When you crunch the numbers on a multi-million dollar property deal, it doesn’t stack up. So why do people continue to invest in expensive homes?
One of the most essential skills you can learn as an investor is the ability to “crunch the numbers”. In a nutshell, this means you’re able to quickly work out whether a deal is viable by making a few short calculations.
It can be as simple as working out a property’s yield. If you buy an asset for $400,000 and it rents for $400 per week, the yield is 5.2%. I reached this figure by multiplying the weekly rent ($400) by 52 weeks of the year ($20,800), then dividing this amount by the purchase price ($400,000).
Yield is obviously a pretty important figure to know when you’re working out whether you buy a property.
This is why Ed contacted me with the following question about low-yield properties:
“How can people be paying $1.6 million for a property that then rents for $700-$750 per week? That’s going to take something like 50 years to pay it off, assuming lots of things…”
First of all, you have to be on a really high income to buy a $1.6 million property.
But putting that aside, when I received this question from Ed, I immediately grabbed my calculator and crunched the numbers. I assumed a mortgage interest rate of 4.7% and worked out that the mortgage on a $1.6m property would be just over $75,000.
Assuming that the property rents for the full year at $700 per week with no vacancies, it would return $36,400 (without accounting for property management fees).
It doesn’t take a genius to realise there’s a massive shortfall here, worth almost $39,000. That, to me, is a truckload of money to be losing on a property, even if it is able to be negatively geared!
Now, I understand that negative gearing is good for those of us who are earning a high income.
Let’s assume that the owner of this $1.6 million property is a high income earner who negatively gears his investment and gets 50% back.
Even if this is the case, that’s still an excessive amount to be out of pocket. It amounts to over $19,000 a year, or around $375 every single week, that the investor is handing over to their bank.
But do you know what really scares me about this property?
It’s the fact that if this property was vacant for any period of time, you’d have to find more than $6,000 every single month, just to pay the mortgage… and that’s only the interest component!
Plus, let’s not mention how your finances would cop it if negative gearing was actually altered or taken off the table by the government, as has been discussed at length in recent months.
Til next time, happy investing!
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