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Monday, 25 February 2008

7 Steps to Becoming a Property Millionaire, Prt 5 (Settlement & Renting Out The Property)

Source: Keith Mason

Step 5: Settlement

After buying the property off the plan, we then wait for settlement. While waiting, time is working on your side. You are now controlling an asset, which is rising in value without having paid for it. Only on settlement is when you need to borrow the money from a lender to pay the balance for the property.

The longer the settlement period, the more benefit you gain. If the market is rising faster than the average like it does in the second half of the property cycle, then by settlement it's valuation should be considerably more than when we initially put down the deposit.

The property cycle is generally 7 to 10 years long. In the latter part of the property cycle, values may rise 15 to 20% p.a. or more. In 2007, Melbourne house values rose by 25% while Brisbane rose by 20%.

Let's assume that the market has risen only 10% since we put down the deposit 12 months ago, so the property is now valued at $330K. We can approach the lender prior to settlement with the new valuation and ask for a higher loan.

Assuming the bank was initially prepared to lend 90% of the original value of $300K, this loan would have been $270K. Now they may lend 90% of the new value of $330K, which would be $297K, and so we only need another $3K of our own cash to settle. Our total cash outlay has been only $19.5K approximately (or as little as $6.5K in Victoria).

In a faster rising market, this amount can be reduced even more due to the increased value and extra borrowing capacity, to the point where it is possible to purchase and get back all the cash outlaid at settlement. This would allow us to get started on the next property straight away and repeat the process.

Note that the loan we take out is interest only, so that the repayments are lower. We don't need to pay off any of the principal at this stage.


Step 6: Renting Out The Property

Finding a good property manager is important. It's not recommended that you manage it yourself especially if you own multiple properties in different locations.

It's really important to do the numbers on your property before you sign a contract. You need to know if it will give you a net positive or negative cashflow after all expenses and tax deductions are taken into account.

Your serviceability of the loan on the property will be affected by this. If you are not on high income, it's probably better to look for a property which will break even after tax deductions.

However, if it is slightly cashflow negative and you are earning good income then this is not a bad thing. As an example, let's say your property is negative cashflow $50 per week, this would only be $2,600 per year.

This is also generally tax deductable and could reduce your tax (see your accountant). Your $300K property is increasing in value by approximately $30K per year, so you are outlaying $2,600 each year to get a return of $30K each year.

Go to the next part: The Power of Compounding, Summary.

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