How your loan structure could be hindering your property investment potential

Are your loans stopping you from being a successful property investor?

Many investors wonder how they will ever build a property portfolio when they’ve been told they can’t access any more equity by their lender.

Or they feel like they can’t afford the payments on the loans they already have and even one property feels like a stretch, even though on paper their properties are nearly cashflow neutral or even positive.

Or they feel like they are still paying too much tax.

You would be surprised how many times people come to us with these same questions and don’t realise that often the loans they took out are causing some of the problems and holding them back from being a successful.

So how does this happen?

The first thing to remember is that banks and lenders are not property investing or tax specialists. Their job is to sell a product. It’s a bit like buying a car to tow a caravan; if you just ask for the cheapest car and don’t mention they want to tow a caravan you will probably end up with the wrong car.

John’s case study

Here is a typical case study from our team in Melbourne, where John* was referred by a friend.

John explained that he has 10 properties all with loans to one major big four bank lender, and would like to buy property number 11. However, this time when John approached his previously helpful bank manager, he was told that the bank could not lend him anymore money and he didn’t have sufficient equity.

For John this was a big surprise because he was on a much higher income than his last property purchase and the majority of his properties had also increased in rent and market value, thus increasing his equity position. He was also sure by his calculations that because of this all his properties were almost positively geared and in fact his previous accountant had told him that he would have to pay tax on the new rental earnings.

So, what was going on and why couldn’t his bank manager assist him?

After reviewing John’s financial position and completing a preliminary assessment, John’s finance strategist and accountant were able to determine that:

1. John’s current bank loans had expired on interest only and rolled over into principal and interest payments. This had the effect of increasing his monthly commitments and reduced his cashflow;
2. John's current bank had also cross collateralised his whole portfolio (10 properties including his owner occupied property), which impacted his overall equity position and borrowing capacity. Therefore, any changes to the current loans (and/or any request of additional lending) required the valuation and reassessment of all the properties/loans in his portfolio. This meant that his borrowing capacity was being tested on the total loans at the higher of the bank new loan testing interest rate further restricting what he could potentially borrow;
3. Due to John’s substantial borrowings with the one bank, he had also reached the bank's loan limit and mortgage insurer exposure level of $2.5 million, meaning that he could not borrow any“additional money” and/or had to reduce the overall loan-to-value ratio (LVR) to 70%. This also negatively impacted what equity could be accessed and also what John could then borrow;
4. Several of John’s loans where on older loan products with interest rates that were 0.1 percentage points or more  higher than new more competitive loans being offered by the same bank; and
5. John’s previous accountant had been overlooking some depreciation that John was entitled to. The team also identified some tax deductible loan portions that further improved John’s tax position & negative gearing add back for serviceability.

The solution for John was to regain control of his financial position

Once John had worked with his lending and accounting specialist he was in a much better position to achieve his goals.

The 1^st step was to have his team arrange for valuations on each property in his portfolio, all ten in total. Once the valuations were received, he was able to ascertain his equity position and start reviewing his borrowing capacity on all the current loans in his portfolio and ascertain whether further equity could be obtained as well as funding for the new purchase.

The 2nd Step was the “uncrossing” John’s securities with his current Bank so that all loans were secured against individual properties/or the property in which they related to. This provided John more flexibility in his portfolio and the ability to change lenders/access equity/sell property more readily should his financial position require this.

Once the 2nd step was completed, the uncrossing securities and overall restructure, he was able to refinance 2 of his current properties loans to a new lender to release further equity of $300K and obtain a  pre-approval with a third lender of $500K to purchase his 11^th property.

Keep in mind that all of this has allowed John to rebalance his portfolio and exposure levels for future property investing. And the initial steps of reducing his loan exposure with his current Bank to below the $2.5 million has given him enough room to potentially increase these facilities in the future.  In addition simply by completing these steps, he has drastically improved his cash flow position, saving over $2,000 per month!

The end result

• Ensuring John’s property portfolio was uncrossed and balanced to suit him (and not the bank);
• John’s borrowing capacity was maximised by utilising his negative gearing and add backs to access $300,000 additional equity for further investment and “buffer” purposes;
• All his loans and sub accounts were structured correctly for accounting and tax purposes;
• His loans were negotiated to obtain the maximum discounted rates where possible to improve cashflow;
• All his investment loans were interest only and not principal and interest; and
• A loan approval for his 11^th investment property at $500,000 loan amount.

Albert Waldron and Lauren Mamaj are part of the team of property investment specialists at Chan & Naylor, national property, business tax accounting and wealth advisory group