The scenario
Our fictional Australian couple has two kids, ages 5 and 7, and are looking to build a portfolio that can support their goals to retire early and replace their current income.
Ages: 35
Current household income: $100,000
Current savings: $60,000
PPOR Value: $475,000
Loans: $275,000
Five in five: climbing the property ladder
Five properties in five years. It has a real nice ring to it, but most experts would agree that it makes a better headline than property investment strategy.
They will tell you it’s dangerous to target a number, and that you shouldn’t stockpile properties just for the sake of adding to your portfolio. But that headline certainly sells property investment books and seminar seats, and who doesn’t want to take the express route to becoming a property tycoon?
With that in mind, Your Investment Property brings you a one property at a time guide to a steady climb up the property ladder. We saddle the team at Empower Wealth with a tough task – take an average Australian couple and get them safely to five properties in five years, with a lean and sustainable portfolio that will lead them to property riches.
Like many of her peers, Catherine Bakos of Empower Wealth warns against targeting a specific number. But she says there are advantages to building a portfolio quickly in order to be able to take full advantage of capital gains, and that a well-balanced approach can help investors build a large portfolio quickly. So, she says, an average investor can get to five in five years, and with the right strategy that portfolio could lead to an early retirement funded by more than $100k in passive income and millions in equity.
The Strategy
In order to facilitate the rapid portfolio growth considering their current savings and cash flow limitations, the couple will likely have to tighten their belts over the next few years and forego large ticket purchases and the annual overseas vacation for the next several years. Bakos and the team at Empower Wealth say the couple’s savings and equity in their primary residence allow them to get somewhat creative with how they finance the new property purchases, and they forecast the equity in the PPOR can be the source of much of the financing for the purchases down the line.
The strategy they have worked up focuses on a mix of properties exhibiting good capital growth and others with higher than normal yields, in order to ensure the couple can continue to service their anticipated borrowings. Bakos says even couples starting out with solid resources often hit a brick wall with financing because they do not target enough cash flow neutral or positive properties. But, Bakos also warns against being overly seduced by yield. “You definitely need to pay attention to and understand the growth drivers,” she adds, “because I never like the idea of buying a yielding property that won’t grow”.
The strategy focuses primarily on lower and mid-priced units and houses, and tends to have a regional focus. Only one of the regions identified is within 30 kilometres of a capital city, however Bakos says good capital growth can be found in well-chosen regional centres as well.
Where to start
Purchase #1
Location: Abbotsford/ Richmond, Vic
Price: $390,000
Portfolio Value: $390,000
Investment Loan/LVR: $358,800/92%
PPOR debt/LVR: $358,800/79.67%
“Ok, the first thing I wanted to do for these guys is give them a bit of an equity boost,” Bakos says.
She picked a small unit in the Abbotsford-Richmond area, a few kilometres from the Melbourne CBD. The neighbouring suburbs have a history of high growth at around 9% annually, but have hit a little bit of a rough patch over the past year along with the rest of the Melbourne area. Bakos sees that as an opportunity, especially in this price range.
Bakos says picking an area with a high capital growth rate at the outset will give our couple the best possible chance of building solid equity in case they need a source of funds in addition to their PPOR to fuel later purchases.
In order to maximise the tax deductibility of their debt, the team at Empower Wealth says the couple should take half of their savings, $30,000, and use that to pay down the mortgage on their PPOR. This way they can take out an additional fully tax deductible loan on the PPOR in order to fund the purchase of the new investment property.
Purchase #2
Location: Ballarat, Vic
Price: $235,400
Portfolio Value: $656,600
Investment Loan/LVR: $216,568/92%
PPOR debt/LVR: $373,810/77.63%
For the second purchase, Bakos and her team recommend heading out of town and up the highway in search of higher yields and lower entry prices.
“Ballarat is interesting because its commuting distance to Melbourne and it’s its own centre of activity with its own employment on offer up there and our government has pretty much made it a hub,” Bakos says.
“We’ve got government work, we’ve also got industry and a university up there. So it is a vibrant township with a long-term history of employment.”
Though prices have been on a steady upward climb over the past several years, and average above 9% over the past decade according to RP Data, they remain affordable. Bakos says our couple should be able to buy a modest miner’s cottage in Ballarat for $235,000. Vacancy rates in the area have been close to nil, and Bakos says she likes the area because it is exhibiting some strong and consistent growth driven by several different factors. “In addition to that we’ve got a lot of Melbournians who are cashing in the Melbourne lifestyle and buying in Ballarat, and a 64 minute ride on the fast train gets you in to Melbourne city so it is a viable commute”.
Again, the Empowerment Wealth team recommend utilising a strategy aimed at maximising tax savings, which will again require using $20,000 of the couples’ accumulated cash reserves in order to pay down some more of the original loan on the PPOR. This in turn frees up $20,000 in additional equity making up part of the $35,000 taken out to fund the new purchase. Again, the loan secured against the new property will be at 90% LVR, requiring payment of lenders mortgage insurance, a necessary evil according to the Empower Wealth team.
Purchase #3
Location: Gladstone, Qld
Price: $320,572
Portfolio Value: $1,027,346
Investment Loan/LVR: $256,458/80%
PPOR debt/LVR: $433,953/78.72%
Year number three brings the biggest change in tactics yet, as Bakos leads our couple to the Queensland mining town of Gladstone, a darling in recent years among property speculators. Bakos acknowledges that Gladstone appears to represent a bit more risk, but she says it would be unfair to label it a one-industry boom town.
“The LNG is very prominent and you know $15m into a gas pipeline is a pretty exciting project but there is other industry in Gladstone,” she says. “It was already on the map before this was announced.”
“If you’re buying in Gladstone I wouldn’t be dazzled by the new house and land packages on the outskirts of town. I would get right in close to town and it doesn’t matter if it is not a glossy new apartment.” She says there are affordable units in that area, and she expects them to still be around 2 years from now. For about $320,000, Bakos and her team prescribe our couple pick up a high yielding unit with what they see as solid capital growth potential.
Another $20,000 buy down on the PPOR mortgage will again ensure that the full $80,000 needed for down payment and purchase funds will be fully tax deductible.
Purchase #4
Location: Port Pirie, SA
Price: $138,915
Portfolio Value: $1,242,724
Investment Loan/LVR: $111,132/80%
PPOR debt/LVR: $468,682/69.4%
The team points our couple south with the next purchase, identifying the regional South Australia town of Port Pirie as a strong yield producer that will help our couple avoid the funding brick wall many investors encounter at this stage.
Though it has only 16,000 people, Port Pirie is a well-established community with a sizable lead smelter in town and some miners use the town as a base while working in the nearby Olympic Dam mining area.
Despite this industry, there is a sizable proportion of the population on the dole, but Bakos says that is not necessarily a bad thing.
“Because if you have got people who are on centre link payments and showing no signs of getting off, those tenants don’t really want to move,” she says. “We’ve got continuity, consistent income and they’ve got a township that socially supports them and they really want to stay there.“
Purchase #5
Location: Ballarat, Vic
Price: $288,375
Portfolio Value: $1,620,225
Investment Loan/LVR: $230,700/80%
PPOR debt/LVR: $540,776/61.09%
With property number five, Bakos leads our couple back to a familiar spot – Ballarat. Our guides at Empower Wealth tell us that our investors would have several compelling reasons to head back to growing community 50km north of Melbourne.
“I wanted to get something that exhibited an attractive blend of growth and yield,” Bakos says. “And also for any investor there is always a benefit in having a couple of places in one area too. You’ve got the one property manager, you’ve got a little bit of familiarity with the town, and an economy of scale of sorts.”
Five in five. Now what?
According to the team at Empower Wealth, our couple would be looking at a retirement income in 2032 of more than $107,000 pa in present value terms. This is greater than their current employment incomes, and it would come at their 55th birthdays. So, following this prescription, they have effectively replaced their existing working income and as the years roll on in retirement they can consistently give themselves a pay rise each year.
This income target is of course contingent on the property market continuing to show steady growth, but Bakos says the portfolio should be diverse enough to weather isolated setbacks along the way. The key, she says, is maintaining the couple’s serviceability throughout the initial buying spree by picking properties that have that good mix of cash flow and capital growth.
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