Are there more changes on the way from APRA – can it get tougher? The answer is yes so you need to prepare BEFORE you go to the bank. We discuss how to prepare a ‘financial buffer’ with Andrew Mirams.
Kevin: I did a video recently with Andrew Mirams from Intuitive Finance, and we talked about the changes with APRA, more changes on the way, even getting tougher for property investors. I’m going to continue that conversation in today’s show. Andrew joins me once again. I want to talk about financial buffers.
Good day, Andrew. How are you doing?
Andrew: I’m doing really well, Kevin, thank you. And you?
Kevin: Good, mate. Fine, thank you. As we said in that video, things are likely to get a bit tougher. Do we need to be thinking more about increasing that financial buffer? And maybe you might just describe what it is, Andrew.
Andrew: Yes, I think that’s a great point. Firstly, what is a financial buffer? We hear that thrown around quite regularly, and I think the average investor, someone doing it for themselves or thinking they know what they’re doing, probably doesn’t set themselves up correctly with these sort of things.
Any business, anyone running inventory or stock and things like that, has an overdraft that they trade through. It allows them to buy and sell their stock and deal with short-term cash flows and things like that.
In property investing, that’s exactly what a financial buffer is. When you’re buying investment properties and buying properties, it’s time that makes you money. The asset will make you money, but it only makes that over time. So, you want to buy time, and that’s exactly what a financial buffer really is.
Kevin: How big should that buffer be?
Andrew: That’s a great question, Kevin. Everyone’s situation is very different. You have your first-timers starting and they might be in one position, and you have your mid-tier investors and then your student investors.
But whenever someone has enough equity to at least buy a property or another property or something like that, I always try and look at what their rent is going to be and then what their costs might be.
Let’s say they’re going to earn $20,000 a year in rent but their costs are going to be $30,000. There’s a tax consequence and everything like that. We don’t talk about that; we just look at the net cash flow there of $10,000 a year.
We’d always like to try and have at least half of a property cycle. We talk about a property cycle being that seven to ten years, so always at three and a half to five years as a minimum. Hopefully that’s bought us enough time for the property to improve, and then we re-evaluate from there.
It’s costing you $10,000 a year, depending on your properties or whatever, and we do a little bit of analysis around that. It depends on what state you’re in, what rent yield, what your overheads are, and what type of property it is – body corporates versus a house and things like that. There might be maintenance.
We try and factor all of those things in and do a little bit of a back of an envelope and say “It’s going to cost you X amount. Now let’s try and multiply that by five times.” I think that’s probably a pretty good buffer to have. If you didn’t have to worry about your property for the next five years because you had the resource there to fund that, I think that’s probably a pretty good position.
Kevin: Over that five-year period, too, that situation, you would think it’s going to get a little bit better – wouldn’t you – as you pay down a bit of that debt, as well. So that buffer, while you wouldn’t change it, becomes even better the longer you keep it.
Andrew: Yes, it should do. Really, any client who has a home loan and then they’re buying an investment property for the first time, you want to make sure your personal exertion income is still going towards reducing the non-deductible debt, and you want to make sure your investible debt or your deductible debt is working for you.
While one might be coming down, the other one might be going up. But at the end of the day, what we’re trying to do is base it from your personal circumstances, making sure you have a personal buffer, that if you want to go on a holiday or there are some urgent repairs to home or your car needs to be replaced or something like that, that you have sufficient personal resources.
Then where we can, we want to make sure we also have… We don’t want to buy a property and then in a year, we’ve put someone in jeopardy that they have to sell because you won’t make money necessarily in a year. It’s over the journey that you really make money. By buying the right asset and then giving it time to grow is where you’ll make your money in property.
Kevin: At the opening of this chat, I mentioned about the Skype interview that you and I did, the video about APRA. Go back and have a look at that, too. It’s simply called “Are There More Changes on the Way from APRA?” Have a look at that because inside there, we talk about how the banks will start to look at you. You need to be looking at your disposable income.
I would imagine, too, Andrew, if you’re going to go to a bank and you talk intelligently about your buffer and you talk about what you’re suggesting, they’re going to have a lot more confidence in you as a borrower, aren’t they?
Andrew: Yes, if you’re a little bit more astute, you set yourself up well, and you get to the right people who can explain and articulate that, then yes, you’re going to get a far greater hearing because there is a lot more scrutiny on living expenses, there is going to be a lot more work around that.
There’s a lot of work being done to make sure that people aren’t over-extending themselves. So, by having yourself well-resourced with the right buffer in these times, it’s going to buy you that time.
We are going into a bit of a credit contraction. We started it a couple of years ago, and we’re still going through it where we have two markets – Melbourne and Sydney, particularly – over-heating and the regulators have some concerns there. They’re just trying to slow the markets down to a more normal pace, which from your and my perspective, Kevin, makes good sense.
Kevin: It does.
Andrew: We want slow and steady growth, not the boom/bust cycles because that’s not good for anyone. We don’t want to over-expose people and so probably, we haven’t been doing enough analysis around clients’ living expenses, people’s living expenses. Let’s get that right and then look at what their borrowing capacity is.
Make sure you have an adequate buffer in place. You’re better to have it and not need it, in my opinion, because when you need it the most is when you’re least likely to get it.
Kevin: As I’ve said a few times in here, it’s how you look to the bank. You could be even smarter than that. You could go and talk to Andrew and his team at Intuitive Finance who will take care of all of that for you and make sure you do look good when you talk to the bank.
Andrew Mirams from Intuitive Finance, one of our regulator contributors. By the way, if you have a regular question for Andrew, fire it in through the website. I’ll pass it on to him, and we’ll make sure that we answer it in one of our forthcoming shows.
Andrew Mirams, Intuitive Finance, thanks for your time, mate.
Andrew: Thanks, Kevin. We’d love to speak to anyone who thinks they could do with our assistance, and appreciate your time.