Property is a popular investment option for Australians, but like with any investment, there are risks to consider as well as possible rewards. Before you start establishing a portfolio, you should be thoroughly informed of the benefits and drawbacks of property investment.
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 want to diversify your investments by building a property portfolio, it might not be as tough as you think. For some homeowners, the equity in their current home may be sufficient to invest in a second home.
The difference between the value of your home and the outstanding mortgage balance is your equity (which includes available redraw funds). So, if the value of your home has improved since you bought it, and you've also paid off a portion of your mortgage, you'll have equity that you may use to buy your second home.
If you’re already in this position or are working towards it, here are some steps to help you start building your portfolio.
The concept of a perfect portfolio, like many other aspects of life, is very personal. It is determined by your objectives, personal and financial circumstances, and risk tolerance.
This means that what works well for others may not work well for you. Some people, for example, may have made a fortune by purchasing older buildings and renovating and reselling them. Others may have made money by purchasing new homes and holding them for a long time.
There are thousands of strategies for building a property investment portfolio, but one technique stands above the rest: balance.
Balance is the one element that can help you maximize your profit while minimizing your risk, regardless of your situation, age, or experience. If you want to be a successful investor, you must include it in your portfolio.
What exactly is a property portfolio?
A property portfolio is a group of investment properties owned by an individual, trust, or corporation. Individual investors usually live in one of their properties while renting out the others.
In some circumstances, the rental revenue from a property exceeds the loan instalments; in others, it is less. When rental revenue exceeds outgoings on investment property, it is considered to be positively geared; when it falls short, it is said to be negatively geared.
Most people invest in real estate to create an income stream that will go into their bank account whether they show up to work or not. As a result, positive gearing is usually preferable to negative gearing.
However, due to the high level of competition among landlords, it is not always possible to make enough rental income to stay in the black. Furthermore, current legislation permits owners to deduct losses on investment properties from their taxable income, so negative gearing has certain advantages.
How does a well-balanced portfolio appear?
When it comes to real estate, most investors share a common goal: to create a portfolio that pays for itself each month while continually increasing in value.
To do this, you'll need some properties with high rental yields as well as some with strong capital returns, as it's uncommon to find both.
The former can be found in rural working cities like Geelong, Ballarat, or Bendigo, tourist hotspots like Cairns, or any other city that attracts a big number of people to live on a short-term basis - and can give yields of up to 7%. The latter are found in aspirational areas with long-term, family appeal and can provide capital growth of up to 5-10% each year.
Balance can also be attained by following a diversification policy. Purchasing properties in several states reduces your exposure to location-specific downturns, and investing in both residential and commercial real estate will help you weather storms in either market.
How can I create a well-balanced portfolio?
While all roads lead to Rome, each investor's trip to the promised land of good cash flows and long-term capital growth will be slightly different. And they'll have to take their time because investing in real estate is a long-term strategy, not a get-rich-quick scam.
Contact your bank
Your mortgage lender or bank can assist you in determining the value of your current home and the amount of equity it may contain. If you just bought your home, you may need to give your equity some time to build.
When you have enough equity in your home, you may be able to utilize it as a down payment on your next home.
Establish your investment strategy
Are you seeking for rental income or capital growth when it comes to investing in real estate? You should ideally have a strategy in place that provides both, but this is not always attainable.
A favourably geared property is one in which the gross rental income exceeds the continuing costs of ownership.
If you have a large income, you may prefer to prioritize capital growth because you are confident you can make the mortgage payment. Some investors, on the other hand, seek to negatively gear their properties in order to lower their tax bills at the conclusion of the fiscal year.
Negatively geared houses have rental income that is less than the ongoing loan repayments and other expenses. The losses sustained while renting the investment property can subsequently be credited against your wage, lowering your total taxable income and, as a result, the amount of tax you must pay.
Choose your property
Once you've settled on your investing approach, you may start looking at available homes and where you want to buy.
Budget for all expenditures associated with owning an investment property, such as council rates, management fees, and landlord home insurance, as well as periods when the property may not be rented.
What are you trying to achieve?
Depending on your goals, financial status, and risk tolerance, you could adopt a more aggressive or more conservative strategy to build your property portfolio. In either case, your approach must be well calculated and consistent with your specific goals and risk tolerance. What's the sense of amassing a large property portfolio full of investment properties if you can't afford to keep them all? Similarly, you should understand what amount of investment is appropriate for you so that you can take the necessary calculated risk without limiting your potential. It is critical that each property you purchase has a specific function and contributes to your overall aim; do not simply purchase properties for the sake of owning them.
What is your starting capital?
You could have $50,000 to $60,000 to invest, or you could have $200,000 to invest. With $50,000, you should be able to buy one house at a discount and leverage the equity in six to twelve months to buy another (if your lender will let you). With the right plan, you may be able to use a single deposit to purchase a number of investment homes over time, but not immediately. If you had additional funds, say $200,000, you could be able to buy four houses for less than market value, then use the equity from those four to buy four more in six to twelve months. While a lower deposit can be used to purchase a home, you will also need to cover the cost of lenders' mortgage insurance, which adds a significant cost to the investment and lengthens the time it takes to remove equity. Is it preferable to wait and save your pennies, or is it better to invest with what you have now? Is it possible to generate a property deposit using other sources of funds or assets? In any case, your ability to save and deposit money affects the rate at which you can develop your property portfolio.
What kind of properties are you looking to buy?
Purchase "bread and butter properties," or properties with long-term growth potential. If your properties rise at a 5% annual rate, your portfolio will pay for itself in the background while you focus on living your life. Aside from buying with potential for growth, you should always buy below market value to establish a net worth position from the start and leave a buffer in case you need to sell quickly. As a result, it is critical to avoid all bargain cash cows, and not all positive cash flow properties make good long-term low-risk investment opportunities. Purchasing properties with neutral to positive cash flow means that your portfolio will take care of itself and will not deplete your own cash flow each week.
How have you structured your financing?
It is critical to establish the proper borrowing structure from the start of your investing. It's no good buying your first home only to discover 12 months later that you can't access your equity to buy another. Choosing the correct broker with experience in financing large property portfolios might mean the difference between easily building a huge portfolio and becoming stuck after buying one or two properties. The same may be said for your entire success team. The right financial planner, accountant, solicitor, and buyer's agent will work with you to achieve your objectives. The wrong ones, those that have no understanding or experience in the property investment approach you've chosen, will do nothing to help you succeed.
What is your mindset?
Are you determined to reach your objectives? Do you think they're possible? You may be hesitant to invest because you are afraid of what can happen, or you may not want to invest in properties that you would not live in yourself. Fear and negativity will only hold you back in any case. Replace your worries with diligence, and extensively investigate the market and your money. If you make the correct purchases in the proper order, in accordance with your goals and the recommendations of your success team, you are reducing risk to the greatest extent possible. After that, all you have to do is stick to your strategy - and execute it with courage.
There are numerous books and blogs to read, as well as courses available to aspiring investors. When it comes to real estate investing, the more knowledgeable you are, the better off you will be. To acquire current market guidance, speak with professional investors, accountants, and real estate brokers.
Uninformed and inexperienced investors can soon find themselves in a bind. Educating oneself allows you to avoid traps and to recognize and capitalize on possibilities in the real estate market.
Your investment objectives will affect the technique you use to develop your portfolio, therefore it is critical to define them precisely. Think about the following:
- When would you prefer to retire?
- How much money will you need each year once you quit working?
- How much total income will you require in retirement to support yourself?
- How much of your retirement income should come from your real estate portfolio?
Create a timeline based on your current age and your planned retirement age to determine how much income your portfolio needs to provide. Determine your short, medium, and long-term objectives in order to reach that figure. This information will be critical when deciding on an appropriate investment strategy.
When selecting which investing strategy is appropriate for your requirements, there are numerous factors to consider. They are as follows:
- Is the property residential or commercial?
- Should you buy existing stock, fresh stock, or off-the-plan?
- Will you keep your possessions in the long run?
- Alternatively, do you wish to renovate for profit and reinvest the proceeds in higher-quality real estate?
- What would the expenditures be if you decide to renovate?
- Should you buy for a high rental yield, which means you'll have to pay taxes on the rental income?
- Should you buy for capital growth, which can offer big long-term returns?
- Can you benefit from negative gearing? (This is usually a preferable alternative for high-income earners who intend to keep their property for a long time.)
The answers to these questions will help you decide what type of home to buy and which suburbs or places to look in. Risks associated with alternative strategies must also be considered.
After you've decided on your goals and methods, it's time to think about how your portfolio should be organized.
Here are some things to think about while creating a portfolio structure:
- What is the most effective strategy to manage your assets?
- Where can you add flexibility to maximize profit distribution and tax benefits?
- How can you shield your assets and yourself from potential legal action?
- What expenses must you account for?
A portfolio can be structured in a variety of ways, including family and discretionary trusts, under a corporate name, or in your own name. Self-managed super funds are becoming more popular. It is critical to assess which is ideal for you; this will depend on your goals, risk profile, and whether you are purchasing for yourself or with someone else. Whatever choice you choose, it's critical to start your portfolio in the most efficient way possible.
It's a good idea to talk to a mortgage broker about how much of a deposit you'll need and how large a loan you'll be able to service.
Create a comprehensive picture of your financial condition before consulting with a broker, including loan information, salary figures, credit card statements, and other documents. Your credit report will also be required by a mortgage broker. Before beginning the investing process, any unresolved issues should be addressed.
- What kind of loan are you going to get? An interest-only loan, for example, can maximize your available cash, but paying down the debt also has advantages. Each choice has its own set of terms and repayment amounts.
- What are the advantages of fixed-rate loans over variable-rate loans?
- It is critical to select a loan that best fits your investment strategy. A loan with a low-interest rate, for example, may appear to be a smart option, but what is the penalty if you decide to pay it off early? An investor who intends to remodel and sell for a profit in the near future may be charged a substantial penalty for paying off the loan early.
When it comes to debt repayment, you must consider:
- Are you able to make your mortgage payments?
- If not, how will you make up the difference?
- What happens if interest rates rise and your repayments rise as well?
Having some money or assets will help you acquire a loan. Those who currently own property can leverage their equity to obtain a loan for a second property. Aim for a 20% deposit whenever possible to avoid the additional cost of Lenders Mortgage Insurance.
It's pointless to start looking for a home before you know how much money you'll be able to borrow. Online calculators can be useful, but they should only be used as a guide. Also, keep in mind that a bank's pre-approval is not a guarantee of a loan.
Other Financial Considerations
When constructing your portfolio, keep the following in mind:
- What tax advantages are available?
- How can you make the most of them?
- What additional expenses will be incurred? (Legal fees, stamp duty, strata fees, property management, and maintenance, among other things)
- Could you utilize an offset account to minimize your loan interest payments?
There is a lot to think about when it comes to property investment. Being an educated investor will put you in the greatest position to realize the benefits of property investment.
In the end, your perspective will determine how quickly you expand your property portfolio. If you set your mind to reaching your goal, you will soon see it materialize in front of you. At Klearpicture, we've seen investors who started with very little and traded in their car to earn a deposit build larger portfolios than individuals who started with hundreds of thousands of dollars but never completely committed to living out their ambitions.