Should I Consolidate or Diversify my Loans?

,

When I speak with new clients starting their investment journey in commercial property, the first thing I need to understand is how financially ready they are to invest.

Understanding their available equity and how best to leverage it with the banks is critical. One practice that I see all too often is the diversification of lending across multiple institutions. Many investors believe there is safety in using different banks across their investment portfolio. This article answers the question: Does an investor benefit when they Diversify their loans or Should they Consolidate their loans with a single bank?

It is important to assess the pros and cons of using multiple lenders when building a portfolio of investment properties, as shown below:

Diversify (Multiple Lenders)Consolidate
  • You can create competition for your business across multiple banks, thereby attaining the lowest possible interest rate
  • You can access all your equity through the one bank, this gives you much greater leverage and borrowing capacity
  • You’re borrowing with the one institution is more significant, hence you are able to negotiate lower rates and better terms for all your loans versus a single loan
  • You will be able to play one bank off against another giving your business to the most competitive lender
  • Payments from multiple tenants can be easily consolidated into the one account and directed to your domicile loan
  • You are not at the mercy of one bank and can readily change to another bank if rates or fees are not in your favour
  • You simplify administration and only need to deal with one bank, one set of accounts, one password, one login, one bank manager to call
  • You are not tied to one bank if they change their lending policies on LVR and risk

 

The four Diversify points above all sound like reasonable statements, however it would be extremely rare for a major lending institution to change their national lending policies to win your business especially if the loan being considered is less than $1,000,000. Therefore, whilst these motherhood thoughts of safety are comforting, I doubt in the heat of negotiations they would result in the outcome you anticipate.

In the book Engines of Wealth, we outline the top priority to build wealth is Leverage! In order to grow your investment portfolio, you need access to all of your equity, without this your ability to borrow will be restricted.

As an example, let’s take a look at an investor with a portfolio of 4 retail properties each with a purchase price of $400,000 and each with different residual amounts on the loans with four different banks. Then we will compare their borrowing capacity versus consolidating these four loans.

 

Example: 4 investment properties with CBA, ANZ Bank, Westpac and NAB

consolidate-or-diversify-loans

 

This investor has plenty of equity at their disposal. Each of the 4 properties are valued at $400,000 and the banks lend based on a typical 70/30 LVR (Loan to Value Ratio) position, then they would need to invest ($400,000 x 30%) = $120,000 of equity in each property. As shown in the above diagram, this investor has paid down the loans over time and currently has a total of $520,000 of available equity. The problem with this Diversified investment strategy is trapped equity! In total $280,000 of equity is stuck in NAB, $180,000 is trapped in Westpac, $80,000 is locked up with ANZ Bank and finally CBA may be charging this investor mortgage insurance because this LVR position is only 75/25, which is less than their standard 70/30 lending policy.

By diversifying these loans this investor is unable to cross collateralise their equity across the banks. They can only access the $520,000 in available equity to buy another property if they Consolidate the loans with one bank.

In addition to this, under the diversified model each bank would mandate rental payments be directed into the individual loans to meet their banks mortgage repayments while the more sensible approach for the investor would be to direct payments off a domicile loan that isn’t tax deductable.

Applying this example to a Consolidation strategy with all 4 loans with one bank, then this bank will hold security over all 4 shops. The total equity position is:

 

 

 

 

This is a very healthy LVR position. At 70% LVR the bank would lend $1,120,00 for this portfolio, hence with only $600,000 in remaining debt it releases $520,000 in spare equity to procure an additional property.

Based on the same 70/30 LVR, this investor would be able to buy a 5th property valued at:

 

 

 

 

Using a Diversified strategy to buy a 5th property, this investor could at best leverage the $280,000 equity available with NAB to buy a property valued at:

 

 

 

 

Diversifying your loans traps equity within individual banks and makes it very hard to leverage all of your available equity.

The team at Engines of Wealth would be happy to assess your situation and provide our experience on unlocking your full borrowing potential.

________________

Please contact the Engines of Wealth team if you have any questions:

stephen@enginesofwealth.com

phillip@enginesofwealth.com

/by

FOR THE TIMES THEY ARE A CHANGING

, ,

Last week the Engines of Wealth team achieved a milestone that I believe is a sign of the changing times, we assisted Valma secure her first commercial property investment. What makes this notable is her tender age of 85 years young. This sale is not a one-off occurrence, prior to that we had helped Kathy, 72 years old and Rod 83 years old secure their first retail shop investments, but at 85 years, Valma takes the trophy.

Most people’s vision for retirement involves simplifying their life with a modest home and lifestyle. Like Valma, for many Baby Boomers and previous generation, the plan was to retire with a lump sum of cash, deposit it into a bank term deposit at 5-6% and live off the interest. The problem for many retirees is that this plan no longer works in today’s economic environment. Plummeting interest rates have impacted term deposits to the point that returns have become untenable, forcing retirees to look in radically new directions to survive.

The story of Michelle is an increasingly common example, Michelle owns her modest 2-bedroom unit outright and retired 8 years ago with a lump sum of $600,000. She invested this nest egg in a term deposit in the bank. In 2011, Michelle was able to invest her money for 12 months at 6.15%. Her $600,000 generated ($600,000 x 6.15%) $36,900 per year or $709 per week. Michelle’s money in 2011 supported her basic lifestyle, this was 50% higher than those retirees surviving on the single pension in 2011. This approach was, and still is, the retirement strategy for many older Australians.

Rolling forward to 2019 and something serious has gone wrong with this strategy – the bottom has fallen out of interest rates. The Reserve Bank of Australia on Oct 1, 2019 lowered the official cash rate to 0.75%, the lowest level ever in Australia’s history! Adding to the woes is that all messaging coming out of the RBA is that interest rates will continue to fall, so there is no upside in sight for Michelle and others like her. The best deposit rate I found for retirees’ lump sums today is uBank at 1.8% for 6 months.

Michelle’s retirement nest egg would today only generate at best ($600,000 x 1.8%) $10,800 per year or $207 per week. That is a third of what it generated in 2011 and less than half the $466 weekly pension. Michelle, like many must now scrape by with a part pension and a fraction of the money she received just 8 years ago.

I speak with lots of people like Michelle that have followed this same retirement plan. This age old, seemingly low risk, term deposit strategy that has worked from the 1960s to just a few years ago. What has happened over the past 5 years was not anticipated and as a result many are now enduring a brutally hard retirement lifestyle.

The graphic below details the fall in term deposit rates over the past 35 years and really brings home the problem that many older Australian’s are facing.

People in their 70’s and 80’s assumed their investment nest egg of cash in the bank would generate them enough money to live on. In 1985 they would have been getting 12% on their money and in 1995 they would have been earning a tidy 10%. Fast forward to today and retirees are now only getting around 1.5 – 2.0% on their money, that’s not enough to live on. For Valma, Kathy and Rod they were faced with spending their nest egg or seeking alternative ways to generate a return, this is what led them to the Engines of Wealth team to investigate purchasing a commercial retail shop.

I interviewed Kathy after her purchase as I was intrigued to understand the drivers that led a 72-year-old retiree to buy her first retail shop. Her reasons were twofold, firstly, she realised she could not live on the interest her money was generating in the bank and that meant she needed to spend some of her nest egg each year to survive. Kathy’s decision to invest her money in a retail shop at secure 6.5% cash flow return, meant she would now be generating sufficient income for her to live on without eating into her nest egg.

The second driver for Kathy was protecting her children’s inheritance, Kathy had benefited from an inheritance from her parents and hence it was extremely important to her to also leave something for her children. It comforted her to know she would be able to leave them the legacy of an income generating shop, that was increasing in value each year as the rent increased.

There is a growing number of retirees suffering from what is happening with interest rates and the solution needs to be something other than traditional, low risk investments like bonds and term deposits. This older generation is particularly sceptical of turning to the stock market, as they experienced the GFC and know how volatile local and global financial markets are at the moment.

I am glad that by reading my book, Engines of Wealth and then contacting me, I was able to help improve their livelihood and ultimately empower them with the knowledge and confidence to change their investment strategy. Kathy and Valma both said they are delighted to have secured a safe, steady income stream from their commercial shop and take comfort in knowing their money is protected in bricks and mortar, both have dramatically reduced their stress levels, they are now no longer worried about their future prosperity.

I would like to finish with a photo of a very proud 85-year-old Valma, in front of her shop. Congratulations Valma, an outstanding achievement.

/by

Engines Of Wealth Are In The St George & The Sutherland Shire Leader!

,

We are thrilled to be featured in todays edition of the St George & Sutherland Shire Leader!

We were recently interviewed by The Leader regarding our book and thoughts on the Australian property market.

As the title states, we believe that you shouldn’t give up on your home ownership dream! You just need to rethink your investment strategy.

Our book outlines the steps we took to building financial wealth and security. We go into explicit detail on how you too can build this wealth and positive income stream for yourself!

To read the full interview CLICK HERE >

To get a copy of our book Engines Of Wealth CLICK HERE > 

For One-On-One Consulting or Buyer Agent Services please CLICK HERE > 

/by

Commercial Real Estate – A Way To Eventually Own Your Own Home

We were recently interview by The Leader and questioned about our views on commercial real estate and first home ownership in Sydney. In recent years Sydney property prices have sky rocketed. This has resulted in a lot of first home buyers unable to get into the market. 

Read more
/by

Air Conditioners

, ,

One of the key reasons we selected commercial retail shops as the foundation of our wealth engine was due to the low maintenance aspect of these shops. In fact the only real major items of plant and equipment that is the responsibility of the landlord to fix is the hot water system and the air conditioner. The hot water systems are typically not that expensive at around $1,000 installed and will last between 8-10 years. So whilst it’s a good idea to understand how old the hot water system is it typically won’t be a factor in your property due diligence. Read more

/by

Dangers of Short Lease Terms

, ,

One of the key things I like to see when buying a retail shop is a long lease. Not only does a long lease offer you security over future rental payments it wins the banks confidence in the asset as it presents with a higher WALE (Weighted Average Lease Expiry). In Engines of Wealth we discuss the WALE of a building as a measure of the lease term left to run. Read more

/by

The Value of Depreciation

, ,

In my opinion Depreciation is the secret sauce when selecting retail shops as our wealth building engine. Our wealth building strategy is to create a long lasting income stream that is indexed to inflation and tax effective. Read more

/by

Guarantors

, ,

A guarantor must be identified on the tenant’s lease, it could be the tenant or a friend/relative. A guarantor should be a person that has suitable assets to provide security over future rental payments. The subject of a guarantor is not only an important consideration at the time of purchasing a property, it is also important when a tenant has decided to sell their business or assign the lease to another party. Read more

/by

Hairdresser Barber

,

As mentioned a few times in Engines of Wealth, I own seven Hairdressing salons and would gladly have more, they make dependable tenants. With that many hairdressing salons in my portfolio I am keen to learn more about their business, so I interviewed a local Hairdresser/Barber to gain greater insight and improve my investment calculations. Read more

/by

Real Estate Agent

, ,

In Engines of Wealth I discuss at length how to interact with real estate agents from a buyer’s perspective, but when considering them as a tenant and agencies are one of my preferred tenants, there is a twist. When considering the viability of a real estate agent in your shop first you need to ascertain if they are among the 90% that sell residential properties only. Remember the catch-cry “Location, Location, Location”, all areas are not equal and if your shop’s neighbourhood is not providing attractive prices or has too much competition then a real estate agency may struggle. Read more

/by