Creating Wealth through Property Investment
Real estate ownership can be a critical driver of wealth creation. That statement is true anywhere in the world for one simple reason – there’s only so much land to build on! Property investment provides a path to wealth like no other.
When investing in property the rewards can be substantial and the risks, while both present and real, can also be controlled and mitigated. The key is not to blunder blindly into property investing but understand the fundamental rules and how they work together to create successful property portfolios.
Why is this important? With real estate investment, you will be working with BIG numbers. While the potential upsides are excellent, there are downsides to consider as well. A lack of education could result in missed opportunities or worse. You could end up purchasing the wrong asset at the wrong price and be left substantially out of pocket.
Understanding the rules is vital for mitigating these risks. If you apply them effectively, you’ll have the right foundations for building an outstanding investment property portfolio.
This article will briefly introduce key points to consider when investing in real estate. Remember, however, this is in no way an exhaustive list.
Rule 1: Think of investing in property as a business
Perhaps you’ve never thought of buying investment property as a business, but it is. It’s a way to make money and incorporates many of the same elements that a business does.
So then, as a business, you need to pay attention to it and not let it sit and stagnate. Investing in property is a long-term commitment, but that doesn’t mean you ignore your investments. You will need to look after your yields, your expenses, and even your tenants. Keep on top of anything and everything that has the potential to have an impact on your profits.
As a bare minimum, you should:
- Put together a business plan that includes a detailed investment strategy.
- Set up generous buffers to meet business expenses (e.g. improvements, repairs, rental vacancies, etc.).
- Put together a team of professionals who can help your business grow. This includes a financial planner, a good finance broker, and a highly reputable property management company. You may also want a knowledgeable solicitor/conveyancer.
- Identify and establish business relationships with a collection of quality tradespeople whom you can call on when necessary.
Rule 2: Understand How to Use Leverage
It is important to understand the difference between good debt and bad debt.
Good debt refers to borrowing that can actually fuel personal wealth creation. It is when you borrow (such as an investment loan) to buy an appreciating asset such as land, real estate, or shares.
Bad debt is the opposite. It often refers to things such as credit cards or consumer spending that doesn’t have a positive financial return.
Leverage refers to the use of good debt (borrowed funds) to amplify returns from an investment or project. Understanding leverage is key to wealth creation with property and managing your investment property portfolio.
When lending money (for good debt such as home loans or investment loans) banks look more favourably upon certain aspects of your finances. If you have financial discipline and knowledge about what banks look for when evaluating your loan application, you’ll be in a good position to make your financial profile as appealing as possible.
Typical Lending Criteria
To name a few, below are factors that a bank will consider:
- A solid employment history.
- Savings account with aged funds.
- Good credit score.
- A low debt to income ratio.
Furthermore, lenders will look at the attributes of the property you are purchasing, such as:
- Property location (postcode).
- Market drivers (suburb yield, economy, population, demographics, etc.).
- Value of the property.
- Dwelling size.
- Exposure (i.e., whether the lender already has too much capital invested into a particular marketplace).
There are a few things you can do to improve your chances to obtain finance (and the ability to leverage good debt).
- Reduce your outstanding “bad” credit. This means any credit card or personal loans you may have. It may also include the mortgage on your personal place of residence.
- Sell off any underperforming properties and use the funds to beef up your existing buffers.
- If you’re not saving regularly, start saving now. Lenders want to see that you are consistently saving over time. If you were to obtain investment finance for a property, save the equivalent of expected loan repayments (minus the income).
Rule 3: Correctly Structure Your Investment Property Portfolio
An investment property structure simply refers to how you manage the ownership of an investment property. Essentially there are four ways to hold title to property:
Each of these types of ownership structures has benefits and risks. These depend upon your particular situation and what you want to accomplish through investing in property. Property investment is not only a way to compound wealth but can also be used as a tax shelter with a suitable structure.
Consult with a qualified financial professional who is experienced in property investing to determine which type of structure will suit your particular situation. Wealth creation with property can be approached in a variety of ways.
Rule 4: Capital Growth vs Cash Flow
There are two aspects to choosing property for investing. First of all, it is important to find a suitable location to invest in property. Secondly, it’s equally important to find the right property within a growth location to maximise your profits.
For example, if the area demographic prefers houses over units, which property type will likely deliver the better yields? Although both can provide capital growth, you should also pay close attention to cash flow.
During your time as an investor, you’ll hear varied opinions about whether capital growth or cashﬂow is the superior metric for investment success. There are entire strategies built on one or the other, and they’re often pushed by “property advisors” with a vested interest.
Maximising capital growth should be your primary objective, but cash ﬂow must also be factored in or you risk losing grip of your valuable assets.
The reasoning for this is, capital growth builds empires. Owning a portfolio of property that increases in value by a modest six to ten percent every year means you are on track to ﬁnancial freedom. Choosing capital growth alone, however, is pointless if the cashﬂow (rental return) generated by your investment is too low. You won’t be able to service your loans or pay other holding and maintenance costs.
To enjoy the beneﬁts of capital growth, you must be able to retain possession of the asset. If you can’t service its debts you’ll be forced to sell prematurely and will lose out on all the upside.
Rule 5: Multiply Your Property Investment Returns
Holding just one property investment creates a wealth path.
Now imagine what those returns would look like if you controlled two, three, ﬁve or even 10 investments.
Successful portfolios aren’t created by buying one or two high-priced assets and waiting for the gains. You need to diversify your holdings across multiple, price-accessible investments. This sort of purchasing allows for ﬂexibility and manageability.
You can ofﬂoad one or two if need be without dramatically impacting your overall portfolio value. You are agile, will see better rental returns, and can pivot as needed in response to future opportunities or threats.
The more you acquire, the easier wealth creation gets.
Bonus Rule: Preserve Your Wealth
While a great deal is said about building wealth, little attention is paid to maintaining it.
Creating the right mindset, learning how to use leverage, and choosing the right structure are only part of wealth creation and preservation. Preserving and protecting your wealth is just as important.
You will also need:
- The right insurances to protect your assets and income..
- Adequate buffers to help see you through unexpected eventualities.
- A well-planned exit strategy to reduce your debt and minimise your tax.
If you are interested in speaking to our financial advisor about wealth creation through property investment, contact us now.