Accumulation And Cashflow - Which To Target First?
If your goal is to use property to fund your lifestyle, which should you target first: accumulation or cashflow? Luke Bailey explains.
Many new and aspiring property investors are drawn to the idea of using property as a way to fund their lifestyles.
The two main ways of doing this are to either accumulate a portfolio of properties as a longer-term investment or look for short-term cashflow generating type strategies, like buying and renovating homes for a quick profit.
So if your goal is to use property to fund your lifestyle, what should you target first? Accumulation or cashflow?
There’s never going to be one strategy that suits everyone, but I believe that if your end goal is to use property as a form of income, you need to go through two separate phases in your investing journey.
For me, accumulation is the first phase. It’s where you go and build equity by purchasing high-quality investment properties. Once you have a solid foundation and have generated some equity, you can then look to the second phase, which is to turn property into your primary source of income, by generating cashflow.
Personally, having been involved in property since I was a teenager, many of the most successful investors I’ve come across have started out using this two-phase approach.
In the accumulation phase, you are looking to build a solid asset base of high-quality investment grade properties. Ideally buying properties below market value where the rent will cover all the associated costs, which we would call being neutrally or positively geared. I’m not a fan of negative gearing for a number of reasons.
Firstly, to effectively lose money in the hopes of making it back through future capital gains isn’t necessarily a good way to invest. Secondly, the lower rental yield on a negatively geared property will reduce your borrowing capacity which in turn will slow down how quickly you can get to your end goal.
The purpose of this first phase is to buy high-quality properties that at a minimum pay for their holding costs. While at the same time, being in blue-chip locations that will achieve above-normal capital growth.
So why start with the accumulation phase before moving onto cashflow?
One of the major reasons is the fact that you will start off using and maximising your borrowing capacity and in doing so you are leveraging other people’s money. In this case, the banks.
If a property grows at 7% per annum, you’re not making 7% on your money. You’re achieving 7% on the value of the entire asset which is mostly borrowed. That allows you to generate a far higher ROI because of the power of leverage. This will allow you to grow your equity position quickly before moving on to your next purchase.
You will get to a stage, some years down the track when you have a nice nest egg built up. This will be a different number for everyone based on what you need and your lifestyle. You will get to the point where you now have a few different options you might want to explore in your life.
Maybe you’re wanting to reduce the hours from your current job? Maybe you want to move into a different career? Either way, you'll be faced with the question of how you’ll fund your lifestyle in the future.
This is when phase two comes in, which is the cashflow/add value stage. There are many ways to do this and I could probably write a whole book on the various ways to create fast cashflow. But for the purpose of this article, I am wanting to tap into a really great strategy I have seen many people use.
Firstly, depending on your level of expertise, you could look at doing small but profitable renovations. If you’re a beginner and just starting out, sticking to a cosmetic renovation might be the way to go. Alternatively, doing a small structural renovation or a combination of both could be a great way to maximise your returns.
I recently met an investor that had accumulated a portfolio of seven properties that over time had performed quite well. He was now wanting to create $100,000 of income per year. He decided to draw down on some of the equity he had built his portfolio to then buy, renovate and flip one to two properties per year. This was purely to fund his lifestyle and to fulfil his dream of working part-time in his current trade-based business and to spend more time with family.
Ultimately, why accumulation first and renovations second? Why not the other way around? The answer is that once you’ve built your asset base and leveraged the bank's money to build a solid equity foundation, that equity will continue to grow over time.
You can now extract that equity and then move into buying, renovating and flipping properties. Depending on what your target income is, you may be able to achieve this from just one property per year.
I have seen this strategy work so many times I have lost count. It’s certainly not the only strategy to fast track your way to creating a better life and more freedom, but it’s certainly a great one.
There is no need to re-invent the wheel. All you need do is realign it with your desired end goal.