Podcast: How to Use Other People's Money to Invest | Ep. 218

Posted by Ed McKnight on 23/04/20
How to Use Other Peoples Money to Invest 001
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Listen to the Show

Show Notes

What's Covered in the Show?

In this episode, we discuss how to use other people's money to invest. Essentially, this is the concept of leverage.

When you invest in property, you borrow money from a bank, but any returns made on that property are yours to keep.

If you are keen to use the calculator mentioned in the show, you can find it here on the Opes Partners webinar. And if you are keen to learn more about property investment, be sure to follow us on Instagram.

Transcript

Transcript of the Podcast


Ed McKnight: Hello and welcome along to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and today on the show we're going to be talking about how do you finance your next investment property through leverage.

Now, this is something we've talked on the show about quite a bit, and it's so fundamental to investment property. How do you leverage property, use your existing properties in order to purchase more properties. But I'll tell you what, after the surveys and the webinars we have done over the last couple of weeks, it is a topic that we need to talk about because it is so fundamental to investing in property.

So rather than saying, go back and listen to episode three, we're going to recap leverage because it is such a fundamental concept. So Andrew, walk us through what leverage is and how it works differently if you already own investment properties, and if you don't already own an investment property.

Andrew Nicol: Leverage is kind of the secret sauce of property and what sets it apart from any other investment and leverage just being able to use someone else's money. And you do that in two ways, I guess with, with investing in property, you do it through, the purchase of the property. So you borrow money from the bank, generally speaking, to buy the rental property. And then you leverage someone else's money for the income, which is the tenant.

So you get two sources of leverage. And I'm going to focus on the bank side of things today because that's probably the immediate one. And so why this is so important is because for every dollar that you put in, the bank gives you some money as well. Now I'm going to keep this really simple and just work on a 80 % maximum borrowing for owner occupied 70% for investment.

So I'm taking out the new build exclusion for today, and I'm taking out split banking to try and maximise the borrowing. Again, just to keep it simple, because we're going to take a bit of a dive in the numbers and I don't want it to get too confusing. Now let's just start out firstly with the deposit side of things. Under the current LVR restrictions, you need to have a 30% deposit to buy a rental property. So whether that be from usable equity or from cash. So if you buy a property for $550,000 as a rental property, you either need to have $165,000 in cash or usable equity.

Again, it's different if it's new, but today just keeping it simple. A 550 purchase price under current LVR restrictions, you need $165,000 in cash, but the cool thing is if you've got $165,000 in cash, if you go into any of the other investment categories, shares managed funds, cash, whatever, you're getting your return just on that 165, you're not getting a return on anyone else's money because you can't leverage against any of those other asset classes.

However, with property you can. So if you do that and you bought a property for 550 the bank will give you another $385,000 so your total investment being 550, that is what you're going to keep all of the profits on despite the fact that the bank put in 70% of the money to buy it, which is an awesome investment. It's kind of like having a rich uncle that's willing to put 70% of your investment and you just have to pay the interest back on that. And of course, interest rates are so low at the moment.

Now let's talk a little bit about where do you get that money from. So if you don't have $165,000 in cash, and I think that would be fairly typical for most people that look at investing in property, what you do likely have if you own your own house, there's some equity and therefore some usable equity within that house. Now, equity and usable equity are two different things. So you're equity in your house is quite simple. If you've got a home for $600,000, that's your market value of the property and your lending is $200,000 then you've got 400,000 worth of equity.

But you can't take all of that money out because, and the only way you can get it is actually by selling it, because the bank always has a safety limit that they'll lend you up to. And so again, under current rules, that 80% is the maximum. Here's how you work out your usable equity, you take your market value, which is 600,000 and you times that by 80%. Now, that gives you all what I call a bank value. So the bank value in that instance is $480000, that's the maximum that any bank would lend you against that property.

Now let's say, you've got lending off $200,000 and you take that off the bank value, $480,000 minus the actual lending right now, including limits is $200,000 that gives you your usable equity number, which in this case is $280000. Using the same model of 70% borrowing for a rental property, $280,000 worth of usable equity is your deposit gives you up to $933,000 worth of purchasing power as your new rental property, which is really cool. Let's throw an investment property in the mix, let's say that someone has their own house for 600,000. Same rule 80% bank value, 480 and their lending is 200000 and they've also got an investment property with the same bank and its market value is 550 and the lending is 500 because they borrowed a few years ago to buy that and it's gone up a bit in value.

Now the bank value on that rental property is 385 now that's because it's only 70% of the value because that's the maximum you can lend on existing rental properties right now. So just to recap, $600,000 for the owner occupier at 80% is 480 bank value, then 550 at 70% is 385, so the total bank value in this scenario is $865,000. Now to recap again, the lending 200,000 and 500,000, that's 700,000 so what you're do now is you subtract existing lending, 700,000 from the 875 bankable value, so the most that you can lend against that, that gives you 165,000 and the reason that's dropped down is because 30% of the investment property is stacked against the owner occupier.

And so 165 as your deposit gives you again 550 as your potential purchase price for another rental property. Now, the great thing about that example is it shows that if you bought a property a couple of years ago, you've probably had the benefit of some increased growth in that property as well as your own home, and the more properties you add onto your portfolio, the faster that wheel spins because all of a sudden you've got multiple properties going up at 5%, whatever the capital growth rate is that eventually release more and more usable equity for you to use as your deposit.

So even in the second scenario, if someone with their own house and a rental property which they virtually borrowed 100% on, the able to buy another rental property to add to their portfolio by unlocking that usable equity and by working out what the actual bank value and I appreciate that actually this can get a little bit confusing, so Ed and I talked off air, we're going to build a calculator this week by the time this comes out for our website so that you can calculate your own usable equity, which will tell you your usable equity and then we'll make it show you what that translates to as a purchase price borrowing a 100% for a new property or an existing rental property to add to your portfolio. Ed, anything more from you?

Ed McKnight: Fantastic. That's right. So if you are as confused about all those numbers as I am. And actually the interesting thing Andrew, is everybody gives me, takes the Mickey out of me for my love of numbers but then I sit down and listen to you yabber on for eight minutes about numbers, like it's bloody candy or something. And we need to take the Mickey out of you a little more about this.

So that's correct. We aren't going to build a calculator because I know the, the answer that you probably want is, look, how much can I borrow, ballpark. We're going to put that calculator together, put it on the Opes website and drop a link into the show notes.

Now the other thing that we're going to do as well is next Tuesday. Andrew is hosting a webinar and this time Andrew's going to take over the reins and walk us through how different cash flow scenarios work. So he's going to walk through these exact numbers and talk about the difference between old and new, how to calculate usable equity, how to figure out whether you're in a position to invest or not. And a whole heap of other numbers.

Looking at real kind of case studies about how numbers stack up. And I just want to position this, you know, and say, look the ones that I typically do a kind of broader or more macro, I should say, in terms of it's, it's about regions it's about, you know, how many Airbnbs are there in McKenzie district or in Christchurch. This is going to be about how to analyse a specific property, a specific deal. This is how Andrew's going to walk us through next Tuesday.

I'm also going to drop that webinar link into the show notes, or of course you can always go to the Opes website and check that out there.

Of course, please don't forget to rate, review and subscribe to the show. It really does help us get the message out to more and more people.

Thanks for listening to the Property Academy podcast. I'm your host Ed McKnight, and I'm Andrew Nicol, and we're going to be back again tomorrow with even more daily strategies, tactics, and insights to help you get the most out of the New Zealand property market.

Until next time.