How do you build a portfolio you can retire on?
The ultimate goal for most property investors is to create a portfolio that will eventually provide them with enough cash to live off.
Indeed, residential property is becoming increasingly appealing as an asset class among SMSFs and among those who are waking up to the grim reality that their superannuation and pension are going to fall drastically short when they come to retirement age. For others among us, we simply want to live a life of financial freedom as quickly as possible!
I’m often asked by investors: “How many investment properties do I need to retire?” That’s a question that can’t be easily answered. Rather than a question of properties, it’s a question of “how much positive cash flow should I be generating?” Or, “how much equity do I need?”
For example, you may have several properties in your portfolio but if they haven’t increased much in value and/or they aren’t putting profit in your pocket each week, then you’re no closer to retiring than you were when you started investing! In fact, you’re further away than ever as your portfolio is costing you money, rather than making you money.
Another investor, may have just two properties in their portfolio. However, they made some smart property selections and seen their portfolio and rental income significantly increase in value in a just a few years.
So, how much do you need to comfortably retire for, say, 20 years? My current basic method of calculation when working out how much we need is based on $100,000 per couple per year for 20 years. Which means we need $2 million to comfortably retire on a 20 year timeframe.
The second question I’m asked is “how do I achieve this through property investment?”. There are several strategies – each with their advantages and disadvantages. The one that will work best for you comes down, as always, to your personal risk comfort level.
Strategy 1: Positive cash flow
This strategy focuses on building a portfolio of cash flow positive properties until you are generating $100K per year in profit.
Pros: The 20 year timeframe doesn’t apply here, assuming cash flow is maintained. You have the option to continue to build your wealth using your income and equity, and you will have some excellent assets to pass onto your family. Importantly, this strategy won’t leave you out of pocket while you’re building your portfolio!
Cons: Maintaining your portfolio (as opposed to selling it off) means you will remain at risk of market fluctuations during your retirement phase. Unless you pay down at least some of your debt, you will also maintain high levels of debt. You also need to be willing to continue managing, at least to some degree, your portfolio of rental properties.
How to do it? Creating this level of positive cash flow is challenging but certainly not impossible. It is founded on solid research which will identify areas where there are positive cash flow properties and some capital growth. Locations are likely to be regional areas undergoing significant economic development, which do generally carry greater risk. Once invested, with your cash flow and sufficient market growth, you should be able to purchase again within 24 months. Repeat this formula until your annual cash profit from your rental income has reached $100,000. Make sure you have a sound risk management plan in place and you are regularly (every six months) reviewing your portfolio and the markets you’re active in so that you are well positioned to react quickly to any negative situations.
Strategy 2: Growth – and then liquidating
This is probably the lowest risk strategy. It focuses on capital growth alone – building a portfolio of growth properties until you’ve created at least $2 million equity. At which point, you sell them and live off the cash profit.
Pros: Low risk. You’re not at the mercy of the markets as you have liquidated your assets and transferred the cash profit to a savings account and/or other low risk investments.
Cons: Your cash won’t last forever. A strict timeframe will apply and you will need to budget carefully. You also won’t have any property assets to pass to family members.
How to do it? The main issue with this strategy is that you are negatively geared. You will be relying fully on capital growth for financial gain. Smart property selection is crucial so thorough research is required to ensure you’re buying property that is going to deliver sufficient capital growth. As with strategy 1, if you can locate areas that deliver in excess of 10% growth a year, then you should be in a position to add to your portfolio every 12 to 18 months. The number of properties you need to invest in before you find yourself with $2 million in net assets will vary greatly between investors and will depend entirely on market growth and whether you have been paying down any of the principal.
Strategy 3: Growth – and then paying down debt
This strategy is combination of 1 and 2. You build a portfolio of both cash flow and growth properties. Once you’ve created sufficient equity, you then use some of that equity to pay down debt, essentially turning your negatively geared properties into positively geared properties and creating/increasing your passive income.
Pros: This strategy allows you to create a passive income to live off while maintaining your growth assets.
Cons: You will still be at risk of market volatility and will need to manage, at least to some extent, your remaining rental properties. You will also still have some debt.
How to do it? Focus on acquiring two or three high yielding properties first to provide cash flow security. Then, diversify into a couple of capital city properties to offer long term growth security. With this combined capital growth and positive income, look to reduce LVR across your portfolio to around 50% over a five to 10 year period. This will increase your cash flow, provide higher security and reduce risk during the retirement income phase.
Regardless of the strategy you choose, remember to seek the appropriate advice from your property investment strategist, financial advisor and accountant to ensure you’re making the right decision for your financial situation and goals.
Step 2 to conduct due diligence like a pro
In my last blog I discussed a simplified due diligence process to help you undertake market risk assessment in a more manageable way.
As promised, this blog will set out the due diligence process that you should follow once you have identified a potential investment property.
When get to this point, it’s important not to let your emotions take over. If you’re satisfied with your market due diligence, you may think you’re onto a winner. But failing to thoroughly investigate the property itself can have dire consequences.
No one wants to find out months into having purchased an investment that it has serious issues which could significantly affect your return. Identifying potential issues will help you avoid buying a dud or it will arm you with the ability to negotiate on purchasing terms.
While your settlement agent will be able to assist with some or all aspects of your property due diligence, it’s essential that you’re aware of what’s required. It starts with asking the vendor for a copy of the contract of sale.
The contract of sale contains information on what the vendor is offering to sell you – but it’s not always clear and the standard inclusions will vary from state to state. Below is a list of what it may or may not include. Where information is not included, you should source it for yourself, or request that the vendor provide it as a special condition of the contract. What is provided to you by the vendor should be checked for accuracy. Even if you never intend to occupy the property yourself, these factors can affect the property’s value and its tenant appeal.
Your property due diligence check list:
1. Land survey – Ideally, the sale contract will include a plan of the land, or land survey, (standard in some states) but it many cases it won’t. A land survey is particularly important if you are intending to sub-divide or develop. Lenders also often require an up to date survey.
How to get one: If you haven’t been provided with one, you can source one from the state land authority or, you may need to appoint a surveyor to undertake one. Even if you are provided with a survey, you’ll need to check that it’s consistent with the actual property and you still may need to appoint a surveyor.
What the survey will provide:
· The dimensions of the land
· The location of the property in relation to other houses and cross streets
· Identification of any easements which may permit a person (usually a government authority) to use your land for running electrical mains or drainage. Easements can affect how and where you build on that land.
· Identification of any restrictive covenants which may prevent you from using the land in a particular way such as not building above a certain height
2. Sewer plan – this shows the location of any sewer mains and the property’s connection to them. As with electrical and drainage easements, if your property contains a sewer main, it may affect your use of that land, potentially preventing you from building on it or near it.
How to get one: Your local water authority will be able to provide you with information on your water and sewerage connections and a sewer plan (for a small fee).
3. Zoning or planning certificate – Zoning information may be included in the contract for sale in the form of a zoning certificate or as part of the Certificate of Title (depending on which state you’re in). It will inform you of what the property can be used for, what planning and development regulations apply and whether it has sub division potential.
How to get one: Your state land authority or local council will be able to provide you with an official record of the property’s zoning for a fee.
4. Local planning and development documentation – in some states, the vendor will be obligated to provide information from the local council indicating whether any works are planned on adjoining properties, local roads etc which could affect the use and value of the property. It’s also worth checking with the vendor or agent if there have been any problems with the neighbours.
How to get this: The local council will be able to provide you with information pertaining to civil development plans and building approvals in your area.
5. Building inspection and termite reports – You must ensure that the building’s structure is sound and not affected by termites if the property is located in a problem area. If buying a strata property, providing this information will be the responsibility of the owners corporation.
How to get this: You may be able to request a building inspection report from the vendor using your chosen licensed builder or architect as a special condition of the contract. Alternatively, you can undertake this yourself with your chosen person.
6. A list of fittings and chattels included with the property – this might seem obvious, but sometimes what the buyer expects and what the seller is offering can vary. Items that can require clarification include carpets, blinds, certain appliances, garden sheds etc. If in any doubt, make sure you check what fixtures are and aren’t included and have these clearly stipulated in the contract.
7. Additional considerations for strata properties – If you’re looking to buy a property under a strata scheme there is some additional due diligence to be done. You’ll need to find out what strata levies you’ll be required to pay, if the financial position of the strata company is solid, and assess its ability to maintain the property and its building insurance policy.
How to get this: You’ll be able to request all this information from the strata company (owners corporation).
Once you’ve satisfied your market due diligence and property assessment criteria, then it’s time to put in your offer!
NEXT WEEK – How to negotiate like a pro and tip the odds in your favour!
Placing your property investment in the right hands
Selecting the right property manager will make a significant difference to the success of your investment property – in terms of rental income & protection of your valuable asset.
It’s worth spending the time selecting your PM carefully to ensure you select the right person for the job the first time round.
How to spot a star performer!
Firstly, find out who the service providers are in your property’s area. Those that are well established in the area should have considerable market knowledge and insight which will help position your property for the best returns and tenants.
Online research is a great way to check them out. Find out what other investors are saying about their services. Facebook, forums, Google etc will potentially all have reviews on your prospective PM.
Also take a look at their property listings – where they are placed and the standard of their listings. Have they used quality images and copy? Are the properties presented well?
Ideally you want to select an Agency and PM who is largely focused on utilising the digital space to market properties. The vast majority of renters search for properties online and this will ensure your property attracts maximum interest.
At the very least, they should cover realestate.com, Domain, your state’s Real Estate Institute, as well as their own website. While print advertising still has some value in some areas, it has become an increasingly unpopular approach – the costs of marketing your property are built into the management fees so make sure they are being invested well.
This should help you weed out a few at the first stage. Then you can undertake your own interview process with the rest.
During the interview process you will need to establish:
They have extensive local knowledge
Your PM should have sufficient local insight to be able to offer you advice on improvements you could make on the property to increase its appeal to the local renters market and maximise rent. This could include reducing the garden maintenance by replacing high maintenance plants with water wise, hardy varieties, putting in air conditioning or clearing space for a second off road parking area.
They employ a thorough tenant application process
It’s amazing how many horror stories you still hear about tenants not paying rent and trashing properties.
Where possible, you want a property manager that has strong relationships with corporate tenants. Securing a corporate tenant isn’t always possible though so your PM should also have stringent measures in place to ensure your tenant passes the relevant checks. Ask them how their tenant application process works. As a minimum, they should be checking for steady employment, sound previous landlord references, no listing on the national tenancy database and have full confidence in their financial position. Many PMs don’t document their checks sufficiently. This doesn’t mean they’re not choosing the right tenants, but if something does go wrong, the information isn’t there for you to refer to. All this information should be recorded by your PM and you can request to see it.
They take a proactive approach to inspections & maintenance
These should be conducted every three months and the findings reported along with any maintenance. This is your PM’s opportunity to note, regardless of any requests by the tenants, any issues they observe at the property. Items which are the responsibility of the tenant, should be brought to the tenant’s attention immediately and rectified by the next inspection.
You must be confident in your PM’s ability to stay on top of your property’s maintenance on your behalf. Otherwise it can lead to costly repairs and property devaluing.
They have a policy of open, regular communication and they are responsive
The inspection report should form part of the quarterly property report your PM provides to you to keep you informed. Ask for an example of what their reports look like to ascertain the level of detail and professionalism.
A lack of regular communication and responsiveness is one of the biggest complaints from investors in regards to their property management service. Make sure they have systematic communications in place and that they stick to them.
There are a wide range of fee options offered by the industry, review them carefully when selecting your manager but cheapest is often not always best. Weigh up the services you’re getting for your money – it’s worth paying a bit more for peace of mind, security and care of your valuable asset!
Holidays – The perfect time to plan your next investment move!
Holiday downtime can provide the perfect opportunity to reassess your current investment position, conduct a portfolio and financial health check and plan your next investment move – putting you in the best position to maximise returns in the new year.
Portfolio health check
Take a no nonsense look at each property in your portfolio, how it’s performing and whether it could be improved.
Strategy – First, review your strategy and goals. If your portfolio is not currently meeting your objectives, establish a plan to realign and improve performance. If your portfolio is negatively geared, you may need to revise your approach to focus on positive cash flow investments so that you’re not left out of pocket in 2014. Or, you may need to consider properties that will deliver some instant equity if your portfolio has not been growing as rapidly as you had hoped.
Finance – Are your current products and lenders providing you with the most competitive interest rates and fees? If you’re not sure what you’re paying, request this information from your loan provider and then compare with other products available. Utilise comparison websites and mortgage calculators. If you find better deals elsewhere, use this information to have your broker renegotiate with your current lender first to assess whether they can offer better terms. If not, consider refinancing – it could make a significant impact on your return.
Tax planning – Start preparing your investment property records well ahead of the new financial year to ensure you’re maximising your interest and tax depreciation deductions, and you have recorded any costs that can be used against Capital Gains Tax should you decide to sell in the future. Your property manager is the best person to access and provide you with this information.
Also review with your accountant whether you are utilising the best form of property ownership for tax purposes and your personal circumstances.
Maintenance – Up-to-date maintenance is critical in attracting the right tenants and rent, which in turn maintains the value of your property. Your property manager will be able to tell you what maintenance should be prioritised. Plan out what needs to be done, particularly if a lease is due to expire.
Structure – Is your portfolio structured to facilitate fast growth? Having all properties tied up in a single structure can be a major disadvantage as it often reduces your borrowing capacity and the ability to find better deals with other providers. Consider separating new investments into standalone structures so that equity in each property is protected, enabling you to continue building your portfolio by using a line of credit against the properties which have generated equity.
Equity – Establish what equity your portfolio may have generated by having the properties re-appraised by your local real estate professional. Also consider how some aesthetic improvements or additions could create equity that would allow you to expand your portfolio. Talk to your mortgage broker. This will give you an idea of what you have to work with for your next investment.
Plan your next move!
Spend some time utilising the wealth of free online resources to identify locations which display all the signs of good yields and capital growth. Research key factors such as industrial growth, infrastructure investment and low vacancy rates which suggest a population on the increase.
Investigate specific investment opportunities in your target areas, looking at those close to key infrastructure that would appeal to high salary workers, and calculate the potential yield and growth. Create a shortlist of opportunities and questions you have for the agents and you’ll then be ready to hit the ground running in the new year, giving your portfolio a flying start to 2014.
Maximise your equity to build a portfolio quickly
There are many factors that can impact your buying power when investing in property. Being aware of them and understanding how they can drive or limit your strategy is the key to fast portfolio growth.
Utilise LMI to get started sooner. If you are just starting out on your property investment journey you will either use a saved deposit or equity in your home to make your first investment. First time investors shouldn’t delay their wealth creation by waiting until they have a 20% deposit to get started – it’s common to borrow 90% and take out Lenders Mortgage Insurance (required if your deposit is less than 20%) to get into the market as quickly as possible. LMI is an acceptable and tax deductable method to get your portfolio started and growing. When your portfolio has generated sufficient equity you can start to buy properties with a larger deposit – without requiring LMI.
Maximise your buying power. Each lender has different assessment criteria and your approved amount could differ significantly between lenders so shop around to make sure you are maximising your borrowing capacity and getting the best interest rate structure.
As you grow your portfolio, you will want to diversify your lenders. It can be tempting to stay with the one lender for simplicity but there is ultimately a limit as to what a single lender can offer. Using different lenders provides greater flexibility of products, reduces risk and provides more opportunity to further build your portfolio.
The best way to make sure you’re getting the best deal every time is to engage the services of an experienced mortgage broker – one that specialises in investment property. A good broker will know which lenders are likely to be more flexible with their borrowing capacities and will offer a variety of products from different lenders. Developing a long term partnership with a broker is a key element of a successful investment strategy and rapid portfolio growth.
Create instant equity. Look for opportunities in the market that will deliver instant equity within six months of settlement. Instant equity might come in the form of a house and land package, renovating a well-located but older unit, or adding an extension, such as a granny flat. If a property can deliver at least $50,000 equity through one of these means you will be very well positioned to purchase again within 12 months.
Unlock value. As a property’s value grows, the equity in the asset increases providing a source of funds to borrow against. ‘Unlocking’ this value allows investors to buy more property quickly without needing to save for a deposit. Maximising the equity in the property will increase your borrowing capacity and could even generate enough for you to invest in more than one property.
Agents will often provide free valuations to give you an idea of the market price and can also offer advice on how to improve a property and which areas you should focus on. However, lenders will do their own valuations and investors should be prepared for these to come in under what they believe the market value to be. Keeping the property well maintained and making aesthetic improvements will ensure you achieve the highest valuation possible.
Pick your investment strategists carefully
Today’s property investor is faced with an increasing number of investment options delivered by “experts”, all promoting their strategies for success.
With so much on offer how does the modern day investor select this all important mentor to advise, motivate guide them to investment success?
Before engaging with any property investment strategist, investors should undertake their own due diligence to ensure they are taking advice from someone experienced in the market with a proven track record of success – not someone with a mandate to sell product.
A true mentor can offer unbiased, honest advice and develop a strategy in line with your financial capabilities, goals and appetite for risk. They will put you on the right path to achieving your goals.
Here are the TOP 4 questions to ask your strategist to separate the investment coach from the overzealous salesperson:
- Are they themselves a successful property investor?
Take advice from those who have already walked your desired path. Ask them how long they have been in the market, what their portfolio looks like and where they have had successes and failures.
- Do they own or are they investing in property in the areas you are discussing and what products have they invested in? Are they established houses, apartments, off-the-plan, development sites?
They should practice what they preach. If they are not taking their own advice, there is cause for concern.
- What is their current investment strategy and growth achieved?
Your strategist should have the ability and confidence to share their own investment strategy with you and the growth and cash flow they are achieving from their portfolio. This includes how they have structured and financed their investments, techniques for maximizing equity and cash flow, where they have bought and why and where professional support services are required. This is not undertaken with a view to replicating their own model for success – everyone’s financial situation is very different – but they must be able to demonstrate a depth of knowledge and experience across all facets of property investment – finance, investment and property markets.
- Ask to speak to a number of their long term clients who have successfully created wealth with their help
Many will have case studies and success stories to refer you to but it is also extremely valuable to speak direct to other investors who can tell you one to one what their experiences have been like. Positive client references are a reliable indication of the credibility and capabilities of your strategist.