Granny flats are a very popular topic at the moment. What we’re going to talk about today is the benefits and the downsides of doing so, and how that affects your borrowing capacity as well.
I get asked all the time from people looking to invest: should I construct a granny flat or should I buy a granny flat? There’s not a lot involved in it, but it’s good to just shed some light on the benefits, pros and cons.
Should you build a granny flat?
The short answer is it really depends on where it is, specifically which suburb. Obviously, a lot of people aren’t doing them in Sydney because most investors aren’t contributing that amount of money. Investing in a million-dollar property and then spending more money on a granny flat is even more expensive in Sydney.
But then if you talk about the markets where they are moving to, the outskirts of Brisbane, Adelaide, Newcastle, all of these more affordable sub-1 million dollar markets, it really comes back to the demographic who are living in that area.
At a high level, you want to try and purchase in a market that’s dominated by owner-occupiers because they’ll drive the growth.
When a bigger proportion of granny flats start to influence a market, you’re changing the ratio of owners to investors in that market. That’s why I say it’s suburb specific, because if you’re buying in an area where you have affluence and you have people who like the feel of a neighbourhood and community, people will not buy a house with a granny flat and have a right of way down the side of their house or people coming and going at all hours.
Granny flat rental yields
Most granny flats are rented out and they’re not expensive to rent out. Again it depends on where it is, but with granny flats you’re sort of looking at $500 per week to lease out.
Two-bedroom, modern kitchen, everything. Quite affordable. Even cheaper than apartments really. But as you said, very much dependent on where you are.
If we look at Newcastle as an example. You’d be hesitant on buying a $3.5 million property in Bar Beach and then throwing a granny flat at the back. It does really well for your out-of-pocket expenses each week, but who’s going to want to buy that?
That’s the thing: it’s important to just keep in mind what the end goal is. Are you an investor where you need to increase your yields to be able to go and refinance and keep expanding your portfolio? It makes sense in a situation like that to add a granny flat to try and increase your yields so you can keep servicing more debt.
But you’ve got to take into consideration what house you are adding that granny flat to and will it diminish its end value? If it will diminish its end value, then take that into consideration for when you’re expanding your portfolio.
Evaluating the resale market for investors
Always consider the end value and the market that you’re adding it to. If you’re buying in a lower socioeconomic suburb like Jesmond in Newcastle, a granny flat might make sense because it’s more affordable housing and most of that market is dominated by investors.
You’re going to resell to an investor who’s the biggest cohort in that market. But then it also comes back to the fact that investors make financial decisions, so they’re going to take that into consideration with the resale price. It really depends on the market itself and what the goal is for expanding a portfolio.
I know a lot of people who come to me are just mum and dad investors, and all they want to do is add a granny flat to the back of a property because they need to service the debt. But then it doesn’t really make sense.
The typical strategy is they buy an $800,000 property. They need a $200,000 cash contribution to put a granny flat in the backyard. They then get an increased valuation based on the end value of $1.1 million.
Even yields in these markets are still only 5%. You’re not cash flow positive. We’ve done modelling on it with the granny flats: you are literally buying your rental income. You just pay $250,000 for a granny flat to get $500 bucks extra to service that debt. At the end value, you’ve paid off that money with somebody else’s money. It’s fine, but it does diminish the end value.
Borrowing capacity and serviceability benefits
If you increase the end value of the property to $1.1 million in this circumstance, you’re still only cash flow neutral before expenses.
It doesn’t really make sense unless you just have a serviceability shortfall and you need to increase your yield to keep expanding your portfolio.
We’ve talked about on previous episodes that people are buying through corporate structures and then basically putting a granny flat in there. Then that corporate structure is cash flow positive quite soon, literally within 12 months. When they go to buy another property through another corporate structure, that original property with the granny flat is excluded because it’s cash flow positive and you get a letter from your accountant saying that it’s trading profitably.
That’s the reason why people are doing it. What people really need to think about is that it is a good way to grow and get three or four properties, but then you’ve got three or four properties of the same thing. There’s no diversity in your assets; location would probably be the only differing factor. Which can be a bit of a concern.
Conclusion: why you should do your research first
To recap: it can work, it’s just location dependent. But just bear in mind that it significantly reduces your owner-occupier appeal, which can affect your capital growth. Again, buy in markets where your primary demographic are investors. Like Dee Why on the Northern Beaches; 53% of people in Dee Why are investors buying in that market.
Do your research. Don’t just think it’s a blanket fix for all things. Start thinking about whether that would reduce the owner-occupier appeal in that area. That’s it for today. In a future episode we will talk about other dual occupancies. Dual occupancy specifically will be a better topic than just granny flats. Granny flats have been a very popular topic of late, so we just wanted to unpack whether that’s a good idea or not. Thank you. See you on the next one.