Will you ever build a portfolio that size on a few dollars a week positive cashflow from your rents?
By now it should be clear that the only way to build a substantial asset base is to take advantage, leverage and compounding growth of well-located properties.
In my mind the only way to become financially independent through property is to first grow a substantial asset base (by buying high-growth properties) and then transitioning to the next stage – the cashflow stage – by lowering your debt, but not paying it off completely.
Fast forward 10 or 15 years and imagine you own your own home plus $5 million of well-located investment properties.
If you had a typical 80% loan to value ratio, you would be negatively geared.
On the other hand, if you had no debt against your property portfolio you would have positive cashflow, but would forgo the benefits of leverage.
Somewhere in the middle, maybe with a 50% LVR, your property portfolio would be self-funding. You may even have a little cash flow left over, but not enough to live on.
If you think about it, it will be much easier to amass a $5 million property portfolio with $2.5 million of debt than the same size portfolio with no debt.
You could then go to the bank and explain you’ve got a self-funding portfolio that isn’t reliant on your income and in fact, there’s a little cash left over for serviceability. You would then ask for an extra $100,000 loan, so you’re increasing your LVR slightly.
The good news is that you don’t have to pay tax on this money because it’s not income. But you would have to pay interest, which won’t be tax deductible if you use the money for your living expenses.
This means after the interest payments you’re left with around $93,000 to live off.
Crunch the numbers.
At the end of the year, you’ve “eaten up” your $100,000, but in a good year, your $5 million property portfolio would increase in value by, say, $500,000.
In an average year it will have increased in value by $400,000 and in a bad year it may have only gone up by $150,000 or $200,000.
Of course your rents will also have increased because your properties have increased in value.
Sure you’ve used up the $100,000 you borrowed, but because your portfolio has risen in value, along with rents, your LVR is less at the end of the year than the beginning, so you finish off the year richer than you began it. You truly have a cash machine, and then you can do this over and over again.
Does this really work?
In the old days living off equity was easy.
You just had to go to the bank and get a low-doc loan and as long as your properties increased in value it was smooth sailing.
Sure it’s harder today, but it’s definitely doable. You just have to lower your LVR to show serviceability to the banks.
Needless to say, you can’t achieve this overnight. It takes time to build a substantial asset base and a comfortable loan-to-value ratio. But if you take advantage of the magic of leverage compounding and time, it happens.
Do you have an asset protection plan?
Of course this strategy depends on the growth in your property portfolio and your ability ride the property cycle.
This means that as you build your asset base, buying high-growth properties and adding value, you will need an asset protection plan to see you through the ups and down that you’ll experience.
After all, over the next 10 we’ll have good times and bad. There will be periods of high interest rates and times of lower interest rates. And we’ll have periods of strong economic growth, but there will also be times of downturn.
Savvy investors count on the good times but plan for the downturns by having an asset protection plan, as will as a finance strategy and tax strategy to make sure they set up their structures in the most efficient way.
Don’t get me wrong, while I’ve just made gaining financial freedom form property investing sound simple, it’s not easy. And that’s not a play on words.
Fact is, around 20% of those who get involved in property investment sell up in the first year and close to half sell their property in the first five years.
And of those investors who stay in property, about 90% never get past their second property.
So if you want financial freedom from property investment to fund your dreams, you’re going to have to do something different to what most property investors are doing. You’re going to have to listen to different people to who most Australian property investors listen.
You’re going to need to set yourself some goals and follow a strategy that’s known, proven and trusted.
Then you grow your property investment businesses one property at a time.
Of course, you need to buy the right type of properties.
One that has a level of scarcity, meaning they will be in continuous strong demand by owner-occupiers (to keep pushing up the value) and tenants (to help subsidise your mortgage); in the right location (one that has outperformed the long-term averages); at the right time in the property cycle (that would be now in many states); and for the right price.
Michael Yardney is the director of Metropole Property Investment Strategists, a best-selling author and one of Australia’s leading experts in wealth creation through property. For more information about Michael visit www.metropole.com.au and www.PropertyUpdate.com.au.
