For many years, Australians have used property ownership to build wealth. The market has strengthened consistently over the years. This has meant higher prices and tougher banking requirements have put property ownership out of reach for many.
Many see property investment as a more secure choice than stocks and shares. The market moves slower and usually gives you time to adapt your property investment strategies. You also take on less risk when you invest in property. Plus, it’s easier to secure high-value assets with a lower initial outlay.
But, what to do if you can’t enter the property market on your own? Joining forces with a friend sibling or parent is a viable option for many. Combining resources with two or more people can make the difference between joining the property market or getting left behind. The following case study examines how we used one such strategy to a client’s advantage
Case Study – Mary and Alexi
Mary came to our attention in a slightly roundabout way. While she had an interest in property investing, she had yet to pursue it. Instead, it was her son, Alexi, who told us that she was starting to feel concerned about her future.
The Successful Investor’s team met with Mary to discuss her situation. It was only after she retired that she’d started giving serious thought to her future. A scary thought kept coming to her when she did this.
She realised that she hadn’t invested enough towards her future. As a result, she wanted to know where she stood and what she could do about it.
At first, the situation seemed bleak. Without an employment income, it seemed like Mary may not be able to invest at all. But after some more thought, we developed a set of property investment strategies that might help her.
Instead of having Mary go it alone, we suggested she consider entering a partnership with her son. The combination of the equity she had in her own home and her son’s wages from his teaching job did the trick. Lenders suddenly took more of an interest and were more willing to discuss financing.
Together, they were successful when they approached the bank for the funding needed to buy a house and land package. While it’s still in development, this package has already increased in value by $90,000 under their stewardship. Mary now feels much more comfortable about her financial future. Plus, this investment strategy has helped Alexi enter the property market years sooner than he thought possible.
The Property Investment Strategies
The above case study focuses on a land and house package that’s already achieved capital growth. But there are several smaller strategies that went into investing in that property in the first place.
Let’s now look at some property investment strategies that can help you to achieve financial independence.
Strategy #1 – Have a Solid Finance Structure
Finance was the big problem that Mary faced when trying to invest. Without her own salary to rely on, she was not in a position to get a loan from the bank. In her case, creating a financing structure that involved her son was the solution to her problem.
Your financing structure plays just as much of a role in your success as the actual property. A poor home loan can see you failing to capitalise on your investment as much as you should.
Focus on two core components when building a financing structure:
- Making extra repayments when you can.
- Get a loan with a great rate with all the features you need.
Many investors try to repay the bare minimum for their home loans. While this may help with immediate cash flow, it opens them up to paying more interest over time. Just two or three extra repayments per year can save you tens of thousands of dollars in interest. As a result, it’s crucial that you build a financing structure that allows you to make additional repayments.
The inclusion of an offset account can also help. Linked to your mortgage account, an offset account allows you to use your savings to decrease a loan’s principal. As you save more money, the principal goes down. This means your interest payments go down. Of course, taking money out of the savings account leads to those payments going back up. But clever use of an offset account helps you to keep your interest repayments low while repaying the loan faster.
Speaking of low interest, it’s likely that you don’t have the best home loan product for your situation. Many lenders offer professional packages, which come with lower interest rates.
You usually have to pay an upfront fee for these packages. But in return, you can save thousands of dollars through a lower interest rate. Combine that with early repayments and you can reduce the amount you repay considerably.
Here’s the key takeaway. A bog-standard financial structure doesn’t suit your investment needs. Creating a structure that takes your situation into account is one of the key property investment strategies.
Strategy #2 – Use Your Equity
Equity also played a key role in the property investment strategies for Mary and Alexi. Namely, the equity Mary had built up in her own home over the years
It’s easy to work out how much equity you have. Simply subtract the value of your home loan from the value of your property.
That’s total equity. Without going into Lenders Mortgage Insurance territory usable equity is 80% of your property’s value, minus any debt you currently have against it. Banks won’t allow you to take out all of the equity that you’ve built in your home because they hold some back to protect their own interests.
Your useable equity can fund the deposit for a new investment property. In fact, many investors use this strategy repeatedly to build their portfolios. They buy an investment property with the equity from their own home. Then, they buy a second investment property a few years later. This time, they use the equity from their own home and the first investment. They repeat this process every few years to build a portfolio.
The key is that you’re smart with your equity. Don’t spend too much and make sure you always put it to good use.
Never use all your usable equity. Unless you have other emergency funds leave a portion of it aside just in case you need it. To know what value property you can buy with your useable equity use the Rule of 4. At an 80% LVR multiply your usable equity or cash deposit by four to discover the value of the property you can buy including buying costs.
Strategy #3 – Use The Power of Leverage
There’s a simple concept behind using leverage. You’re looking to use the leverage that you build to fund purchases that you couldn’t otherwise afford.
Two people may have built $100,000 in cash. One uses that equity to buy an investment property worth $400,000, whereas the other invests in shares or another investment vehicle.
One has an asset of $400,000 to grow in value, the other just $100,000. The person who uses leverage creates the groundwork for further investments. Later, they can leverage the equity from that first property to fund another purchase, then another. Eventually, they build far more wealth through leverage than the person who invested without leverage.
It’s all about making purchases that you couldn’t otherwise make. These purchases must also serve a purpose. Many wealth creation strategies rely on using leverage to build more wealth.
Strategy #4 – Remember the Bottom Line
Many investors make a big deal about the negative gearing and positive cash flow strategies.
At first, negative gearing doesn’t seem like the most effective of property investment strategies. It involves buying a property that costs more to maintain that the amount of money that it generates.
That means you get a negative cash flow.
In some cases, this can harm your investment efforts. You have to rely on other funds to keep the property going. If you don’t have those funds, you’ll struggle to repay your loan. This could lead to a default, which means you lose the property.
However, many investors use negative gearing to create massive savings on their tax bills. Others may buy a negatively-geared property now because it has the potential to generate income or capital gain in the future. That’s something that many new investors struggle to understand. There’s nothing wrong with buying a property that costs money each month. But you must understand the financial commitment you’re making and feel sure that the strategy works for your circumstances.
It comes down to a simple question – can you afford to spend an extra $200 or $300 per month on a property. If you can’t, perhaps you’re not ready to invest yet.
Positive cash flow means investing in a property that generates more revenue, after allowing for tax breaks and deductions, than it costs to maintain. This means you repay whatever costs you have and make a little money each week.
The big debate comes down to which of these methods work best. But the simple answer is that neither is better than the other. Investors can use either to attain success. It all comes down to your situation and understand different cash flow strategies before you buy. Figuring it out as you go means you’ll get a rude awakening later.
Remember the bottom line. That’s what really counts. You don’t have to stick to either gearing strategy for every property that you buy. Whichever improves your bottom line the most is the one that works best. Don’t ignore one strategy in favour of the other. Nothing comes from being loyal to a particular gearing strategy.
Don’t think that you can only invest for either capital growth or cash flow. You should have a balance of both, particularly in the early years of your property investment strategies, to achieve success.
It comes down to making the right decisions for your situation. Build a financing structure that doesn’t leave you paying more than you should. Use your equity wisely and as leverage for making larger purchases. Finally, don’t stick to a particular strategy just because you’ve heard it’s the best one. Choose whichever strategy suits your particular circumstances. Finding the right advice is the key. That’s what The Successful Investor has to offer.