7 steps to success for your property portfolio
Protecting your investment portfolio from inclement economic weather can be as straightforward as choosing the right property to suit your budget, to mitigate risk to your cashflow.
In the current elevated interest rate environment, it pays more than ever for property investors to carefully consider their property portfolio.
As I say in my book, Bulletproof Investing (page 105), “Cash flow and growth are interrelated in any investment, almost like a fulcrum or seesaw.”
So, how can you achieve your portfolio growth and mitigate risk to cash flow?
I’ve put together my key tips relevant to all investor profiles, from first time property investors through to those keen to grow their portfolios.
1. Only buy properties that pay 4 per cent rental yield or higher
To ride through this economic climate, your investment strategy should focus on properties yielding a minimum 4 per cent. This leaves more dollars in your hands, between 2-3 per cent after expenses, easing the impact of any interest rate fluctuations.
We buy property because we want it to grow in value, that’s what will ultimately make us wealthy out of property investing. But we need the property to pay for itself too, otherwise we won’t be around long enough to see the growth.
2. Only buy new properties
One of the fastest ways to churn through expenses on an investment property is improvements to the dwelling, renovations, and upkeep. Focus on new builds which will be low maintenance and produce positive cash flow from the first day, rather than require expensive ongoing maintenance.
Depreciation is also the single biggest cash flow benefit afforded to property investors. Why? Because it’s the only expense we don’t actually pay. It’s a paper loss that, instead of paying out of our rent, it is paid for by the tax we would otherwise pay the Government. 100 per cent of the cost of building a house is tax deductible.
3. Holding property must cost less than 10 per cent take home pay
My rule of thumb is the cost of holding a property should not exceed 10 per cent of our after-tax take home pay – regardless of whether interest rates are high or low.
While we can’t control interest rates, we can manage the risk by making careful decisions when it comes to the properties we buy.
I’m not a fan of selling property if you can avoid it. The only time I’d encourage people to consider selling is where the cost exceeds 10 per cent of take-home pay.
4. Don’t buy units or townhouses
Another sure-fire way to burn through expenses on an investment property and reduce your rental yield, is through body corporate fees. Freehold land and houses don’t have this added cost, where all units and townhouses do. Also, as we know, the true value of any property is in the land, something units can’t offer.
5. Buy at the affordable end of the market
Vacancy rates are often overlooked by property investors, but it is a critical piece of the puzzle in delivering high yield and cash flow. You want to ensure you have a tenant paying you rent 50 or 51 weeks in a 52-week year.
In this respect, the less affordable the rent is, the fewer tenants you have to pick from.
Buying properties that are affordable is important – at or below median house price, and where the rent you’re budgeting on doesn’t exceed 30 per cent of the average income in the area.
6. Pay interest only
Unless you’ve paid off your own home, it doesn’t make sense to pay down principal on investment loans that earn an income and are tax deductible, while you still have a mortgage on your home – which doesn’t earn you rent, nor gives you a tax deduction.
The bank doesn’t want this either, so make sure you set your loans up to be interest only across all your investment properties. If you’ve paid off your home loan, only then should you be paying down your investment debts.
7. Lodge a tax variation when interest rates are high
Interest rates go up and down. The reality is, if we hold an investment property over 10 years, in six to eight of those 10 years we’re going be in a normal inflation environment (2 to 3 per cent) and pay an interest rate of between 4 per cent and 5 per cent on our mortgage.
For 1 to 2 of the 10 years, our interest rates are going to be high, and for 1 to 2 of the 10 years our interest rates are going to be low.
When interest rates are high, like they are now, a great tool that’s available to property investors is to lodge a tax variation. This means, using the example below, rather than waiting until the end of the year to receive the $12,395 tax refund, property investors can receive this progressively throughout the year by paying less tax in their weekly, fortnightly, or monthly pay.
Property price: $750,000
Rent at 4 per cent: $30,000 p.a.
Net rent 3 per cent: $22,500 p.a.
Interest on 80 per cent loan at 6 per cent: $36,000 p.a.
Cash flow before tax: $13,500
Depreciation: $20,000 p.a.
Paper loss: -$33,500
Tax refund (assuming 37 per cent tax rate): $12,395
After tax cash flow:
- -$13,500 (before tax cash flow)
- +$12,395 (tax refund)
- $1,105 p.a. (after tax cash flow)
As you will read in Bulletproof Investing, the message is you need to have a plan when it comes to cash flow and the plan should be to find a healthy balance between cash flow and growth, regardless of what asset you’re choosing to invest in.
When you combine the three aspects of bulletproof investing – investing in land, using leverage to accelerate your progress, and planning cash flow well, you ultimately unlock the secret sauce of all investment gurus: compound growth.