Ep 35. Releasing Equity with James O’Brien
In this episode, Michelle chats with James O’Brien from Shore Financial about the benefits of releasing equity.
Here’s what you’ll learn from today’s episode:
What does releasing equity mean?
Could releasing equity be beneficial during the rental crisis?
Why some families are choosing to release equity to buy property together
Do you still need pre-approval if you have released equity?
Speakers in today’s episode:
Michelle May - Michelle May Buyers Agents
James O’ Brien - Shore Financial
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VIEW TRANSCRIPT
Michelle May: Hello and welcome to another episode of the Buy Your Side podcast, the property podcast, to help you make smarter property buying decisions. My name is Michelle May, and I am the principal of Michelle May Buyers Agents here in Sydney. Now, when I do my research for what we can possibly talk about and impart knowledge on to those listeners out there, I came across an article recently, which was one of the salubrious papers, little bit extreme from time to time, but they had an article where some ingenious person had hung up some Ikea curtains on an enclosed balcony and put it up for rent for a $300 a week. It did come with “cooked rice, and cooking stuffs and cleaning stuffs”. But it begs the question, are we now getting to a point where renting is so crazy expensive out there that we're getting close to a point where you may as well buy a property?
So my mind immediately turned to James O'Brien, the fantastic financial guru from Shore Financial, to talk about this a little bit more in depth. How are there smarter ways of getting into the property market, either by yourself or with maybe help from Mum and Dad? So once again, James, thank you so much for coming on the show today. How are you?
James O'Brien: Very good. How are you, Michelle?
Michelle May: I'm good, thank you. Look, another day, another dollar. Real estate up and down, it's always crazy. And I came across this article and immediately I thought, we have to discuss this. I mean, I sent it to you, you saw the pictures. What are your thoughts?
James O'Brien: Oh yeah, that's mental. The pictures of the actual property that you showed me, the balcony that they've enclosed to rent out as a property is ridiculous. That shouldn't be allowed. Each to their own, I suppose.
Michelle May: Yeah, it is. I mean, this person's obviously being smart. They want an extra bit of income. I feel sorry for the poor person who has to put themselves in that situation. And you and I both know where that is, that's in the centre of Sydney. But you don't go a day without hearing about the rental crisis and how difficult it is to rent. So, now that the prices of renting have become so high, I put it to you, what does it actually look like to buy and what would the difference between buying and renting? So, if we're talking about a two bedroom apartment with a cost of, what were we talking, $900,000 - $950,000, can you run us through the numbers and what that would look like? I recently bought an apartment for $950,000 for a client that would rent out for $900 a week. Two bedrooms, two bathrooms, one car. So if we take that as a model for the listeners out there, what would that actually look like with mortgage repayments?
James O'Brien: Good question. It depends on the size of the loan, so how much cash they're putting in to purchase the property. You said $950,000 as a price point. Let's do two price points: if we said, $900,000 and we assumed that the property buyer was a first home buyer, in New South Wales they'd be eligible for two separate first home buyer grants, or options. One of those being the First Home Buyer Guarantee, which waives their requirement to pay Lenders Mortgage Insurance. The other one being the First Home Buyer Choice, which negates their requirement to pay upfront stamp duty and instead they pay an annual land tax. If they're buying a $900,000 property and they're qualifying for both of those, then they can actually buy the property with $50,000 cash. That's all the cash they need. And then their loan would be $850,000. There or thereabouts. So if they're buying for $855,000 as a first home buyer, they've got minimal cash that they'll need to put in only $50,000. On a typical owner-occupied interest rate at the moment of say previously 4.8% or 4.9% with the most recent RBA increase of 0.25%, 25 basis points, the monthly repayments would be about $4,600, or a weekly repayment of $1,077.
Michelle May: Right? So $177 more than if you were to rent it. Wow. I mean, it's another $200 you need to cough up, but at least it's something that's becoming yours. Do you think that that divide has never been smaller, between renting and and buying?
James O'Brien: Good question. I mean when the rates were so low, the repayments were incredibly low, so rents were lower as well. Particularly during covid, when people were struggling at first, people were struggling to actually rent their properties out, and you had people that were breaking lease and moving into a bigger, better rental property for a much lower price.
And now the pendulum has swung completely the opposite way, where we have a shortage of rental properties and people are paying a premium to get into them. So back then the interest rates were so low, even though rents were lower, it was almost comparable, whereas now it's almost out of desperation and due to lack of rental supply, it would be questionably easier for someone looking to rent, it would be questionably easier for them just to buy and then they own the asset as well.
Michelle May: And particularly now with all the incentives in New South Wales, that really makes a big difference.
James O'Brien: That price point you mentioned before of $950,000. If it was in that hypothetical, and let's say it's someone that had a bit more cash, or they're able to access cash from family. They did either a guarantor loan or parents, let's say parents gifted them some funds. So perhaps parents released equity on their property. Gifted them some funds and their loan was an 80% loan. 80% of a $950,000 property. $950,000 is a loan of $760,000. So in a case like that, the monthly repayments would be $4,150 and the weekly repayments $957. So that is equal to or close, very, very, very similar to the weekly rent, in that hypothetical you gave me before.
Michelle May: Yeah, absolutely. Let's face it, if you are in a position to knock on Mum and Dad's door, you could even consider getting a friend to take that second bedroom and help you pay down your mortgage and pay back your parents. Which brings us to what we initially had decided we were going to talk about, which was the benefits of releasing equity. Whether that's for your own gain, or whether it's for helping your children. So talk us through what does releasing equity actually mean for those people who've never heard that term before?
James O'Brien: So the equity available in your property is the value of the property that doesn't have a loan against it. An equity release, is you using that available equity and borrowing against it for another purpose. The most common sort of purpose that we see in day-to-day situations, is people releasing equity to purchase another property. Either they're upsizing, downsizing, or most common what I see is people using the equity available in their property to buy an investment property.
Michelle May: Are there different requirements, if you release the equity for different reasons?
James O'Brien: Good question. Not really. There are different impacts. So for instance, if you are releasing equity to buy a vehicle, which is completely acceptable, or if you're releasing equity to give those funds to your kids to help them buy properties, also completely acceptable. From the bank's perspective, that's an acceptable purpose for borrowing against the available equity or releasing equity. But in both of those situations, neither of those purposes of the funds generate income, so they wouldn't be impacting your borrowing capacity.
Whereas if you've got a property, you are releasing equity to buy an investment property and as a part of doing that, you're also getting a pre-approval in place to buy the investment property, well, then you can also factor in the proposed rental income, which would then impact your borrowing capacity. So, each scenario will vary slightly. But generally speaking, your question was, are the requirements the same? Absolutely. It's a home loan application, so you'd need all the normal stuff that you would for an application for finance.
Michelle May: And so I imagine you put in this request with the bank. Is there a maximum percentage that you can borrow?
James O'Brien: Yeah, good question. Absolutely. So pretty much every bank is going to be comfortable with you lending up to 80% of the property's value. Some banks have a greater risk for appetite and they'll be a little bit more willing to allow you to borrow over 80%, particularly if it is for the purpose of investing in another property.
Yeah. There are some banks that will be more relaxed about that, but the general rule of thumb is 80%. So there are really common examples that we'll see of people either upsizing or buying an investment property. I had one recently, actually, literally a few days ago where a client, about five years ago bought a property for approximately $1m for the sake of round numbers, we'll say $1m. And they bought with an 80% loan at the time. So an $800,000 loan. They got their property valued recently, and it was valued at $1.5m. Now they can borrow up to 80% of that current valuation, which would be a loan of $1.2m. Over the last five years, they'd paid their $800,000 loan down to about. $650,000 - $700,000 So the difference between that $650,000 - $700,000 and the $1,200,000 that they can borrow up to, it's $500,000. So they can use all of that to help them buy an investment property. Does that make sense? So, that $500,000, they can use that as the 20% deposit for the investment property and even to cover the cost of stamp duty and any other incidentals related with the purchase.
Michelle May: But they would still have to go through a pre-approval to ensure they can still do the repayments for that second property. Right?
James O'Brien: Definitely. Yeah, a hundred percent.
Michelle May: You can't just bypass that because you've got a chunk of cash.
James O'Brien: Yeah. That'd be awesome if you could. You are absolutely right. So on that, as a normal sort of part of the process, we'd arrange for the equity release to occur at the same time as doing an application for a pre-approval to firstly ensure that they've got their ducks in a row and also, from an affordability standpoint.
Michelle May: Yeah. That's still the biggest factor.
So it is worth going to a broker then, from what you're telling me because, going back to your original lender, they may give you the equity, but you still need to shop around for a new pre-approval, and maybe would it be right in thinking, would one bank over another potentially give you more than another? Run me through that because obviously I don't understand how that all works. .
James O'Brien: You're bang on the money there. That's absolutely correct. On the one hand, yeah, you've got more competitive offers and rates and better repayments. You may potentially have that at a different lender, but more importantly is that second point you address there - whichever bank you go to, they're going to do their own valuation of your property. And different valuers value the same property at different amounts.
Really good, fairly recent example is there was a terrace in Paddington. Really small terrace. I had one valuer from one bank, value it at $2.5m, another value it at $2.75m. Another value it at $3m.
Michelle May: Yeah. Wow. Can we just talk about that? That is kinda crazy. Like, I mean, that's half a million dollars, which you could buy a whole house for in Queensland.
James O'Brien: So it's a huge variance in the values. And each one of those, none of those were what we call a desktop or an automated valuation. They were valuations where a human had turned up, looked at the property and put a price on it. And they had, each of them had comparable sales to defend their argument or defend the value that they put on the property. But it is something that can fluctuate hugely, wildly as that example points out.
Michelle May: I'd love to see those valuations. Because I mean, this is what we do all day, right? We appraise property and have comparable sales and look at medium prices changing, we determine if this is a good street or not. Is that a good kitchen or not. But those valuers, my goodness. That's quite shocking.
So yes long story short, it does pay to come to you.
And going back to parents using the equity to help their kids, because I'm quite passionate about getting young people on the ladder. If Mum and Dad can help there, do you sometimes get the whole family coming to you and saying, hey James, we need help. Can you sort it all out? Is this becoming a more regular occurrence?
James O'Brien: I don't think it's becoming a more regular occurrence. It happens from time to time, but yeah, it's definitely something that does occur. Last year an interesting case I had was Mum and Dad wanting to downsize and daughter and son-in-law wanting to upsize and they decided to buy something that was multi-generational living. So Mum and Dad were able to, before selling the property, they just released some equity so that they could put in their contribution to buy the property and the kids, they had a bit of cash, but then were selling their property using equity from that and borrowing more, for them all to move into a big multi-generational place. And that looked like a main house with then a secondary residence out the back.
The term granny flat wouldn't be paying it enough credit. This thing was amazing. It was incredible, so it was like two residences on the one property. And it was perfect, it really fit the bill. But that was a good example of where, the whole family came to me and said, yeah, let's make this work
Michelle May: As buyers agents, I have noticed over the last couple of years, there has been a change in the wind there where we are getting more people who are banding together. Whether it is sisters who want to purchase an apartment together just to get more buying power, but also Mums and Dads who are helping kids. But also, that dual living so the granny flat and what have you, because it just gives you more buying power, right?
James O'Brien: Totally. It definitely does.
Michelle May: It is the way forward.
James O'Brien: Yeah. The one pitfall there is in getting the liability with someone else in the future, if you plan to do something on your own or with a partner that you don't currently have, then the financial arrangement you have with your friend or your brother or your sister can really impact that future borrowing situation.
Michelle May: And I think that, like we say in Dutch, you don't cross the ice over one night's frost. As if to say, you need to think about this. Don't go in feet first. And I would definitely recommend talking to maybe a solicitor or lawyer about this, setting up some rules of engagement. It's all great to get into it. It's all rose tinted glasses, but what happens in worst case scenarios and really discuss those worst case scenarios. What if your sister falls in love and wants to move out, like you said, or Mum and Dad need more care or whatever the case may be.
James O'Brien: I think rules, rules of engagement is a really clever way to put it, Michelle. That's smart. They're saying, if we are going to get into this, if there's gonna be, brother, sister, we're getting into this together and we're buying a place, let's have a plan.
So let's do it for five years. Once we've achieved X amount of growth in the property, then let's sell it. We'll both take the proceeds from the sale and we'll buy our own places.
Michelle May: But also similarly. What happens if the property drops in value? What do we do then? You know, if there's capital growth to be had, does the person who puts in more money get a bigger share? And when it comes to Mum and Dad releasing equity, is that a gift? Is that a gift to the kids? Or is it a loan? Does the loan have an interest rate? You know, is it an early release of your inheritance, all those things, they're uncomfortable conversations, but they need to be had.
James O'Brien: A hundred percent. All things that need to be considered
Michelle May: And we all know how it works when money is involved. It brings sometimes, unfortunately, it brings out the worst in people and you don't want to lose relationships over it, essentially. But you do see it happen, don't you? So be prepared to have those difficult conversations and definitely talk to your broker because it sounds like there's definite options out there to getting into the market. Maybe buying is a better option if your rent is crazy, and you are having to consider renting an enclosed balcony for $300 a week. I mean, I'm laughing, but inside I'm crying. I'm telling you, this is sad, isn't it? Hopefully this episode will give people some options to consider.
James, did you have anything you wanted to add? If nothing else, your phone number and your email on how to get in touch with you. Obviously if people want to reach out.
James O'Brien: Absolutely. Always here to help. So happy for anyone to get in touch. Contact number 0415 391 002. And email address jamesobrien@shorefinanical.com.au.
Michelle May: Well, thank you so much, James, for your always helpful explanation, in this case about releasing equity and the equation versus renting and buying. Thank you again for your time and hopefully we'll get you back on to discuss more things, mortgage and finance related.
James O'Brien: Oh, I would absolutely love that. Michelle, thank you as always for having me on. It's always a pleasure and lovely talking to you as always.
Michelle May: Talk to you soon and thank you for listening. I hope that was helpful. Until next time.