Part 2: How to make $1m on a lower income

First published in YIP magazine May 2012.

This is the second part of How to make $1m on a lower income, to read part 1 click here.

We took a fictional couple with a very average income, and a lower level of savings, and asked the question: could they make a million dollars in 10 years through property investing? 

We posed the question to three highly regarded property experts to see what sort of strategy they could come up with to reach this goal. They were Margaret Lomas of Destiny Group, Brendan Kelly of RESULTS Mentoring and Ben Kingsley of Empower Wealth. 

To guide our experts, we’ve created a profile of our investor as being a married couple who: 

• earn a combined income of $90,000
• have $50,000 in savings
• have no outstanding debts
• ideally don’t want to go above a 90% LVR
• own no property
• are paying $400 rent per week
• have no dependents 

Margaret’s Plan

 Step 1:

Being able to identify the right kind of property to buy will be paramount in the decision making process for this investor. 

Unpredicted future events are always a hidden risk in the property market. This means that apart from having a clearly identified strategy that takes into account their personal risk profile, current expenses and time till retirement, this investor must have the ability to identify recession proof growth drivers. Without this, they will not be selecting the right areas in which to buy. 

While it is tempting to go for long held, well-established and sentimentally favoured areas where people aspire to live, these will be among the more underperforming choices. These kinds of areas have little in the way of new drivers. There’s no big kicker that will add to growth. There’s also the possibility that these areas could stagnate over this couple’s crucial investment period – there will be fewer people in the market to upgrade, which is where the growth impetus in these markets often comes from. 

The best bet for this investor would be to purchase in areas where there is a population growing faster than the national average. In addition to this, there needs to be a growing median household income, a diversified industrial base and strong infrastructure plans in place to support the growing community. 

Other drivers will be just as important. These include community projects to boost employment opportunities and a downward trending vacancy rate. A diverse age demographic will also be critical to ensure that this investor is buying within an area that is stable. 

The strategy

In our scenario, the investor will purchase a total 11 properties over the 10 year period. They could possibly buy more, and may even decide to, but we’d prefer they start with a low risk, more conservative approach aimed at reducing the size of their debt along the way. 

This is how we believe the plan will progress: 

• All 11 properties will be purchased in the first 6 years
• The debt on the first property will be paid off in 8 years. 

Growth projections

The property selection

The first property would price around $240,000. We have used this price, inflated each year to account for growth in values, as a benchmark for each purchase. 

For the first purchase and all subsequent purchases we suggest a diverse range of areas for this client, namely: 

• Adelaide suburbs such as Elizabeth, Davoren Park, Christie Downs, Huntfield Heights and Hackham
• Prominent centres in regional NSW, such as Bathurst and Nowra
• Victorian energy centres Morwell and Warrnambool
• Greater Brisbane suburbs such as Beenleigh, Woodbridge and Logan 

All are areas that currently have the growth drivers mentioned earlier – showing, we believe, some of the highest chances of growth in both value and rent return. We’d also recommend they purchase houses in these areas, rather than units, because that would better fit the lifestyle choice of their current age demographic. 

Financing

We have used the investor’s requested 90% loan to value ratio, although our advice would be not to exceed 80%, since a 20% buffer would be more prudent considering the unstable nature of the property market. Given the rate at which we advise this client to add property, and as a result of our debt reduction strategy, this LVR will have been reduced to a more comfortable 65% by the end of the 10-year period. 

To finance this strategy we recommend either one line of credit with split accounts for each property (which will reduce the costs of additional mortgages) or a flexible interest only loan with an offset account, which also allows for principal reduction.This is because debt reduction is a major feature in our strategy, which is crucial in this climate. 

Projections

By the end of year 10, this investor will: 

• Based on a 6% per annum growth rate, have a net worth of $1,335,000 (assets less liabilities at that time) and a potential net passive income from those assets of $5,562 per month 
• Based on a more conservative 4% per annum growth rate, have a net worth of $836,000 (assets less liabilities at that time) and a potential net passive income from those assets of $3,483 per month 

Something to keep in mind here is that even though we’re projecting a modest rate of capital growth – such unstable economic times can’t guarantee this. We’d like to see our investor chipping away at the debt to achieve an element of growing equity, even during periods of low property growth. We don’t think it would be wise for them to be undertaking any strategy involving no debt repayment – or worse, any form of capitalising debt. 

Our projections take into account not only the investor’s borrowing capacity, but what they can actually afford given their daily expenses. They were made using potential capital growth rates of 6% and 4% because basing a strategy on any higher compounding growth would be highly dangerous and simply not achievable in today’s climate.  

We have also considered the depreciation allowances and other tax benefits which would be available to this investor given their current income levels. Most importantly, we’ve projected all of our figures by considering the tax position of the investor each time they purchase, and taking into account the deductions already being received from existing properties at that time.  

Most projections usually consider the property and a general tax position (for example a 30% marginal rate) whereas we like to consider where the investor is at the time they make the purchase, considering all deductions which may exist from other investments.  

Investor timeline

Disagree with Margaret’s strategy? Read Brendan Kelly’s strategy in part 3 of this feature.