Using cash reserves

Paul asks:
(updated on Sunday, June 21st 2015)

To diversify my investment portfolio I want an investment property. I have a mortgage free family home with a value of $450,000. I've found a house that costs $145,000 with a RV of $149,000, rates of $2,200 and an expected rental of $255 per week. It is a small three bedroom house on a large section with loads of room for development. I have some cash reserves to build a garage, put in a heat pump, etc. As I have never done this before, does the figures work to make this worthwhile? Should I use my cash reserves to lower the mortgage amount or to tidy up the property to make it more attractive for renting?

Our Experts Answer:

It is likely that you will be able to raise 80% finance through a revolving credit of around $360,000 on your mortgage free home, which in turn could become the 20% deposit for further purchases of up to $1,800,000 in properties. I would suggest that you approach your bank manager or a mortgage broker to assess your borrowing capacity. Subject to your income and expenses, the amount of borrowings will depend largely on your serviceability.

The next step is now to consider what type of properties? Cashflow or capital growth? How many? At what values you would like to buy and hold your investments? In this current boom market more money is made through capital growth than cashflow and I therefore suggest you could consider an investment property in the hot central Auckland market which still has a reasonable amount of growth left.

The property that you are considering at $145,000 which is only $4,000 (2.7%) below the RV doesn't sound to be much of an investment bargain, after all, money is best made when you buy!  So negotiate harder or walk away, there are a lot more other properties around! Although this place would be cashflow positive of around $50 per week net after paying Interest (@ 5.5%), rates and insurance (only if you receive 52 weeks rent per year). The amount reduced less after paying an accountant to do your returns, less taxes to be paid if it is profitable. If you are buying in a rural town or city then there is a possibility that the market value may drop below your purchase price of $145,000 (as has happened in places like Whangerei) negating any rental profit that you will make.

Avoid using your previous cash reserves for rental improvements like a garage or a heat pump, rather borrow from a revolving credit and let the rental property pay for the additions. Don't trade your "time for money", use borrowed money to make more money and to enjoy the profits.

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