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.
How to avoid the top 4 mistakes, made by beginner investors
There are many potential pitfalls and challenges along the road to property investment success.
The advantage of being a novice investor in today’s world is that plenty of others have already made the mistakes for you. Learn from these simple yet common mistakes and investment portfolio will be off with a running start.
Mistake #1: Not having a plan! Get started as quickly as you can but make sure you have a clear strategy. Property is typically seen in Australia as a stable investment but unfortunately this doesn’t mean that just by purchasing any property you will generate a sufficient return. Property type, location, rental yield and growth prospects must be matched to your objectives. Investing in the right property is the foundation of a successful portfolio; consider if it will earn you a regular profit or leave you out of pocket and it’s ability to enable you to invest again within 12 to 18 months.
How to avoid it: Firstly, start by clarifying your goals. What do you want your investments to do for you? Do you want them to enable you to retire early? Fund an overseas holiday every year? Build your dream home? How much income do you need your investments to generate for you to reach your goals? Once you have this information, enlist the advice of a property strategist. They will match your personal situation and goals to properties that will help you achieve them.
Mistake #2: Failing to maximise your borrowing position. This is one of the biggest obstacles to rapid portfolio development. Many investors are attracted to the simplicity of dealing with their usual bank. They fail to realise how much their borrowing capacity can be affected by dealing with a single lender and how much it can differ between lenders.
How to avoid it: Shop around for a proactive mortgage broker who specialises in property investment. Along with your mentor, they will become a critical part of your investment ‘team’ – and the best part, they don’t cost you anything.
Mistake #3: Trying to self-manage a property in a location where you don’t reside. The best investment opportunities are unlikely to be close to where you live. To maximise returns and mitigate risk you need to take a nationwide and diversified approach. This often means holding property thousands of kilometres away from where you live. Trying to self-manage to avoid agent fees all too often ends in disaster. Unpaid rent and a poorly maintained property will soon cancel out any savings you have made on agent fees.
How to avoid it: Use the local experts. A good property manager won’t feel like a drain on your return. They will have a good corporate leasing client base, know how you can achieve top rent and most importantly, provide you with piece of mind that your asset is being well managed and maintained.
Mistake #4: Lack of long-term support. It is very easy to get ‘lost’ on your investment journey. It requires a disciplined, business-like and persistent approach. A lack of support in these areas is why many give up if things don’t go exactly to plan.
How to avoid it: Like a mortgage broker, an investment strategist or coach is a vital element of your support team. These are the people who have done it all before, and very successfully. They will provide ongoing assistance to ensure you stay on track, maintain motivation and reach your objectives.
Make the most of the professional services available to you. Taking advantage of these resources and learning from others’ mistakes will ensure you’re in the best position possible to maximise and fast-track your success.
Is it a smart move to purchase a home before an investment property?
As Australians, we place a high importance on owning our own home. After a car, it is usually our next ‘big ticket’ purchase and is considered one of life’s major achievements – a symbol of a sound financial position.
But is it? Is buying a home as a your first property purchase really a smart move?
The old mantra of ‘rent money is dead money’ has been so entrenched in our culture that many of us fail to clearly assess the financial impact and consequences that can come with purchasing a home as your first property. The decision to purchase a PPOR first can weaken your financial position and servicing ability with banks, and increase your cost of living. More often than not, you will also find you have to live in an area that does not tick all your boxes due to affordability.
If you had the choice of purchasing your dream home in five years, or a lesser quality, poorly located home now – wouldn’t you wait?
A mortgage delays your wealth creation potential. Many first home buyers and beginner investors jump straight into buying a property to live in. In the vast majority of situations, it is going to cost you more to own your own home than to rent. To maximise your property investment potential, the best approach is to keep your living expenses as low as possible while you establish your investment portfolio; monthly mortgage payments on your PPOR will only hinder your borrowing capacity and slow your ability to grow a portfolio. Continue renting or live with family and resist non-essential spending while you improve your financial position.
How the living costs weigh up. An example of buying a PPOR versus renting and investing a $500,000 property in a positively geared market and continuing to rent:
- Deposit: $50,000
- Loan: $450,000
- Repayments (principal + interest, rate of 6%): $675/week
- Cost to you: $675/week
Positive investment property –
- Deposit: $100,000
- Loan: $400,000
- Rental income: $1,100/week
- Repayments (interest-only, rate of 6%): $461/week
- Profit: $639/week
- Rent a $500,000 property: $500/week
- Total profit: $139/week
All too often investors who choose to purchase a home to live in as their first property find themselves in a position where they have to wait a number of years to be able to purchase again.
While living in your own home may be tempting, the benefit of remaining in the rental market while you spend a few years developing your investment portfolio means you can fast track your portfolio growth and maximise your net worth.
A little sacrifice in the short term can mean a far better financial position and lifestyle in the long term!