Part of my financial adventures is running a couple of rental properties. One was purchased from my mum’s estate when she passed and I would hand it back in a second to have her home again. It’s not to be, so instead I have it rented out to a delightful chap. Mid-2018 I purchased another property using my equity in the first property and while I’ll write more about that experience in the future, for the moment I’d like to reflect on what it’s like to run a rental.
I use a local real estate to manage both properties. It costs 8.8% (including GST or tax for non-Aussies) per property. In exchange, they manage tenant issues including complaints, finding new tenants, organising repairs and tradies and also paying all the bills that come in. In terms of the time it saves me the 8.8% has been well spent. For example, my first property was vacant for three years – that’s how long it took to clear it out (dealing with a mountain of stuff and emotion at the same time is hard). In that time taps weren’t used, washers hardened and other issues cropped up. The first 6 months has meant a significant amount of expenditure to cover these problems – all organised by the real estate. I work full time so I don’t really have the slack to be organising and chasing this up and it also means I don’t have to find money to pay the rates, water or other maintenance bills – it comes out of the rent and whatever’s left over goes to my account.
Here is the rub though – the rent doesn’t always cover the cost of the loan repayments. Although this means that it’s negatively geared – i.e. the costs can be used to offset my normal salary tax – I would much prefer it was in the positive, even if I pay tax on that. I repay around $250 / week on this loan, and the rent is $270 (less 8.8%) which is $246.24 a week of income. This means it’s running a loss at the best of times. When a bill comes in or something needs to be replaced, that loss is larger. While this is tax effective in the long run, it also means I have to continuously top up the account the loan repayments draw from or it will run in arrears and I’ll default on my loan. It’s not a big deal though – I manage it carefully and overall, the yearly loss will be around the $2000 mark. Not too bad for an asset that is becoming more valuable to me every week as I pay down the mortgage. I run a series of tracking sheets to keep an eye on this, with an aim to what I’ll need to do come tax time on June 30th.
The positives are that once the loan is paid off, I’ll start earning passive income every month and with the loan on track to be paid off in 20 years or so (it’s a 30 year loan so I’ll save a bucket on interest), I’m in good shape for retiring. Over the life of the loan, every extra dollar I pay off rewards me with $2 or even $3 less interest I have to pay! While not exactly an investment per se, the return on this is higher than anywhere else. With two loans, I can spread the money around and see savings on both fronts. This is an example of finding places where your money can really work for you. Every spare cent I have goes into these mortgages. I’ve had one for 3 years and I’m 9 months ahead on repaying it, and the other, which I’ve had for 6 months, the repayments are 11 months ahead. The second mortgage is a lot smaller so the returns on it (time wise) are much greater. Can you guess which one I’m hammering?
It’s the bigger, more expensive of the two – not the littler one! The more I pay off early, the less interest I have to pay even though I could pay the other off quicker! Yay! And as I mentioned yesterday, there will come a time when the weekly payment covers more of the capital and the interest will reduce soon. At my current rate (which will accelerate this year) that’s in around 2030. Probably not good enough so I need to go harder to get this thing knocked on the head.
The second property I bought, with a much smaller loan, initially cost around $2000 – most of which was lawyer’s fees. Everything else was covered in the loan and while I have had to pay for insurance, that’s all I’m out of pocket. Not bad when you consider I purchased a two bedroom unit with long term tenants using nothing but the equity (difference between house value and amount owed to the bank). The rent on this property was far under the market due to negligence on managing it. I have raised it very slightly, but would prefer to keep a good tenant than gouge one over the short term. Long term it will work out and be closer to the market value. I worked this property into the system and now it’s ticking along steadily. I’ve budgeted for some upgrades and repairs for both places over the next 12 months (preferably in the 2019/2020 financial year). So this is great: minimal outlay with attached home buying stress and another property in the portfolio. I’m not doing this again any time soon I can tell you. The banks are much tighter on this kind of activity and they would only loan me a small amount – which was fine, the property wasn’t terribly expensive.
It seems to be all great, however there are a few caveats. The current interest on the loans is around the 4.6% P.A amount. If that goes up, the slim difference between rent and loan repayment will expand and I’ll need to be very careful of money management. It doesn’t look like this will happen in the short term based on the rumblings from the Reserve Bank of Australia (commonly known as the RBA) and I’m delighted to share that the National Bank of Australia (my bank) didn’t put up their loan rates for existing loans and I wrote to them to express my gratitude! Also, the loss of a tenant or major repairs could be very hurtful to me – at least while I build up a nest egg. Around tax time I’ll be able to make a large claim and the return is already slated for mortgage payments – but that’s a ways off. In the meantime they’ll tick along, with the real estate managing it and reporting to me what’s happening. I’m looking for property number three – something like this:
But realistically we’ll probably be purchasing a family home sooner rather than later! Stay tuned for my adventures in buying rental properties!