How to build a property portfolio in 2016
It seems like only yesterday that many ‘advisors’ recommended negative gearing as the strategy of choice to build a property portfolio. As a matter of fact, many people still think this is the best and only way to build wealth today. Unfortunately, they are wrong. Particularly in 2016.
This year smart investors are adjusting to the opportunities and trends emerging from 2016’s key market forces. These include :
- tightening financial approvals and serviceability requirements emanating from bank standards mandated by the Australian Prudential Regulation Authority (APRA)
- potential pockets of oversupply – largely in units – in a range of suburbs
- current and planned zoning changes approved to facilitate infrastructure improvements
- employment and population changes, particularly as a result of the slowdown in the resources industry and increased focus on innovation and housing as industries on the upswing
- green shoots of responses to emerging waves of change such as energy efficient housing materials, battery storage as a power source, electric (and soon to be driverless) vehicles
- new property categories and uses created by enablers like Airbnb
- easing capital growth rates in Sydney and Melbourne
- SMSF property purchases – for those who have rescued some funds from stock market.
More so than ever before, in 2016 diversification will be easier to achieve and the primary key to success, with a strong follower of adding value to release or unlock equity. If you have a range of properties, consider the trends above to ensure your existing portfolio is optimised.
In preparation to build your portfolio, the choices are extensive but the trends should influence your strategy to ensure targets are achieved as quickly as possible. Before deciding which is best for you, consider the following key strategic components.
Typically, pursuing a high yield strategy involves purchasing property with a yield of 7% or higher when considering rent as a proportion of the purchase price. Properties meeting this criteria may be well priced studios or units located closer to our CBDs, or houses located in outer or regional suburbs.
- the property will not require any cash top ups from you
- it is not dependent upon negative gearing
- if your circumstances change (you leave your job) you will not be forced into selling until you want to sell
- often at an affordable price point for early stage investors
- ability to locate suitable properties
- if selecting units – will have lowered ability to add value (although still a good opportunity)
- rent implications if a change in planning laws allows an increase in supply (more units being built)
This strategy is underpinned by the acquisition of property primed for capital growth of 8% or more each year. Prices rarely grow at a consistent rate and do not always rise, but properties supporting this strategy have projections for price growth over time. The properties are usually located within our CBDs in suburbs where growth drivers are prevalent.
- will not require as many acquisitions as high yield
- suits higher income earners who can wait for capital growth
- can require ability to cover loss as rental yield may not cover all costs
- may require a higher deposit as purchase prices are higher
- may slow rate of acquisitions due to serviceability requirements
Cash flow positive
Government planning rules have provided opportunities for this strategy to emerge and gain momentum, largely to accommodate our increasing population. Properties suiting this strategy often have two rental incomes and are located within CBD suburbs or large regional towns. Think dual key, where there is a three bedroom house attached to a one bedroom unit, or a house with a granny flat.
- rent can cover all costs
- may stand independently (not dependent upon your income)
- beware if depreciation and/or negative gearing is the only way new dual key properties are cash flow positive – if you leave your job, they will lose their positivity
- may require an extra cash injection initially – eg – to build the granny flat
This strategy involves a level of skill or experience. If this is your preferred approach and you don’t have experience, you will need to work with service providers who can complete the work for you. By selecting well and then through renovation or development, adding value can provide a boost to your portfolio by increasing both your property’s value and cash flow through a higher rent.
- can turn a negatively geared property into a positively geared property
- keeping within budget is critical
- ensure you don’t over capitalise – match the outcome to suit the market/tenants
Other strategy pillars
After giving some thought to the strategy that suits your requirements, you will need to consider the following three strategic pillars – property type, entities and market factors.
The range of property types you choose will often be dictated by the area you are purchasing in. The first decision you will need to consider is whether you prefer existing or new properties. Existing properties have the benefit of being tangible, however if purchasing new properties, you may have the opportunity to adjust or design the property to meet the market or your own requirements. Existing properties can often be renovated to add value, while new properties will have a higher depreciation percentage for the first few years of ownership and lower stamp duty. There are many other pros and cons, so be sure to run the numbers on each option.
The next choice involves the property type including units, townhouses, houses, commercial properties or a range of combinations. Once again, consider both the overarching and local market trends while making your selection.
Entities and structures
During the early stages of investing, the most appropriate way to purchase property may be in your own name, however it is best to ensure you obtain detailed advice on your longer term portfolio planning. Other entities for purchasing property include an SMSF, company, trust, partnership or joint venture. Selecting the most appropriate entity will have impacts on your tax and serviceability. The structure should match your overall plan, or end game.
In addition to entities or structures, you also need to ensure your loans are established correctly and effectively. Again, these choices will depend on your personal goals and the way you like to manage your finances, however you should give strong consideration to utilising interest only loans and multiple offsets where appropriate to facilitate paying down loans in a targeted way.
Market factors and location
A skilled investor knows the primary rule relating to market factors. That is, market factors should inform your strategy, not drive your strategy. Your next purchase should be made when you and your portfolio are ready, not when the market is in a ‘good’ stage. We have multiple property markets in Australia, so your choice at this point is to select the best market, and then the property that matches your strategy. Waiting on the sidelines will only cost you money, as it is possible to succeed in any market.
Letting your strategy guide your choices will also mean you can purchase in locations that match your criteria. This means you can increase your focus on ripple suburbs if one market is becoming overheated, or you can sell in times when the market is at its peak if that meets your goals.
Optimum pathway in 2016
Now it’s time to pull it all together. Start from the market trends, use the key strategies and pillars to design an approach that meets your needs, resources and requirements. As mentioned earlier, diversification (buying a range of different types of property in a range of areas) or building a ‘balanced’ portfolio will be critical to success this year.
This can be achieved by alternating your purchases – for example, one high yield in one State, then capital growth in another State. However, the optimum approach will depend on you. Decisions should be made based upon your serviceability, ability to access equity, skill, interest, and your goals. Consider questions such as ‘how quickly would you like to replace your income’, and ‘what is the income you would like to live on’ at a bare minimum.
With each purchase, the impact on your portfolio should be analysed from a yield, capital growth and serviceability perspective. Ensure you regularly review and stress test your portfolio and prepare for any unforeseen impacts – this includes appropriate insurance and use of buffers to allow for changes in incomes.
Using this approach will set you on a solid path to success. Just keep in mind the key pitfalls . . .which will be our next blog topic.
Buy smarter = limitless ways to build lifetime income
Crave Property Advisory is a unique property strategy and buyers agent service. As the only independent and unbiased advisory that can help you use any property strategy Australia-wide, Crave’s services extend to home, investment and commercial property. A highly client focused organization, Crave developed the Modular Investing System (MI System) to provide clients with the ability to use a tailored mix of strategies and efficiently build profitable portfolios that create lifetime income.
Debra Beck-Mewing is the CEO of Crave Property Advisory, and has more than 20 years’ experience in property investing, Australia-wide. She has used a range of strategies to build her property portfolio including renovating, granny flats, sub-division and development. Debra is skilled in identifying development opportunities, and sourcing properties that have multiple uses and multiple exit strategies. A licensed real estate agent, Debra also holds a Bachelor of Commerce and Master of Business.
Disclaimer – This information is of a general nature only and does not constitute professional advice. We strongly recommend you seek your own professional advice in relation to your particular circumstances.
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