Should you sell your investment

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Good reasons to hold,Good reasons to sel l , andHow to calculate the impact of sel l ing on your f inances.

The December/January festive season is a great t ime to take stock. It ’s a chance to think about what ’s been good, what we’d l ike to change, and whatthe next year might have in store for us. Some people make travel plans. Others pin New Years resolutions to the fridge.It ’s also a f itt ing time to check your f inancial position and ask yourself a fewpointed questions. Which is probably why twice in one day, two different friends asked me about it .Specif ical ly, they sought my thoughts on sel l ing respective investmentproperties. I mentioned the coincidence to a third friend. She replied: ‘Yeah, I ’vebeen wanting to ask you too. ’ Property is a large f inancial commitment. It can require cash f low to service it . Itmakes sense to consider that decision careful ly. I answered the question three times for three different scenarios and foundmyself saying the same thing over and over again. So, I ’ve put together this eBook to coverthe main themes I found myselfrepeating:

If you're thinking about sel l ing an investment property, I think you're going tofind this eBook to be a useful tool .

A common

As an added bonus, I 've included the Excel spreadsheet.   I f you would l ike to see how the calculations could work in your situation,   youcan download the Excel spreadsheet here.

Here's a summary of what we' l l cover in the fol lowing pages:

The short

Pay less interest on your home.The property is underperforming.You have a better option.It used to be your Principal Place of Residence (PPoR).You're losing sleep over it .

1 .2 .3.4.5.

You bought it recently, i .e . less than f ive years ago.It 's a sol id performer.High potential for growth.It 's a key part of your strategy.You don't have a home mortgage.

1 .2.3.4.5.

An updated rental assessment  – are you charging enough rent?An updated sales estimate  – what could you expect to sel l the property for?Your yield   for each property – are you happy with performance?Your overal l Debt to Asset Ratio (D/A, or LVR) – are you within 80%?Your strategy  – is the property delivering what you wanted?

1.2.3.4.5. We'l l cover how to get each of these calculations in this eBook.

(Psst : grab the spreadsheet to fol low along here. )

Good reason to sell

If you’ve got capital t ied up in an investment property as well as a mortgage onyour home, there’s a trade-off . That capital could be better off on the homemortgage than the investment. Your home (or principal place of residence, PPoR) is an asset to the bank. It ’soften the biggest 'asset ' a person owns. …but it ’s not *real ly* an investment. You don’t earn an income from it , or get any tax benefits from it . You have to sel lit to real ise the profits . I f you’re l ike most Austral ians, you took a mortgage to buy your home. This meansyou’re paying interest. For a typical loan over 30 years, you’ l l pay back double theamount you borrowed. You’ l l be paying with after-tax dollars too, so anything youcan do to reduce it wil l be worthwhile. I ’ve heard people say they don’t pay down their home mortgage because they can‘do better ’ with the money. They mean they can beat the cost of paying theinterest with the earnings they’d make on that capital elsewhere. That ’s a bold claim. A reasonable interest rate to expect over the l i fe of a loan would be in the orderof 7%. On top of the interest, you’re paying with after-tax dollars, so you’recloser to 10% including that. I f you can guarantee a 10% return on your moneyevery year for 30 years, you’re ecl ipsing 99.99% of investors. Including theprofessionals. Guaranteed reduction in home mortgage interest might be a better bet.

Good reason to sell

Yield , i .e . cash f low. For an investment property, that ’s rent.Capital growth , i .e . value increasing. For this instance, it ’s property pricerising.

Property purchase price = $380,000Rent = $400 a week * 52 weeks per year = $20,800Costs = $5,000 (e.g. rates, agent ’s fees, insurance etc)

Look up the property on https://www.realestate.com.au/property/, or Ask your bank for a valuation, or Pay for a valuation yourself .

With unlimited options and l imited capital , we want to be sure we’re getting thebest return we can. So how do you assess whether your property is performing to your expectations? There are two universal performance measures with any investment: 1 .2 .

How do you calculate each? Yield is annual rent divided by the purchase price. The trick is whether you lookat gross (revenue only) f igures, or net (revenue minus costs) f igures. For example:

Gross yield is $20,800 / $380,000, or 5.5%. Net yield is ($20,800 – $5,000) / $380,000, or 4.2%. As for capital growth , you compare current value with the purchase price. To geta current value estimate, you can:

Real estate agents wil l provide recommended l isting prices for free. Be warned:they’re relentless. Once you open the l ines of communication, expect regularapproaches about sel l ing.

Good reasons to sell

Property purchase price = $380,000 in 2006Property sale price = $520,000 in 2013

Positively geared is when costs are less than income. In other words, theinvestment property makes money. You don’t have to shell out anything tomaintain it (excepting those hopefully rare periods of major maintenance orvacancy).Neutrally geared is when costs are roughly the same as income. You may nothave to fork out any dosh, but you’re not making an income from it either.Negatively geared is when costs are greater than income. You have to put incash over and above the rent to make the books balance.

They may also provide an inflated estimate to get you excited enough to l ist withthem. Wherever you get your valuation, remember: it ’s a guess. A property is worthwhat someone is wil l ing to pay for it . Unti l that person signs an offer, you can’tbank (ha!) on the value. Treat it as a guide. Calculate capital growth by dividing the price increase over the purchase price.For example:

Capital growth is ($520,000 – $380,000) / $380,000. This is 37%, or 5.3% peryear. Like the yield, that 's gross. Because of the costs of buying and sel l ing and thanksto inflation, you wil l not make this much money when you sel l . What does good growth look l ike? Historical ly, house prices increase by 7% a yearin Austral ia. This is an average; some years are higher and some much lower. Andyes, we have experienced negative growth in some years ( i .e . loss) . Investmentproperty is a long-term game. It ’s not helpful to look at growth within 5 years ofpurchase, unless you real ly want or need to sel l . There’s a third measure for investment property. It ’s gearing – as in positive,negative or neutral ly geared. What does this mean? In order of desirabil ity:

Why on earth would anyone want a negatively geared property?

Good reasons to sell

Well , i f you're in Austral ia, it 's because you can claim the loss on your incometax. The government reduces your taxable income by the amount you're out of pocket.In effect, it subsidizes part of your property cost. It ’s a common strategy if youpay a lot of tax. It can be useful i f there is opportunity to secure a property withhigh potential for capital growth. However, the bottom l ine is : it ’s costing you money. When the proverbial hits thefan, it ’s a pressure you may not want or need.

Imagine you have the inside l ine on a fabulous investment opportunity. You’reconfident your returns wil l be better than your current investment property.Even taking into account change-over costs. It may then be worth cashing in yourchips and changing your strategy. One example is the recent government init iative: the National Rental Affordabil ityScheme (NRAS). It includes the incentive of nearly $100K cash back from thegovernment. This might represent an improvement on your current property.That is , i f the NRAS property is not overpriced…

You l ived it in immediately after you bought it , andYou moved out of it within the last six years.

There may be a tax benefit to sel l ing an investment property i f :

The benefit is you may not pay any capital gains tax (CGT) on the sale i f you makea profit . Timing is everything…

Good reasons to sell

Is your investment property keeping you awake at night? Worried about the impending bathroom replacement because you found a leak? Struggling to get reasonable and consistent tenants? Fretting about repayments with a potential redundancy on the horizon? If you’re losing sleep, perhaps you should lose the property. Sometimes the gainsaren’t worth losing quality of l i fe over. Cut your losses and f ind something thatdoesn’t cause you distress to invest in instead.

Good reasons to hold

Property is expensive to buy, and not just because of the property price. It ’s al lthe other stuff that comes along with purchase and sale. Costs to buy include things l ike stamp duty, conveyancing and inspection fees.Costs to sel l include things l ike agent ’s fees, conveyancing, and any remediation.These can mean tens of thousands of dollars on entry and exit . Getting in and out of property is an expensive exercise. Expect to hold for aminimum of f ive years to reduce the impact of these costs. I f you decide to sel lyour investment property inside that period, be prepared. Understand the costsand your true position before you take the leap.

Getting good yields (>5%)? Seeing strong capital growth in the area? Positivelygeared? No major maintenance on the horizon? No trouble getting solid tenants? The impetus to sel l in this case is probably small . I f it ’s not costing you anymoney to own ( i .e . it 's positively geared) and al l indications are that it ’sdelivering a good return on your money, perhaps holding is a reasonable planright now. That said, sel l ing when everything’s looking good is obviously mucheasier than waiting ti l l something goes wrong!

When I moved to Perth in 2005, each week 1 ,000 people were arriving from theeastern states to l ive and work. That rate kept up for seven years. That 's 50,000+new residents arriving each year in a city with a population of 1 .9 mil l ion, and al lof them needed a home. What do you think happened?

Good reasons to hold

First it drove up rents. Then it drove up house prices. I f you bought in 2003, you were sitt ing on a gold mine within four years. Duringthat t ime, house prices nearly doubled across Perth. Rents were increasing atstaggering rates in high demand areas – 20% per annum in some cases. Seeingthis influx of new residents due to the mining boom, would you sel l or hold? I ’mguessing you, l ike most who had the choice, would hold. How about now? To carry on with the Perth theme: major capital spending in mining has sloweddramatical ly. Iron ore prices have been a veritable rol lercoaster. People are now leaving WA at a greater rate than those arriving. Rents are dropping. City apartments that rented for $1 ,250 a week in the boomare now struggling to f ind tenants wil l ing to pay $700 a week. Sale prices have dropped 20% in some suburbs. They're showing no signs ofturning around yet. There is no doubt demand in the sales market has dropped offsince mid 2014. When demand fal ls , prices must fol low to some degree. In this kind of market, thetemptation is to sel l . Of course, anyone with time travel abi l it ies would go back and l ist their propertyfor sale in early 2013 when the market was sti l l buoyant and high demand wouldhelp achieve a decent sale price. Listing your property for sale in 2020 insteadmay mean you make less profit than you may have expected seven years ago. The trick is to balance your expectations of growth with sale t iming. Do you hangon ti l l you’ve eked out every last drop of growth, accepting the risk that you mayovershoot the peak to see your profits decline? Or do you get out a l itt le earl ier,risking a smaller capital gain but f inding the market more favourable? Not a good decision to make emotionally, so plan ahead by keeping an eye onforecasts and population trends.

Good reasons to hold

Does your f inancial strategy hinge on passive income from an investmentproperty? Do you rely on the deductions you achieve through real estate to keep your taxmanageable? Do you need the equity you can achieve through property to take the next step inyour plan – developing, subdivision etc? These are good reasons to hang onto your investment. My key reason for investing in property is the income I ’ l l get from the rent whenthe mortgages are paid off (mainly paid off by the tenants in particular) . It ’ssomething akin to an annuity  in my mind, but l inked to inflation as rent wil lincrease as the economy grows. Here’s how the math works for me with one of my properties: I bought a 2 bed, 1 bath apartment in Taringa, QLD in November 2001. Init ialoutlay was $30K, purchase costs were in the order of $3K and I spent $6K onrenovations. The apartment became positively geared within 5 years, and prior tothat cost me around $5K a year on average, including a kitchen replacement andnew air conditioner. It ’s now generating around $7K a year profit and the mortgage is steadilyreducing. Current rent is $300 a week – not bad for a property I got for under$105K (current value is around $300K). Disregarding inflation, my costs amount to $64K, give or take. I ’m earning $7K perannum (p.a. ) currently, which is around 11% p.a. return on my cash. When the mortgage is paid off (thanks to my tenants since this investmentproperty is positively geared) I can expect to earn closer to $13K p.a. , which is a20% p.a. return on my cash. And at the end of it , I st i l l have the capital asset inwhich I currently have around $250K equity.

Good reasons to hold

I ’d need a pretty impressive annuity deal to guarantee similar returns givencurrent annuity rates are in the order of 6% (due to low interest rates) . I f I sold now and took that $250K equity to buy an annuity at 6%, I ’d earn $15K ayear. So today, it ’s marginal which is the better investment. I could probably do just as well with the equity i f I invested it elsewhere. However, i f it weren’t for that property I might not even have that $250K. I wouldhave had to execute some pretty impressive investment strategies elsewhere toturn $64K into $250K – a nearly four-fold increase – over the last 14 years giventhe f inancial crisis . Also, i f I lock myself into a 6% annuity, I could be missing out on signif icantincome increases if interest rates rise. Rent wil l general ly keep up with themarket so I ’m getting the potential upside. And f inal ly, annuity deals can bestructured to consume your capital – so you get higher payments – or keep someor al l of the capital for a pay-out at the end. At least with property you alwayshave an asset. Bottom l ine, rental income is key to my strategy, so I ’m holding. How about you?

Remember the f irst reason I mentioned – sel l ing an investment property to payoff a mortgage? If you don’t have a home mortgage, you’d be looking to investthat cash somewhere else. Real estate, shares, indices, foreign exchange,commodities… whatever. It ’s got to go somewhere, and preferably somewherethat ’s going to make you a t idy profit . Locking in a saving of 10% p.a. by putting it against your home mortgage is a no-brainer. But you can’t guarantee 10% returns on your investment cash. Sure, manypeople can and wil l do better than 10%, but there’s no guarantee. So do the math– are you confident you could do better elsewhere? If not, perhaps it ’s a goodidea to hold.

Example scenario:

Let ’s take a hypothetical situation as a way of working through the abovereasoning and calculations. (Psst : I f you’d l ike a copy of the Excel spreadsheet I use to do these calculations,download it here. ) Let ’s say a portfol io consists of two properties, A and B:

Original deposit = $300kMortgage = $700k (so, purchase price was $1 .0m)Current estimated value = $1 .1mEquity = $1 .1m – $700k = $400kInterest on mortgage = 4.9%Loan term = 30 yearsRepayments = a bit less than $3,800 per month

. . . is the principal place of residence ( i .e . home) purchased last year:

Original deposit = $100kInitial mortgage = $150k (so, purchase price was $250k)Current mortgage balance = $100kPositively geared from sixth yearTotal ongoing costs t i l l positively geared = $40kCurrent estimated value = $700kEquity = $700k – $100k = $600kInterest on mortgage = 4.9%Loan term = 30 yearsRepayments = $530 per monthRent = $590 per weekOngoing costs = 20% ($118 per week)

. . . is the investment property purchased a decade ago:

Example scenario:

You paid off the mortgage at the agreed minimum monthly rate.It took the ful l 30 years, with no offset or extra payments.You maintained 4.9% interest rate ( laughable real ly – 7% would be a betteraverage to use) .Inflation is not taken into account.

Over 30 years, the total repayments made wil l be just ten grand shy of $1 .4m.That ’s nearly twice the original value of the mortgage. So it didn’t cost $1m asoriginal ly paid, it cost $1.7m – a 70% increase. This assumes:

In addition, you paid $1 .7m of after-tax money, so you probably had to earnaround $2.4m to do that ( i f your tax rate is around 30%). Not such a bargain now,is it? Ah, the price of l iving in a home you love with no rental inspections…

Before costs, you’re earning $590 per week * 52 weeks per year = $30,680After costs, you’re earning ($590 – $118 = $472 per week) * 52 weeks per year =$24,544.The purchase price was $100k deposit + $150k mortgage = $250k

If you owned this property, chances are you’d be pretty happy right now becauseit ’s providing you with some income. But let ’s do the numbers anyway. First up, yield:

So your yield is :$30,680 / $250,000 = 12.3% before costs, and$24,544 / $250,000 = 9.8% after costs.

Example scenario

These are very respectable yields. In fact, they're stel lar. However, I ’d guess that the rent is a l itt le low at $590 per week if the property isworth $700k – that ’s $84 per $100k, where I would hope for closer to $100 per$100k. Perhaps there’s a good reason. Maybe the property is run down, or common, orthere’s lots of competition. Either way, I ’d be asking for a rental appraisal . Total input in the f irst f ive years was $100k deposit + $40k to maintain = $140k(I ’m ignoring buying costs for this example) . After that, it ’s making you a profit of around $18k a year unti l the mortgage ispaid off , which is 13% return on your capital ( ignoring inflation effects) . After 30years total , the mortgage is ful ly paid and you get the ful l benefit of the yield. Ital l looks solid, pending no surprises.

Total asset value (A) = $1 .1m (Property A) + $700k (Property B) = $1 .8m. Total debt (D) = $700k (Property A) + $100k (Property B) = $800k. Total equity (E) = $400k (Property A) + $600k (Property B) = $1m. The Loan to Value Ratio (LVR) banks use to assess viabil ity is calculated as:= Debt (D) / Assets (A) = $800k / $1 .8m= 44%. This is well below the l imit of what most banks wil l al low (usually in the order of80% in Austral ia) and indicates that risk is manageable provided cash f low issuff icient to service the loans. Assuming that ’s the case, you’re in good shape.

Example scenario

Keep going. Leave Property A as PPoR, and keep Property B.Sel l Property B, putting al l profit on Property A to reduce interest paid.

There are dozens of options. Here are two popular ones: 1 .2 . Let 's work through the calculations to see how each one pans out f inancial ly.

You’re earning a passive income from the investment property, so you couldconceivably direct that cash towards repayments on Property A. Assuming 30% tax on the $18k you’re making a year, you’ l l have $12.7k to do thatwith. That ’s over three months of repayments each year on Property A. In addition, you’ l l st i l l have a solid investment whose income wil l increase ifinterest rates increase (as happens in t imes of growth) – so you’ve got a bit ofhedge against interest rates impacting your Property A repayments. In the end, you’re sti l l paying $2.4m for a $1m home, but you’ve only got to frontup around 70% of that cash – the rest comes from rental income on Property B.

Let ’s say you sel l for $700k and it costs you $30k to sel l . After discharging the $100k mortgage, you walk away with $570k. I f this property wasn’t your principal place of residence when you bought it ,you’ l l be capital gains tax when you do your income tax return.

Example scenario

Your mortgage becomes $185.5k, with 29 years remaining on the term.The new monthly repayment is just shy of $1 ,000.

Assuming the original cost was $300k ($250k purchase + $50k costs) and yourmarginal tax rate is 30%, your tax is calculated as fol lows: Profit from sale:= $700k – $30k sale costs – $300k= $370k. 50% wil l be taxed per capital gains tax (CGT) rules) := $370k / 2 = $185k. Taxed at 30% (the rate would be your highest bracket, so could be 47.5%, but we' l lstick with 30% for now):= 0.3 * $185k= $55.5k. So your cash balance after settlement and tax:= Sale price - sale costs - mortgage remaining - tax= $700k - $30k - $100k – $55.5k = $514.5k. I f you wanted to put 100% of that cash against Property A, you could either: . . .pay down the mortgage. In this case:

You now have a $1 .1m asset with $185.5k debt, so your Debt to Asset Ratio becomes = $185.5k / $1 .1m = 16.8%. When you’ve paid off that loan, you wil l have paid the bank $365k on thatmortgage. Added to the $3,800 a month you paid for 12 months, you’ve spent$3,800 per month * 12 months + $365k in remaining repayments + $514.5k profitfrom Property B + $300k init ial deposit = $1 .26m before tax. That ’s a damn sight better than $1 .7m.

Example scenario

D = $700kA = $1 .1mD/A = $700k / $1 .1m = 64%

You no longer have a passive income from the rental property, but your outgoingsare signif icantly reduced. You can probably borrow for another property quiteeasi ly, either by saving up a new deposit or securing against Property A. . . . , or, you could put the profits into an offset account. When you use an offset account, the positive balance is held against yourmortgage. You are charged interest only on the difference between the mortgageand offset balances. In this case, you’d sti l l have a mortgage of $700k which requires $3,800 a monthrepayments, but you’re only being changed interest on $700k – $514.5k = $185.5k. The end result is you pay off the loan much quicker – in fact you stop beingcharged any interest in 4 years and 8 months after the Property B sale, when youroffset account balance overtakes your loan balance. Your loan is completely paidoff in 16 years and 3 months if you continue to pay at $3,800 a month. Compared with paying down your loan, your D/A becomes:

You wil l pay $3,800 per month * 207 months (17 .25 years) + $300k from the init ialdeposit = $1 .07m after tax. You’ l l also sti l l have the $514.5K in the offset account when you f inish paying itoff , which you can then use as you see f it . ( In practice, you' l l draw down the offset once the loan = $514.5k. Same difference. ) As you can see, either option works. I f you pay down the mortgage, you reduceyour debt and slash your repayments by more than 70%. I f you use an offset, you keep your repayments high, but you signif icantly reducethe time taken to pay off the loan. It ’s a question of preference – which are youmore comfortable with?

Applying this to your

There’s a hefty amount of info in this eBook. If you don’t know where to start,consider taking these actions:

. . .or properties i f you have more than one! Here's what you might l ike to check: Get an updated rental assessment  – are you charging enough rent?Get an updated sales estimate  – what could you expect to sel l the property for?Calculate your yield   for each property – are you happy with performance?Calculate your overall Debt to Asset ratio  – are you within 80%?Check against your strategy  – is the property delivering what you wanted?

. . . i f you think you might want to sel l . Which makes most sense to you (f inancial ly and in the ‘not losing sleep’ sense)?Again, don't forget to grab the spreadsheet i f that would help.

Don’t fal l into analysis paralysis – give yourself a couple of hours to run thenumbers, see what they’re saying and then take action accordingly. Rememberthese words from Theodore Roosevelt :

‘ In any moment of decision,  the best thing you can do is the right thing,  the next best thing is the wrong thing,  and the worst thing you can do is nothing. ’

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