Performance the key to fine tuning a property portfolio
If the objective is to build serious equity using real estate, selling the first property and starting from scratch is probably not the best plan of attack.
As 2022 draws to an end, many property investors will assess their portfolios against their investment strategies for the new year and beyond.
One of the most common questions asked by residential property investors is whether they should sell a top performing asset, realise the good capital gains and use it to buy another property that might show an even better performance - or indeed, should they invest the profits in another asset class?
While the temptation to trade up is understandable, property investors need to take an unemotional approach to the financial realities of disposing of a prime asset, as opposed to disposing of an underperforming one.
The decision to dispose of an underperforming property is a legitimate one, especially if a property’s capital growth has not kept pace with annual inflation, which has risen to the highest level since 1990.
Typically, underperforming properties lack the scarcity value and are not in consistently high-demand locations. Underperforming assets have often been purchased for rental yield rather than capital growth and don’t always make good investments.
Investors who regard an asset as unlikely to perform for the long term should have the property independently assessed with a view to cutting their losses fast.
If the asset is an outstanding long-term investment prospect, then the short answer to disposing of it in order to trade up is an emphatic “don’t.
Starting from scratch?
The other temptation is to sell a prime property asset that has shown impressive capital growth in the first few years, in order to realise the profit while it’s there and before any future downturns erode it.
If the objective is to build serious equity using property, selling the first and starting from scratch – as opposed to using the accumulated equity to help fund the second – is a very good way to line the pockets of others by way of acquisition and disposal costs, such as stamp duty, real estate agents’ fees, capital gains tax and any improvements needed to maximise sales potential.
Contrast this with the tax-free accumulated equity that can be used to fund a second property, which in turn, can also be leveraged for further investments.
The core reason for holding a plum property asset is that the compounding capital growth will substantially increase an investor’s net wealth with every passing year with minimal effort and cost.
Rental income will help fund the holding costs in the early years, eventually replacing a wage or salary in retirement. The other key consideration is that no matter how bad a downturn or recession is, prime property assets have a strong “bounce back” factor.
Such assets typically show very little, if any, downside and can quickly overtake their previous high value point once a depressed property cycle turns upwards again.
Finding that gem
Finding prime property assets isn’t an easy task, as evidenced by enduring strong investor competition for affordable properties in prime, high capital growth locations.
Even if you sell well, finding the next plum asset can be a lengthy process. Worse still, the longer it takes to re-enter the market, the wider the gap will become between the new buy-in price and the finite amount the investor has at their disposal.
So, the wisdom is to have a portfolio of multiple assets all increasing in value concurrently rather than trying to do it one at a time and giving up a substantial amount of the profit along the way.
The multiple asset approach builds equity and financial independence much more quickly and securely because the investor is not wholly reliant on just one asset.
Quality investment grade property is scarce, and wherever possible should be retained, so it can continue to appreciate within your portfolio, not someone else’s.