Asset rich, cash poor
Property as an asset class dovetails right into an Australian investors psyche as Australians are true believers in brick and mortar. It’s not just a belief but it’s a trust that over time, property will appreciate.
The standard protocol for an Australian property investor is to purchase the property, with borrowed funds and wait until time passes allowing the property to appreciate. Once there is sufficient equity accumulated with the property growth, it is then refinanced in order to extract that equity. That equity is then used as a deposit on a new investment property where time passes and the scenario is repeated. This occurs over and over again, over a long period of time accumulating more assets, more debt and more income.
Historically, interest rates in Australia are more than the rental income generated so this strategy will be negatively geared, unless manufactured growth is implemented. This portfolio will grow in size, debt and income until some day in the future when the acquisition process ceases, thus the debt stops increasing and the growth of the income increases to a positively cash flowing state.
The component in this strategy that works against the investor is time. Time is the secret sauce that the investor requires to make the strategy work and be positively cash flowing. Until the property portfolio is built up and ceases adding more debt, the investor will have a hard time cash flowing positively.
Accompanying time as a major component to a successful Australian property portfolio is an increasing or appreciating market. In an appreciating market, this strategy can work very well. The more properties the investor can purchase the quicker they can reach their goal of portfolio size generating the amount of income they strive.
Unfortunately, the last eight years hasn’t been that strong a market and in general, nationally it’s been mostly flat. There are specific pockets that have done better than others but for all intent and purpose, the general market has been flat. A flat property market prevents the equity from materialising, thus no capital to build the portfolio. Valuers don’t help either. In a flat market, valuers tend to be more conservative with their valuations making it that much more difficult to extract equity.
Have you ever heard the term ‘asset rich but cash flow poor’? This is what happens in a flat property market when the investor realises they are not receiving an appropriate amount of income but have a sizable asset and debt position. Is there anything that can be done to mitigate this situation? I believe so. I believe that by diversifying into the US property market, the investor will derive the cash flow any property investor would dream of. We can increase the investor’s cash flow by almost three times without adding any more capital or debt. As a matter of fact, we can lower the debt by 100 per cent of the amount of the assets.
Here’s how we do it:
Let’s make a few assumptions. Let’s assume we are dealing with a $5 million Australian property portfolio at an 80 per cent LVR, generating 6 per cent rental income and the current interest rate is 6 per cent for debt service. Let’s also assume that we can get a 70 per cent LVR loan at 5.75 per cent fixed in the USA (which we can do) and generating 13 per cent rental income. Let’s assume that the Australian dollar and the US dollar are trading at parity.
$5,000,000 = $4,000,000 debt and $1,000,000 equity = 300,000.00 Revenue
-240,000.00 Debt Service
AU $60,000.00 Cash Flow
Chart 1 shows a $5M portfolio at 80% LVR generates $60,000 p.a. in cash flow. When we sell half the portfolio we lower the asset position in Australia by $2.5M which consists of $2M debt and $500k equity.
Sell $2.5M of Aussie property to invest in US property
$2.5M = $2M of debt and $500k equity in Australia
Take $500k and convert to US at 70% LVR = $1.5M investment capital (approximately)
$1,500,000 =$1,000,000 debt and $500,000 equity = 195,000.00 Revenue
-57,500.00 Debt Service
US $137,500.00 Cash Flow
Chart 2 shows the power of $500k equity in the US property market once leveraged with a 70 per cent LVR loan. The investor will have $1.5M of investment capital where $1M is debt and $500k equity. This $1.5M invested will generate $137,500 p.a. in cash flow.
So what does the total portfolio look like?
Total assets drop from $5M to $4M, a decrease of $1M. Total income increases from $60k per annum to $167,500 per annum ($60k/2+$137,500), and increase of 2.8 times. Total debt outstanding decreases from $4M to $3M, a decrease of $1M.
– 2.8 times greater cash flow without adding any more equity.
– Greater growth potential on the basis that the US market is close to or at the bottom of the cycle. Potential foreign exchange gain over time with the Australian dollar historically trading at $0.80 to $1.00 US dollar.
– Diversification of assets and cash flow; Diversification into two separate currencies.
S. Gregory Uehling is Director and Principal of Tandem Uehling. He is a dual Australian/USA citizen who has lived in Australia for the past 11 years. Greg has had his own Australian based Proprietary Limited Company for over 8 years with financial planners and accountants topping his client list. Greg visits the US regularly while providing his tailored services to his customers in Australia. Tandem Property USA is a wholly owned brand of Tandem Uehling.
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