How Should First Time Investors Get Started?

[youtube id="HKMmJNnO7OE" align="left" mode="lazyload" maxwidth="500"] How should first time investors get started? Should they save a deposit, use vendor financing, do a joint venture or something entirely different? How should first-time investors get started in the property market? Should they save their own deposit? Go to the vendor finance route? Go into a joint venture? Or use some other strategy? Hey! I am Ryan from OnProperty.com.au, helping you find positive cash flow property and this question was asked by Gordon. Thank you Gordon for sending in your question. If you want to have your question answered, just email it to [email protected]. So when you are a first-time investor, it could be very difficult to get into the market. It could be extremely expensive to get into the market and you feel like you are trying to save, but it just takes forever to get there and you are not making any progress. So, is there a better way than saving your deposit? Should you look at joint venture? Should you look at vendor finance, etcetera? Or should you just stick with the staple approach of saving your deposit? I cannot answer the question for you, but I can give you some pros and cons and things to think about with each of them. The most common way to get into the market is obviously saving your deposit yourself. This can be difficult. Saving a deposit even if it is 5% plus cost, or maybe 10% of the purchase price; if you are purchasing a $300,000 property, that is $30,000. A $500,000 property, that is $50,000. That is a lot of money to save. In some cases, that might be a year or more worth of your wage, which can be extremely difficult to do. So, the negative with saving your deposit is obviously that it can take a great deal of time. It involves an extreme amount of discipline to not go out there and not buy the latest iPhone, or not buy a car on a loan, or not purchase the latest thing that you want to purchase. It takes an extreme amount of discipline to be able to do that. A large portion of my audience that does have that discipline, but I am sure there are some of you out there who just really struggle with that, and that may be unachievable for you. So, the negative of it is it can take a lot of time to do. The positive of that is you then have full control. You can purchase a property yourself in your own name or in a trust if you decide to go down that route; but you have the deposit. You are investing it for yourself. This gives you full control over your decisions: what suburbs you want to invest in, what type of property, how much money do you want to spend, are you going to do a renovation, what are you going to put the profits towards, etcetera, etcetera. So, when you purchase a property it means you get full control over it. You are the decision-maker. You can make whatever decision you want. That is a huge benefit to it. It can be beneficial going into yourself rather than going in something like a joint venture when it comes to buying property number 2 and 3 and things like that because the banks will look at the entire loan against your income. So, it can negatively affect lending in the future if you do a joint venture. Saving a deposit is probably ideal in most situations if you can actually go about and save the deposit. Hopefully after then you can do something to that property to improve it, to increase the equity on that property, and then maybe in the future you may be able to borrow against the equity to go again because it can be difficult to save a deposit over and over. So, Option number 1 is to save a deposit. Option number 2 is what is called vendor financing. Now, this is quite common in places like the USA; not as common in Australia but still possible, I think, in almost every state. You might need to double check; I know there are some rules about this agreement in South Australia, so definitely check there. But just check with your local state laws whether or not you can do vendor financing. So vendor financing works like this: the person who is selling the property provides you with the property, but rather than you going and getting a loan from the bank and then paying those people in a lump sum, or basically you pay your deposit, the bank pays them the remainder of the sum; what is actually happening is that the person who owns the property is extending a loan to you. So you may still give them a deposit, it may not be as large, it might be just as large, it depends on the agreement you create. You give them a deposit and then they extend a loan to you based on how much you purchased the property for. So let us say a $500,000 property, let us say we give a 5% deposit of $25,000; you then owe that person $475,000. They will then create a loan structure which will be paid off over X number of years at X percent. So vendor finance can be beneficial because if for some reason you cannot get a loan from the bank, vendor financing may be your only option to get a loan. That is good in that aspect. It can also help you if you have a smaller deposit. Some people will accept smaller deposits for vendor financing. The negatives of vendor financing is that you are likely going to overpay for the property. So you are going to pay more than the property's worth, which means you need to do something to grow the value of that property or you need the market to go up just to catch up with what you pay for the property. So generally, you are going to overpay because you are not in a position where you can pay cash or you can get your own bank loan and the bank pays cash for the property. Generally, you also pay above average interest rates. So if you can go to the bank today and get probably somewhere between the 4% or 5% interest rate, you are going to need to add 1%, 2%, 3% to that. So rather than 4% to 5%, it is probably going to be somewhere between 6% and 8%, so you are going to be paying a high interest rate for the property. This kind of makes it difficult for me because the numbers do not tend to stack up the higher the interest rate becomes. So if you can get an interest rate of 4%, so many properties are positive cash flow it will look great on paper; as soon that goes to 7% or 8%, it does get hotter. So when you go vendor financing, the numbers might not stack up as much especially if you are paying more for the property and you are paying a higher interest rate and you are not putting down as much as a deposit; so you could be negatively geared there, which maybe a negative for you. But it may mean that you can get into the market earlier. Another thing to think about when it comes to vendor financing, aggressive is the wrong word but very assertive, very proactive in terms of finding these vendor finance deals. You need to go out there. You need to make offers on a bunch of properties. Most people have never heard of vendor finance, so you need to explain it to them. You may be dealing with the real estate agent, you need to craft emails that will get passed onto the owner and explain in a good way. Generally in an area where that property is going to turn over and sell quite quickly unless you are willing to offer a decent amount more than what the property is worth, people will probably not consider it. So expect to be knocked back a lot of times. Expect to do a lot of work for just one person who is going to say yes to a vendor finance deal. The other option you could look at when you are investing for the first time is to actually go into a joint venture. So this is where you partner with someone else; you can buy new deposit, you can buy new incomes so that maybe separately neither of you could get a loan nor afford a property. But together, you can go ahead and purchase a property and afford it. There are pros with this. Obviously, you can get into the market. You are not overpaying for the property or overpaying on interest rates like with vendor finance. You can start getting growth on that property. Negatives with this is that obviously, you need to work with someone else so there are going to be compromises along every step of the way basically because it is very rare for 2 people to exactly agree on one thing. Obviously, you need to draft up contracts and things like that to ensure that money is handled correctly, profits are handled correctly as well. And another negative with joint venture is that when you go to borrow again, maybe you want to buy a property by yourself next time, the banks will assess you both as having the entire mortgage. So even though you might only be responsible for half of the mortgage, you are probably liable for the entire mortgage. So what this means when you go to get a loan the bank is going to say, "Okay, you co-own this property that is worth $500,000 or has a loan of $500,000 with this person. We are going to assess your borrowing capacity based on assuming that $500,000, you are responsible for the entire thing." And this is in case your partner disappears to live in Cuba and never pays the rent or never pays the mortgage again, then that mortgage is left with you. So there is a risk there that you may have to pay that full mortgage in the future. So this can negatively affect your property portfolio moving forward. I guess the solution to this would be short-term joint venture deals. Maybe you could go in with someone, do a renovation, sell the property in a certain amount of time. And that would then clear that co-debt that you have together and put you in a better position. I am not a mortgage broker so do not take this as mortgage advice. Always go and see a professional mortgage broker when making these decisions. So, so far we have covered saving your deposit. We have covered vendor finance. We have covered joint venture. The last one that I want to cover is equity in your home.