Ben Hughes

At the moment I’m knee-deep in investment options, trying to get my head around negative gearing, transactions costs and lots of other fun stuff.

Yesterday we bought a new house. For the last 5 years we’ve been working fairly hard to pay off our unit. We’ve always planned to buy a bigger place and keep the unit as an investment property. Now that the time has come, we need to work out if that actually makes financial sense.

I’ve been randomly tweeting about this stuff as while thinking it through, and some people have asked questions that are too hard to answer in 140 characters. So I’ll attempt to go through it all here. Of course, this isn’t financial advice for anyone else: it’s just my understanding of my situation. It’s quite likely I’ve completely messed this up. Once I think I have a fairly clear idea of things I’ll be seeing a financial advisor. You should too.

Broadly, we’re considering two options: keeping our current place and renting it out, or selling it and buying something similar to rent out. At this stage we’re not looking at other investment options.

Some numbers

Lets say the unit is currently valued at X. 5 years ago we bought it for 2/3X and currently owe 1/3X. That is, we’ve paid off roughly half of the original mortgage.

We’ve bought the new house for roughly 2X. To pay the deposit and stamp duty on it, we’ll be re-drawing everything we’ve paid off the unit’s mortgage, bring that mortgage balance back to 2/3X.

The trick to working all this out is to remember to treat both loans as part of the same portfolio, rather than trying to calculate things seperately. Regardless of how things are arranged, the maximum debt we can be in is 80% of the value of the portfolio (X + 2X), ie 80% of 3X, or 2.4X.

Scenario 1: Keep the unit

Here we start with 2/3X debt on the unit’s mortgage. We then borrow (2.4-2/3)X = 1.73X, which is the most we can borrow while staying under 80% total debt:equity. We have 1/3X in cash (redrawn) which takes us just over the 2X needed for the new house, with almost enough to cover the 4.5% stamp duty.

Because the unit has been owner occupied, only interest on the current 1/3X mortgage balance can be claimed as a tax deduction. This turns out to be an important part of the calculations.

So, we have a total debt of 2.4X, with the interest on 1/3X being tax deductible. The rental rate of the unit is enough to cover repayments on the exiting 2/3X loan, plus a little left over. After a year we may, if lucky, make about $5000 profit. Maybe.

Because we’re making money, there’s no other tax advantage in this scenario.

Scenario 2: Sell and buy

As before, we take out a loan for 1.73X and redraw 1/3X. Now, we sell the unit for X, pay out the 2/3X loan and are left with 1/3X cash (minus stamp duty etc). This goes off the new mortgage, reducing it from 1.73X to 1.4X.

Now, we buy an investment property exactly the same as the original unit, for X. We borrow *all* of that money, using the equity in the new house. This means we have 1.4X + X = 2.4X debt, and 3X equity. 80%. Yay.

At this point it looks a lot like things are the same as in scenario one, except we had the hassle and transaction costs of selling and buying the units. But lets look at how the debt is distrubuted.

The home loan has 1.4X debt, and has no tax benefits associated. The unit loan has X debt, the interest on which is all tax deductible. The rent we receive will not cover the repayments, and any net loss is also tax deductible. This means a proportion of the repayments we make are tax deductible.

Let’s compare

Here’s the crux: in both scenarios we have a debt of 2.4X and are making the same repayments on that debt. In scenario one none of the repayments are tax deductible. In scenario two, a proportion of the repayments we make (those above the rental income) are tax deductible. And, of course, a larger percentage of the interest is tax deductible as well.

What does it all mean?

If there were no transaction costs the clear winner is scenario two: same overall debt and repayments, much better tax benefits. However, 4.5% stamp duty is a significant cost. Back of the envelope, it would take at least a couple of years for the tax benefits to make up for the transaction costs. In the mean time, we have to find the cash to cover the stamp duty: we can’t borrow it without going over 80%.

A rule of thumb

Basically, the more you owe on your current property as a proportion of its current market value, the more attractive it is to keep it as an investment. Provided of course than you can afford to buy a new place while keeping your total debt:equity under that magical 80%.

To me this is pretty counter-intuitive and really highlights how ridiculously complicated our tax system is.

For us, it’s borderline. So borderline that I’m going to a financial planner to get them to crunch the real numbers. I think in the medium term, scenario two will end up winning out.

Thoroughly confused now? Awesome. That makes two of us.

Footnote: what’s this 80%?

80% debt:equity ratio is the level below which you don’t need to purchase mortgage insurance, which is quite costly and usually rolled into the loan. It’s also easier to get approval if you have at least 20% skin in the game.

A very scary thing happened to me earlier this year: I started to grow up. After I turned 30 in January things seemed to naturally progress in that direction. I was already doing a job that made career sense, rather than something I was passionate about. I started shaving regularly - like every couple of days; and getting my hair cut every 6 weeks. I started wearing dress shirts every day instead of just when I felt like it. My wife and I started looking at buying a bigger house.

Finally, I was becoming a grown-up. But it all started to unravel when I realised that what I meant by “growing up” was “giving in”.

In the beginning I had a really positive feeling about the changes. I like looking decent, so making that happen regularly was nice. I was starting to get used to (and occasionally enjoying) my more management-oriented role at work. It felt like I was taking the next step. But I wasn’t. I was jumping onto a different track. It was incredibly draining.

That’a a lot clearer with hindsight. After some soul-searching I decided to go with passion rather than career progression and landed a new job.  It’s a 100% technical role and I’m loving it. I may well still be in the honeymoon phase, but all of the things that used to worry me have gone. There’s essentially no hierarchy, so comparative career progression is not even possible, let alone a concern. The environment is as casual as you can imagine and because I cycle to work now, pretty much every day is jeans and a t-shirt day. I shave… well… when I remember. I’m not worried about the problems of the organisation: there don’t seem to be many, and CEO’s more than capable of handing whatever there is.

After looking at some IT industry salary figures, I’ve realised that I’m in a very sweet spot. Firstly, I’m paid competitively to do something I love. Secondly, the higher paying management-oriented jobs don’t really pay that much more, until you get into the CIO level.

I came so close to embracing a me that doesn’t exist, to becoming what I thought I should be rather than what I want to be. And while I have plenty of room for personal improvement, it’s amazingly freeing to leave the expectations (mostly my own) behind and go with what I love.

God, I hope I’m never tempted to grow up again.

Posted via email from Ben’s Stream

It’s been a pretty average week at work, so I was happy to look at job ad when someone sent one my way. It sounded awesome: big picture, big results stuff. I was thinking about applying until I realised that it would be a non-technical role, which completely put me off. 

A few months ago I moved from a part management part technical role to almost purely technical, and I’ve been seriously enjoying it. But despite that, it doesn’t feel like what I want to be doing for the next 30 years. 

What do I want to be doing for the next 30 years?

I enjoy technical work so long as it’s tied to a higher purpose. Collaborative problem solving and technical leadership stuff are also up there, and I’m fairly comfortable with looking after staff. But start talking about budgets, Gannt charts,  project plans and “resources” and I’m looking for the door. Which leads to a bit of a confession: I’m not a finisher.

I mean, sure, I get things done, but by the time I’m 80% there I’ve lost interest. All the “personality tests” back this up - using HDBI terminology I’m imaginative and analytical, with a decent amount of interpersonal, and almost no sequential aptitude. That is, big on ideas and problem solving, decent with people, and not so good on the details. Knowing those traits is one thing, but mapping them to a career path is something else, particularly in my current organisation.

So why, when a job comes along that seems to be a great match for me, do I brush it aside just because there’s no technical component? What’s so important to me about being a developer anyway? Is it just the comfort of working from a safe knowledge base, or is it something deeper?

For many reasons outside of this, now is not a good time for me to be looking at changing jobs so I won’t be applying. But if I want to make any sort of progress from here on I think I need to understand what’s holding me back.

Maybe I need a life coach. Hell, maybe I just need a holiday.

There seems to have been a strange trend developing in some circles of management in the last couple of years - a relentless optimism that is almost depressing to observe. It’s nothing new that the self-help-guru cross doublespeak dialect that passes for management language absorbs and spits out phrases without taking much notice of their intended meaning, but lately it’s really getting on my nerves. Particularly the phrase “it’s OK to fail”.

Now of course it is OK to fail, in fact it’s unavoidable if you actually do anything. The idea behind having a culture that’s accepting of failure is that people won’t try and cover them up, and as a result the organisation as a whole can learn from the experience. The first step in establishing a that kind of culture is to encourage people to be open about it. Unlike the current trend where a failure is re-spun almost as if it were intended as a lesson from the outset, it’s important to actually acknowledge that something went wrong.

We learn from failure because it’s painful. It is somewhat perverse that by spinning everything as a positive, the organisation is denied the opportunity to actually learn from the failure because the pain is never felt. I’ve talked to people who insist that there are no negatives - everything is just an opportunity for improvement. They don’t seem to understand that by under-selling the downside, they are effectively undermining any real chance for improvement. Because by not acknowledging the scale of the problem the appropriate time and energy cannot be invested in solving it.
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