Can I use the profits from a duplex development to start up a new business? Ask Margaret

Hi Margaret,

I am currently working full-time earning $875 per week after tax. I want to buy a franchise coffee business that is about $500,000 inclusive of everything.

If I buy a property and build a duplex, strata subdivide and then sell one for $600,000 and keep the other, can I use that money to invest in the coffee business?

Or does that $600,000 need to go back to the home loan repayment?

Assuming: 

• Purchase price of property - $650,000
• 15% deposit no mortgage insurance - $97,500
• Construction loan - $450,000
• Total loan - $650,000 + $450,000 - $97,500 = $1,002,500
• Repayment (5%) - $4,062 per month
• Rental income from one half of duplex ($450 per week)

Kind regards,

Daniel

Margaret's answer on the next page. Please click below.

Hi Daniel,

Regardless of what you intend to use the money for at the end of your project, when you borrow from a bank to purchase or develop residential property, you must at all times have in place enough security to cover the outstanding balance of the loan in the proportions required by the maximum LVR allowed.

In your case, you are after a 15% deposit loan ($85% loan). So, when the time comes to sell one duplex half, you must pay back enough of the original loan to ensure that the remaining loan does not exceed 85% of the remaining security.

In your case, if you ended up with two duplex halves each worth $600,000 and you sold one, the remaining security value is $600,000. This means the maximum loan you can have outstanding, at 85%, is $510,000.  If your loan was $1,002,500 you would have to repay $492,500.  You can keep the remaining $107,500.

Having said that, it’s probably not going to be so straightforward. 

Here are some things to think about:

1. Developments always cost far more than people realise.  Subdivision alone can run to more than $100,000 by the time you add a driveway and or even begin construction.  There are many costs and council contributions that people simply never think about that can blow out a development and mean that you don’t make any money or worse, come out behind the eight-ball.
   
   
2. When you sell you will pay capital gains tax at your highest marginal rate of tax.  If you sell inside 12 months, you pay CGT on the full gain.  So, let’s say the gain after allowable costs is $100,00, and you are in the 45% tax bracket, you pay $45,000 CGT.  If it is more than 12 months, the gain would be halved to $50,000 and you would pay $22,500.
   
   
3. When you sell a duplex, you will lose its rental income and when you start your coffee business you will be considered a new business. This will change your borrowing capacity – in fact it will probably be two years before you can borrowing anything.

I gather you are thinking of being able to put in place this loan now, while you are working, and then use the funds once you sell the property to provide a home loan rate loan for the business.  Unfortunately you won’t be able to achieve this.  Some lenders will, however, provide franchise finance and include a fit-out loan too, so this is the pathway you are better going down. 

If I may observe – starting a new business takes a lot of time and effort and I am not sure you want to complicate that by also taking on a development of this type.  Simplify your life by concentrating on one project at a time!