All Topics / Heads Up! / Several questions about the book

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  • Profile photo of JustAllanJustAllan
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    @justallan
    Join Date: 2003
    Post Count: 168

    [?]

    Have been reading the book and I have a few questions, for anyone willing to offer answers…

    1. On page 67 there’s a table with a list of expenses. There are headings “to” and “put”. What are these – accounting terms? What do they mean?

    2. What benefit is there (if any) in paying only the interest component of a loan? As far as I can tell, that means you would pay the interest, then next month you’d owe the same amount all over again – surely this isn’t a good wealth-building strategy – so I must be missing the point!?

    3. On page 69, the result is 9.3% cash on cash return… Isn’t this less than the 11 second solution?

    4. Why is the 11 second solution set at 10.4% – why not 8%, 9%, or even 11% etc.?

    Thanks for reading…

    Allan.

    Profile photo of showmethemoneyshowmethemoney
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    @showmethemoney-2
    Join Date: 2003
    Post Count: 103

    Hi Allan

    Here is my interpretation

    1. I believe To and Put are accountancy terms, double ledger accounting perhaps.

    2. Paying interest only loans improves your cashflow, therefore increasing the number of loans you can service and therefore the number of properties you can hold.

    Also only the interest component of an investment loan is tax deductible.

    You are correct in that the balance will be the same at the end of the loan as at the start.

    Typically an interest only loan will be 5 years max (10 years is available at some banks). On a typical Principal and Interest loan you will find that the balance after five years will be nearly the same.

    Also the balance in five (or ten) years on the interest only loan will not be worth the same in real dollars due to inflation. Hopefully the investment property will have appreciated as well.

    3. The 9.3% is the Cash on Cash Return. That is the return on the actual cash you put into the deal. This is not what the 11 second rule calculates. The 11 second rule is a first pass calculation of gross yield, ie rent versus price.

    4. I suppose the 11 second rule is set at 10.4% as this is the figure which should ensure that most properties are cashflow positive after outgoings etc. Also it is easy to work out. If the rule was 11% or 13% then it would probably be the 57 second rule or the calculator rule [:)]

    Hope this helps

    Clive

    Profile photo of JustAllanJustAllan
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    @justallan
    Join Date: 2003
    Post Count: 168

    Hi Clive…

    quote:


    Paying interest only loans improves your cashflow, therefore increasing the number of loans you can service and therefore the number of properties you can hold.


    quote:


    You are correct in that the balance will be the same at the end of the loan as at the start. Typically an interest only loan will be 5 years.


    Thanks, that helps a little… The bit I’m really having trouble with tho’ is, why don’t these people pay off some of the loan principle also? Ok, they receive income from rent, pay out interest only, claim it back on tax – so they receive that same amount back again as income. But their debt does not decrease. Then when they buy another property their debt would actually compound.

    Thanks to the booming RE market the last few years, I can how this is a good strategy for *income* – but unless I missed an important piece of information, this looks like financial suicide in the long term. (Interest rate rises, stagnating property prices/rents, etc.)

    I mean to say – in five years time they have to start paying the principle back anyway – so why not just do it in the first place? Is the sole idea to receive five/ten years worth of free tax deductions as income?

    Furthermore, which repayment method (interest only, or interest & principle) would *lenders* be more comfortable with when you approach them for the next loan?

    Anyone?

    quote:


    The 9.3% is the Cash on Cash Return.


    quote:


    I suppose the 11 second rule is set at 10.4% as this is the figure which should ensure that most properties are cashflow positive after outgoings etc.


    Yep, I guess I just need to understand why the level of 10.4% works. Unless I missed this information in the book!? Anyone?

    Allan.

    Profile photo of showmethemoneyshowmethemoney
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    @showmethemoney-2
    Join Date: 2003
    Post Count: 103

    Hi Allan

    Regards paying off principal vs int only. If one wishes to pay down principal then they take out a P & I loan. Extra payments etc can be made to speed up the process. Remember though that these payments are made from after tax money, so if you are on the top tax bracket then effectively you must earn $2 to pay off $1. Also remember that a dollar today is worth more than a dollar tomorrow or five years time. All of my loans are fixed interest only (all the properties are -ve geared). This gives me peace of mind with rising interest rates. When the loan periods have expired I have taken up a new fixed interest only loan, unless I believe rates are going to fall. This has worked well for me as I have been able to control more property than if I had taken out the equivalent loan amounts on P & I.
    With int only, surplus cashflow can be reinvested elsewhere, eg shares, cash management, other property to build up a sinking fund to pay down the balance upon loan expiry.
    If property price growth is non existent or low then yes, paying down principal is necessary in order to allow further borrowings. With many positive cashflow properties this well may be the case.

    My experience with banks has been that they have tended to want to lend me money on P & I terms, and I have had to insist on fixed interest only products. Conservative managers I think.

    Regards the 10.4%, the book doesn’t specifically state how this number was arrived at. My guess would be that after extensive research on a number of property deals that it became evident to Steve that this was the gross yield required to make most properties cashflow positive. As an exercise examine a bunch of properties and see what the gross yield would need to be to make them cashflow positive.

    Sorry about the long winded reply, hope it helps.

    Regards

    Clive

    Profile photo of Steve McKnightSteve McKnight
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    @stevemcknight
    Join Date: 2001
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    Hi,

    I’m sorry, but I don’t have a copy of the book handy (I’m at home), so I cam only answer generally:

    quote:


    1. On page 67 there’s a table with a list of expenses. There are headings “to” and “put”. What are these – accounting terms? What do they mean?


    My guess is that this is a solicitor’s statement? I’ll look it up when I get to work and provide a more accurate summary.

    quote:


    2. What benefit is there (if any) in paying only the interest component of a loan? As far as I can tell, that means you would pay the interest, then next month you’d owe the same amount all over again – surely this isn’t a good wealth-building strategy – so I must be missing the point!?


    There are two benefits:

    1. Your cash return is higher as you don’t make principal repayments.

    2. For commercial loans, where the term is usally a max of ten years, trying to make P & I repayments would be a huge strain.

    I’ve talked about P & I vs. I/O loans in a recent newsletter – check your past editions.

    quote:


    3. On page 69, the result is 9.3% cash on cash return… Isn’t this less than the 11 second solution?


    I’ll need to look this up, but my initial guess is Showmethemoney is right – the CoCR you quote is net, whereas the 11 Sec Solution works on a gross figure.

    quote:


    4. Why is the 11 second solution set at 10.4% – why not 8%, 9%, or even 11% etc.?


    Hmmmm – why does 2 + 2 = 4? It just does. The answer always results in a 10.4% return because of the execution of the equation.

    Cheers,

    Steve McKnight

    **********
    Remember that success comes from doing things differently.
    **********

    Steve McKnight | PropertyInvesting.com Pty Ltd | CEO
    https://www.propertyinvesting.com

    Success comes from doing things differently

    Profile photo of ian_from_brisbaneian_from_brisbane
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    @ian_from_brisbane
    Join Date: 2003
    Post Count: 97

    Hi Allan,

    For an example, if you were to apply the 11 second test to a $50,000 property, you would need $100 per week in rent, correct?

    Well, multiply this $100 by 52 weeks in the year and you get $5200. Then divide this by the price of the property ($50,000) and you get 0.104 which is 10.4%

    -Ian

    Profile photo of wirrumbirrawirrumbirra
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    @wirrumbirra
    Join Date: 2003
    Post Count: 6

    Here goes my first post[:)]
    A further question relating to the 11 second test and Cash on Cash. I have been doing some extensive internet searching for properties and have come across a number that give the magic 10.4% or better. Then when I go through the process of doing the maths in relation to the ConC it often comes out less than 10.4%. My confusion has been should this property be rejected as it no longer meets the 10.4%? Or, because it continues to be +ve and better than you could get investing with a bank should you continue on?

    Profile photo of melbearmelbear
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    @melbear
    Join Date: 2003
    Post Count: 2,429

    Welcome wirrumbirra

    The 11 sec sol is a filtering tool, that is telling you what your rental yield is, and is a good indicator of whether or not a property will be cash flow positive. If int rates keep rising, it will not be such a good indicator.

    Your CoCR is a totally different beast, and this is where you can do your own subjective analysis to see if you are happy with that return, or if in fact you could beat it elsewhere (ie the bank), and/or get CG as well.

    Cheers
    Mel

    Profile photo of wirrumbirrawirrumbirra
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    @wirrumbirra
    Join Date: 2003
    Post Count: 6

    quote:


    Welcome wirrumbirra

    The 11 sec sol is a filtering tool, that is telling you what your rental yield is, and is a good indicator of whether or not a property will be cash flow positive. If int rates keep rising, it will not be such a good indicator.

    Your CoCR is a totally different beast, and this is where you can do your own subjective analysis to see if you are happy with that return, or if in fact you could beat it elsewhere (ie the bank), and/or get CG as well.

    Cheers
    Mel


    Melbear

    Many thanks for sharing this. I am looking forward to learning more. [:)]

    Profile photo of AdministratorAdministrator
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    @piadmin
    Join Date: 2013
    Post Count: 3,225

    Hi Allan and Wirrumbirra,

    Another way to see it is that it’s because there are 52 weeks in the year. If you divide the number of weeks by one half, or multiply by two, you get 104.

    Phil

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