Property is a popular investment strategy for Australians, but like any type of investment, there are risks to be weighed up alongside the potential rewards. It’s vital to be well informed about the pros and cons of property investment before you begin building a portfolio.
A successfully managed portfolio can mean financial independence later in life. This is a long term game, so if property investment is something that intrigues you, start laying the groundwork early to reap the rewards in the years to come.
If you own a home and are thinking about diversifying your investments by developing a property portfolio, it may not be as difficult as you imagine. For some homeowners, the equity in their current property can be enough to invest in a second property.
Equity is the difference between what your property is worth and your remaining mortgage balance (which includes available redraw funds). So if the value of your home has increased since you bought it, and in that time you’ve also paid off a chunk of your mortgage, you’ll have built up equity that you may be able to leverage to buy your second property.
If you’re already in this position or are working towards it, here are some steps to help you start building your portfolio.
Like many things in life, the idea of a perfect portfolio is highly personal. It depends on your goals, your personal and financial situation, and how much risk you can handle.
This means that what works well for others may not be the right strategy for you. For example, some people may have made a fortune by buying older properties that they have renovated and flipped. Others may have made money by buying new houses and holding over the long term.
There are dozens of ways to build a property investment portfolio, but there’s one strategy that trumps them all: balance.
Regardless of your situation, age or experience, balance is the one thing that can help you maximise your profit and minimise your risk. It’s the one thing you need to factor in your portfolio if you want to succeed as an investor.
What is a property portfolio?
A property portfolio is a collection of investment properties owned by an individual, a trust or a company. Individual investors typically live in one of the properties they own and rent out the others.
In some cases, the rental income they earn on a property is greater than their loan repayments; in others, it is less. When the rental income is greater than an investment property’s outgoings, the property is said to be positively-geared; when it is less, it is said to be negatively-geared.
Most people get into property investment to set up an income stream that steadily flows into their bank account whether they turn up to work or not. So positive gearing is typically preferable to negative gearing.
But high competition among landlords means that it’s not always possible to earn enough rental income to keep in the black. And current legislation allows investors to deduct losses made on an investment property against their taxable income, so negative gearing has some perks, too.
What does a balanced portfolio look like?
When it comes to property, most investors have a similar aim: build a portfolio that pays for itself each month, while consistently growing in value.
To achieve this, you need some properties that deliver high rental yields and some properties that promise high capital returns, as it’s rare to find properties that offer both.
The former can typically be found in regional working cities such as Geelong, Ballarat or Bendigo, tourist meccas like Cairns, or in any other areas that attract large numbers of people to live on a short-term basis – and can offer yields up to 7%. The latter can be found in aspirational suburbs with long-term, family appeal, and can offer capital growth of up to 5-10% per annum.
Balance can also be achieved by pursuing a policy of diversification. Buying properties in different states will reduce your exposure to location-specific downturns, and investing in both residential and commercial property will help you weather storms in either market.
How do I build a balanced portfolio?
While all paths lead to Rome, each investor will need to chart a slightly different course to reach the promised land of positive cash-flows and long-term capital growth. And they’ll need to take their time, as a property is a long-term investment strategy, not a get-rich-quick scheme.
Speak to your bank
Your mortgage lender or bank can help you determine what your current property may be worth and how much equity could be in it. If you’ve only recently purchased your property, you may need to give your equity some time to grow.
Once you have enough equity in your property, you may be able to use that towards a deposit for your next property purchase.
Define your investment strategy
When it comes to owning investment properties, are you looking for rental yield or capital growth? Ideally, you’ll have a strategy in place that delivers both, but this is not always possible.
Broadly, a positively geared property means that the gross rental income is greater than the ongoing costs of owning the property.
If you’re on a high income, you may choose to prioritise capital growth because you’re confident you can cover the cost of the mortgage. Alternatively, some investors choose to negatively gear their properties to reduce their tax payment at the end of the financial year.
Negatively geared properties are those where the rental income is less than the ongoing loan repayments and other costs. The losses incurred in renting the investment property can then be offset against your salary, which ultimately reduces your total taxable income and therefore, the amount of tax you have to pay.
Pick your property
Once you’ve decided on your investment strategy, you can begin looking at what properties are available on the market and where you want to buy.
Make sure you budget for all the costs that come with owning an investment property, such as council rates, management fees, and home insurance for landlords, as well as periods in which the property may not be tenanted.
What are you trying to achieve?
Depending on your goals, your financial situation and your risk appetite, you could take a more aggressive approach or a more subdued one to growing your property portfolio. Either way, your approach needs to be well calculated and in line with your personal goals and risk appetite. What is the point of building a big property portfolio with many investment properties if you can’t afford to hold them? Similarly, you should know what level of investment is safe for you so you can take the required calculated risk and avoid limiting your potential. It is vital that each property you buy serves a clearly defined purpose and helps you achieve the end goal, don’t just buy properties for the sake of owning them.
What is your starting capital?
You may have $50,000 to $60,000, or you might have $200,000 to invest. With $50,000, you should be able to purchase one property below market value and use its equity in six to 12 months to purchase another (if your lender will let you). With the right strategy, you may be able to use one deposit to buy many investment properties over time, but probably not straight away. If you more savings, perhaps $200,000, you may be able to buy four properties below market value, then access the equity on those four to buy four more in six to 12 months. While you can buy a property with a lower deposit, you will also need to cover the cost of lenders mortgage insurance which adds a high cost to the investment and increases the waiting time to withdraw equity. Is it worth waiting and saving up your pennies, or is it better to invest with what you have got right now? Are there other sources of capital or assets which you can use to generate a property deposit? Either way, the savings and the deposits you are able to affect the rate at which you can grow your property portfolio.
What type of properties are you purchasing?
Purchase “bread and butter properties” – that is, properties with expected continual growth. If your properties are growing by around five per cent each year, then your portfolio will be paying for itself in the background while you focus on living your life. Aside from purchasing with upside for growth, you should always buy below market value so you can establish a net worth position from day one, and leave a buffer in case you need to sell quickly. For this reason, it is important to be wary of all bargain cash cows, and not all positive cash flow properties make good long-term low-risk investment prospects. Buying properties with a neutral to positive cash flow means that your portfolio will be taking care of itself and not hurting your personal cash flow each week.
How have you structured your financing?
It is of utmost importance to set up the right borrowing structure from the very beginning of your investing. It is no good to go and buy your first property, only to find out 12 months down the track that you can’t access your equity to purchase more. Choosing the right broker with experience in financing large property portfolios can be the difference between accumulating a large portfolio quickly, and getting stuck after purchasing one or two properties. The same can be said about your success team at large. The right financial planner, accountant, solicitor and buyer’s agent will all partner with you to help you achieve your goals. The wrong ones – those with no knowledge or experience in the property investment strategy you have chosen – will do nothing for your success.
What is your mindset?
Are you committed to achieving your goals? Do you believe they are possible? You may be held back by fear of what could happen, or you may not want to invest in properties that you wouldn’t live in yourself. Either way, fear and negativity will only hold you back. Replace your fears with due diligence, and research the market and your finances thoroughly. If you are making the right sort of purchases, in the right order and line with your goals and the suggestions of your success team, you are minimising the risk the best you can. After you have done this, you just need to stick to your strategy – and do it with guts.
There are many books and blogs to read; as well as courses that budding investors can take. When it comes to property investment, the more informed you are, the better off you‘ll be. Talk to experienced investors, accountants and real estate agents to get current market advice.
Uninformed and naive investors can quickly find themselves in all sorts of trouble. Educating yourself helps you to avoid the pitfalls and gives you the ability to spot and take advantage of opportunities that the property market offers.
Your investment goals will determine the strategy you employ in building your portfolio, so it is important to pinpoint your exact aims. Consider the following:
- At what age would you like to retire?
- How much money will you need to live on each year when you stop working?
- How much total income will you need to support yourself in retirement?
- What proportion of your retirement income should come from your property portfolio?
To determine how much income your portfolio needs to provide, develop a timeline based on your current age and your planned retirement age. Pinpoint the short, medium and long term goals you will need to reach to achieve that figure. This information will be vital when it comes to choosing a suitable investment strategy.
There are many elements to consider when determining which investment strategy is best for your needs. They include:
- Residential or commercial property?
- Should you buy established property, new stock, or off-the-plan?
- Will you hold your properties over the long term?
- Alternatively, do you want to renovate for profit and use that profit to invest in higher quality property?
- If renovating is on the cards, what costs will be involved?
- Should you buy for high rental yield, meaning you’ll be taxed on the rental income?
- Should you buy for capital growth, which can generate significant returns over the long term?
- Can you take advantage of negative gearing? (This is usually a better option for high-income earners who plan to hold property over the long term).
The answers to these questions will guide what type of property you’ll want to buy, and which suburbs or areas to search in. There are risks associated with various strategies that must also be weighed up.
Once you’ve settled on your goals and strategies, it’s time to consider how your portfolio might be structured.
When developing a portfolio structure, here’s what to consider:
- What is the best way to control your assets?
- Where can you create flexibility so that profits can be distributed and tax benefits maximised?
- How can you protect your assets, and yourself, from possible litigation?
- What expenses do you need to account for?
You can structure a portfolio in multiple ways, including family and discretionary trusts, under a company name and or in your own name. Self-managed super funds are an increasingly popular option. It’s important to consider which is best for you; this will depend on your goals, risk profile and if you are buying for yourself or with another person. Whichever option you choose, it’s vital to set up your portfolio in the most effective way right from the start.
It’s a good idea to speak to a mortgage broker about what size deposit you need and how large a loan you can service.
Before speaking to a broker, develop a clear picture of your financial situation including loan information, salary details, credit card statements and more. A mortgage broker will also need your credit report. Any outstanding issues should be attended to before beginning the investment process.
- What type of loan will you take out? For example, an interest-only loan can maximise your available cash, but paying down the principal also has benefits. Each option comes with its own conditions and repayment amounts.
- What are the benefits of fixed-rate loans versus variable loans?
- It’s important to choose a loan that best matches your investment strategy. For example, a loan with a great interest rate might seem like a good idea – but what is the penalty if you decide to pay out early? An investor who plans to renovate and sell for a profit in the short term may face a significant fee for exiting the loan early.
When it comes to repaying the loan, you must factor in:
- Are you able to meet mortgage repayments?
- If not, how will you make up that shortfall?
- What will happen if interest rates rise and your repayments increase?
Having some money or assets will assist when getting a loan. Those who already own property can use that equity to take out a loan for an additional property. Wherever possible, aim to put down a deposit of 20 per cent to avoid the added cost of Lenders Mortgage Insurance.
There’s little point in beginning your property search until you know how much you will be able to borrow. Online calculators can help but should be used as guides only. And remember that pre-approval from a bank is not necessarily a guarantee of a loan.
Other Financial Aspects
When building your portfolio, you should also consider the following:
- What tax benefits are available?
- How can you best take advantage of these?
- What will additional costs need to be accounted for? (Legal fees, stamp duty, strata fees, property management, maintenance and more)
- Could you use an offset account to reduce the amount of interest paid on loan?
When it comes to property investment, there is a lot to consider. Being an informed investor will put you in the best possible position to reap the potential rewards of property investment.
In the end, it is your mindset which determines how fast you will grow your property portfolio. If you set your mind to the task of achieving your goal, soon you will find it materialising in front of you. At Klearpicture we have seen investors start with very little and traded in their car to get a deposit who have now built bigger portfolios than those who have started with hundreds of thousands in savings but never fully committed themselves to live out their dreams. We have much young staff within Binvested who are great examples of what you can do when you put your mind to it.