The Financial Analysis
Get a DIY financial analysis package
Not only has our society’s interest in investing and making money led to an increase in the number of investment seminars it has also spawned a large variety of money magazines. As well as running articles about making money, they also show ads promoting do-it-yourself financial analysis packages.
These DIY packages are fantastic. Of course, I haven’t tried every package available, but those I have seen are easy to use and can instantaneously tell you how an investment property is geared. Negatively geared properties cost you more money than they make from rent. Neutrally geared properties cover the costs associated with keeping them through rental income. And positively geared properties leave you with money over after all costs have been accounted for. This last scenarioio is the most desirable scenario.
Some of the information required to generate an accurate analysis includes:
- Property price (what you paid for it)
- Property value (what you’d get if you sold it now)
- Outlays (costs incurred purchasing the property, such as taxes and legal fees)
- Loan details (outstanding borrowings and interest rate)
- Rent (allowances can be made for possible vacancy)
- Outgoings (all costs of holding the property, other than loan repayments, such as council rates and maintenance)
- Capital growth (estimated figure only)
- Inflation rate (estimated figure only)
- Depreciation (information from quantity surveyor’s report)
- Personal income (for tax purposes)
This may seem like a fairly extensive list, but by obtaining an independent valuation, estate agents’ rental estimates, and a quantity surveyor’s report, I had all the information I needed to complete a financial analysis of the property.
As I mentioned earlier, in my case the property price I paid for my apartment was $205,000, and the property value had been independently assessed as $245,000. My outlays consisted of stamp duty and conveyancing costs.
All the information you’ll need
Loan details relate to the amount of money you wish to borrow against the security of the property, and the interest rate the lender will charge you. At this stage you can choose between interest-only or principal and interest repayments, and you can see how this choice alone can significantly impact on how your property is geared and your ability to service the loan. Current interest rates can be found in any large daily newspaper, by searching the Internet or by calling any bank/lending institution. To determine rent I used the average of the three rental estimates I had obtained.
Outgoings I knew from having lived in my apartment for six months. In the case of a new property, I recommend you use the outgoings amount shown in the vendor’s statement section 32, which accompanies any contract of sale. If your property is in another state or country, you might need to look elsewhere for this information. This figure, whilst only being an estimate, must not be less than what the actual outgoings will be once the property settles. As a result, in my experience, this figure is always generous.
Capital growth of the property into the future will always be nothing more than a guess. In my analysis I used a conservative 7 percent annual growth estimate. The reason I believe this is conservative is because although annual capital growth rates will fluctuate over a 10-year period, the general consensus is that a property’s value should double after this time, and from past sales evidence the capital growth around my property (in this case the CBD) had easily exceeded 10 percent per annum on average over the previous ten years.
The inflation rate, like the capital growth rate, over an extended period is nothing more than an estimate. In my analysis I used a rate one percentage point higher than the inflation rate at the time.
The figures I used for depreciation (there are separate depreciation amounts for building and for fittings and fixtures) were provided by the quantity surveyor.
Finally, there was personal income, which in my case wasn’t immediately clear. Because I had decided to leave my recent employment, I was without a regular weekly income. During the period I was preparing my financial report, I occasionally worked on a casual basis. As part of my report, I included a letter from an employer stating that I was working as a contractor on a set daily rate, which also showed a projected figure over a 12-month period. I did this to give the impression that I was earning a regular salary, and to avoid the necessity of providing old tax returns and group certificates.
Prepare for the worst
The benefit of using a DIY software package is that the financial analysis will immediately calculate how your property is geared before and after tax. By manipulating the numbers, you can see the minimum rent you must achieve to have a positively geared investment. Your inputs can be changed to see in advance what affect a changing market may have on your property and ultimately your hip pocket.
When doing such an analysis, you can be as conservative or optimistic as you like. In fact, you can try both outlooks in turn. You can project how the equity in your property will grow in the future, and you can change your loan type from interest-only to principal and interest, enabling you to determine your best financial strategy. You can even change your annual salary to take into account any promotions you hope to secure, and you can see how salary increases (and the different tax brackets) affect your personal tax position in relation to how well geared your property is.
Using all the information I had gathered, I determined that I could easily positively gear my apartment based on a rental figure much lower than the estimates provided by the estate agents.
Because of my conservative nature I produced a financial analysis showing conservative estimates in all the input fields. My report showed loan interest rates, outgoings and inflation rates much higher than necessary, and taxable income and rental lower than indicated in my accompanying documentation.
Importantly, though, I never took my eye off the bottom line—I wanted to ensure my property was positively geared. I prepared my financial analysis using these conservative inputs because as an investor you must be prepared for the worst-case scenario, and I needed to show the bank that this was so.
- Get a DIY financial analysis package
- Collect the information you need, and input it to see whether your property is positively, negatively, or neutrally geared
- Experiment with different parameters in your analysis to see how different scenarios could play out
- In your final analysis, be conservative so the bank can see you’re prepared for the worst