From The Australian, Wealth:
Building a portfolio of multi-million-dollar properties is easier than you might have thought, Ed Charles writes | July 18, 2007
WHAT can be better than owning property?
All you need to do is to know how to navigate the mortgage maze and have a sense of timingfor the peaks and troughs of the property market to build a multimillion-dollar portfolio, according to experts.
It also takes self-discipline and nerves of steel, as you will need what is, for many people at least, frightening amounts of negative gearing.
A growth portfolio worth $5 million would be backed by $4 million in low-doc mortgages with an annual interest bill of some $300,000, and that’s not including a large mortgage on the family home.
There is a whole industry built on guiding people into building these types of property portfolios.
Some schemes involve expensive seminars and training.
Some use high-pressure tactics to sell property off the plan or involve investors in property investment clubs that are effectively selling property the promoter already already owns.
The Australian Securities and Investments Commission (ASIC) warns investors away from these.
Other schemes take the form of financial self-help books detailing the exact steps to follow for a few tens of thousands of dollars.
Most describe an easy, commonsense approach to achieving the goal of a multimillion-dollar portfolio.
As with all investments, the first step is to involve an independent financial adviser and build it into an overall financial plan, but besides that where should people start?
“The average person should start by buying their own home,” says property investor and author Michael Yardney, who runs a consultancy, Metropole Properties.
It is easy for anybody who has equity in their family home to build a portfolio, he says, if only we could get over the hurdle of taking on debt.
“The problem is that we have been taught by our parents that you should buy a home and pay it off.
“Then, when you have some equity your home you can go off and buy an investment property.”
Yardney, who is author of How to Grow a Multi-Million Dollar Property Portfolio, says people should embrace debt, and instead of paying off the family home they should borrow against it to finance property.
“It is not a common concept,” he says.
“It was not what was taught by our parents, but it is the way the wealthy grow their portfolios.
“You cannot save yourself to wealth. The only way you can become wealthy is to borrow, and borrow against assets that increase in value.”
Of 1.4 million property investors in Australia only 0.5 per cent — own five properties or more.
“Most people only ever buy one or two investment properties, which means they never get the financial independence they want, or they deserve,” Yardney says.
Yardney’s plan, like most of these types of these plans, is based on the premise that property increases in value by 10 per cent each year, on average.
That means the value of a property doubles every 10 years. Over the past 40 years in Melbourne the median house price has increased by 9.5 per cent each year, BIS Schrapnel property analyst Angie Zigomanis says.
The calculations of real returns are complicated. In the 1970s and 1980s inflation was high and median house prices increased only by 3.5 per cent in real terms.
With low inflation, property price increases are 6 to 6.5 per cent in real terms, Zigomanis says.
The important thing to remember is that these are only averages for Australia.
Within that are hot and cold spots. Some inner-city suburbs outperform the market and other suburbs, especially the outer ones, consistently underperform.
Currently Perth and Darwin have peaked while major cities on the eastern seaboard are still on an upward trajectory, which Zigomanis predicts will peak by 2012.
He warns that the next upturn will be led by construction rather than price because incomes can’t support a doubling of prices every 10 years.
“You could try and be lucky and pick the suburbs, but we probably don’t expect to see 10 per cent annual growth.
“You will get suburbs that will outperform. It is a matter of trying to pick the winners, I guess,” he says.
Many people buy investment properties before they buy a home, simply because an investment is more affordable and helps build a deposit.
Investor Mark McCarthy followed a similar plan and started buying property in Sydney 10 years ago.
At the time he did not own a home but used his income and savings to help finance the investments.
The plan was to finance a large portfolio, but it proved hard work and he stopped at three, having also bought a first, and then second, home.
He bought at the median of $250,000 to $300,000 in each market and now, thanks to value increases, his portfolio is worth more than $1.5 million. He says there is no such thing as a quick buck in property and he still had to finance the difference between rental income and interest payments, although tax concessions helped.
“The more properties you buy, the more debt you have to service. You have to keep paying the money back,” McCarthy says.
“Now, after years and years of very low yields the wheel has turned and the rents are going up. Hopefully we will get to the point that they are cash-positive.”
In the early days of a portfolio, Yardney says, it’s useful to combine buying a property that will improve in value with a small amount of renovation, with negative gearing benefits.
As the investor’s portfolio and wealth grows, the idea is to venture into property development to help accelerate profits.
Initially, the idea is to borrow the 20per cent deposit required for an investment property.
“Now we are going to get a bit controversial,” Yardney says.
“You can service it with debt.”
Low-doc and no-doc loans only require the borrower to state they can afford to make the repayments, Yardney says.
The deposit is borrowed on a mortgage from the family home together with transaction and maintenance costs and the first five years of mortgage payments.
On average, Yardney says, for every $100,000 of property investment there is a possible $14,000 annual return — $4000 (a 4 per cent yield) from rent and $10,000 (10 per cent) from capital appreciation averaged over the long term.
Interest costs are about 7 per cent, with 1 per cent set aside for outgoings.
“You are probably making $6000 for every $100,000 worth of investment you buy,” Yardney says.
“In comparison, a $20,000 windfall, if it went to pay down the family mortgage, would only save an owner $1400 a year. You are missing out on $6000 of growth.”
Most people have a problem with the shortfall between the rental income and interest payments, even if they have spare money each month to pay it.
The idea is to wait for the equity in your home and investment grow.
Then it is time to repeat the process and buy another two rental properties.
As with all good recipes it is simple from then on: repeat as required.