a bigger home or a different area. And they've got this sort of couple, you know, some of them have got more than one investment property that are really horrible and they're not good assets. But they are also severely impacting their ability to actually move into the home that they really want to live in. And so they then can't quickly. So it's not just that, yes, you have to go and do that if, to sell those things, et cetera, that takes time. Good point. And so if tick, like you look at a rising market, right?

Veronica Morgan: The minute, you know, those people are really hamstrung, so they've, they've invested with all the writing tensions, but like you say, they haven't had that life chat first to think, okay, really? Where do I see myself and what, what do I need to have in place? Or what do I need to not have in place so that I have that freedom to do that. And so that, that is something that I really do see a lot. And that is something that we really didn't see at all until really from 2016 when the whole, the lending rules changed. And so, you know, the whole yeah. Buying an investment property. Yes, you're absolutely right. It has to be taken in consideration with where you're at now, because it can become a new saran generic. There's also the, I was to say, there's also the argument in a low interest rate environment and with the TAC, the favorable tax treatment of buying your own home, that, you know, some people are saying, well, I'm going to invest in my own home more than actually buying additional properties. So are you seeing that decision?

Chris Bates: I think it's a really good point. We'll cover that in one of the other questions that literally is said, because absolutely low interest rate environment encourages home ownership rather than investments because people say, well, yeah, I'd really love another bedroom or study or to get to that better straight or a different suburb. And when interest rates are low, it's easier, it's more affordable for people to do it. Hence why I've got this boom at the moment through driven by home buyers because people are saying, well, yeah, I only live once. I really want to love the place I'll leave. I can take on that extra 500 or a million dollars of mortgages. I always think that's a really good point. You said about the time to sell it's one of the big negatives I guess, of property is that it doesn't just happen overnight.

Chris Bates: And sometimes the person who buys your property wants a longer settlement and they're the ones offering the most money. So, you know, with shares, you can sort of wake up tomorrow and go right left to liquidate and let's get everything in the bank account. Let's move on to the next thing. And the thing that really stands out, this is where a poor asset really just, you know, their veil sort of comes back is because poor assets take longer to sell. You know, if you've got a great asset, I've got lots of clients at the moment who are in this real stock sort of Mexican standoff. They, they haven't got the guts to sell their home. Even though they know it's a great asset and they really want to upgrade because they know what they want to buy is just not, not there.

Chris Bates: And they know that it could take six to 12 months. They don't want to be out of the market for six to 12 months. So they're in a great position because they know their property will sell within two or three months. But they're stuck because they haven't got the guts to sell and be out of the market in such a hot market. So the second thing, I guess, go back to live, this question is how much are you on top of your debt? You know, it's not about what percentage, but it's, how fast are you paying it off? You know, how much are you smashing your mortgage down? And, you know, you can really easily just do some calculations of if you kept your current repayments or, and then you put a couple of way drives in there, potentially if you're, you know, you think that's likely the, how fast is this going to be pay off?

Chris Bates: You know, if it's 20, 21 now you know, are you gonna be paying your mortgage off in the next 10 years? And if you're in your thirties or forties, you know, what, what will you do when you get to 15? Your mortgage is paid off where you think about doing, you know, other investing then. So if you're asked, smashing your mortgage down and you're paying a lot more than minimum repayment, and you're likely to pay it off in say the next 10, you know, maybe even up to 15 years, I'd be arguing you to you just to say, well, why don't you just slow down that, paying off a little bit, not much and direct a little bit of that cashflow to support an investment property, because even though you might be paying off your home slower, you still got a lot of runway, you know, retirement is not around the corner. And so yeah, definitely paying a mortgage. You know, you need to have a bit of equity there, but you don't have to have it down to 30%. There's not these sort of round numbers that are there is like a rule of thumb. I just don't think everyone's got different circumstances.

Veronica Morgan: Although I guess if you're going to use that equity to borrow against for another property, you do have to have a certain amount in there don't you?

Chris Bates: Absolutely. And so this is you know, the interesting thing with this is last year, we were getting a lot of poor valuations with property. And so equity is basically whatever the property is worth today, but not what it's probably worth. And that's always a bit of an eye opener and frustration for clients because we'll order evaluation, you can do it free with pretty much any lender and a client might think it's worth a million dollars, let's say, and we'll get the value back and it'll be eight 50 or it'll be 900 or nine 50. It's very rare that we get evaluation and we go, Oh yeah, that's fair. We're happy with that. When really there's no incentive for the valuer to, to put something on a big number on it. Ultimately, you know, to protect themselves, they're going to go a little bit under what they probably even think it's worth.

Chris Bates: So let's say you think it's worth a million. The vowel will come back at nine 50, then eight, the water equity is, is 80% on nine 50. So that's 760. And then so a lot of clients will say, well, I've got heaps of equity in my property. Well, your equity really only starts once your mortgage is under seven 60. And so if you've got a mortgage of say 700, well, you've only got 60 grand of equity in that property because it's only after 80% of what the valuation is. And so I get a lot of clients saying I've got a property worth, a million dollars. My loans only 700, I've got 300 grand of equity. Well, no, you, haven't not in the bank size. You've only got 60 grand. And so that's a bit of an have in discussion. That's what you would use for the deposit on something else, which 60 grand wouldn't be enough for a deposit on.

Veronica Morgan: That's such a good point. I'm glad you've explained that. And the other thing too, that equity isn't just debt reduction is growth. And this is why it's really important to look at capital growth when you're buying property. Even if it's your own home, a lot of people do say, Oh, capital goes to any port and I'm gonna live in it for 20 years, but it is important if you want to dig down into the equity in order to buy an investment property. Right. Well, it's important for lots of reasons, but that's just one reason. And so in that, you know, so therefore you want the property to grow in value because that, that plus your debt reduction or that your, whatever you're putting your offset account is the equity. And so, you know, that's, that's really where you make money while you sleep in a way with property.

Chris Bates: Absolutely. I mean I don't really like that line as well. That kind of frustrates me a little bit. When clients say, Oh, it doesn't matter if it doesn't grow, it's my home or I'm going to keep it forever. I'm never going to sell it. Nothing is to perpetuity nothing's to infinity. At some point it sells even if it's a death. And so then that money would go to your kids or your sister or whatever. And so I'll a hundred percent, you know, especially when it's your home. Absolutely. You know, you need to be personally making sure it's a great asset to grow. Plus get the lifestyle, you know, you don't have to have one or the other, you could have an unusually the properties that grow the best have also got the best lifestyle they're on the better streets, et cetera. So yeah, try to try to do both it's if it's great to there's not growing and it's not great to live in, then I have to argue whether you should be buying

Veronica Morgan: Well with that. Assuming all the things, things are equal, you know, you're going to need, I'm guessing at least 40% equity in order to be able to do anything. Would that be fair to say

Chris Bates: Potentially, I mean, it really comes down to, you know, have, how much is the house worth or what your home is, what it's worth. You know, it could be a $2 million home, right. And you know, your loan could be down to say 1.2. And then, you know, if you're 80% on 1.2 million, 1.6, that's a lot of equity there that could go. So it really depends on how big expensive your home is, but you're right. You're going to need a fair whack. I just want to say as well, some professions don't need to go up to 80%, you know, in terms of the equity, they can actually go up to 90%. So, you know, accountants, doctors, surveyors you know, et cetera lawyers yeah, they can borrow at 90%, not only on the equity, but also on the investment property.

Chris Bates: And so they have got a massive advantage on other buyers out there because they can leverage their equity a lot further than the average puncture on the street without paying any lenders mortgage insurance. So, yeah, equity is always a funny one. I think people think they've got a lot more equity than they always do because of the low vow because of the 80%. And how much equity do you need now, this is a funny one. So a lot of people think if I'm going to buy a property investment property at a million dollars, I'm going to need a 20% deposit plus 5% for stamp duty. So that's 25%. So I need $250,000 of equity to buy in a million dollar place. Well, not really, you know, you really need a, at least a, probably a 10% deposit ideally, and plus 5% for stamp year.

Chris Bates: Should I be aiming for that 15% because Linda's mortgage insurance, doesn't get that expensive until you sorta go over 88 to 90%. And it's also deductible over five years. So if I'm going to buy an investment property, as long as I've got enough equity to cover a 10% deposit plus stamp duty. And if I have to pay a bit of lenders mortgage insurance, I'm not that bothered because it's tax deductible and it's not that expensive at 90%. So I think that's a really good point where you should be doing it, but we haven't got to a third indicator. And that's buffers. You know, you don't really want to be using all your equity. You've got nothing in your offset account, you've got no other savings and then leveraging it up. And then if something happens to your situation, whether you or your partner or your health you know work, et cetera, and your income doesn't come in, you can literally blow up everything because you can run out of cash. And so buffers are the absolutely. If there's not a decent buffer built up in the offset account, I'll encourage clients to keep on saving because the biggest risk with property investment is you have to sell you know, at poor times. And so buffers is the name of the game, not only in property, but in business in life, really.

Veronica Morgan: So we have an offset account. So say that you've, you've got nice big chunk in your offset account. And that's part of the equity that you're going to use to buy an investment property. Once you buy that investment property, do you have to then pay down the, your home debt with that offset, that amount in the offset? Is that how it works? Cause how does the bank get access to it to make sure that you can't then go and spend it on a flashy car?

Chris Bates: A really good point. So we've got a client at the moment who you know, he's got low one millions of say, let's do the numbers 1.2 million of debt, but he's also got 700 grand in his offset account. Just because he, we did an upgrade and we were able to sort of give this big buffer to him, right. But he wants to buy an investment property right now. And because of his income for him and his wife and how much they can borrow, the only way that they can borrow a decent amount to buy a decent investment property is to pay down that mortgage of 1.2, five, and re use that money in the offset account to pay off the mortgage. So that mortgage won't be 1.2, five. He'll probably have to pay it down to about 700 to seven 50, which will still give him a buffer around 200 grand is probably what we're trying to do.

Chris Bates: But what that does is it means that he's home debts from a tax from a borrowing capacities. Now any seven 50, not 1.25. So a bank says, well, yeah, if your home loan is only seven 50, we'll then do a lot more for an investment property. And so when clients are in a position where they're got a massive amount in the offset account then the bank uses the limit of the line. They don't even look at the offset account. And so for them, sometimes they have to pay off their home to allow them to buy an investment property if their incomes are restricting them. But if they can borrow a lot of money in the incomes are really strong, then potentially they can keep this huge amount in the offset plus buy an investment process.

Veronica Morgan: So I think that's one of the things you've often said before. How do you improve your borrowing capacity? Earn more money? Yeah.

Chris Bates: It is, it is true. I think the so for example, I it's a real eye-opener. We get clients who say, well, the property is servicing itself as positive. The cashflow should not just be out to borrow another one. Well, no, like a really it's pretty mind boggling. Like if you buy a million dollar investment property, you may get $600 a week rent, do you reckon maybe,

Veronica Morgan: Oh no. These days where you might, yeah.

Chris Bates: Let's just say 630 grand to heat. And if you then have to, the bank will then haircut that $30,000 a year. Now, usually by 20%, it could be more so your $30,000 a year rent is now only 24,000 because they haircut it in case they can see and cost to run your property, et cetera. And then if you times that $24,000, let's just call it 25. If you times that by six that's 150,000, that's roughly how much you can borrow based on the rent. So the other eight 50 or 800 let's just call, it has to be funded by income. So you have to have the income to support that debt. The rent only covers a very small amount of that debt in terms of income. So that's usually an eye-opener for, for clients that it's income that drives big portfolios. You can't just keep on building property portfolios based on rent.

Veronica Morgan: It's that old Chestnut. Right. So the second question in terms of location, does the advantage of having local knowledge outweigh the risks of having all your eggs in one basket? And if the advice is to diversify, does that mean look at a different suburb or is it better to look in a completely different city? Diversify makes sense in theory, but buying in an unfamiliar city seems risky. It's such a good question.

Chris Bates: I think he's a good one for you to start on this one, Veronica and I'll chime in at the end.

Veronica Morgan: Huh. So, okay. There's this thing called home bias where, and I've met so many people over the years where they have bought quite literally a property around the corner from their existing home as an investment. And they do that for a number of reasons, you know, they can drive pass so they can keep an eye on it. They know the area, they feel like they, they feel like they understand the dynamics of that area. They've already paid money to buy into that area. So therefore they've, they're biased or automatically to think that that was a good decision. So they follow that with another decision. So there's lots of reasons why our, our behavioral biases support us wanting to buy in a good in, in the location in which we're in and E and look, I've done it myself. Let's face it. You know, I've, I've my properties.

Veronica Morgan: You know, at one point I had two in Leichardt now I don't recommend that. And I have none in Lockhart now, but, but you know, I've done it myself. So and then there's a good argument to say, well, if that's a great area, then why not? You know, but the problem is that even in a great area, you can have macro environmental things that happen in that area that affect every property in that area. So I'll give you an example at the moment, and it's sort of a slightly off piece, a little bit, but I have an investment property in Alexandria. It's a house. I don't have an apartment there. I have a house now, capital growth wise. That's doing very, very well. It's a great street. It's in demand, you know, et cetera, et cetera, et cetera, but rent wise.

Veronica Morgan: And this is not specifically in relation to whether you choose because we don't buy for rent, right? We've already said that, but that rent on that property is impacted severely because of the glut of apartments in this, in the same suburban, further on into an adjoining suburbs. So, so it is impacted by things that are completely irrelevant to that property and that class of property. And, and if I go to sell that, which I'm not going to, but it would do very, very well. I know it will do very well. I track it, but, but renting the yield is appalling. So that's just an example, I guess, of some thing that can impact the property that is completely out of my control. And if I decided I was just going to buy a whole bunch of houses in Alexandria, they're all going to be impacted by that.

Veronica Morgan: Whereas if you know, I've got my eggs in various baskets and they're in different suburbs, then they're going to be impacted differently by those forces. So that's just one example. There, even in a great suburb, you can be impacted. So diversification is a good thing. The other on the flip side of that local knowledge is also essential to make good decisions. So whilst yes, you can be completely biased by your local knowledge. You know, if you'd have no local knowledge and you think you completely agnostic about where you buy, you can be very much open to be swayed by data effectively and making data driven decisions without any real understanding of the fundamentals of a particular market. So, so these are the sorts of things that we need to be aware of our limitations, but also our temptations, I guess, to be swayed by various rules of property. Right? So I think that the other thing that comes down to it that has to be considered is when you're buying an investment property, you have to think, I want to buy the best possible grade property I can buy. And if I can't afford an, a grade property in the area that I know, and that I understand that I need to then start researching other areas where I can buy a great property.

Chris Bates: Yeah. I think that a home bias is a really good point. I think confirmation bias is so strong and, you know, when you own something, you also overvalue it. So if you're in your suburb, you think your property is better than every other property. And you also think that your area is the best area in the world and you know, et cetera. And so you think your property is doing better than it probably is. You also think that your area is going to keep on doing what it's already done, you know, recency bias, et cetera. So and it's just so strong and, you know, it's so easy as well, you know you know, think about you're walking down the street and see someone renovating or should buy an investment property and there's a sign that it's just make it happen.

Chris Bates: And so it's so, so common. And I think I personally would try to obviously know that you're potentially going to do that. And then just look at I, you going to be able to afford the best assets in that area, you know, the, a grade streets, et cetera, or have you got a budget that's you know, the buying the season the days. And so if you are buying the poor assets in that suburb, that's really, you know, time to move on, you know, look at our alternatives, if it is the best assets and you really do know the best streets yes, it's worthwhile considering that, but you do have to be, like Veronica said conscious that there could be some sort of macro or local area thing that could double hit you. And that may, may or may not sort of wipe you out, I guess, whether that decision was good.

Chris Bates: I think ultimately, you know, every suburb or every city, I think has different price points where you're going to get a quality asset. And I think if you've got, for example, a budget of 500,000, you say, I want to buy a great investment property in Sydney, a bit tough Veronica. Yeah, exactly. But maybe, you know, if you really are probably arguing, maybe try to improve your borrowing capacity first or save more or build more equity or increase your income. But maybe somewhere like Adelaide, but even Adelaide might've run on you. So depending on what your sort of capacities for an investment property that ultimately, I believe determines what cities you should look at, you know, because it's certain cities you're going to be able to get a much more value for money, you know, much more bang for your buck if you have certain borrowing capacities, because

Veronica Morgan: Yeah. Be careful on that though. Just when you say that, because a lot of people, for instance, say, I dunno, 10 years ago, they'd be saying, Oh, I'm not going to buy an investment property in Sydney because, you know, for the price of a one bedroom apartment, which, you know, as, as proof is proof is in the pudding. Let me tell you though, the one bedroom apartments is sitting out doing so great, but for the price of a one bedroom apartment in Sydney, I could buy a two bedroom in Brisbane. Yeah. And it's like, just because you get more bedrooms, doesn't actually make it a better investment property. It is that the gray, the caliber of that property in those areas. So just, I just wanted to clarify that Casio on secure. Okay. If I can get bigger somewhere else, it's better. It isn't, that's not how it works.

Chris Bates: No, just in terms of more bedrooms or more lands, you know, a lot of people say that this, the amount of land 700 squares is better than say 200 square meters of land. And we might go, well, you know, if it's a much better location and it's 15, 20, K's closer to the city and it's got a heritage looking house on it. I'd much rather have that than 700 squares in the middle ring. And I think there's that belief that land, the mantle land that you get land banking is, is the great strategy when ultimately it's the scarcity of that land that really draws process. So yeah, I've got against buying locally, but you do need to make sure you're getting absolutely quality in that suburb. You're not just buying something that's easy. The reality is the best quality properties in a suburb trade, a lot less frequent and a lot hotter and a lot harder to get than the the season days. And even the bees.

Veronica Morgan: One last thing on the diversification location is land tax. And so if you're buying houses, then there's a real argument not to buy them all in one state because every state territory has a threshold for land tax. And you know, it's not a national tat it's on a federal tax, it's a state-based tax. And so if you have say you have three houses and they're all in Sydney you are going to be paying a hell of a lot of land tax. Whereas if you had one in Brisbane, one Sydney, one in Melbourne, you might not be paying any, or you might be paying a very small amount of Lantech. So, and that, that is a tax that I rail against. I really hate it. And particularly because it's got nothing to do with your income. And so, you know, regardless of whether you even get any income on that property, you are going to be paying it.

Chris Bates: Yeah, I think it's it's a really good point as well with, you know, we've seen clients that have heavily gone into say new South Wales or Victoria and the land tax bill does add up, you know, the percentage as you go over different brackets can be a lot of money. And so, yeah, it's a good point, but I do be careful there. Don't just assume that I want to save on land tax. So I'm going to swap swap States and then you take a different budget to, you know, Victoria or new South Wales you're living in Brisbane. And you also then sacrifice and investment quality to save online texts. So I'd not rather pay a bit more actual land tax and get the Garth on the quality asset.

Veronica Morgan: If you like, what you're hearing here, please share this episode with others, you feel would benefit. And while you're at it, why not leave us an iTunes review five stars, please. Every review helps make it easier for other people to find us and hear what our amazing guests have to say. We love hearing your questions and we're planning more listener Q and a episodes. Please send your questions in. You can send them via the website, which is the elephant in the room.com today. You or directly via email to questions@theelephantintheroom.com. Did I, you okay. The question, is there any guidance around the value of an investment compared to the value of your place of residence? Assuming you can service repayments, for example, would it be weird to have an investment property worth more than your place of residence? Assuming you are happy living in a modest home, and this is a good one. And I've got two examples to talk about this, but you go first. It is a really good question.

Chris Bates: Is it weed? I mean, that's, it's just a lot that, that term of phrase as well, because you know, you really thinking about things deeply here in Ukiah. Oh, look, I've got a house and for the shoot really expensive investment property. What I love about it is though, is that what you suggesting there is quality, not quantity. You're saying it's going to be an expensive place. It's going to be, you know, a lot more than our house, but we're going to get a quality asset. And I think that's a, it's a good thought process to think through. Like I said, at the start though, this is where I'd also be thinking through, is your home a really quality asset? You know, is it that, you know, should you potentially be using your servicing and upgrading your home you know, and get it grow tax-free and interest rights have a huge play in these because when interest rates are low, then you can afford to take on a lot more debt and get a much more expensive investment property.

Chris Bates: And the cashflow, the ongoing sort of thinking you need to sort of fund every year, you know, even before you get your tax back every year, you've got to kind of pay that money first has a huge impact on whether, you know, you should sort of take out a lot of money for an investment property interest on these, another sort of thing as well. You know, that's why you know, a lot of homes it's really hard to get interested only on at the moment, the way that the banks have to sort of, you know, fund their loan book. They can't really give you interest Eileen to homeowners, but they can give it to investors. So if you are a bit concerned about taking on a lot more debt and you don't want to take on a big home debt, well, if you can guarantee yourself interest only for say five years you can guarantee it a very low interest rate and you can get yourself a quality asset, then maybe that's a lot less pressure on your cashflow than taking on home debt. So there are all sort of good questions, but I think it's weird because what you're really doing is suggesting that you're going to borrow a really quality asset and just super happy in your home because you've sort of thought that through. So yeah, I don't think that's a good question.

Veronica Morgan: I think that the weirdness comes through Oh, but you know, that's sort of not what everyone else does. And I think, I think that's really fabulous that, you know, this is why we love this question, this whole question so much. Oh, you know, I've, I've got a you know, I've got some clients who leave in a they're live in Sydney, but in a sort of a, in the outer suburbs they've grown up there, their friends or their family are there. They are so established and settled in that area. They love it, you know, and it's a less expensive area and they've got good incomes, right? So they are going to be buying a property as an investment that potentially be worth more than the home that they live in. Because they are going to buy that investment in in a much more, I guess, established area for capital growth.

Veronica Morgan: Right? And so they're mating, they're making lifestyle decisions around that. It's like, this is where we want to live is where our families are. Well, why would we push ourselves outside that area? And we don't have to spend that much money to live here. We can live in a lovely home without having to go crazy. And so they've got the ability, the way with all to invest in a effectively it'll be smaller, but probably more valuable than what their home is. So that that's a really sensible thing to do. And I've got another client who, you know, they've got a young child they're living quite minimally, you know, in terms of they've got a, quite a compact place, but they're quite happy there. They're probably only going to have one child. And then as that, and that child isn't yet at school. And so they are actually looking at buying an investment property is significantly larger than the current home that they're living in.

Veronica Morgan: Now, I wouldn't necessarily go about it this way, but this is the way they're going about it, that they potentially could move into that investment property when it's when they order it gets, it gets bigger and needs more space. And, and so, and also then they can make, and so they've obviously got a structure thing we'll get to structuring, cause there's part of this question coming up, but you know, they've obviously structuring things to allow themselves maximum flexibility around that. And there are tax implications, et cetera, but that is, that's what their decision is. And they are very happy living where they're living for the moment and for the foreseeable future, it's going to be ample for them, for their needs. Yeah,

Chris Bates: Absolutely. Like not everyone should just keep on chasing the postcode and keep on chasing the bigger Hass you know, living simply living with lower debt and having sort of investment properties is a pretty good place to live, you know sort of way to live is because you haven't got these sort of big burden on your sorta cashflow to pay this sort of big mortgage. And so we say people in different States regionally, you know, come to us and maybe their house is of seven or 800,000, but it's a really great house and it ticks all their boxes and they're not going to leave, like you said. But they're also, you know, got great jobs and they're earning great money. And so they're going well, let's, let's use all that equity there and let's buy, you know, into Sydney or Melbourne or Brisbane, et cetera. So yeah, it's, it's a good question. I don't think you should be really focused about how much it is. It's really a case of what's the quality and can you afford to hold it long-term

Veronica Morgan: I guess the only downside is that that your, one of your bigger assets is going to be taxable when you sell it as opposed to your home. That's probably one of the downsides.

Chris Bates: Is there a good climate if you, but if you're in an area where you can't really upgrade, you know, and you don't really want to then yep. Yes. You know, I've got this bigger asset growing tax-free, there is a really chick, a tricky thing you could do with a six year rule, potentially you need to get tax advice around it, and that's moving into a home making that your principal place of residence, which could be your investment property, staying in it for a period and moving back into your other property. And things like that are a little bit tricky, but you could potentially do so. Yeah, that hopefully answers that question for you.

Veronica Morgan: Okay. The fourth question we've got in terms of type of property, is it good to diversify from your first property or just to focus on a quality asset? For example, our home is a townhouse. Should we try hard to get a freestanding house for an investment property? And I guess this goes into diversification, not just in location, but it isn't the actual property itself, right? Yeah. And

Chris Bates: I think when I read this question, I think, okay, a townhouse now there's two jobs of townhouses. Is that the cookie cutter? I all look exactly the same. They built by sort of mum and dad investors a lot of the time. And you know, they're three or four and a block and they're in areas where they're going to build a hell of a lot more of them. Hence why that that's a new townhouse in the first place. If you've got one of those, I really got to argue whether it's a quality asset. But there are the eighties and the seventies and the nineties townhouses, which you would probably see a lot in Veronica around the city. And some of them are an amazing place to live. So there's two types of townhouses. So if it is one of those new townhouses, Mike, my gut would be, well, you know, I know you like it, and I liked this new, but could you be better off in buying investment property, just upgrade your home and get into the housing market for your home. Renovate it and make it feel like a new home. If that's what's important to you, why you want to live in a townhouse rather than you know, having a poor asset, let's say a new newer townhouse, and you've got this great investment property that you could get growing tax-free and all the lifestyle benefits of lean say a house versus a townhouse.

Veronica Morgan: I think the property type has to be considered sort of as a function of location and budget. And so when you're looking at a pure investment, I think what you're saying is, is really good advice. Yeah. If you currently are living in a poor asset, why do people can, once again, we said that capital growth does matter, even if it's your home. But people will still might choose to stay there because that you know, that they are settled and happy and content, and, and there's a lot in that there's, there's, you know, there's, you shouldn't go disrupting yourself now that you've owned it. You know, now that you've bought it, don't go disrupting yourself because you think, Oh my God, now I've got a C or a D grade asset. Because there are costs associated with that, all the rest of it.

Veronica Morgan: So, you know, but obviously would prefer to you question that before you actually bought it in the first place. Right. So if you're there and if you're happy yeah. Y Y you know, disrupt yourself, but the property type comes into it. So, like for instance, the townhouse in the inner urban areas you know, that's a really viable option for families. Now, if families are priced out of three bedroom houses, you know, they're getting prostate a two bedroom houses. And so a townhouse could have, you know, three good sized bedrooms, two bathrooms got parking's, it's got a courtyard garden. Well located. I would go for that every day of the week over I a crappy house. You know, I mean, in fact, just this weekend pass, you know, I looked at, I was in Randwick and I looked at two properties and both quarters, similar amount of money I wouldn't go farther and for different reasons, but one was a house in a really down at, you know, not the greatest part of the suburb.

Veronica Morgan: And the other one was a townhouse in the, in the better part of the summer. And, you know, if the townhouse was a, a better, a better townhouse, I would have gone the townhouse over the, every day of the week. So then it comes down to apartments. We haven't been talking too much about apartments because of course, as a consequence of COVID apartments are really suffering and God knows, you know, they're not growing at the same rates houses. Some of them are going backwards, right? So, but in some areas where there's apartments are scarce, or when there's large apartments, or, you know, there's, there's apartments, shouldn't be discounted, but it does come down to your budget and location and really focusing on that scarcity aspect. And so, you know, and, and then it comes down to, well, what's an appropriate property to buy in every location. So yes, if you can get a freestanding house, but it is in a great spot and it's within your budget and you're buying an A-grade. I said, absolutely do it. It might be that another townhouse in a better suburb might be a smart thing to do or an apartment. So I guess that's where I'm coming at it with there. It's not as simple as saying, all houses are better or houses are always better than townhouse.

Chris Bates: Yeah. It's a good point. Exactly. And I think interesting point around apartments, we're already starting to say the pressure shift from houses to apartments, you know, because how's the running on families and, you know, they've, you know, running 15% or 20%, you know, if somebody was worth one, five now worth, say born eight or two, right. That's gone, it's now no longer an option for families, you know? And you know, and so what they're doing is they're saying, well, I don't really want to move to the middle and outer ring. I can't move, I don't want to move to Northumberland gone or central coast. I said, very little options now for that sort of young couple that's, you know, either got one child or thinking about having a child and they're already shifting to buying apartments. And so the quality sort of family owner-occupier apartments, I'd argue, they're doing really well. And they're already starting to go really well. So yeah, not all apartments are equal, which we've said a thousand times on this podcast. But yeah, it's interesting to see that this, all the shift is already happening from houses to apartments. I believe,

Veronica Morgan: Sorry. The fifth question, what are some tips and considerations for structuring mortgages? For example, we can make, we can currently make minimum repayments and keep any extra in an offset just in case you want to buy or rent elsewhere and keep our current places and investment property is the first time she's entered that one. However, it's looking more like a, this will be our forever home and future property purchases would be investments. Or if we didn't want to leave here, we'd be happy to sell it rather than rent it out. Would that change? The strategy answer is yes, of course, but over to you,

Chris Bates: That's a really good question as well. I like you know, there's a very savvy point in there where, you know, just dropped it in there. The big thing that a lot of people just don't know, and this is one of the reasons why I've been a big fan of offset accounts and also a big fan of interest only because what Lily said there is it, you know, the reason she's keep doing the minimum repayments, which sounds crazy. You're up. Why are you only doing the minimum if you can afford it and keeping every single extra dollar in an offset account. And what that's doing is it's keeping the potential tax deductible debt on that property. It's not deductible now because it's our home as high as possible by she said, just in case she wants to buy something else or rent something else and keep their current places and investment property.

Chris Bates: Because as soon as you pay off that mortgage, then you're reducing it's tax deductible debt because basically it's the debt that you first get to buy that property is what's deductible. And when you pay it down, that's reducing it. So, I mean, literally you're all over the structure, to be honest to how what you want to be doing is, you know, you know, it's very hard, like I said, to get interested in the, on homes back to 2014 though, every home buyer, because you could get interest only on home, then it was exactly the same interest rate. Whether you go interest only or pain, I, we would set up a home loan as interest only with an offset account and educate our clients on the importance of building money in the offset account. And I have clients are really bad with their cashflow or they need that sort of higher repayment or force them to save then.

Chris Bates: Yeah, absolutely go principal and interest. So really the best structure at the moment is principal and interest because you can't get interested in the, on your home have an offset account, but then when you got a home loan debt for any investing, you really want to go interest only because you don't want to be paying off your investment properties and trying to pay off your home. You really want to pass, pay off your home as much as you can with your offset account and then have your investment properties on interest. Only the good news is now that interest only rights on investments are pretty much exactly the same as paying on, and you can get great fixed rates on interest only investments. There was a period there was what was a much more expensive. But it's all the same. So you know, that's probably the, the major sort of answer to your question. There's any other bits of Mr. Veronica?

Veronica Morgan: Probably not. I, I do love the fact that they're keeping maximum flexibility, you know, and freedom is sort of the main reason why, you know, I think property investment done well is a great purpose for it.

Chris Bates: Yeah, exactly. And I think one thing that I didn't say there is you know, if we didn't live here, we'd be happy to sell it. Now I guess that's a, that's a good sort of I say a lot of people get very, very w we own it. We can't sell it, you know, buy and they get so attached to not selling things. And, you know, when I look at client's portfolio, sometimes it's best to sell sometimes some of their best assets. And especially if you can sell them, CJT free because that can potentially allow them to do something else. And it's what would that allow you to do? And the emotional attachment around not selling can sometimes blind people to making a better financial decision. So I really liked that. And what that also encourages is that maybe it's not a bad idea to pay that property down, use some of that money in your offset account to reduce that alone, if that frees up more excess borrowing capacity so that I can go and buy a better investment property and still keep enough money as buffers, which I mentioned around that client earlier.

Chris Bates: So, yeah. Great question.

Veronica Morgan: And our last question, what are the pros and cons of using the equity in your home as leverage?

Chris Bates: It's a really good question as well, because ultimately you've got to be careful, and this is you know, you could do, you know, what really hard, right? You buy save a 20% deposit to buy your first home, which is ridiculous, how much money you got to save, then you buy potentially, you know, not the greatest of assets. And you build a little bit of equity. You're a great saver, and you've smashed your home loan down from say 800,000 down to five 50 or 600,000. You go, right, let's buy an investment property. And then you go and buy a poor asset. Now you're leveraging, you might not have a great asset and you'd go and buy a poor asset. You're leveraging your money. And it wouldn't take much for that best poor investment property to really lose value by buying an apartment in Melbourne.

Chris Bates: And it's lost 20% or a mining town, or there's so many examples all over the country, Perth. And what you basically can do is, is really lose all that hard savings that you first save to buy your house. What you could also do is get stuck because you can't sell the investment property because you would then have negative equity on your home, or you couldn't, you have to pay off your home loan more than, you know, what your sort of debt is. If based on the loss of the investment property. So you've got to be super careful buying poor assets, which we've sort of educated our listeners on over time. The first thing you've also got to be worried about is cross-collateralized cross corridor violations.

Veronica Morgan: You said cross collateralization, what a word,

Chris Bates: What that basically means is it's not really my view on it as well. Whether you cross collateralize or you use equity in your home to buy an investment property,

Veronica Morgan: Let's just explain cross collateral collateralization, just for those who have never heard of the term before. Yeah.

Chris Bates: A good practice. And it's what we do is, is, you know, we would borrow up to 80% on the home to fund the deposit on an investment property. And it could be the same lender. A lot of people think you have to use different lenders and you would borrow 80% on the new property. And so the properties are actually not secured by one another. You've got 80% loan on your home and you've got 80% loan on your investment property. And if anything happened, for example, you didn't pay your mortgage on your investment property. The bank would sell that property first, and then they would come to you and would give you the proceeds. If there's any money left over, or they would ask you for the money and then you may be able to find it and they wouldn't automatically sell your home when they're cross secured. If you get into a point where you go under and you don't pay your mortgages, the bank will ultimately sell your best asset first. They just want to get their money back as quick as they can. And so they might sell your home and then they leave you with an property. So that's one of the risks of sort of cross collateralization.

Veronica Morgan: And that's, it's really important. Cause I know that sort of early on in my investment journey, I had no idea about that. And it wasn't until I got a good broker who sat down and went through everything and went, Ooh, we want to untangle this mess, you know, and it took a while to untangle it, but it's I had no idea that it was a mess and it's one of the reasons why I was recommend going with a an broker who is good at investment savvy, but also at borrowing strategy because you can get into all sorts of trouble when you try to actually borrow to buy investment properties before you're really ready. And it could that be one of the risks of really trying to jump too fast into an investment property

Chris Bates: Because life's unpredictable. And you know, if people put a little bit more thought into their longer term planning, I'd think they'd be able to predict more things than they expected. But a lot of people will think, Oh, I wasn't expecting that, but it probably was going to happen. But anyway a lot of clients can go and buy the investment property. They use all their equity in their home and they borrow 80% on the investment property. So it's actually great because they've got a really big tax deductible debt. And then they go two years later, Oh, we really dialogue this air anymore. We really want to upgrade and they invest in probably hasn't built any equity yet. And so when they look to sell their home, the bank means they in its cross secured, the bank will say, well, you haven't don't own that property anymore.

Chris Bates: We have to pay your investment property, download from, you know, 105% of the property down to 80%. And so you can get his point where you basically lose a lot of your cash by paying off an investment property when you want to upgrade. And you've crossed secured and I've seen a lot of clients get themselves into this sort of pickle. So if you are thinking about buying an investment property, you really need to think about it home upgrade first. Do you need to do a renovation, all those sorts of things and then structure your investment property around that. So you're not gonna stitch yourself up. And there also is things where you know, you can secure against investment, property loans and things like that if you have to, but at least think these things through before you go out and use your home leverage.

Veronica Morgan: So that's it. That was six amazing questions from Lily. Thank you so much. We did say when you emailed us that we are going to build an entire episode over this and so we have, and so we do encourage you to send questions through to us and we'll have more Q and a episodes coming up, but let's, let's see if we've got a Dumbo for this week. You've got one Chris.

Chris Bates: Sorry. Totally put me on the spot. Have you got one first Veronica while I think about one

Veronica Morgan: Look I've always got Dumbos. I'll give you a narrowly averted Dunbar has that. So I I do these property sort of strategy sessions every now and then for people. And someone came to me and said, look, you know, my property's on the market, we're ready to go. And you know, we're planning on upgrading our home, et cetera, et cetera. But now we feel like we've made a mistake and we want to pull the property off the market. And I'm like, can I, you know, kind of pay for your time basically just to help us through this. And, and so yes, of course you can sat down and started going through. It was just as I said, a narrowly averted Dumbo. So what was amazing is that, that because of markets going off, they were being advised by all these well meaning friends and family and all the rest of it, everyone with an opinion on property that had completely swayed them on what their plan was.

Veronica Morgan: And, you know, but these people, they don't know what they're talking about. B they don't understand, you know, market dynamics in different areas. See, they don't get the idea, the concept of caliber of asset, asset, Cal asset caliber. You know, there's, there's, you know, B in terms of, well, if you don't do it now, what is it going to look like in five years time when you go to do it, all those sorts of questions and never, ever sort of explored properly when friends are just offering this and well-meaning advice, like why would you sell a property in that suburb? It's just, you know, all that stuff, it's completely complete ignorance. And so they were getting very, very you know, a lot of noise. And as I said, narrowly averted, because they actually popped their head out and went, Oh, no, we actually need to get some clear guidance.

Veronica Morgan: And, you know, they're, they're following a path with more confidence now because we talk through lots of all these questions we're talking about today, you know, what are their long-term plans? You know, th that, how good is the asset you've actually got now? If you don't sell it, what's what's going to happen. You know, what, what led you to buy it in the first place, et cetera, et cetera, et cetera, you know, how, how well do you have you explored your next step? All of those things that we talked about, so that, as I said, they can move forward with what they're going to do next with confidence, but it was just amazing how they were going to pull the pin on the sale of their property, which may have been the right thing to do. Don't get me wrong, but based, purely on, on, you know, all those people with their opinions.

Chris Bates: Yeah. I mean, I've had a few of those as well, where a client very close miss, literally the second, you know, bitter at the auction that first loser, I guess and missed out on a property and came to us after that and told us the experience and was so relieved. And when you look at the quality of the asset and what they purchase, you know, a couple of months later it's chalk and cheese, and we're not talking a big difference in terms of the sort of amounts. And, and I just didn't know what they were doing. You know, they're not from Australia, they were wrapped up in this sort of hype of it, or and, you know, I think what the, sometimes they weren't really going for, they really want, they were just going for, you know, that's good enough for us.

Chris Bates: And you know, and that's what was driving them. And I think ultimately now they look at what they've purchased and, you know, just by getting knowledge, they did engage buyer's agent that I think was really good as well, just in the negotiation phase and got something pre-marked pre auction. And so that was a big one. What was I saying? Two interesting one from lending? I think we've always got a challenge in, in broking where clients come to us way too late for pre-approval and banks have flooded, you know, all the lit stats are out there showing how much lending is happening and how the banks are all struggling to, to process pre-approvals and purchases and refinances. If you are in the market diabetes Dumbo and say, look, I really want to buy that place, which we got, we always get emails every week.

Chris Bates: And they haven't really even got the documents ready. They haven't got, you know, the numbers done and haven't launched a pre-approval. But an interesting one that just happened over the weekend, client came to us and our financial advisor referred them to us. And you know, she's really smart, she's a lawyer. And she, you know, she said, I want to work with you. I've already got pre-approval with one of the big colorful banks. And that would be a good option, but they're not the only option. And we said, look, the auctions to the property. She wants going very soon. Let's suss out how good that pre-approval isn't that looked pretty good. We did all our own numbers. But when she went and purchased this property, the bank that she wanted to use wouldn't actually lend a 90% NOLA.

Chris Bates: Mark is she's in sort of the legal field. And so we've been able to pivot with her and go to a different bank. And and if there's not extended the six week settlement, and because she engaged a broker and not gone direct to the bank, she would've got there and got stopped and then had this whole stressful experience. But we were able to pivot on that same day and say, Nope, no, they won't do it. But these three banks will do it. Let's just launch with these guys. And so I think that's a really good, you know, scenario where a client potentially just going and got a pre-approval with a bank and said, she'll be right. That's fine. And then it wouldn't have been fine in this situation. She would have been a very, very stressed because she's just purchased