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Could this strategy be the cash cow you need?

For a relatively small outlay, this strategy could create instant equity and a handsome passive income. What do you need to know to get it right?

paul glossop1

Blogger: Paul Glossop, director, Pure Property Investment 

There are plenty of buyer’s agents out there looking to source properties with the potential for an ancillary dwelling (granny flat). And there is no shortage of property investors looking to buy existing council-approved granny flat/ house/ dual income properties.

But this raises the question: are these dual-income properties the holy grail cash cow they are made out to be?

Based on my experience, and that of my clients, if you get in early and do your checks and balances, there is a very tidy passive income and tremendous equity that can be generated for a relatively small outlay.

Below is a case study of an actual property we sourced in southwest Sydney in 2012.

We purchased a small fibro three-bedroom house on a corner block of around 550 square metres with the intent of adding a two-bedroom granny flat to the property. The house needed some TLC and it took some vision to see where the granny flat would go, given there were large trees and a garage where the granny flat was to be built. Nevertheless, we persevered and engaged a builder to cost it up and proceed with the build.

Whilst building this granny flat, the local council had only just changed the LEP (local environment plan) to allow these constructions on such small blocks. As such, we were out on our own a bit with no comparable market rentals or sales to truly see what rent and capital growth we would achieve. This was a calculated risk!

Upon completion of the four-month build of the granny flat, it took no time at all to find a suitable tenant. On top of that, the existing tenant in the house had agreed sign a fixed lease before the construction of the granny flat (knowing the construction was going to take place). This was important to ensure we had cash flow during the build.

So with both properties rented at a combined yield of around 9 per cent, we were happy as Larry with the final result right?

Wrong!

There was one huge issue we failed to factor in: how do we get a valuation that will reflect the great yield we’re now achieving? The problem was there were no comparable dual-income property sales in the area, so when we asked the bank to value the property we were handed a valuation that was less than we had put into the property! The silver lining was the fact that we had generated instant cash flow.

Fast-forward three years and we have recently had the same property revalued. Staggeringly, we have gained close to 100 per cent capital growth on the property valuation. Granted, the Sydney market has performed very well in that time so this was partly due to the land value rising during that time – but it was also largely due to the local area seeing more comparable house/ granny flat sales to value the property against.

The secret? Patience. The market needed time to turn over these types of properties before we could realise the equity in this project.

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The breakdowns for the total project are below:
Purchase price: $250,000
Granny flat build: $100,000

Current rent break down:
House: $360p/w
Granny flat: $315p/w

Current total gross yield on outlay: 10 per cent-plus
Current valuation (May 2015): $650,000
Total equity on initial outlay: $300,000

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Comments (7)
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  • avatar
    <p>I have a principle place of residence which I don't owe too much on, a SMSF Investment Property acquisition underway, and my very first investment property that I purchased 10 years ago for $198,000 at Gwandalan NSW. It has a small dwelling (1bd Fibro house, kitchen living dinning, bathroom and laundry, shed and carport) on a block size 506sqm - it has not had a lot of capital growth, however the rent covers the cost of the mortgage and I only owe $85,000 - Property Valued Recently at $260,000. I am of the mind set "don't sell", and a friend advised I should put a Granny Flat on the back... After reading your article (which she also recommended) I am considering the idea of building a Granny Flat and 2 x carports. - Would this be advisable, or would it be a bad investment considering the area and the slow growth.</p>
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  • avatar
    <p>Paul - good to talk to you in the last couple, and glad that we here at Ipswich Granny Flats could be of assistance. Looking forward to doing some work together ...<br>Sonia, Ipswich Granny Flats</p>
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  • avatar
    <p>That is a very detail explanation of the vital financing aspects to consider when - firstly- doing your due diligence on the total (parent) property investment. <br>The key with these developments, as you have alluded to is understanding the current and more importantly the future demand for both the tenancy demand for 1-2 bedroom granny flats in the area. Along with the Copa arrive sales for house + granny flat developments.<br>With this example, the development in question did not have comparative sales on the market to gain a solid market comparison. Though the recent council LEP changes and the local areas demand and projected jobs/ population growth meant that it was a calculated risk to build this elk of property.</p><p>Both the research of the property and the financing structure are as vital as each other. Get it right and you will reap the benefits, get it wrong and it may take years to re coup the losses.</p><p>The best advice:<br>Use an accredited buyers agent with relevant experience and examples And track record of success.</p><p></p>
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    Home loan Warehouse Wednesday, 17 June 2015
    <p>As someone who assists investors on a daily basis and almost as often sources granny flat loans I feel well qualified to answer the question, "are granny flats a holy grail cash cow?".<br>Firstly, I must confess a bias. I truly believe that cash flow in a property portfolio is like oxygen. It is essential to survival. So when I say I think that minor dwellings are a good idea then I am sure you will not be surprised.<br>However, at the finance end of things we deal with real numbers rather than projections so the results are real, the rental yields are the actual yields and we are limited by the valuations of the lender in question. <br>What we see is what you would expect. We see mixed results. Some great and some - well below average really. From our experience those investors who spend the correct amount of time of due diligence reap the rewards. Those who had over a little too much of the process seem to be at a disadvantage. Knowledge truly is power.<br>When you build a granny flat you are really becoming a property developer - all be it on a small scale .<br>On that basis those who achieve the best results look first at the product they are creating and what the demand for it is in the open market. Is it saleable in this market and is it saleable at a different stage of the property cycle. <br>It is only when they have satisfied this requirement do they look at other aspect of the proposed project such as yield. <br>What are the facts: On a square meter basis a granny flat is extremely expensive to build when compared to a larger dwelling. There a solid reason for this but the number do not lie. Because of this there is a risk that the value of the property after you build your granny flat will not have increased by the cost of construction. Or explained differently your increase in value for every dollar you spend is less than a dollar.<br>How often does this happen: Not often but is does happen so it is important to get two valuations before even considering construction of a minor dwelling. Firstly, we should get a bank valuation of the site as is with the existing house on it. This is our starting point. Secondly, we need to get an "on completion valuation" or as if complete from our lender to clearly establish the lender opinion of the project. <br>Are granny flats the holy grail? Well I would think not but they ARE a valuable strategy for the right investor buying the right property and creating the right mix of investment products. Results vary significantly as you would imagine. <br>Investors who make the right choice will be able to potentially make significant equity gains as well as stabilize the cash flows of their investment portfolio. Investors who build the wrong granny flats in the wrong location will spend more on construction than they increase the value of their properties by. This is a case of clear YES and NO signals from the market place. YES or NO that the market wants what you have created.<br>Significantly, in recent weeks all major lenders have significantly tightened their serviceability models. This simply means that the way the calculate what and investor can afford has been tightened. Not to exaggerate but these changes will significantly impact investors that have more than a couple of homes. <br>In this environment rental income and cash flows inside your portfolio are more and more important. The granny flat strategy may well solve some of these new income pressures. However. the key will be gaining correctly structured finance with the right lenders. <br>As most of you know I am a huge property nerd and would be happy to chat about property so feel free to contact me.</p>
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  • avatar
    <p>Definitely lots of pitfalls but some real upsides with dual income properties. I think they are a great addition to a portfolio once investors have 1-2 stable investments under their belt!</p><p>And completely agree on the use of a buyers agent to source the best properties... Money well spent for my husband and I </p>
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  • avatar
    <p>Big fan of these dual income properties.... We bought one through a buyers agent a few years back and it paying big dividends.... Great read!</p>
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  • avatar
    <p>Big fan of these dual income properties... They are tough to find and I'm all for using a buyers agent to source out the gold!</p><p>Get read</p>
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