Aussie Firebug

Financial Independence Retire Early

The first of our investment properties (IP) has officially been sold 🎉👏

This is part of our strategy for creating a passive income to fund our lifestyle in retirement. The investment properties had a different purpose in our original strategy for reaching financial independence, but they now will be sold off over the next few years when the time is right.

 

What Was The Return?

I’m so glad I can finally crunch all the numbers for you accurately now it’s been sold because you never quite know how much your true return will be until you actually sell your investment property.

Without a doubt the most interesting question on most peoples minds would be:

‘So how much did you make?’

To cut a long story short, we had an annualized after-tax return of 36.48%. 

If you’re interested in all the finer details of how we arrived at that figure please read on.

 

The Numbers

This IP was built in south-east Melbourne for $340K in 2013. I lived in it originally to receive the FHOG.

Buying expenses

  • $30,000 – Deposit ($9,000 from me plus $21,000 FHOG)
    • I borrowed 91.33% of the property plus LMI. I would not recommend this but that’s what I had and the banks were allowing it back then. I wouldn’t have got that loan in today’s market.
  • $4,634 – LMI even though my parents could have gone guarantor (no hands out for me)

I built this house so there were no expenses for conveyancing or stamp duty. All the loaned money went to the builder who was selling land and house packages.

I had a loan of $319,815 (the LMI got attached to the loan plus some other expenses).

Actual money spent so far: $9,000 

Sweat Equity

  • $3,840 – Landscaping. A new garden for the front, back and sides. Plants, pots, mulch, stones etc.
  • $12,000 – Built a deck. Materials, building permit, labour help costs
  • $1,400 – Concreating
  • $4,410 – Other costs. Materials, Skip bins, money spent on food and other things while renovating etc.

I spent countless weekends with my old man and mum going up to the house to add value to it. This not only saved us money, but I also learnt a bunch of new skills. Win-win.

Total: $22,061

Actual money spent so far: $31,061

Cash Flow/Holding Costs

 

Cash FlowYear 1Year 2Year 3Year 4Year 5
Rent – All Expenses-$7,590-$3,929-$2,744-$3,047-$5,841
Depreciation-$8,228-$8,283-$7,445-$6,858-$6,641
Tax Refund$2,654$4,519$3,770$3,664$4,618
Total-$4,935$589$1,025$617-$1,223

 

Total cash flow over the 5 years = -$3,927

Notes:

  • The first year I had to live in the house for 6 months receive the FHOG. This meant that I couldn’t claim all of the expenses for that year. Only for the 6 months I had it as an investment
  • I ended the lease with the tenants and cleaned the house up a bit which is why year 5 is so expensive. I had to cover interest repayments for a few months before the house was sold.
  • Depreciation is not including in the cash flow because it’s not an actual loss of cash flow whereas the tax refund is money coming into my account
  • I used the diminishing value method for depreciation. Don’t ask me why it somehow depreciates more in year 2 than year 1 🤷, that was what was on the report.
  • Tax refunds are based on the 37c tax bracket

Actual money spent so far: $34,986

Selling Costs

  • $700 – Conveyancing (had a friend do it cheap)
  • $2,210 – Used an online agent to sell the property. No way I’m paying 2.5% plus marketing just to list it on RealEstate.com and host a few open days
  • $3,850 – Staging. Maybe unnecessary but I like to think it worked

Total Selling Costs: $6,760

Total money committed to this investment over 5 years: $41,746

The IP was sold last month for $512,500

I invested $41,746 of my own money and received $197,697 in return over a 5 year period.

 

ROI vs ROI On Money Invested

Way too often when anti-property commentators are trying to convince investors that another market has had superior returns over the last X amount of years they usually leave out the most important part of the equation.

Property investors use leverage to buy their investments.

Without factoring in leverage, I don’t understand how anyone can make blanket statements about the true returns of real estate. It’s not comparing apples with apples.

With that said, I want to provide you with both returns numbers so I can further illustrate the point that the only real return number you should be measuring is how much money you put in and how much you get out.

ROI

Capital Gain = (gain from investment – cost of investment) / cost of investment

= ($512,500 – $386,821) / $386,821 = 32.49%

Annualized Capital Gain = 5.79%

 

Gross Yield = Annual Rent / Purchase Price * 100

= $18,720 / $340,000 *100

Gross Rental Yield = 5.51%

 

Net Yield = (Annual Rent – Annual Costs)/ Purchase Price * 100

= $15,985 / $340,000 *100

Net Rental Yield = 4.70%

 

Total Annualized Return

8.28% + 4.70% = 12.98%

Notes:

  • I’m not 100% sure I can simply plus the two return figures together since one is annualized and the other is just an average rent of $360 per week (maths wizards please correct me). But the overall point still stands that the investment doesn’t look great without leverage.
  • The above calculations are assuming that we buy the property outright. This would mean no interest repayments or LMI costs.
  • 12.98% may sound like a decent return, but what’s not factored in is the 100s of hours of labour and travel spent on this property to achieve this result. Considering you could have got better returns from shares over the same time period with no work required, you’d be mad to buy an investment property outright.
  • I have not factored in the replacement costs as the house depreciates. This hidden bill will rear its head eventually. Something shares don’t suffer from.

 

ROI On Money Invested

This one is a lot easier to work out and the true measure of the investment, not an assumption.

ROI = (gain from investment – cost of investment) / cost of investment

= ($197,697 – $41,746) / $41,746 = 373.57%

Annualized Total Return = 36.48%

 

Tax?

In an extremely fortunate turn of events, IP1 became my PPOR after I first moved in to receive the FHOG.

Even though I rented it out, I never bought another house to live in which was not specifically planned but worked out incredibly well. There’s a special rule where you can treat your dwelling as your main residence after you move out for up to six years even if it’s used to produce an income.

Believe it or not, this means that I don’t have to pay a single cent of tax due to the CGT exemption for main residence rule 😱🤑.

 

My Experience With IP1

Investment property 1 taught me more life lessons than any investment in the future ever will.

It was the first house I ever bought, renovated, sacrificed countless weekend adding value to it with my old man helping me out and a whole raft of issues that I had to figure out along the way. From dealing with tenants, discovering how many hoops you have to jump through with banks, lodging insurance claims, rushing to finish the concreting in 38-degree heat (would not recommend), hosting open days and so much more.

Some say property investing can be passive. IP1 was definitely not passive!

It was hard work which did eventually pay off in the long run. Now, how much of its success can I take credit for? That’s a very good question.

Looking back in hindsight I can point out a few key things that happened that I had nothing to do with and was 100% luck

  • FHOG being available boosted my deposit meaning I only had to put down $9K (crazy)
  • The banks lending criteria was completely different back then. No way I get a loan in today’s market only having $9K to put down
  • For the majority of my loan, interest rates were being cut. Every couple of months I had to pay less and less in interest which at the time seemed cool but it’s only with hindsight I can truly understand how fortunate of a time it was to be in real estate. It has only been the last 18 months I have seen my I/O loans rise in rates
  • Melbourne experienced a property boom basically the whole time I had the property. It was only the last 3 months that the prices started to drop and the loans market really tightened their belt. The property was actually under contract before I sold, but it fell through because the buyer couldn’t get finance. I experience this two more time (not officially under contract though) before I had a buyer who was cashed up. Based on what similar properties were selling for, I estimated that IP1 dropped by around $30K since the start of 2018.

I fully admit that all of the above was unforeseen, I was just hoping for the property to keep up with inflation and use leverage to amplify the gains.

One of my favourite quotes of all time comes from the Roman philosopher Seneca.

Seneca

I’m a big believer that you can create your own luck. Whilst I still think that the majority of the return from IP1 came from an uncontrollable event (market boomed), there were things that definitely helped bolster the profits that were in my control.

  • I actually identified the FHOG as an opportunity not to be missed. I signed my contract on the 29th of June which was one day before they scraped the FHOG all together back in 2012. This opportunity was available to all my friends, but most of them did not take it
  • I realised that it was unlikely for me to make a lot of money if I paid for everyone else to do the work for me. I looked to physically add value where I could and since I was full of enthusiasm and energy back then. Countless weekends were spent working on the house. Sacrifices were happily made if that meant I could reach my goal of FIRE quicker
  • I sought advice from experienced property investors who knew what to look for when investing…my parents of course! I understand this luxury isn’t available to every but it’s worth seeking one out if you can. There were small things that helped the investment like buying near public transport, schools, amenities, easy access to the M1, in an area with strong employment options and projects scheduled for the future etc.
  • Getting out of my comfort zone to learn new things such as selling IP1 online saving over $15K in commission fees. The experience I gained from negotiating the deals was invaluable. Some might argue that a skilled and experienced agent could have secured a better sale price. That may be true but we’ll never know. What I do know is that I saved over $15K doing it myself and I’m choosing to save $15K over potentially getting a higher profit every day of the week!

 

Why Did I Sell?

The strategy moving forward is to sell all the investment properties and transition to a more cash flow portfolio of ETFs/LICs. IP1 was the first cab off the rank for the following reasons

  1. The market had gone bananas and I was very keen to lock in that profit and not risk something happening, which sorta happened with the market pullback in the last few months. But I’m very happy with the return we got so no complaints here 🙂
  2. I would have reached 6 years next year which would have affected the main residence status for tax purposes. This means that I would have had to pay taxes on part of the sale
  3. There was some upkeep work that I was fed up with. IP2 and IP3 are part of a body corp which takes care of a lot of the maintenance.
  4. Whilst IP1 had gone up considerably in value, the cash flow was still shithouse! Technically positive cash flow after the tax refund during the last few years (apart from the selling year due to the extra costs). It still was nowhere near as good as what shares could offer for half the investment.

 

Conclusion

Overall IP1 has been a very successful investment in terms of both return and life skills obtained. I was very fortunate to be in the market during the time I was and I’m pretty confident in saying that I’m most likely never going to make as much money in any other investment ever again.

This may sound like a bummer but the truth is that IP1 was a hell of a lot of work! I can’t be effed doing all that again and I doubt I will have as lucky timings with the market twice. It’s a risk I don’t have to take and Strategy 3 suits our current lifestyle better being so passive.

What’s really hard to measure and has not been factored into the above return is all the physical work required. It was essentially a side hustle I did on weekends (not every weekend but a lot). If I deducted the hours worked * an hourly rate, the return would be less.

I’m still a fan of property investing for the right investor, but I am no longer the right investor and will continue with our strategy of selling off the other two IPs when the times right.  It’s my opinion that there are more problems to solve with real estate and more opportunities for those who seek the challenge vs shares.

How has your experience been with real estate? I would love to hear from others positive or negative in the comment section below 👇

 

 

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