Portfolio growth stages
For most investors there are three stages to building a property portfolio and converting the benefits from investment to lifestyle;
Acquisition
Acquisition and Consolidation
Consolidation and Lifestyle
Each of these stages can range from a few years to a decade or more and there are no rules for how fast you should aim to go. Maintaining healthy surplus cashflows and cash reserves is always prudent.
Stage 1: Acquisition
Assumptions
Properties are generating cash flow so that the investments are self-funding.
Surplus cash flow from higher yielding properties/personal income, supports high capital growth properties.
Short to mid-term focus on building a larger capital base, whilst maintaining neutral cash flow, supported by personal income and/or tax benefits.
Mid-to-long term focus: capital growth.
Key aspects
Ability to recycle equity from these initial properties within 12-18 months, to enable further property purchases.
Hands off management and low repairs and maintenance for ongoing ownership.
Surplus cash flow to create buffer to manage interest rates increases, unforeseen vacancies and rising costs.
Buying rules
Aim to be cash flow positive or neutral with tax benefits at 100% debt funding.
Capital growth properties; buy below registered valuation and/or add value. The aim is to recycle a 20% deposit for the next purchase within 12-18 months via 3 methods:
I. Purchase below value, through growth before settlement buying off the plan
II. Adding value by increasing rent
III. Natural capital growth post purchase with timing the property cycle right
IV. Debt reduction
Gear LVR to maximum based on your risk profile and lending criteria. To maximise purchasing power you can finance to 80-85%.
Easy to manage properties that attract good quality tenants.
Low maintenance for long term hold properties.
Invest in high capital growth areas (lower yields) if they can be supported by cash flow from higher cash flow (higher yielding) properties.
High cash flow to high capital growth properties acquisition ratio; Ideally two high cash flow to support one high capital growth acquisition with combined positive cash flow each year that provides a buffer of a minimum three months of expenses for this group of properties.
Stage 2: Acquisition + Consolidation
Assumptions
The need to move your portfolio to being funded solely off rental income ratios, so that borrowing ability is not affected by changes in personal salary with future acquisitions.
Key aspects
Focus on balancing cash flow with capital growth acquisitions.
Recycle your equity into new purchases, ensuring breakeven cash flow on high growth properties.
Focus on increasing yields on existing properties with regular rent reviews. Maintain three months of expenses as a cash flow buffer.
Maximise your tax effectiveness.
Interest rate management: spread loan term expiry dates and fixe rates on some debt to manage fluctuations and exposure to rate increases.
Using surplus cash flows to support lower yielding, higher capital growth purchases.
Put a more aggressive debt reduction plan in place to increase cash flow and equity.
Buying rules:
Cap your LVR at 70%, based on equity growth from your portfolio also being recycled.
Focus on high growth areas and time market entry with expected value uplift ahead.
Minimum break even cash flow, but ideally moving toward a 20% surplus.
Maintain your ability to recycle equity
Stage 3: Consolidation + Lifestyle
Assumptions
Portfolio is cash flow positive pre-tax and is heading towards 30-40% cash surpluses, thus reducing reliance on tax benefits and/or stable income from employment.
May not have income from salary.
More time available for lifestyle choices.
Travel, hobbies, sports and family life the key focus.
Your portfolio provides income whilst also maintaining and growing your capital base.
Profits are partly used to reduce debt on some properties.
Interest rates and loan terms have been strategically managed to spread risk from market shifts.
Portfolio consists of mainly high capital growth properties and/or good “add value” potential.
Cash flow is positive (20%+ surpluses) across the entire portfolio, due to a combination of
- high cashflow properties supporting the higher growth properties.
- debt reduction plan from surplus cashflow.
- principal being repaid on some loans.Most, if not all properties are managed and are in good condition with no deferred maintenance issues.
Key aspects
Focus on capital growth properties, keeping your income from your portfolio strong so it can be used to support your lifestyle.
Reviewing of all existing properties, selling anything that is underperforming, high maintenance or past its ‘best by’ date in terms of cash flow or growth.
Replacing those high maintenance or past the ‘best by’ date properties, with higher growth properties and gearing your LVR to ensure positive cash flow.
Review of loans, structures and tax position.
Some loans are now being paid down from profits, or some are on principal and interest, instead of interest only.
New purchases are in high growth areas with healthy yields.
Buying rules
LVR coming down to the 50-60% range.
Investing in high yield and/or high growth areas (above national average over a 10 year period).
Well maintained and/or low maintenance type properties.
Easy managed and highly desirable from a rental market appeal point of view.
Add value potential e.g. land banking or subdividing.
Yields will be related to interest rates, so can only be accurately determined at that time.
Equity release options
This can start once you have built a sufficient capital base and want to release some of your profits for lifestyle options.
Option 1: Debt reduction; to decrease interest costs and increase cash flow
Sell lower performing properties and use the profits to reduce debt on balance of portfolio.
Use profits from business to reduce debt, thus increasing cash flow.
Option 2: Add value
- Renovate existing properties, increasing value and lifting the rental returns and yields, which provides greater cash flow.
Option 3: Develop
- Start to develop the “land banking” opportunities held within the portfolio, increasing cash flow and/or creating lump sums of cash which be used to reduce debt and/or to support lifestyle.
Option 4: Sell and use profits for lifestyle
- Select a property to sell and use the profits to fund lifestyle, leaving the remaining portfolio to grow and continue to produce cash flow.
- Repeat as funds run out and the market conditions support selling.
Option 5: Equity release
- Borrow against the increased equity in the portfolio, using these funds to cover lifestyle expenses and the interest on that debt (subject to banks lending criteria).
- Note: the growth rate on the portfolio will need to be in excess of the interest payable and drawn down capital, so that the net equity is increasing each year, hence why the shift of focus to capital growth type property’s needs to take place as early as possible in the overall strategy.
Next Steps
Get professional advice on your asset and tax structure to ensure it supports your goals.
Decide on your portfolio game plan and annual acquisition targets.
Meet with your financier and work out your funding plan based on your acquisition targets.
Meet with The Property Factory and share your acquisition plans, so we can align our service with your requirements.
Celebrate - aim to reward yourself each year. Don’t wait until you retire to start enjoying some of the benefits.
Disclaimer
The information provided in this property acquisitions strategy options document is general in nature only and does not constitute personal financial advice. The information has been prepared without taking into account your personal objectives, full financial situation or needs. Before acting on any information in this document, you should consider the appropriateness of the information having regard to your objectives, financial situation and needs. Before making any decision, it is important for you to consider these matters and to seek appropriate legal, tax, and other professional advice.