Settlement Date – 30/10/2009
Client – Interstate Brisbane – 1783
Purchase type – Investment
Purchase price – $526,000 -
Transaction type – On Market – private treaty
Suburb – Clear Mountain, near Brisbane
Property Type – Vacant Block of Land
Attributes – Large elevated block of land with city and farmland views, purchased to build large owner occupied Taj Mahal.

Settlement Date – 30/10/2009
Client –Local – 2019
Purchase type – On Market private treaty
Purchase price – $335,000
Transaction type – Owner Occupied work transfer
Suburb – Port Macquarie
Property Type – Established
Attributes – 3 bed with ensuite and double garage in a nice part of town near the water.

Settlement Date – 27/10/2009
Client – interstate Brisbane – 1638
Purchase type – Investment
Purchase price – $690,000
Transaction type – On Market – Private Treaty
Suburb – Currimundi, QLD
Property Type – Currently a 3 bed with ensuite shack made of Bessa blocks
Attributes – Located 150m from the beach, this property was bought for the land content only. The client intends to demolish the existing dwelling to construct a new home at a cost of $400k. it is expected that the property will be worth approximately $1.1m upon completion. The client specialises in purchasing tired houses, renovating or redeveloping them and revaluing to extract equity. They typically buy 1 to 2 properties a year and have successfully done well with more than 10 such deals across the Brisbane area.

Settlement Date – 23/10/2009
Client – Interstate – 1602
Purchase type – Investment
Purchase price – $380,000
Transaction type – On market – Private Treaty
Suburb – Manly – Inner Brisbane
Property Type – 3 bed townhouse with 1 bath and single lock up garage, 100m2 living area
Attributes – Four streets back from beach, the client used a buyer’s agent to source this property as they are in the Army on deployment. Currently renting for $380pw.

Settlement Date – 09/10/2009
Client – Local – 1545
Purchase type – Investment
Purchase price – $485,000
Transaction type – On Market
Suburb – St Kida, Melbourne
Property Type – 2 bed unit with single bath and off street parking
Attributes – Car space has its own title. St Kilda is a very trendy and popular area and it is anticipated that this property will rent for $470pw. The client used a buyer’s agent to source this investment property as she was buying into an area she was unfamiliar with.

Settlement Date – 23/10/2009
Client – Local – 1120
Purchase type – Investment
Purchase price – $195,000
Transaction type – Off the plan town house
Suburb – Queanbeyan, ACT
Property Type – One bedroom unit on first floor with LU garage.
Attributes – Living area is 35m2. The property was bought from a developer around12 months ago, but has only just settled due to garage and boundary issues with Council. Rented at $245pw.

Settlement Date – 23/10/2009
Client –interstate, Victoria – 1678
Purchase type – Block and build
Purchase price – $295,000
Transaction type – construction
Suburb – Point Cook, VIC
Property Type – 3 bed with single garage, entry level property
Attributes – Located close to a new shopping centre and public transport and only 20 minutes from Melbourne CBD.

Settlement Date – 13/10/2009
Client –Local – 2004
Purchase type – Investment
Purchase price – $445,000
Transaction type – On market, Private treaty
Suburb – Flynn – Canberra, ACT
Property Type – 4 bedroom with ensuite, double lock up garage and in-ground pool
Attributes – Close to Belconnen Mall (Westfield), this property will rent for $440pw

Settlement Date – 26/10/2009
Client –interstate – Sydney – 1653
Purchase type – 2 bed unit
Purchase price – $255,000
Transaction type – on market found through realestate.com
Suburb – Wiley Park (Punchbowl area), Sydney
Property Type – 2 bed unit wit off street parking
Attributes – Renting for $340pw, the property had been re carpeted and painted by the vendor.

Settlement Date – 13/10/2009
Client –interstate– Victoria – 1618
Purchase type – Investment
Purchase price – $350,000
Transaction type – Auction
Suburb – Soldiers Hill (near Ballarat), VIC
Property Type – Two x 2 bedroom units and one x 1 bedroom unit
Attributes – 3 units on a single title which means multiple tenants and multiple income. All three are currently renting for $355pw, but with a cosmetic make over this is expected to increase to around $520 pw.

Settlement Date – 27/10/2009
Client –Brisbane – 1562
Purchase type – Block and build
Purchase price – $484,000
Transaction type – construction
Suburb – Warner, QLD
Property Type – 4 bed ensuite with double garage and attached 2 bed flat with single garage
Attributes – Comparative sales in the area suggest that this property will be worth approximately $550k on completion, with the flat renting for $300pw and the house for $370 pw.

Settlement Date – 26/10/2009
Client –Local – 1627
Purchase type – Investment
Construction price – $157,265
Transaction type – Construction of dual occupancy on back of existing investment property
Suburb – Hamlyn Heights (Geelong area), VIC
Property Type – construction of a new 3 bedroom home with ensuite + double lock up garage – around 123m2
Attributes – This client specialises in buying large blocks in this area, building on the back and then splitting the titles. They bought the original house in June 2008 for $245k and the end valuation for both properties upon completion will be around $490,000, which spells an $88k gain over both. They will be held and tenanted for $250pw for the old front house and $350pw for the new back one. The client’s wife does it all by satellite!

Over the last few years Developer’s Edge have managed to help many clients achieve extraordinary results in property by using developer strategies with their next property investment. The team at Developers Edge provide a one stop shop approach in helping investors create wealth in property. The key services that the company provides are:

• Identifying suitable properties
• Conducting a feasibility analysis
• Assisting with negotiation
• Conducting a due diligence investigation in order to determine the suitability of the site
• Assist with town planning applications
• Construct dwelling
• Provide regular feedback
• Co ordinate sales or rental

Nick approached us initially in 2005 after a recommendation from Ed Nixon. Nick lived in Canberra, where he worked as a contractor assigned to work for the Defence department. We had several conversations over the telephone on the type of development opportunities available and the funds required for each. In the end, it was decided that we were to look for an old house in an established area that could be subdivided to create two new detached dwellings.

We spent a few weeks looking for an available site and eventually found an old run down house that had been on the market for several months. It was initially listed for $340k however, the vendors were motivated sellers and through some good negotiations we managed to help Nick secure the block for $290k.

We chose to focus our research in the Redcliffe area, as we identified this as an undervalued suburb that had good scope for future growth. Redcliffe is located approximately 30km north of Brisbane and is a highly desirable locality due to its proximity to the water. The other main feature of the area is its position; being on a peninsula and surrounded by water means land supply is limited. Most of the land there has been developed and the way forward seemed to be through redevelopment.

Demolition began soon after settlement.

The site was acquired in November 2005 and the project was finished in August 2006. The total time for the project was ten months. The feasibility report below shows a summary of all the costs associated with the project and the overall profit in the project. The end values were determined by a bank valuation on project completion which was conducted by Nick’s bank.

At the end of the project we were able to organise tenants for Nick and each property was rented out for $360.00 and $340.00 per week.

As we were nearing completion Nick decided that he would like to repeat the process again. Therefore, soon after we were able to find a site in Scarborough, another suburb in Redcliffe. This time the 809sqm site was acquired for $329,250, however it was on a single lot. This means we had to apply for a Development approval and pay extra council contribution charges. The project also took a lot longer to finish. Regardless of the extra costs associated with this project, Nick still made a profit of $110 000.00 on completion.

Currently, Nick and his partner Jill are having time off investing while they focus on a new arrival in the family. They have accumulated a lot of equity as a result of using a developer strategy with their property investing and once Jill is back at work, they will be ready to continue with their winning ways.

Mortgage managers are finance specialists who organise funding for property investors and home buyers from numerous sources. Their role is to not only arrange the necessary funds for your property loan, but also manage and administer your loan for its duration, from credit assessment right through to monitoring your repayments, applicable insurance and renewals, interest rate adjustments and any variations for the life of the loan.

Many prospective borrowers are not fully aware of how mortgage managers operate (or even their existence for that matter!), and as such are concerned as to their safety and reliability. The fact is mortgage managers do not represent any type of issue for borrowers and can be of great benefit, as they do not lend their own money for home or investment loans, but instead source their funds from a variety of independent lenders. In other words, they do not act as banks or take deposits.

Mortgage Managers use many different sources to arrange funding for home and investment loans, including unit trusts, superannuation funds, securitised funds and even the banking sector. In fact a common source of funds for mortgage managers are some of the smaller banks that do not have extensive and costly branch networks, which allows mortgage managers to pass on their more competitive rates to clients.

The mortgage manager is not responsible for any funding at the end of the day, as the original provider of the funds (who works through a trustee) owns the mortgage in entirety. The trustee’s role is to ensure that the mortgage manager is professionally and appropriately managing your mortgage on a daily basis.

For instance, if your mortgage manager ceased operations at any time over the duration of your mortgage, the trustee would appoint another mortgage manager to continue administration of your mortgage under new management.

Mortgage Managers are a great asset to borrowers, for two reasons.

Firstly, because they have their own DLA’s (Delegated Lending Authority), if they like the application they can approve it on the spot without referring to the funder. This usually results in faster approvals and gives them the ability to pick and choose the type of business they’d like to have on their books.

And secondly, they are competitively priced. An example of this is a mortgage manager called Choice Lend (Funded by NAB), who are currently offering investment loans for 5.80%, which is not bad when you consider that Westpac are charging 6.06% for their comparative product.

Mortgage Managers are certainly worth considerating now that NAB is one of the major underwriters in the market.

Last month I said that lending policy had normalised… How wrong was I? Since making that announcement, the Westpac group (Westpac, St George and Rams) have announced major changes to Low Doc loans and want to see Business Activity Statements with all new applications.

Now I know I’ll get chastised by investors, but in my opinion this is a good move. The fact is Low docs have been abused by brokers and consumers for too long and I can comfortably make this claim because we fielded many phone calls from investors we simply couldn’t help because of decreasing property values and the fact that they were too highly geared in the first place. With the new rules in place, if you want a fair interest rate on your low doc loan, you need to provide BAS statements for a 12 month period. There are still Low Doc loans about that don’t impose this BAS requirement, but the interest rate reflects the risk, with the average rate on one of these packages currently at around 6.87%.

Now on to this month’s gossip that we are hearing around the traps…

• NAB has been given the all clear from the ACCC to acquire the Challenger group
• The Bank of Queensland is still for sale
• Suncorp still cannot find a buyer

To keep you informed and in the bank loop, so to speak, here’s a snapshot of some the lending policy changes we’ve seen recently;

Adelaide and Bendigo Banks

With rising interest rates, these two banks are well positioned to reclaim some market share this new calendar year, as they are 96% retail funded by depositors; meaning as rates rise, so too will their margins ahead of deposit rates. They have reported that their focus this new calendar year is on growth through home lending via their third party and direct channels. Let’s hope they can create some competition for the majors.

ANZ

ANZ have made a change to their professional package, reintroducing the 0.7% discount if you borrow over $250,000 in aggregated borrowings. Whilst they are saying this is a special offer, the last special they ran lasted for 2 ½ years!

Bankwest

Bankwest withdrew their rate tracker product, which guaranteed to be 0.9% below the 4 majors for the first 3 years before reverting to their basic discounted rate. This has been a popular product, but due to poor service levels in processing the loan wasn’t supported as well as it probably deserved.

ING

Released their online everyday account (Orange Everyday) which will become very popular; it doubles as a Visa debit card and soon to be announced offset facility. There are also some very attractive features like access to 26,000 ATM’s in the country fee free (as long as you do cash outs of more than $200). In addition, there are a bunch of other attractive offerings including a payment from ING to you, the customer, if you withdraw funds via EFTPOS. ING finally have a full banking solution for investors. Look out majors here come the Dutch!

Actually I’m so impressed with it that I’ve opened one myself! If you want to know more about this facility, please click here.

NAB

I usually don’t have much to write about the NAB because they are a relatively bland lender when it comes to investor offerings, but this month they have brought something out which is of interest to the beginning investor. If you borrow over $250,000 and keep your Loan to Value Ration at or below 75% they will give you 0.8% off their standard variable rate. Usually this sort of “extra” discount is reserved for someone borrowing in excess of $1,000,000. Well done NAB!

St George / Westpac

The Westpac group tightened Low Doc qualifying criteria by requesting Business Activity Statements for all new loans where self certification of income is used. Unfortunate, but it is a sign of the times. If you need a low doc loan there are still options available outside of the majors.

Rams

Increased their rate by 0.35% off the back of the RBA (everyone else just went the 0.25%). The media gave them some negative press, but neglected to mention that they still have a cheaper rate than the majority of lenders! No more low docs in company names over 60 % and all require BAS’s.

Collateral

Last month we discussed the second “C” of credit – Capacity and this month we’ll take a closer look at the third critical “C” – Collateral. Put simply, collateral is what you offer the bank as security over the loan you are applying for and could be a term deposit, a business (as security for a business expansion loan) or commercial or residential real estate, to name a few examples.

All of these represent potential collateral that you can offer your lender as security, in the unfortunate event that you cannot honour your repayments.

The type of collateral you present to the bank will dictate the lending percentage they will approve against that security for your new loan. This is known as the “Loan to Value Ratio” or LVR. Essentially, the lender will assess the security you are offering over the loan (generally by sending out an independent valuer to conduct a sworn valuation) to determine whether its value is sufficient to cover your required borrowings, as well as how easily they can liquidate (or release) it to recover their debt if necessary; the latter being of the most significance to the lender because let’s face it, that security is their only fall back option if you default on your loan and they need to recoup their loss.

When a valuer visits one of your properties to make their assessment, they are not just putting a price on it. Rather, there are a number of factors taken into consideration when they write their report to the lender, including;

• recent comparable sales that have occurred in the area,
• the likelihood of the value of your property reducing over a given time.
• the marketability of the property if a sale is required
• overall location and neighbourhood and how these factors could impact on resale
• a risk rating
• any environmental issues that could impact the value of your property over time

As you can see from the above list, the valuer’s assessment is largely seeking to determine how well the property offered as collateral would retain its value, along with its potential for resale over the long term. From the valuer’s report and depending on the property’s liquidity, the bank will determine its acceptability as sufficient collateral for the loan you are applying for. However a word of warning – not all lenders like all forms of security and many have certain preferences.

Because liquidity is really the key to the lender’s acceptance of any type of collateral over your loan, let’s consider this factor in more detail. The term deposit you offer as security would be able to secure a loan of equal value because it is highly liquid – in other words the funds can be released and secured by the lender relatively quickly. On the other hand, that small student accommodation you’re looking to buy and offering as collateral may only be able to support around 50% of the loan because it is perceived as a risky investment that could be difficult to resell given certain market conditions. All of this is about liquidity.

So how is liquidity determined? Here are some of the common factors considered by lenders when assessing the liquidity of the collateral on offer by loan applicants;

• How many comparable properties have sold in the last 3 months? In other words – is the area popular with buyers and therefore do properties move within a reasonable amount of time on the market?
• Can the market absorb the sale in a timely manner?
• Is this a common type of property for the area or is it an orphan that could take longer to move?
• Are there buyers willing to purchase this property?
• How might the local economy impact on the property’s resale potential? Eg. Regional areas that have only one industry propping up the local economy can be seen as carrying higher resale risk and less liquidity by the banks.
• Market segment conditions, ie. what segment of the market is this property in and how is that segment performing overall?
• What is the state of the market at the time of valuation – buoyant, balanced or declining?
• What is the predicted state of the market for the next 2 to 3 years?
• What other properties of a simular nature are coming up for sale? Ie. A large release of units in a CBD area?
• What condition is the property in? Does it need major repairs, is it tenantable, etc?

Collateral is one of the easier “C’s” to grasp because there are some general rules of thumb when it comes to determining loan to value ratios and it is quite a simple issue to discuss with your lender. Basically, all you have to ask of your bank is, “Do you lend against this type of security and if so what LVR would you borrow up to?”

So what are those general rules of thumb that the bank considers when it comes to collateral assessment? They include;

• Term Deposits – up to 100% equal loan to value ratio
• Median priced residential real estate – up to 95% LVR
• Fixed and floating charge over a franchise business – around 50 to 70% LVR
• Commercial office space with a tenant – up to 70% LVR
• Single student accommodation – around 50% LVR
• Speciality security like gymnasiums, caravan parks, service stations, hotels, rural holdings, vineyards and undeveloped vacant land is all assessed on a case by case scenario, but as general rule – maximum funding of around 50% LVR

With the radical shake up that has occurred within the lending market off the back of the global economic crisis and last year’s mortgage meltdown in the US, banks are undeniably beginning to reduce their appetite for risk and tighten their purse strings. As a result, we have recently seen a marked reduction in the types of security they will accept and a much more cautious assessment of collateral offered by finance applicants. An example of this is properties held in regional, single industry towns where the LVR has been reduced in many instances from 95% to 90% or sometimes even 80 to 85%.

The bottom line is; the more attractive, sellable and marketable and therefore the more liquid your collateral is, the more likely the bank is to say yes to a higher loan to value ratio and your overall application.

As I present each of these four critical “C’s” of Credit, you are probably beginning to realise that the initial 3 “C’s” – Character, Capacity and Collateral all play an important role in your loan application. Next month, I’m going to cover the final and fourth “C” of Capital. This is the one “C” that is the most negotiated within your loan application and if you are deficient in any of the other three “C’s”, Capital represents your bargaining chip to get the bank to buy your deal.

Like the idea of revamping an entire block of units to make a tidy profit? Chris Gray, TV property expert and CEO of Empire Property Portfolio, explains how he upped the investment stakes by teaming up with five like-minded individuals who now stand to make a whopping $1 to 2 million profit, just by thinking outside the square.

Investing in a block of units that have the potential to add extensive value through cosmetic refurbishment is often the dream of many aspiring property investors. But the reality can represent a very costly exercise. If this is your ambition though and you have the tenacity and drive to give it a go, there is a way to get into the lucrative unit development game without breaking the bank.

The inescapable fact is that the cost of buying a block of units on your own can be prohibitive unless you have a lot of cash to begin with, especially if you intend to purchase in a blue chip area. In order to overcome this obstacle, teaming up with other investors in an arrangement whereby each of you buy individual units, can be a great way to go.

However the challenge is finding investors who want to buy into the same block as you and have the economic capacity to not only acquire the investment, but renovate it as well. Then of course you have to find someone with the right expertise to manage the entire project and minimise budget blowouts.

The trouble with most blocks of units that hit the market is that they have not yet been strata titled, which can make such an investment more difficult and risky, as each investor cannot buy their own unit on an individual title. This increases the probability of ending up in a scenario whereby multiple owners of the one apartment block all have different agendas; potentially creating costly and time consuming issues when it comes to determining exactly how to go about refurbishing the project.

If you happen to be lucky enough to find an elusive strata-titled block, it is likely you will have to compete with cashed up professional builders and developers who are attracted to such “diamonds in the rough” and have the financial capacity to renovate and on-sell these properties at a fraction of what it will cost the individual (or team of) investors.

The upside of overcoming these initial hurdles is that rundown unit or apartment blocks often have massive potential for improvement. There are endless possibilities, depending on what the council will allow you to do and which professionals you hire to manage the process on your behalf and at the end of the day substantial profits can be generated.

Following is a real life case study that illustrates exactly how every day investors with an average purchasing capacity can get into the unit block development game and in doing so, use residential real estate to create a handsome income.

Case study: Sydney unit block
In my travels as a buyer’s agent seeking properties with potential on behalf of clients, I happened to come across a block of seven units in the Sydney suburb of Coogee one day, where two of the units were listed for sale. They were on the market for $700,000 each at the time, so I dismissed them as too expensive and simply moved on.

Two weeks later though, an agent I had bought many properties from in the past and developed a good relationship with, approached me to advise that he knew a developer who owned a further three units within the same block. The developer had spent a tiring three years attempting to persuade the other unit owners to build a penthouse on the roof, but his pleas had fallen on deaf ears. Becoming disillusioned at the apparent lack of foresight from the other unit owners; he was now looking for a quick sale of his three units.

Suddenly the unit block had fresh appeal; with two units listed for sale and three potential silent sales, I saw a great opportunity to own three quarters of the entire block.

As a buyer’s agent who specialises in building property portfolios for time-poor professionals, I always have a number of clients looking for these kinds of deals, so it was fairly easy to find some common-thinking investors who had ready cash to buy into the investment as well as additional money for renovations. I made some calls and soon had one client who agreed to purchase the two listed penthouses and three others who each bought one of the units that were offered as silent sales.
When applying to make any structural refurbishments or alterations to an apartment block, if more than 25 per cent of the strata vote goes against your plans, you can’t proceed. Given that another owner in the building held two units (giving him a 26 per cent vote) I sought to make an offer on these units as well, thereby giving my newly formed investment consortium full control over the entire block.

Over the coming weeks I tried to contact him every way I could – through his strata manager, through the property manager and even via agents who had his details. After persisting for three months, I received a call from the agent who had managed to list these final two units and as they represented such a great potential deal, another of my clients bought one and I bought the other, final unit.

I hired a town planning firm to help me navigate a pre-Development Approval meeting with the council to get them onboard with our plans and discovered that another penthouse level (cost circa $1m and worth $2m+) may well be possible. They also suggested that we extend our balconies in line with the neighbouring buildings, which would not only improve our ocean views, but also increase the unit areas by 10 per cent (adding $50-100k in value to each unit). Additionally, we plan to render the exterior of the block, adding a further $25-50K in value to each unit, and increase the off street parking capacity by three to four car spaces (worth $150-200k overall) as well as landscaping the entire site.

The next step was to hire an architect and of the four I interviewed, one presented an exceptional idea. The block is L-shaped, which included a spare piece of land between two other buildings that served no real purpose. He suggested building an additional four-level block, which could host an impressive entrance foyer and three whole-level studio apartments (costing $750k and worth $1.2 -1.5m in value). Since drawing up the plans, this architect also reconfigured the car park level to increase the car spaces from 9 to 22 (adding a potential value of $650k). We are currently in the throes of another pre-DA process with council to discuss these new additions.

So essentially, what started out as two overpriced units turned into a goldmine of opportunity for six investors. And as we all own our individual units, we have each managed to acquire a very profitable little asset at a fraction of the risk (and price) that would normally come with a deal of this nature.

Close up on our clients

Gavin and his wife live in the Melbourne inner city suburb of Flemington. They currently have a total of 7 properties in their investment portfolio, with their overall strategy as they acquire each asset being to buy and hold for the long term in order to benefit from natural capital growth and strong rental yields.

Gavin explains, “We prefer to invest in regional areas and look for locations that offer rental yields of around 5 per cent plus as a starting point when beginning our research. Additionally, we seek out areas that have a proven history of good population growth, solid infrastructure and general economic vibrancy.”

The couple’s investments are located across Cairns and Townsville in Queensland, the mining region of Kalgoorlie in WA, the northern Victoria regional town of Mildura and Gippsland’s Traralgon.

Initially, Gavin says the pair began investing 6 years ago using a positive cashflow approach and found it relatively easy to seek out and purchase properties that offered the positive returns they required to make their strategy a success.

However he says, “As time went on and property prices continued to rise strongly around the country, it became more difficult and then almost impossible to find such properties unless you were buying higher risk investments, such as in a mining town or in a niche market, like student accommodation.

“We have been fortunate in that we have seen both solid capital growth and continued strong rental yields in some of the properties we bought early on, so our portfolio consists of a mix of cashflow positive and negative. With regard to any property we have purchased that has been negatively geared, one of our main considerations has been our after tax position and ensuring we can afford to hold the investment and that it will do well for us over the long term.”

Gavin and his wife recently acquired a 3 bedroom established house on a 900sqm allotment for $176,000 in the Gippsland (Victoria) town of Traralgon and then purchased the adjoining 3 bedroom house on a 940sqm parcel of land for $184,000. Both homes are currently tenanted for $210 per week.

Gavin says the bustling regional centre in the Latrobe Valley boasts a strong and diverse local economy, low cost entry level housing and good rental demand. Additionally, the state government is showing interest in the area with spending on new and existing industry and infrastructure.

“I used the internet to research the area, including looking up the local council website,” explains Gavin. “I also spoke with people at the local council, such as town planners about land development, infrastructure plans and projected population growth into the future. I sought out local property managers and asked them about things like vacancy rates and what types of properties were most in demand or in short supply by renters and I spent time looking at property prices and negotiating on properties until I got the right buy.”

Gavin says they bought this latest property after giving careful consideration to the fact that Australia’s residential markets in general may not achieve good, natural capital growth for a while longer. With this in mind, they purchased an established home that offered the added bonus of future development potential and the ability to add or manufacture value through renovations.

“This will enable us to increase the rental returns, as well as looking at developing the land in the long term,” says Gavin. “It will help us now and in the future to create a portfolio that provides us with a comfortable early retirement.”

Gavin and his wife say they don’t have a particular number of properties in mind that they hope to accumulate prior to that early retirement.

“We see property investment as a wealth building tool to provide for our future and the future of our children. We treat it like a business.” Currently living as tenants in their Flemington property Gavin adds, “We would also like to be able to use our investments as a way to leverage into our own home in the future.”

Capacity

Last month we discussed the first “C” of credit – Character – that you need to know about in order to significantly enhance your loan application and increase the likelihood of getting the “nod of approval” from your lender. This month I want to walk you through the second “C”, which is Capacity. This is a relatively simple one because it is about the applicant’s ability to service a loan. So what do lenders really look for when they check out your serviceability?

The first point that you need to understand when it comes to Capacity, is that a lender is really only interested in your historical income not your potential future income. This is not to say they won’t take your earning capacity of tomorrow into account, but what they want to see is what you “have” made not what you “might” make. This is only logical as any prediction of future income is only speculative and cannot be relied upon as set in stone.

This is why they like to see two of your most recent consecutive payslips or your last two years of business financials (if self employed); they represent historical documentation and are relatively indicative of what type of income you, the applicant, will make going forward.

Future income (like rent from the newly purchased property) can be taken into account, but it is often discounted to around 75 to 80% of the projected value to allow for variations like vacancies and running repairs, etc.

It’s important to note that if you go for a loan on the basis that you are starting work on Monday after a 12 month period of unemployment, you will struggle to get the application over the line. Conversely, if you are transferring to a new job in the same industry on Monday after working for 3 years in your previous capacity, your application will be looked upon quite favourably. The point I am trying to make is how your history will tell the lender a story about your capacity to repay the loan.

Capacity is all about you proving to the bank that your historical income has the ability to service the new loan. It is about you, the applicant, demonstrating that you have the financial capacity to service the debt without hardship.

Let’s expand on this further and look at some different employment types to see what a credit assessor will be looking for as evidence of capacity to service a new loan in various personal circumstances.

When assessing capacity, the credit analyst will be looking to see where your income is derived from and what expenses you will have, which of course will leave a surplus to service the new loan you’re applying for.

So where is the income derived from?

Is the applicant;

A casual employee
A contract employee
Salary / Wage earner
Self employed
Commission based employee
Part Time employee

What expenses is the applicant going to incur?

Existing home, Investment, car, and credit card loans
Is there a Spouse and children to support?
How much is the new loan applied for?

When it comes to capacity, credit assessors are naturally conservative; they will always err on the side of caution, so let’s take a look at each form of income stream and dissect what a credit officer is looking for.

Casual employee

The difficulty with being casually employed is that while you have a job today, you might not have one tomorrow – to a lender, it’s simply as black and white as that. And because your income stream can stop as suddenly as that, the credit assessor is typically going to say no. But not in all cases…if it can be confirmed that the borrower has been in the industry in which they are casually employed for 2 to 3 years or more and they are able to provide say 2 years of tax returns, the lender can then average out the income from those returns and rest on that. Unfortunately most casual jobs are casual for a reason and generally aren’t reliable enough sources of income for servicing loans.

Contract employee

These days more and more people are electing to enter into contracts with their employers as it often means a higher rate of pay, negotiated terms and a set time frame to complete a project. When assessing a PAYG contractor, lenders are interested not only in evidence of the income but sighting the contract and reviewing its length and terms.

Character plays a role here too because the lender wants to know how long the contractor has been in the industry, as well as the likelihood of contract renewal. They will often contact the contract provider and ask various questions about this. If the contract is short and there have been many different contracts over the last 2 to 3 years with different companies, then a credit assessor will typically request tax returns and again average out the income from those.

Generally speaking though, this form of income is as reliable as full time employment.

Salary or Wage earner (also known as Pay As You Go – PAYG)

The most common from of income is generated from Salary or Wages and is typically referred to as PAYG. For a credit assessor, this form of employment and earnings is easy to assess and they will generally ask to cite 2 consecutive payslips as evidence. The payslips should include the following, which will be carefully assessed by the lender;

Name of employer and ABN (cross checked for authenticity)
Name of employee – matching the borrower
Weekly / Fortnightly Gross income
Any allowances like uniform or acting up
Overtime
Year to Date Earnings matching the weekly income

From this they will calculate annual earnings, taking into account income tax and the Medicare levy and apply the net to their servicing model for the proposed new loan. PAYG income is one of the easiest income streams to work with because it is all laid out in black and white in a single payslip.

Self employed

This is possibly the most complex income to verify for a credit assessor, primarily because the Profit of a business can be manipulated by the owner or accountant.

In this instance, a credit assessor will request two different sets of documents; signed Tax returns and the financial statements that made up the Tax returns.

These tell a story of how the business is travelling financially from a management point of view. They contain opening and closing balance sheets, which is the business’s Statement of Position at the beginning and end of the Financial Year and the Profit and loss, which outlines income and expenses.

Within these statements, the credit assessor is looking for irregularities like non recurring income or expenses. They also perform acid tests on the business financials for solvency and liquidity and benchmark against industry standards.

Because a business can do well one year and not so well the next, banks will usually ask to see two years of returns, they will then average out the income over the two years and use this figure for servicing. Some lenders even go to the extent of requesting 3 years to provide a clearer picture.

Being self employed has it perks, but applying for a loan isn’t one of them.

As always though, necessity is the mother of invention and this is how Self Certified income loans came about; they were designed for the business owner to “self declare” their income with less supporting paperwork. They are also known as Low Documentation loans, and became very popular with property investors looking to hold more property than their payslip would support. However since they were abused, they’ve now had credit policy tightened around them. They are still available for the business owner, but require Business Activity Statements to accompany the application. The idea behind the Low Doc loan was that if the business owner contributed a higher amount of capital (deposit) the bank would OK the loan, but with a higher interest rate to reflect the extra risk involved.

Commission based

Commission based wages are also becoming a more common form of earnings amongst Australian employees these days, particularly in the arena of sales jobs like car sales and of course, real estate. If your primary income is in the form of commission, that is a percentage rate payable on performance, typically lenders will want to see two years worth of earnings evidence such as income statements and/or tax returns.

Based on that paperwork, they will average out your earnings and establish your lending capacity using 100% of the average. If you have been employed in a commission earnings position for less than 2 years, they can discount your average income by 50% to 100%. The point to be noted here is that the lender is essentially looking for evidence of consistent income across the board. They need to reassure themselves that you can make your repayments month to month, without any dry spells of low or no commission payments.

Part Time

Part time employment is treated exactly the same as full time employment, in that as a PAYG salary or wage earner, they will ask to cite evidence of your income and from there, calculate your annual earnings to determine your lending capacity.

Make it official

When considering the documentation you will need to provide with your loan application in order for the lender to assess your lending capacity, it should be noted that a credit assessor will look more favourably upon financial statements and tax returns prepared by practicing accountants. That is because they are nicely laid out and easy to follow, as many accountants use the same software.

Financial statements presented as excel spreadsheets and handwritten tax returns prepared by the borrowers themselves are generally difficult to read and regularly questioned for authenticity. Once a credit assessor begins questioning authenticity, they will scrutinise every little bit of documentation you present to them, so for the sake of a few dollars in service fees it is far better to have a professional complete your annual returns.

Based on these financial documents, the credit assessor will plug all relevant numbers into a spreadsheet and rate your lending capacity on the back of how you derive your income, what it equates to on an annual basis and how much cash you have left over after expenses are accounted for.

Essentially, the credit assessor needs to establish how the loan is going to be repaid and importantly, whether the applicant can continue to make repayments in a high interest rate environment. This is why assessors increase the interest rate on the loan applied for as well as on the current facilities held by the borrower, and is a practice known in the industry as “stressing” the loans or “applying a stressed interest rate” to existing loans. The lender has to be reassured that as a borrower, you can cover all repayments over the life of the loan. Typically when making these calculations, an assessor will add 2% to the current variable rate and calculate all repayments on Principal and Interest over a 25 year period.

Of course many loan applicants have distinct and individual circumstances that may not fit neatly into any of the earnings compartments summarised above. So let’s work though a couple of different scenarios to get a handle on how lenders assess capacity when the applicant’s income is not so black and white.

Future earnings

Some people will need to make a loan application based on future earnings. For instance you might be in the process of acquiring a Subway franchise and you’ve never been a franchisee running your own business before; you’ve worked as a public servant for the last five years. So what happens if the cashflow is futuristic, as in this example? In this instance, the lender will have benchmark figures in place from other franchise stores, so they use these historical figures to determine the future cashflow. Often you will find with major franchises that a large bank will finance them because they have done a number of them in the past. There is often extra risk associated with this type of lending so the interest rate and loan to value ratio are adjusted to match that risk.

On the other hand, if it is a start up business with no track record then providing evidence of capacity is rather difficult.

No evidence of capacity

What happens if you cannot provide evidence of capacity at all? Let’s say your business financials are not up to date or you are a seasonal worker and it’s the off-season? Well there are loan products out there to cater for individuals who find themselves in these circumstances, however they do come with different conditions and require the applicant to contribute a larger deposit.

The bottom line when lenders assess your borrowing capacity is that higher risk loans will usually result in a higher interest rate charged, so if you cannot provide evidence of capacity and can reduce the funding ratio with extra cash then you may be able to secure an asset lend, where you are borrowing against the asset in question at say 50 or 60%, and the lender thereby takes a managed risk.

Overall, there is an array of ways to ascertain whether one can afford the new borrowings they are applying for and the lender has many alternatives to simply assessing your income when determining your lending capacity, including things like Debt Servicing Ratio’s and Interest Time Cover. The take home message for anyone applying for a loan is to have all of your “i’s” dotted and “t’s” crossed when it comes to the paperwork you provide the credit assessor as the easier it is for them to calculate your borrowing capacity, the easier it will be for you to get the nod of approval. <–>

Each month I like to keep you informed on changing policies from the banks. This month I’m pleased to say that lending policy has normalised for the first time in around 18 months. It appears that the banks have found their footing and now that they are happy with their lending policies it is unlikely we will see any further major changes. Mortgage Insurance companies too seem to be content with their revised policies and we should at last begin to see some consistent decisions being made. This doesn’t mean we are going back to the days of old, with Low Docs and easy credit policy, it just means that credit answers are now becoming less erratic.

One of the issues I have with our banking system at the moment is that there is a drastic shortage of competition in the market, with the majority of residential lending still monopolised by the CBA and Westpac. However, some good news has emerged here in the last 2 weeks with the NAB buying out Challenger for a reported $385 million. Their reason for doing so hasn’t been publicly disclosed as yet, but my thinking is they are looking to take advantage of its 4000 odd brokers as a distribution channel of a Challenger branded loan product, backed by the NAB. NAB aren’t well supported by the broker channel to date and I think they have plans to change this. This will be a good thing for the consumer as we may see a re-emergence of the “Non Bank” home loan at sensible interest rates, which will in turn create healthy competition.

As you are already aware, banks are continually changing credit policy and while a lot of the new regulations won’t negatively impact investors, some changes will hurt a little. If you know someone who is thinking about obtaining finance soon who could be impacted by the changes to credit policy as outlined below, please refer this article to them. Click here now to keep them informed and help out someone you know with a common interest and please read on…

To keep you informed and in the bank loop, so to speak, here’s a snapshot of some the changes we’ve seen recently;

ANZ

Still making it difficult for borrowers to get cash out of > $10,000. They are one of the few lenders that will negotiate on rate today, so are proving handy for the client who wants a low rate but is happy to set and forget their loans for a few years. ANZ are reducing Loan to Value ratios on borrowers who buy units smaller than 40m2 from 70% down to 60%, and if you hold more than 10% of the apartment block your LVR will be reduced further to 50%. They call it “Concentration risk”.

CBA

Probably the most proactive bank at the moment. They are currently surveying brokers to determine what they can change in their product suite to make them the lender of choice. (I don’t understand this because between them and Westpac they are getting the lion’s share of business from the broker channel as it is). We suggested that they make their offset account facility a true transactional account with Eftpos and ATM access. Let’s see what happens there.

Heritage Building Society

Still have their basic and professional package suspended from sale through the broker channel (due to demand). We hope to see them gear up their processing team soon as these two products are very popular.

ING

There is rumour that they will be introducing an offset account in the New Year. If they do this, they will most certainly see an upswing in applications from investors.

St George

Now have a minimum unit size of 50m2, meaning small units like student accommodation are becoming increasingly difficult to place on residential interest rates. The good news though is that they are still doing multi units on one title and are one of the few lenders left to do so. We hear that Westpac are starting to make changes internally at St George, so we are hoping that they get rid of the “outsource to India” program. St George has just started their Spring sale with the release of 1.1% off the standard variable rate for 12 months then rolling over into the professional package. There are a few catches, but in general for the savings you can make they are ones you can live with. We expect turn around times to blow out in credit so we’d suggest you use this for refinances only unless you have a long settlement on your purchase.

By Herron Todd White Valuation Group. Excerpts as published in their Month In Review newsletter.

Sydney

The Sydney investor with a lazy $500,000 has a wide variety of property options in the Greater Sydney area.

The ultimate decision will depend on what the purchaser is actually looking for – whether it is for short term capital gain or long term capital growth with steady rental returns.

The short term options are considered more likely in the suburbs with higher value within close proximity to the City CBD. Whilst options are limited as to what is actually available for sub $500,000, it is considered the older units in small complexes in the Inner West, Lower North Shore and South-Eastern suburbs could provide potential for good capital returns through renovations to the property.

Smaller scale complexes generally have lower strata fees then modern high rise developments with lifts and extended common facilities (warning – look closely at the health of the Body Corporate to ensure there are no hidden or future costs for previous poor maintenance – important when purchasing and then wishing to off load quickly as it may hinder the final sale). These properties always have good solid rental appeal and/or resale potential to the first home buyer market.

Suburbs slightly further from the City in say a 10 – 15 kilometre radius which have good access to services such as public transport and motorways are considered options for longer term capital growth. These suburbs, including Mascot, Hurstville, Lane Cove, Lidcombe and Ryde, are considered strong suburbs for continual rental demand and in time will increase in value as options closer to the CBD are priced out of ‘average Joe’s’ reach.

Canberra

In 2008, we commented that $500,000 would purchase a 4 bedroom ensuite home in an establishing outer suburb or a 2 bedroom ensuite unit in the town centres of Woden and Belconnen.

A year on, and not much has changed, the same amount may purchase an older style 4 bedroom home on a larger block, or a modern 3 bedroom ensuite home on a courtyard block in an established outer suburb. Within the inner suburbs you can purchase an older 3 bedroom unit or a new 2 bedroom unit in Kingston or the City. Not forgetting Queanbeyan where you can purchase a new 3 bedroom townhouse or an older 4 bedroom house on a generous block.

On the investment front in 2009, Canberra still remains a solid and stable performer, thanks to a large percentage of transient workers requiring rental properties. There are a number of residential investment options for people with around $500,000 to spend, such as 2 bedroom units in an inner suburb such as Turner, where expected rent is approximately $500 to $550/wk.

Investors seeking new developments will have to look in the in the outer town centres of Tuggeranong and Gungahlin, where $500,000 will buy a 4 bedroom ensuite townhouse that could be rented for $500/wk. These developing centres provide affordable accommodation close to facilities for people who want brand new properties.

Melbourne

In terms of foreseeing the next 12 months, there are good solid signs of recovery with fierce competition between first home buyers, usually being the first sign that affordability has returned to a market and the best time for investors to make a come back. Many of the areas within Melbourne’s inner north and inner north west suburbs such as Thornbury, Northcote and Reservoir provide good opportunities for growth.

These suburbs, located within the 10km to 15km north west of the CBD, are now beginning to perform after being previously overlooked by buyers favouring Melbourne’s eastern suburbs. These suburbs have good proximity to the CBD, good services, schools and parks. It is a natural progression that buyers will begin to purchase here more in the future. Units in Thornbury, Northcote and Reservoir begin from around the $300,000 mark and return rental yields in the order of 4%. Good quality two bedroom houses priced between $400,000 and $450,000 with a garage and a backyard will rent for $400 per week.

We further keep faith in our 2008 predications that Footscray West, Maribyrnong and Altona will also be solid property investment opportunities given the extension of the First Home Buyers Grant to at least December of 2009. Sensing the conclusion of the First Home Owner Grant boost was near, buyers rushed into these areas with median house prices ranging from $300,000 to $450,000 near the end of the first quarter this year. That’s helped keep sales activity strong and median values healthy in the state’s real estate market, despite limited stock and sunken consumer confidence.

Adelaide

The median house price in Adelaide is presently at $355,000 so a price tag of $500,000 represents mainly second or third home owners and investors.

Current ‘lowest ever’ interest rates are allowing purchasers to borrow more and the market continues to show some growth, particularly in traditionally popular suburbs.

Limited growth is forecast to continue in most residential markets with reasonable growth anticipated in the medium to longer term as the current economic predicament (hopefully) resolves itself.

Having half a million dollars available to invest in residential real estate presents a number of options;

City apartment

At present there is a large number of city apartments available, more often than not these are tenanted to students with guaranteed rental returns. There is a selection of apartments available from 1-3 bedrooms, some of which provide yields in the vicinity of 6-8%.

Given the supply of this type of property, the prospect of capital growth is reduced in the short to medium term however, to some extent, this can be offset by the promise of a safe return.

Small suburban house or unit

The inner suburbs have historically performed well due to the convenience of this location being close to the city and facilities. Much of this housing stock also includes popular ‘character’ style homes although often in this price range, properties may require some capital expenditure. In a similar vein, smaller homes can still be purchased in the desirable eastern suburbs, although mostly units, there is still the odd row cottage or maisonette/duplex available.

Property in these areas also provide good rental return with good prospects of finding tenants and proven capital growth in the longer term. This, however, can be a hard market to enter in this price range as there is strong competition with investors potentially being edged out by home owner/ occupiers.

House – 8km+ from the city

Traditional three bedroom homes in the western, northern and southern suburbs outside a radius of 8km of the city are also an option for around half a million dollars as are new courtyard homes/town houses. With slightly less capital growth than the inner suburbs, investors can maximise rental returns and their prospects of finding tenants by selecting houses within walking distances of shopping centres, train stations and bus stops.

Investors seeking a commercial return can also target the student market, an example being a 4 bedroom, 2 bathroom house at Warradale currently on the market for high $400,000’s and leased to students for $730 per week.

Another often less considered investment option is to purchase two houses or units for a total investment of $500,000, which is still a possibility here in Adelaide. The houses would typically be located in the outer northern and southern suburbs – the traditional domain of the first home owner. Rental returns are usually quite respectable and tenants easy to find, however capital growth is less spectacular. This market has possibly also been adversely affected to some extent by the Fist Home Owner/ Builder Grant and Boost which have moved prospective tenants into homes of their own.

The purchase of multiple units in these areas can provide both good rental returns and solid capital growth in the long term and could possibly be one of the better options in the current financial climate.

Brisbane

$500,000 still provides plenty of options for buyers throughout the Queensland capital and with ongoing population growth predicted, most buyers are unlikely to feel too much pain.

Detached homes in the 15km band will see plenty of accommodation for $500,000. Mortgage belt areas such as outer Albany Creek through to Petrie are providing good get in prospects but you must ensure your fundamentals are strong. No busy roads, no train line frontage. A good, basic quality but sound home in an accessible but quiet locality would fit the bill nicely as it is readily rentable and has plenty of upside.

Closer to the CBD and you really are considering whether it’s a top notch unit or bottom rung home. If you’re within 5km of the GPO then you are absolutely in attached housing as $500,000 barely covers land value in most inner city locales. Be that as it may, there has been some surprisingly cheap detached property in these areas relative to last year so if you can stretch the budget a little, it may be worth it.

If you’re in the outer reaches of the city’s radius then the half million mark will get you plenty of property – probably a couple of abodes. Once again shoot for quality and get informed before you take the plunge. Capital growth prospects are likely to be long term so don’t feel pressure to get in quick. The Kedron and Toombul areas still have options so they may well be worth a look.

Hobart

Investing $500,000 into the local residential market in Hobart today gives a range of options. $500,000 gets a good quality home in close proximity to the CBD or a new home with all the bells and whistles and spare change in the urban mortgage belt suburbs.

Investing the whole amount is a no brainer: go to the CBDor close inner city suburbs. These have traditionally been the stronger areas to invest in suburbs such as Battery Point and Sandy Bay will only get a modest to average sized and quality dwelling for the investment, but a prestige locale. Other suburbs such as North Hobart, West Hobart, New Town, Glebe and South Hobart all offer close inner city convenience and this price bracket lends itself to plenty of choices. A reasonable dwelling or unit is definitely on offer here.

Properties close to the University of Tasmania can still be purchased for sub $500,000 and the rental returns are quite impressive. However, once you move out of the CBD and fringe areas, that return will be moderate and capital growth it would appear would be best described as minimal or static in the short term.

Then on the flip side is the question: Could I purchase two or several properties for this money? The answer, of course, is yes. Instead of placing all of your so called eggs in one basket, an entry level, older style suburban home can be purchased for low to mid $200,000. These offer average returns but still the possibility of future growth and the amenity of being still within 10 to 15 minutes drive of the CBD and in close proximity to local services and facilities.

If you wanted to drive 30 to 45 minutes to the CBD then entry level homes can be purchased in the mid to high $100,000 category. You could possibly buy three properties for $500,000 in the townships such as Dodges Ferry, Carlton or Primrose Sands, however rental returns are only fair, as is capital growth.

Darwin

After the huge surge in demand and rise in values, $500,000 will buy the following:

• A basic 3 bedroom, 2 bathroom, inner rural dwelling on 2Ha, or, a good 3 bedroom, 2 bathroom, outer rural dwelling with pool and/or shed in Darwin’s northern suburbs

• A near new 3 bedroom, 2 bathroom, ground level dwelling in the newer suburbs of Palmerston, or an older style 4 bedroom, 2 bathroom with pool and shed in the older suburbs.

• A near new 2-3 bedroom, inner Darwin CBD apartment with district and basic sea views.

Perth

For those of you with $500,000 ready to invest, there are now many areas which exhibit reasonable growth potential at today’s value levels.

The northern suburbs of Warwick, Duncraig and Greenwood are worth a thought. Single residential properties on family sized blocks can still be purchased within our $500,000 budget, and offer good accessibility to the city whilst being 5 minutes from the coast.

The southern suburbs of Leeming, Willetton and Riverton offer similar access to the city and benefit from very good standards of schooling and community facilities, whilst offering a range of housing alternatives.

Closer to the city, strata units in the riverside sections of Como and South Perth provide good opportunities, backed up by a consistently strong rental demand.

Similarly, Fremantle continues to offer well located two bedroom apartments as well as more modern three bedroom villas within our budget. Both of these localities have the added benefit of consistent strong long term growth.

If you have always wanted to build in an idyllic riverside location but never quite been able to get there, new opportunities are arising for smaller subdivided allotments within our budget in the sought after suburbs of Attadale, Mount Pleasant and Bicton.<–>