Author Topic: Aussie mustachian - should I pay off my investment properties?  (Read 2257 times)

eeho

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Aussie mustachian - should I pay off my investment properties?
« on: October 30, 2016, 11:17:00 PM »
Hi Mustachiarinos,

I'm a 30 year old, single, Aussie mustacian with lots of questions that I'm hoping you fine folks may be able to help me out with. I'll give you a rundown of my situation, but there is more about me in my journal (link below) if you are interested in knowing more.

I have 5 investment properties and 1 PPOR that I rent out half of:
* Property 1 - loan $284,222 - interest only until May 2020 - fixed interest (4.49%) until July 2018
* Property 2 - building loan $186,884 - interest only until May 2018 - fixed interest (4.49%) until July 2018
* Property 2 - land loan $76,076 - interest only until May 2018 - fixed interest (4.49%) until July 2018
* Property 3 - loan $173,317 - interest only - variable interest (4.32%)
* Property 4 - loan $144,431 - interest only until August 2018 - fixed interest (4.49%) until August 2018
* Property 4 - top up loan - $26,800 - interest only until January 2020 - fixed interest (4.49%) until July 2018
* Property 5 - loan - $143,899 - interest only - variable interest (4.59%)
* Property 5 - top up loan - $15,619 - interest only - fixed interest (4.95%) until July 2017
* PPOR - loan - $464,000 - interest only - fixed interest (4.15%)

Sounds scary, but the portfolio is slightly positive and all properties offset my taxible income (thanks negative gearing!) which bumps me down considerably from one of the highest tax bracket to one of the lowest. Note that I am not planning on purchasing any more investment properties, or selling any of the existing ones, I am happy with my portfolio as it is. At the moment I'm happy with not paying off the balance of the loans as my savings are better directed to my offset account (against my PPOR) and aggresively paying off some debts (student loans and a loan to my parents). However, my future plans change the game a bit:

* Stopping full time work and moving to the UK to study (estimated end 2021 - 5 years from now)
* Living off money gleaned from property rents (including PPOR), some part time work, savings offsetting PPOR

These plans would mean that it would no longer be beneficial to leave the loans for tax purposes. I'm also worried that interest rates will rise (as they are at an all time low) and I'm not sure what the situation will be when most of the loans come out of their fixed interest periods (July 2018).

I've estimated that in the next 5 years I should be able to save approximately $300,000 ($20,000 to student loan, $35,000 to parental loan, $245,000 leftover).

Total rent at current rates for the 5 investment properties is $4,647, total mortgage payments (interest only) are $3774.

For example at current interest rates/interest only, paying off the property #5 top up loan ($15,619) would save me $65.67 a month; paying off property #4 top up loan ($26,800) would save me $98.90 a month. 

And so:
* Option 1 - hoard the growing savings (after paying off the debts) in offset account against PPOR until July 2017 (when fixed interest period is over) then pay off Property #5 top up loan ($15,619, highest interest), followed by investment loans highest interest first leaving a buffer in the offset account against PPOR (which will then be another Investment Property) as they come out of fixed interest rates.
* Option 2 - hoard growing savings (after paying off the debts) in offset account against PPOR until end 2021 when I finish full time work then pay off investment loans highest interest first leaving a buffer in the offset account against PPOR (which will then be another Investment Property)
* Option 3 - hoard the growing savings (after paying off the debts) in offset account against PPOR and continue to pay the investment loans interest only until the period runs out, then interest and principle.
* Option 4 - ?

Risks when I stop full time work:
* Interest rates skyrocket and I can't cover the interest and principle payments and have to go back to full time work :(
* Multiple properties are vacant over an extended period of time and I can't cover the interest and principle payments and have to go back to full time work :(
* Pay off investment loans and don't have enough accessible money available in offset account if any major unforseen expenses arise.

Happy to provide any other information I may have missed, just ask! Thank you so much for reading.

« Last Edit: October 31, 2016, 04:31:13 PM by eeho »

bigchrisb

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #1 on: October 31, 2016, 12:13:58 AM »
Hi,

Have you worked out what your repayments are going to look like when the interest only terms end?  I don't know what the loan terms are, but it looks like you are going to have a bit of a cash crunch coming up in 2018 when they go to P+I?

Doing a back of envelope, you have approx 1.5M in loans that are interest only, including the PPOR.  Based on 4% interest rates (record low) that's about $5,000 a month in interest repayments.  However, once these revert to P+I, and assuming a remaining 25 year term,  this payment is going to go up to approx $8k/month.   I'd be a bit concerned about that, particularly if I was planning on heading overseas and giving up my job, as it would be a pretty big cash drain, which would get worse if interest rates rose, or I had some significant vacancies / repairs on the properties.

If it were me, I'd be madly stashing the savings in my PPOR offset while I'm working.  Its tax effective and zero risk.  I then would have a cash buffer to draw down to service the principal payments.

What do you think your LVR is?  Do you have any prospect of being able to refinance these when the IO loans expire?




marty998

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #2 on: October 31, 2016, 01:09:49 AM »
Hmmm... I am struggling to get this to add up...

Based on your numbers I get an average of $3927 in interest costs per month, not counting your PPOR.


Sounds scary, but the portfolio is slightly positive and all properties offset my taxible income (thanks negative gearing!) which bumps me down considerably from the highest tax bracket to the lowest.


I also don't see how you can go from the top tax bracket to the lowest using negative gearing and still claim your properties are "positive"??? Surely you don't have $162,000 in depreciation each year taking you from $180k to under $18k?

Do you have land tax problems every year as well? You must have at least $2k per month in Council, Water, R&M or strata, insurance, land tax...

Help me out... I admire the position and asset base you have but I'm scratching my head here figuring it out :D

I agree with Chris that you will face a cliff when the IO periods expire. With new and ever more restrictive APRA rules coming into play there is little chance of refinancing to IO again, and I believe interest rates will be at least 1% higher by June 2018 so you will need to find another $15k for interest, plus principal repayments.

I am preparing for my own IO cliff in 2019 ($468k) and then again in 2021 ($580k). It isn't pretty and it's not nice to deal with, but I will fill up offsets as much as I can in advance.

Can't really set up offsets against fixed loans, so I'm splitting a portion of my spare cash to shares as well.
« Last Edit: October 31, 2016, 01:26:59 AM by marty998 »

nnls

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #3 on: October 31, 2016, 01:11:50 AM »

And so:
* Option 1 - hoard the growing savings (after paying off the debts) in offset account against PPOR until July 2017 (when fixed interest period is over) then pay off Property #5 top up loan ($15,619, highest interest), followed by investment loans highest interest first leaving a buffer in the offset account against PPOR (which will then be another Investment Property) as they come out of fixed interest rates.
* Option 2 - hoard growing savings (after paying off the debts) in offset account against PPOR until end 2021 when I finish full time work then pay off investment loans highest interest first leaving a buffer in the offset account against PPOR (which will then be another Investment Property)
* Option 3 - hoard the growing savings (after paying off the debts) in offset account against PPOR and continue to pay the investment loans interest only until the period runs out, then interest and principle.
* Option 4 - ?

Risks when I stop full time work:
* Interest rates skyrocket and I can't cover the interest and principle payments and have to go back to full time work :(
* Multiple properties are vacant over an extended period of time and I can't cover the interest and principle payments and have to go back to full time work :(
* Pay off investment loans and don't have enough accessible money available in offset account if any major unforseen expenses arise.

Happy to provide any other information I may have missed, just ask! Thank you so much for reading.

I would kinda go options 3. But saving all the money you can in the offset and then using that stored cash to top up payments once you have to pay P+I, as you dont know what your repayments will be in 2018 as interest rates could be a lot higher then. Though hopefully your properties will also be generating more income by then with rising rents.

If the variable interest loans rate goes up I would probably pay that out as its a higher rate.

Assuming that they are all in good areas it would be unlikely that multiple properties would have high vacancy rates.

Northern gal

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #4 on: October 31, 2016, 06:16:34 AM »
As for Option 4 have you considered diversifying away from Australian real estate?

There are reasonably liquid investments other than offset accounts. I agree build up a cash buffer but leverage is part of the beauty of RE investing imho.

Personally I am still kicking myself for leaving my money in offset while the Aussie went from above parity to the USD down to the seventies....

eeho

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #5 on: October 31, 2016, 05:28:26 PM »
Thank you everyone for your input, I really appreciate it.

I'm really sorry but I made an error in my wording re tax brackets, I've amended it now:

Sounds scary, but the portfolio is slightly positive and all properties offset my taxible income (thanks negative gearing!) which bumps me down considerably from one of the highest tax bracket to one of the lowest.


The depreciation on Properties #1 (new build), #2 (new build), #4 (recent renovation) and PPOR (relatively new build, can claim a portion as half rented out) stacks up quite a bit depreciation wise. Also a factor is my salary sacrifice for working in the healthcare sector and regular donations which brings my taxible income from the $80,001 - $180,000 range to the $18,201 $37,000 range. Thank you Marty for picking this up, apologies for the confusion.

Based on your numbers I get an average of $3927 in interest costs per month, not counting your PPOR.

Total rent at current rates for the 5 investment properties is $4,647, total mortgage payments (interest only) are $3774 (not including PPOR where I get $800 per month in rent and pay approximately $1608 in interest (depending on offset amount)).

Do you have land tax problems every year as well? You must have at least $2k per month in Council, Water, R&M or strata, insurance, land tax...

My properties are spread over two states so I haven't had land tax issues as yet, although with my PPOR being in the same state as 3 of my IPs I may be up for a bill (although only half of the property is income producing so I may still scrape by).

Have you worked out what your repayments are going to look like when the interest only terms end?  I don't know what the loan terms are, but it looks like you are going to have a bit of a cash crunch coming up in 2018 when they go to P+I?

Doing a back of envelope, you have approx 1.5M in loans that are interest only, including the PPOR.  Based on 4% interest rates (record low) that's about $5,000 a month in interest repayments.  However, once these revert to P+I, and assuming a remaining 25 year term,  this payment is going to go up to approx $8k/month.   I'd be a bit concerned about that, particularly if I was planning on heading overseas and giving up my job, as it would be a pretty big cash drain, which would get worse if interest rates rose, or I had some significant vacancies / repairs on the properties.

If it were me, I'd be madly stashing the savings in my PPOR offset while I'm working.  Its tax effective and zero risk.  I then would have a cash buffer to draw down to service the principal payments.

Thanks BigChris, I'd estimated about $8k per month for P+I as well. I currently have a 55-65% savings rate and am going super mustachian mode to stash as much cash as possible in my PPOR offset account. I really want to make the most of the next 5 years of high wages to set myself up for the future.

What do you think your LVR is?  Do you have any prospect of being able to refinance these when the IO loans expire?

The last official LVR is 85% but I haven't revalued many of the IPs for a while, and RPdata suggests that they have risen. I'll be doing light renovations on property #3 and #5 within the next 5 years that will raise the value (and add more depreciation).

I agree with Chris that you will face a cliff when the IO periods expire. With new and ever more restrictive APRA rules coming into play there is little chance of refinancing to IO again, and I believe interest rates will be at least 1% higher by June 2018 so you will need to find another $15k for interest, plus principal repayments.
 

That's why I was considering knocking out the IP loans, but I guess the offset against PPOR (which will then be a full IP) which using it to servie IPs P+I would really serve the same purpose.

Though hopefully your properties will also be generating more income by then with rising rents.
If the variable interest loans rate goes up I would probably pay that out as its a higher rate.
Assuming that they are all in good areas it would be unlikely that multiple properties would have high vacancy rates.

I'm hoping so too! It would certainly make things a lot easier if they rose in line with each other, but I'm stashing the case to buffer regardless.
Agreed, It is pretty unlikely that they would be vacant at the same time. 3 of the IPs have long term tenants which makes things more stable.

As for Option 4 have you considered diversifying away from Australian real estate?

There are reasonably liquid investments other than offset accounts. I agree build up a cash buffer but leverage is part of the beauty of RE investing imho.

Personally I am still kicking myself for leaving my money in offset while the Aussie went from above parity to the USD down to the seventies....

Thanks Norgirl - I had considered putting some money in Vanguard to diversify. I may make that a smaller portion than I had originally intended to create a bigger buffer in offset for P+I, but that's just more motivation to stash as much as possible over the next 5 years so I have more to play with.


Really the long term goal would be to pay them all off and live off the rent. I'm looking to study music (classical voice) which doesn't have the best track record for stable income (though I would be trying for paid work such as opera choruses), so I'm hoping I can work the IPs in my favour to provide a more stable income. 

It's going to be a big 5 years!

bigchrisb

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #6 on: October 31, 2016, 05:48:20 PM »
I'm in the position of planning a ~3 year earnings sabbatical overseas (Netherlands for me) starting in July next year.  I suspect its not dis-similar to your intended position, except d-day is a lot closer for me.

I've become increasingly focused on cash flow and contingency planning for this.  In the past, I've been highly leveraged (mostly into stocks), with a top tax bracket income to service the debt.  The high income means I've been able to ride out the spanners life likes to throw at me without needing much access to buffers.

I found that when I started to look at my cash flows, I wasn't sitting as pretty as I thought I was.  Interest is what was front and center of my mind, but all the other cash flows (particularly with property) start to add up.

I ended up doing a cash flow forecast for each month, with everything listed, and a weighted average of the "one offs" that seem to happen all the time.  I then went and worked out how much I thought I needed sitting in the offset account to fund these in a worst case.  I was a lot more than I thought it was!

From your posts you seem to like numbers and spreadsheets.  Why not go through a similar exercise, including all cash flows?  At the end of the day, depreciation allowances are there because you end up having to replace/repair those things eventually.  The same for rates/body corp fees etc.  My experience is that if I was making a tax loss, I was probably making a cash flow loss too.

eeho

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #7 on: October 31, 2016, 08:19:48 PM »
I'm in the position of planning a ~3 year earnings sabbatical overseas (Netherlands for me) starting in July next year.  I suspect its not dis-similar to your intended position, except d-day is a lot closer for me.

I've become increasingly focused on cash flow and contingency planning for this.  In the past, I've been highly leveraged (mostly into stocks), with a top tax bracket income to service the debt.  The high income means I've been able to ride out the spanners life likes to throw at me without needing much access to buffers.

I found that when I started to look at my cash flows, I wasn't sitting as pretty as I thought I was.  Interest is what was front and center of my mind, but all the other cash flows (particularly with property) start to add up.

I ended up doing a cash flow forecast for each month, with everything listed, and a weighted average of the "one offs" that seem to happen all the time.  I then went and worked out how much I thought I needed sitting in the offset account to fund these in a worst case.  I was a lot more than I thought it was!

From your posts you seem to like numbers and spreadsheets.  Why not go through a similar exercise, including all cash flows?  At the end of the day, depreciation allowances are there because you end up having to replace/repair those things eventually.  The same for rates/body corp fees etc.  My experience is that if I was making a tax loss, I was probably making a cash flow loss too.

Thanks again Chris,

I started doing a spreadsheet of every single incoming and outgoing expense a couple of months ago to get more transparency and try to plug the gaps. You can see more on my journal (link below) but I've attached the most recent complete one. The full spreadsheet also has a summary page to track the main points over time. Is this something like what you are doing?

Your plans sound fantastic, how exciting! Busy and frugal times ahead for both of us.

eeho

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #8 on: October 31, 2016, 10:16:50 PM »
The RBA announcement today that interest rates are still on hold and the predictions in this article for next year make me happy : http://www.domain.com.au/news/reserve-bank-leaves-interest-rates-on-hold-cuts-expected-next-year-20161031-gsf1ta/

nnls

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #9 on: October 31, 2016, 10:23:49 PM »
The RBA announcement today that interest rates are still on hold and the predictions in this article for next year make me happy : http://www.domain.com.au/news/reserve-bank-leaves-interest-rates-on-hold-cuts-expected-next-year-20161031-gsf1ta/

It says further cuts next year, I didnt think we would see them go any lower. Will be interesting to see what happens

marty998

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Re: Aussie mustachian - should I pay off my investment properties?
« Reply #10 on: November 01, 2016, 01:03:18 AM »
I get the sense that the author thinks that just because inflation is low and the currency is high that there will automatically be further interest rate cuts.

The new RBA Governor might have a different view. He's quite cognisant of the implications of cutting rates on the property market and knows that another rate cut won't really have any effect on the real economy (because instead of stimulating demand, people will just save/invest in housing).

It's alarming though that full time jobs keep disappearing. trends suggest it will be closer than we think that part time will be the new majority.

You never know, it may force a re-think of the 5 day working week :)