How NOT to Finance an Investment Property….
I’m sure you have heard the saying ‘Don’t put all your eggs in one basket’. It is a metaphor that if you were to potentially drop the basket with all of your eggs in there together – all of them could break and you would be left with none.
This goes for property investing too. What I’m going to focus on in this blog is the lending side of building a property portfolio.
After a conversation with a new lead that came through last week, they said to me, “Chris we need to have a meeting with our bank to see what our lending limit is.” My reply was….. “It’s interesting you are going to a bank to tell you how to build a property portfolio! There’s a good chance that the loans officer you see does not have a property portfolio; do they even understand what you are trying to achieve? They just quickly work out a loan that they sell from the banks products that might not even suit your needs. Do they do a goal setting session with you to try and find out what your short and long term goals are? How many questions do they ask about the property, do they understand what an advance strategy property deal is? How can you know what the rental return of the property is if you have not found one yet?”
Now the bank is a business and they are there to make money for their shareholders – are they going to be the best representation for you and have they considered you in their big plan? Will they offer you the best discount, tie all of your banking together and all your properties in the one place so eventually you are hand strung and have ‘all your eggs in one basket’?
I have often seen clients come to me with two or three properties that are all tied up to the one bank and cross securitized. Behind the scenes what they have no idea about (as it is printed in very small lettering in the loan documents) is clause like an ‘All Money Clause. This type of clause ties any assets you may have with the bank to be security if they need to in the future.
An example of this was when I spoke with a client who purchased a property in Gladstone during the boom; now it was all looking fantastic at the start but then the mining boom crashed and they had financed the property securing it against their own Melbourne property. Now the Melbourne property had lots of equity in it so it was fine when they purchased it, however, two years later the clients went to sell their property in Melbourne which was their owner occupied home. The investment property in Gladstone was cross securitized to this property, so they now had to revalue the Gladstone property which unfortunately had dropped in value by $100k
As the original loan was 100% secured against the Melbourne property there was a problem. For example, the Gladstone property was purchased at $500k so they had a loan of $520k to cover the costs of the property. Now that the property has dropped in value to $400k, the loan is still $520k creating a negative equity of $120k. They sell the property in Melbourne and the banks now reduce the loan to 80% of the $400k giving a new loan of $320k a drop of $200k. Ouch, now they would usually have put 20% deposit toward the purchase plus cost so for this example say $120k.
If when they first purchased the property in Gladstone they could have drawn out the $120k from their original lender ‘ lender A’ and had a new loan with ‘lender B’ for the remaining 80% of the Gladstone property a loan of $400k (80% of the original purchase price of $500k). As long you keep making repayments on the loan with lender B, they would not call the loan in and you can wait out the rise and fall of the market, not having to put any more money from the sale of the owner occupied property in Melbourne.
So if they sold Melbourne they would have been $100k better off by having the property loans with 2 different banks. However, another option to minimise loss on the Melbourne property sale – if they were just upgrading their Melbourne property, would be to have used the portability option in the loan to move this entire loan to the new property and also keep the $120k investment portion, which would continue to be a tax deduction, keeping their owner occupied loan portion smaller and properly set up. See if they had come to me I would have given them completely different advice than what they received from the bank – potentially saving them $100,000!!
This is a great example of why it is so important to have a broker or better still a property strategist look at the overall picture and reduce cross securitization as much as possible so you don’t come unstuck and not properly structured.
When it comes to investment finance and building a property portfolio don’t stick with just one bank, spread the risk and prosper by your rules and not the banks.
If you need any advice or just a quick chat about your financial position or property portfolio please shoot me an email, drop me a text or even better – just give me a call 0434 449 455 – I’m always ready to listen (unless I’m having a surf, in that case – I’ll call you back)