​Breaking into the property market as a low-income investor

You don’t need to have a truckload of cash to start investing in property. Miriam Bell shows how you can build your wealth even on a low income

If you think the idea of investing in property is a pipe dream for low-income earners, you’re not alone. Many aspiring investors make this assumption when they’re thinking of investing in property. However, it’s one of the biggest misconceptions many people have.

While being on a low income might impact on your borrowing capacity – as it can restrict your serviceability – it doesn’t mean you can’t borrow. Nor does it mean you can’t save.

Sure, investing in a flash, waterside property might not be on the cards, at least not right away. But if you have managed to acquire a deposit (via savings, an inheritance, or some sort of financial arrangement) and can prove you can service a loan, then there are affordable options out there for you.

A low income doesn’t mean someone can’t afford to invest in property, Yza Canja, from Property Rocket, says. In fact, some low-income earners might be surprised by what they can borrow and what they can afford to do. But they need to be clear about what they want to do and, if need be, they should think creatively about how to achieve it.

Think profit, not property

Often aspiring low-income investors have been told they can only borrow limited funds, which impacts on the type of property they can buy, Canja explains. Yet they shouldn’t buy a cheap property, just for the sake of buying it.

“That is one of the biggest mistakes: too many people go searching for a property  rather than for a profit. It is important  that they distinguish one from the other. Because you could be investing in a shack and making more profit than someone investing in a four-bedroom house."

Canja believes the concern of low-income investors should be whether a particular deal is possible for them – and, if not, how they might be able to achieve it. "Because a profitable deal is what you want to use as a stepping stone to build a portfolio that works for you and gives you further income.”

It might involve some ‘out of the box’ thinking, but there are ways and means for low-income investors to find profitable deals and leverage their way into property investment.

How much can you realistically borrow?

The first thing any aspiring investor  needs to do is calculate their borrowing capacity. It is important to bear in mind that everyone’s circumstances are different, and this will be taken into account in any lender assessment. Further, all lenders have different servicing models.

Deanna Ezzy, from Trilogy Investment Property Funding, says the following borrowing capacity calculation example demonstrates how such calculations are made.

If an investor went to a ‘middle of the road’ lender for a $240,000 loan, that lender would:

• Calculate the ‘new’ borrowings at a rate of around 7%–8%. Also, in some servicing models the lender will assume it is a principal and interest (P&I) repayment, even if the actual loan is interst-only (IO). This means that your new loan may be 5% IO repayments ($240,000 loan = $1,000 monthly repayments), but the lender will apply their buffer and assume $240,000 x 7.5% @ P&I, which is a $1,678 monthly repayment.
• Only take into consideration 80% of the incoming rent. This means that if, for example, a property is achieving a rental income of $1,300 per month, the lender will only use $1,040 per month for their servicing calculations.
• Want to see ‘gross annual income excluding super’, and would apply standard Australian tax rates.
• Want to know if the applicant is single, de facto, married – and whether they have any dependants. Assuming an applicant is single with no dependants, the average allowance a lender will assume is around $1,200 per month.

Ezzy says this means that, for a loan amount of $240,000, the lender has assumed:

• $1,678 for outgoing monthly repayments
• $1,200 outgoing for living expenses
• $1,040 in incoming rent, and any actual rent paid will then be deducted

“Credit cards are assumed to be at their limit, and usually a 3% monthly payment is assumed by the lender. For example, with a $5,000 credit card, $150 per month will be deducted as a repayment. Even if the card has a zero balance, the lender will assume that the card can be fully drawn at any time.”

After taking all these considerations into account, Ezzy says some examples of the borrowing capacity for various income levels would be as follows:

Ezzy emphasises that these calculations are based on one lender’s servicing guide, therefore it might be possible to borrow slightly more, or less, from other lenders.

Additional considerations

It is also important to remember that when someone buys an investment property (as their first property*) lenders will require them to have 10% genuine savings, Ezzy says. This means that if a property costs $200,000, the applicant has to prove to the lender that they have ‘genuinely’ saved $20,000.

“This means that it is necessary to show the lender that there’s been a steady savings pattern over a (minimum) three-month period.

Alternatively, the funds must have been sitting in that person’s account for a minimum of three months … And the account must be in the applicant’s name.”

Ezzy adds that aspiring investors should also bear in mind that, unlike when purchasing a home, there are no concessions for buying an investment property (eg stamp duty concession, First Home Owner Grant, etc). This means such elements need to be paid for by the buyer.

*It is worth noting that, if this is not an applicant’s first property, the 10% rule still applies, but it can be shown as equity in their existing portfolio.

Employing creative tactics

Having worked through the numbers and established your financials, you now have to decide how to best use your funds to secure a profitable deal. There are a number of creative options that can help you achieve that.

1. The live-in option 

Brendan Kelly, investment coach at Results Mentoring, says that any investor will need to make a decision about the lifestyle they want to live. If they are willing to combine their lifestyle and their property investment, then employing a ‘buy, live in, renovate, sell’ strategy is the way to go.

This strategy is best suited to younger people, because they are more willing to sacrifice comforts and put up with a rougher lifestyle. But Kelly believes it is the quickest, easiest and most efficient way to create some wealth and kickstart an investment portfolio.

"If you can move into a place, do some renovations - not necessarily anything major; cosmetic renovations that make a property look better will do - and sell it, then you can do it at your own convenience. It means you don't need to be in and out in three months. Also you don't have to worry about every dollar going into the place, and you are no worse off because it is your own home anyway."

Following are some other benefits of this strategy:

• It is not necessary to pay capital gains tax (CGT), so when the property is sold the investor does not have to pay a lot of tax. Everything the property sells for is theirs to keep.
• The money being paid to service the mortgage can be considered an investment in the property. Whatever the investor is paying while living there is giving them time to create extra value.

Kelly says that, in a short period of time (eg six months to a year), it is possible to add significant value to a property. And this will make the investor a pile of cash when they sell.

"If you employ this strategy and then repeat it several times, you will have built up the equity to get a property much better than the one you started with. Plus you should also have enough to get a small independent property to invest in, separately to the one you live in."

2. Find a partner

Joint ventures can be a great solution for low-income investors, especially if they do not have sufficient savings for a deposit, or they have a serviceability issue. It is often said that owning 50% of a property is better than owning nothing.

Canja is a firm advocate of partnerships for those who would otherwise struggle to invest in property. But it is important to ensure that a partner knows you are in it with them, she emphasises. 

"They have to understand that you are on an equal footing with them - not necessarily in profits because you might actually give them more to get yourself across the line. But, in terms of the deal and taking risks, you want a partner, not an investor. This means you need to share.”

Even if a partner is a close friend or relative, it is essential to put a binding, comprehensive legal agreement in place. This means:

• both parties agree to a clearly defined set of terms, and an exit strategy
• all possible situations, such as the death of one party or one party’s desire to leave the venture, are covered in the terms
• a minimum term of around seven years (a full property cycle) is included in such an agreement
• a list of all the potential risks, along with viable solutions for those risks, is included in the process

When it comes to finding a partner,  Canja says it is all about networking. “Talk about what you want to do and achieve. Some people will think you are mental, but someone will be interested, especially if you can show you are not trying to sell something; you are trying to make a profit."

Case study: Brendan Kelly

Brendan is a big advocate of the ‘buy, live in, renovate, sell’ strategy – in part because it has worked successfully for him.

The first property he and his wife bought was a milk bar in Richmond, Melbourne. On a small block of just 88sqm, it still had its shopfront and counter when they bought it for $120,000. Over several years, they converted the front shop area into the lounge/dining area. They also renovated the kitchen, bathroom and two bedrooms. In total, they spent $60,000 on renovation work. 

They had selected an area based on the funnel effect. This meant they were able to ride the wave of growth while they completed the renovation work themselves. They were then able to sell the property for $420,000. 

The couple were conscious of their budgeting at that time, so that $300,000 difference really made an impact for them, Brendan says.

“We purchased our next property for $400,000 with about $100,000 worth of debt. So we only needed a very low mortgage for our next property.”

That was just the start of Brendan’s property journey. These days he is a full-time investor and property mentor.

Case study: Yza Canja

Yza came to Australia from the Philippines when she was just 21. After struggling to find work, she eventually got a data entry job at LB Home Loans. This netted her a grand total of $25,000 per annum.

However, it also triggered her interest in property. She noticed that some people had low income but good assets behind them, while other people had good income but nothing to show for it and couldn’t get approved for loans.

She decided that if some low-income earners could own property, then that was an opportunity for her too. After getting the assessors to teach her how to assess a loan, and dedicating six months to educating herself on the property market, she set out to make her first deal.

“I was on about $27,000 per annum by then. And I had no savings, no assets, and couldn’t get help from my parents (because they didn’t have equity and couldn’t afford it).”

Yet she managed to find a property with potential, present the deal to some investors, and negotiate a three-way joint venture with them. “We settled on the property for $419,000, but it was worth $475,000. So I negotiated with the bank to borrow against the value of the property, rather than the price. This meant we put comparatively little money in for the deal.”

They did well with that initial deal, so she and her partners did several more in rapid succession. Yza says this meant she went from $0 to a $2m property portfolio in about six months.

“Those initial properties were profitable, but hard to hold on to from a cash flow perspective. So my next lesson was how to pick the properties that are easier to hold on to.”

These days Yza continues to build and maintain her property portfolio, while providing property education to other investors and working as a finance broker.

3. Think outside the box

Canja also has a few ‘out of the box’ suggestions for aspiring investors. Many people don’t know that it is possible to make a profit by putting a property deal together but not actually owning the property, she says.

“It is possible to match up other people to deals you have found, and to take finder's fees for negotiating the deal. But you have to check the laws in your state, because you might need a real estate licence, depending on how many deals you are planning to do.”

A related strategy is to deal directly with a developer and refer other investors to them. The developer then pays for the deals by, essentially, letting credits accumulate for the ‘deal-maker’. Once the credits have hit a certain amount, it is then possible to use this as a deposit for a purchase (with the developer).

Canja says this strategy is in a developer’s interest too, because it allows them to keep cash rolling round to continue with the development. Plus it also means another sale for them, which means the deal-maker becomes a more profitable referrer because they are buying too.

To successfully employ this strategy, Canja suggests that aspiring investors should:

• make sure they get the right legal advice on the do’s and don’ts involved
• take the time to build the necessary relationships, especially with the developer
• ensure the properties are selling on the open market at market value, otherwise everything is discounted and not of real value
• avoid taking all of the properties; to get a real deal, not a pretend one, it is important to just take a handful

“If done it correctly, this strategy can mean that you don’t need to put a conventional deposit into a property at all. You have put a deposit in, but it hasn’t come out of your pocket. It has been paid on your behalf because that is what you have worked towards.”

Selecting the right property

Whatever the path you decide on, when it comes to actually investing in a property, careful selection is crucial.

Conventional wisdom dictates that the best types of property for lower-income investors are those that are more affordable but have high rental returns. This often means looking to the outlying suburbs of major capital cities, and to regional areas such as mining towns.

Ian Hosking Richards, from Rocket Property, thinks that entry-level investors need to be more focused on value than price, otherwise they can end up buying a non-performing asset, which will impact on their ability to expand their portfolio over time.

For this reason, he says it is important for such investors to:

• learn about property cycles and how to identify the known drivers of capital growth (eg supply and demand, population growth, employment, private and public infrastructure development) in a particular area
• understand how to work out what tenant demand in a particular area is in order to have a clear idea of exactly who their target tenant is and the type of property they require

Brendan Kelly recommends thinking about the funnel effect. This means identifying suburbs which have not yet risen, although every other suburb around them has.

“Then try and establish why it hasn’t. For example, it might be a bit of an industry suburb, but if you drive round and see industry moving on and houses and apartments going up, then you are seeing gentrification. This means growth will be imminent. So you are looking for the telltale signs of change.”

Case study: Bianca & Matthew

Tasmanian couple Bianca and Matthew have managed to build up a diverse property portfolio, despite being on an income of less than $40,000 each.

The king and queen of budgeting started young. They managed to save $9,000 to buy their first home for $60,000 in 1995, when they were just 18. They were earning just $200 per week each, and interest rates were 13%. “It was pretty tough, and we went without a little, but we tried to pay as much off the mortgage as possible to save on interest.”

In 2000, after paying their house off , they were able to get a loan and buy a five-acre block of land, in Tasmania, for $39,000. Then, in 2002, they sold their house for $86,000. But they kept the land block to build a home on it, even though its value had gone up significantly.

This proved a sensible decision: in 2011, the bank valued their home at $430,000. In the same year, the couple paid their mortgage off and started to think about investing seriously.

Working with a coach, they then embarked on a period of rapid acquisition. To do so, they utilised their equity and savings. These days they have a portfolio of four investment properties plus full ownership of their family home.

The process taught the couple the value of buying in regional areas. Once they would have tried to buy close to the city, but not everyone can afford these areas, and regional areas can off er good growth, Bianca says. “We learnt that it’s more about growth. You want an investment to have quick growth so you can pull out equity to buy again.”

Top tips from experts

As with any investor, once strategy, finances, property selection criteria and, potentially, a partner are in place, the end goal is in sight. However, the experts we spoke to have some additional words of wisdom for low-income investors.

Yza Canja

• You need to understand how much you can afford in terms of cash flow. You might be able to afford $100-$200 cash flow for a week, yet on paper you might not be able to afford a property purchase. If you can prove the weekly cash flow you  can afford, it will be favourable with your lender. So you also need to know exactly how much a property will cost to hold on to before and after tax.

Deanna Ezzy

• Save as much money as you can, even if that means moving in with mum and dad in order to save. (Further down the track, living rent-free with parents can also free up serviceability and help increase total borrowings.)
• Have no other (or very minimal) debts. Car loans, personal loans and credit cards will seriously hinder any borrowing capacity a low-income earner has.
• Make sure all other aspects of ‘you’ will appear attractive to a lender, as you are likely to be borrowing at a high LVR, so the risk to the lender is higher. Lenders want consistency in employment and residential history, low activity on a ‘clean’credit file, and a good savings pattern. 

Brendan Kelly

• It is easy to live beyond your means. But if you want to be an effective investor, you simply can’t live beyond your income. Because if you have no capacity to save or manage your money, no one will lend you anything. And remember: accumulating debt on your credit card is a telltale sign that you are struggling.

Ian Hosking Richards

• Don’t be put off by the negativity of others (or yourself). It can be easy to focus too much on what might go wrong, such as not getting a tenant, or potential interest rate rises. This won’t put you in a good frame of mind to actually go out and buy something. But the reality is that a well-researched property can go up in value, pay for itself, cause little grief, and be the perfect vehicle for your long-term prosperity.

This feature is from the October issue of Your Investment Property Magazine. Download the issue to read more!