Instant Equity ideal for first time investors – House & land packages
This third and final installment on ideal options for first time investors looks at house and land packages.
Over the past few years, house and land packages have become increasingly popular with investors as a way to enter the property market and kick-start portfolio development.
Many providers of house and land packages will partner with mortgage brokers to offer low deposit finance options. Vendor finance (covered in Part 2) may also be available.
Often, investors will only need a deposit of ten percent to secure a H&L package. The finance is then drawn down in stages, in line with each phase of construction.
On a $750,000 H&L package, for example, the finance would look something like this:
- land cost: $250,000 – deposit required of $25,000
- build cost: $500,000 – deposit required of $50,000, following settlement of land
- loan drawn down in stages over construction period (four to five months)
In addition to a low deposit, there are several other key advantages H&L packages can offer investors.
Instant equity. One of the greatest advantages of an H&L package is the instant equity that can be generated, allowing the investor to purchase again very quickly. Locking in construction and land prices through a fixed price contract means that in a rising market, any increase in the value of the property between when the contract was signed to completion and handover is to the benefit of the buyer. It is not unusual to see, following the typical five-month build time frame, that the completed property is worth an additional $100,000 over costs to construct, providing the investor with immediate funding ability to purchase another property.
Save on stamp duty. With H&L packages, stamp duty is only payable on the price of the land. On an established house, it’s payable on the cost of the land and the house. This can represent a saving of thousands of dollars.
Increased tenant appeal. The purchase of a house and land package also benefits the investor by offering a wide range of configuration choices – ideal if they are targeting the corporate leasing sector. For example, investors can add additional ensuites to the plan of the home, which will appeal to renters and significantly boost rental returns.
Low maintenance. A new property comes complete with a builder’s warranty and the additional benefit of low maintenance costs. Maintaining older homes can be quite expensive and they are less appealing to corporate tenants. A new home also offers attractive tax depreciation benefits that can significantly boost the property’s return.
With leverage and multiple property purchasing the key to building a successful portfolio, House & land package options can be the ideal selection for beginner investors starting with low deposit funds.
Investing with low or no deposit – Vendor financing
The second part of this blog aims to provide investors with an understanding of another low deposit option available to them – vendor financing.
A big issue for most investors when first starting out is access to bank finance. Even with a decent deposit it can be difficult to meet the banks’ criteria. If you have a less-than-perfect credit history, are self-employed or new to the country, then you will find dealing with the banks even more challenging.
Many people are unfamiliar with vendor finance but it has in fact been used in Australia for over a century and while it is increasing in popularity, it still flies under the radar of most investors.
No bank finance needed
Put simply, vendor finance (also referred to as seller finance or owner finance) is when the seller of the property makes the financial arrangement direct with the buyer – no bank loan required!
Vendor financiers provide a more personal, tailored service focusing on the buyer’s capability to make regular payments, rather than their capacity to demonstrate a savings history, assets etc.
It is a popular service offered by developers who want to increase their pool of prospective buyers by offering more flexible finance options. Vendor financiers will often lend 90 to 100% of the purchase price (LMI will still be payable though if you borrow more than 80%) which makes properties offered under this scheme attractive low deposit options.
The way vendor finance works can be compared to a lease-to-own structure; you make your repayments to the seller and the property becomes legally yours when all payments have been made. You can rent it out, renovate etc but the title to the property will remain in the seller’s name until you have paid off the property and met any other contractual obligations.
A bridging strategy to the banks
For this reason, vendor finance is not generally considered a long term option and is typically used as a bridging strategy. It allows investors to get their foot in the door, secure a property and then look to refinance with a bank (thereby paying off the vendor finance and securing the title to the property) in two to three years when they have established a payment history.
Good property selection means many investors will have generated decent equity in the property over those initial years putting them in a much better position with the banks.
Another point to remember with vendor financing is that it is usually provided at a higher interest rate to bank finance. This is less of an issue in our current super low rate environment but remain an additional motive for refinancing.
Both the seller and the investor are protected against certain risks under a vendor finance arrangement. The vendor cannot sell the property or borrow against it without your knowledge, while the vendor reserves the right to take legal action and terminate the contract if you breach any of the contract conditions.
Low deposit options for first time investors – Part 1: Deposit bonds
For many would-be investors, saving for a deposit presents the biggest challenge on their property investment journey.
A 20% deposit is great – but it can take years to achieve. In the meantime, attractive investment opportunities are missed and wealth creation is delayed.
However, there are options that enable you to secure a property with as little as a few hundred dollars.
Deposit bonds, vendor financing and house and land packages are three low deposit options available to investors. Each of these will be discussed in detail across a three part blog.
Part 1 – Deposit bonds
A deposit bond acts as a substitute for a cash deposit. They can be issued for all or part of a deposit (which is usually around 10% of the purchase price) and provide a guarantee to the vendor that the cash will be provided by settlement.
Offered by most lenders, they are a useful, low cost strategy when a cash deposit isn’t readily available and are particularly helpful when buying properties with lengthy settlement periods, such as those purchased off-the-plan.
A deposit bond has three major advantages for the investor:
- Low cost: The fee for a deposit bond is typically around 1.2% of the amount represented by the bond which can equate to as little as a few hundred dollars!
- Quick: Deposit bonds can often be issued on the same day.
- Sufficient cover until settlement: The lender will determine the time frame that the deposit bond remains active for but it is often six months or more – sufficient time to cover most settlement periods.
These features mean investors have the ability to act quickly, beat other buyers and secure attractive opportunities with very little cash and within 24 hours. They also allow more time to source funds from savings or other investments.
Most vendors and agents will accept a deposit bond, but it is at the discretion of the vendor so investors are advised to check in advance. You will also require approval if you intend to use them at auction.
To successfully apply for a deposit bond, you will still need to meet the bank’s lending criteria. In short, this means the ability to demonstrate that you have the capacity to pay the deposit as part of the full purchase price, plus fees, as well as service any other existing financial commitments you may have at the settlement date.
Stay tuned for the second part of this blog which will look at another low deposit alternative many investors are unaware of – vendor financing.
How will the election impact the property market?
Many investors are waiting eagerly to see what effect the federal election outcome will have on property markets throughout the country.
While there has been a boost to the market provided by low interest rates, investor confidence still remains at an all-time low in the lead up to the election; there is still a level of uncertainty around who will lead the next term and the effect it will have on the country’s economy.
Recently, research analysts RP Data and onthehouse.com released their separate findings on the market movements in capital cities following previous elections.
The findings provided some interesting insight as to what could be in store for the national housing market in the coming months.
RP Data found that Coalition election wins in 1998, 2001 and 2004 were all followed by increases in house values over the following 12 months.
The most recent two elections – 2007 and 2010, when Labor took power – saw house price fall over the following 12 months.
This doesn’t necessarily mean we should associate growth with a Coalition government – Labor had to deal with the GFC during the last two terms. House prices in capital cities have risen 4.9% in the 12 months to July this year, according to RP Data. With the election imminent, the market appears to be in a positive position.
Although the winning party is not yet a sure bet – based on the current interest rate environment, expectations point to housing markets continuing to strengthen amidst renewed consumer confidence and increase investor activity.
Seen once every four years, this pre-decision marketplace offers the savvy investor an ideal opportunity to secure the very best picks, whilst the majority sits on the fence.
WA’s R-Code changes increase opportunities for investors
Western Australia’s residential design codes, or ‘R-Codes’, determine the density of housing by stating the minimum and average sizes of lots in an area.
On August 2nd, the changes to the R-Codes came into affect. Many of them are good news for investors and developers as they will increase the development potential of certain residential lots and properties, providing an opportunity to increase asset returns.
Being aware of the R-Codes can mean a difference of hundreds of thousands to your portfolio’s capital growth and cash flow.
Investors should take the changes into consideration and assess the potential value-add of the new R-Codes to their next or existing properties.
Among the changes of most significance to investors are:
Changes to R20 (i.e. 20 dwellings per hectare): the average size of a dwelling in an area coded as R20 has been reduced from 500sqm to 450sqm. So where previously you could only build one house on a 900sqm lot, for example, you can now build two. This will greatly enhance the money-making potential of many sites and enable sub division without the need for planning permission. This translates to more assets, a quicker build and the ability to bring your product to market sooner.
Furthermore, a minimum site area of 350sqm is now permissible under the R20 code, increasing sub division flexibility.
R25 and R30: While the average sizes for lots under these codes remain unchanged, the minimum site areas have been reduced to 300sqm under R25 and 260sqm under R30, again increasing sub division flexibility and facilitating more rapid development.
Planning approval for a single dwelling is now only required for lots smaller than 260sqm (reduced from 350sqm) also helping to fast track development.
R60: the average size for lots coded R60 has also been reduced from 180sqm to 150sqm
The R-Codes also now make provision for R80 dwellings with an average site area of 120sqm and minimum of 100sqm.
Granny flats: The change immediately beneficial for investors, as it presents the greatest opportunity for increasing cash flow quickly, is the change to the ‘granny flat’ code.
From August 2nd, granny flats will not have to be rented to a family member of the main household. This means that any investors (or owner occupiers) with a property of more than 450sqm can build a granny flat onsite and rent it out to anyone. The allowed floor space has also been increased from 60sqm to 70sqm. It provides an instant opportunity to enhance the value of an existing asset and increase yield.
Maximizing equity to build your property portfolio
Equity is the difference between what your property is worth and what you owe. As a property’s value grows, the equity in the asset increases providing a source of funds to borrow against. ‘Unlocking’ this value provides a significant opportunity for investors to buy more property quickly without needing to save for a deposit.
Investors will need to find 20% from the equity in their existing property as a deposit if they want to avoid paying Lenders Mortgage Insurance (LMI). Maximising the equity in the property will increase your borrowing capacity and could even generate enough for you to invest in more than one property.
Firstly, investors should ensure that the property achieves the highest valuation possible. This means keeping it well maintained and making some aesthetic improvements if necessary. Agents will often provide free valuations to give you an idea of the market price and can also offer advice on how to improve a property and which areas you should focus on. However, lenders will do their own valuations and in the current risk-averse environment, investors should be prepared for these to come in under what they believe the market value to be.
Secondly, shop around for a lender. Each lender has different assessment criteria and your approved amount could differ by ten of thousands of dollars between lenders. Be aware though that each application is recorded on your credit record and this could lead to rejection from your chosen lender if they see you have made multiple applications.
A good way to avoid this issue is to seek help from an experienced mortgage broker. They will know which lenders are likely to be more flexible with their borrowing capacities and can offer a variety of products from different lenders, at no cost to you.
As you grow your portfolio, diversify your lenders. Utilizing different lenders for different properties will give you greater flexibility of products, reduce risk and will provide more opportunity to further build your portfolio. It can be tempting to stay with the one lender for simplicity or you may be looking to co-secure the loan rather than taking out a separate one. While this strategy does have its benefits – potential costs savings and the advantage of not having to pay LMI if your deposit is less than 20% – there will ultimately be a limit as to what a single lender can offer.
If you really want to make your equity stretch further, you could choose to put down a deposit of less than 20%, take on the LMI, and invest in two properties. As LMI is a borrowing cost it is tax deductible over five years for investments. Many investors use this strategy to buy more than one property using their available equity.
In addition to the value of the property you are borrowing against and the equity it has created, the amount you will be able to borrow will also depend on a number of other factors such as the value of the new property, the rental income it will produce, other assets, income and your credit risk. It is important that the impact of these factors on your approval is carefully considered before you submit your application.
As always, professional financial advice is recommended to ensure you make the decisions best suited to your financial position. We recommend using a local area expert when considering finance – http://www.crawfordinternational.com.au/professional-services/