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- Can you create passive income in real estate?
- Positive gearing property generates passive income
- The pros and cons of positively geared property
- Making passive income in real estate through Equity
- What is a property portfolio?
- So, what does a balanced portfolio look like?
- What shouldn’t be in your portfolio?
- 15 tips to start building a property portfolio
Is it really possible to develop financial wealth by building a substantial property portfolio in Australia today?
The answer is yes. It’s simple, but it’s not easy. And that’s not a play on words.
It’s simple if you do what many other savvy property investors have done and built a substantial asset base of investment grade properties that generate sufficient passive income to give them financial freedom.
But it’s not easy, as the majority 92% of Australian property investors never get past the first or second investment property.
But the better way of looking at it is that if tens of thousands of Australians have managed to develop financial freedom through the property, there’s no reason why you shouldn’t be able to build a multi-million property investment portfolio yourself.
So, here’s everything you need to know about building a successful property portfolio.
Can you create passive income in real estate?
In short, yes.
Property is an excellent way to take the next step to gaining financial freedom and create a passive income because both property value and rental income from a property are almost guaranteed to increase each decade.
So how do you make passive income from property?
Here are two ways to do it.
Positive gearing property generates passive income
This is a simple one to grasp.
A positively geared property is simply one that generates a return that is higher than the property costs to own.
For example, if you rent out a property for $700 per week but your combined mortgage and any outgoing expenses amount to only $500 per week you’d be able to enjoy a $200 per week positive cash flow.
A simple way to have your investment property return positive cash flow is not to borrow against your property. But clearly, that’s not possible in the early stages of growing your property portfolio, is it?
On the other hand, you might be able to get a positively geared property if you’re able to put down a large deposit on purchase, which will then reduce the amount you need to borrow.
Of course, residential real estate is a relatively low yield, but high capital growth investment asset class; however in today’s low-interest-rate environment it’s not as hard to buy properties that are positively geared or at least neutrally geared.
Alternatively, buying a property during a time of strong rental demand and low-interest rates could mean you’re able to rent the property for more than your outstanding debt repayments.
The pros and cons of positively geared property
As with any investment, it’s important to be fully aware of all the benefits and disadvantages of owning a negatively geared property.
- A passive income: A positively geared property gives a passive income stream and can also deliver capital gains as the property increases in value over time.
- Less cash flow risk: Because the property pays for itself, and some more, there’s no need to supplement costs with other income.
- Easier lending: Extra positive cash flow on top of your day job means more income and therefore it would be easier to secure a loan.
- Lower capital growth: In general properties with stronger cash flow deliver lower capital growth and high-growth investment grade properties tend to have less cash flow – that’s just how property investment works.
- Lower long term rental growth: It could be tempting to buy a cheaper, cash flow positive property, but apart from not benefiting from strong capital growth, rental growth tends to be lower over the long term, because cash flow positive properties tend to be in secondary locations where the typical tenants do not have strong income growth and the ability to pay higher rents.
- Higher initial cost: The bigger your deposit the more likely the passive income which means many investors may have had to upfront a large sum of money when buying the property.
- Taxable income: Passive income is taxed in the same way your wage would be, which means any income that your property generates would be subject to tax. While rental income counts as taxable income, there is a range of special deductions you can make as an investor to reduce your tax burden.
- Some markets are more volatile: As cash flow, positive properties tend to be located in secondary markets, these locations tend to be more volatile and suffer most when the property market or the economy experiences downturns
Making passive income in real estate through Equity
Aside from a favourable rental income from a positively geared property, another way to make a passive income in real estate is through accessing the equity in the property as it increases in value.
So what exactly is equity?
The equity in your property is the value of your property minus the loan against the property, meaning that when your property increases in value, your equity also increases.
For example, if you buy a property for $700,000 and it increases to $800,000 then you have an equity increase of $100,000.
And there are two ways that you can access this equity.
- Sell the property for the new value, pay off your debt and you’re left with the equity.
- Borrow against the equity on your property.
This second option is the golden egg here because the more properties you own, for each that increases in value, the more equity you’ll have; and you may be able to borrow this money (if you meet the bank’s servicing criteria) allowing you to buy another property enabling you to leap frog the growth of your property portfolio.
Meanwhile, if the value of the property has increased, the rental income would likely have also increased also, meaning you’d get the double benefit of equity plus a positively geared property bringing in passive income.
So now we’ve talked about how to create a passive income through property investment, let’s look at how to build and manage the property portfolio of your dreams.
What is a property portfolio?
The real estate portfolio definition: A property portfolio is a collection of property investments owned by an individual, a group, a trust or a company.
Of course, investors typically live in one of their properties and rent out the others.
There are many benefits to building a portfolio of investment properties as opposed to either owning no properties or owning just one investment property.
Here are four of those benefits:
1. Financial freedom
It has become clear that Aussies can’t rely on the government to look after them in their old age so more and more of us are looking at securing our own financial future through owning investment properties.
It’s hard to achieve financial freedom with just one investment property as the income, even for those positively geared, isn’t enough to also cover any other financial commitments.
Having several investment properties, however, with multiple rental incomes and multiple opportunities, can really set you up financially.
Of course, your financial freedom won’t depend on owning a particular number of properties – more importantly will be how much equity you have, and how hard your properties are working for you bringing in rental income.
I’d rather own one for Westfield shopping centre than 50 properties in regional Australia.
2. More equity
Obviously, the more properties you own, the more equity you have access to as they increase in value.
Another great thing about having a property portfolio is the ability to diversify your investments which gives the opportunity to grow your portfolio faster.
There is a risk inherent in owning several similar properties in one area because if one property type or area doesn’t grow then you don’t have the equity to invest in more properties.
But if you diversify your properties and scatter investments in different high-growth locations and spread in our 3 large capital cities and investing in different types of properties you’re more likely to be able to hedge your bets – if one area declines or stagnates for a while but another one grows you’ll still have access to increasing equity.
Think of it like putting all your eggs in one basket.
Diversification helps to protect against risk.
4. Multiple streams of income
Much like more properties in a portfolio give diversification, having a property portfolio rather than one property also means you’ll have several streams of income.
If you have a vacancy in one property your others are all still earning a rental income, and your income gap won’t cause quite as much stress to your cash flow because there is cash flow still coming in from elsewhere.
So, what does a balanced portfolio look like?
When it comes to property investment, most investors have the same goal: financial freedom, i.e. a “cash machine” from a property portfolio which pays for itself while also consistently growing in value.
To do this you’ll need a portfolio of properties with a mixture of properties with high rental yields and properties which are more likely to give high capital returns.
Building a property investment portfolio takes many years and the first stage involves building your asset base with high-growth properties and then, over time, you can add higher-yielding properties to balance out your portfolio
Put simply… cash flow will keep you in the property game, but it’s capital growth that will get you out of the rat race.
Rental yield is the annual income generated from rent as a percentage of the property’s value.
However, while most investors chase rental deals by buying in secondary locations I prefer to invest in commercial properties which have high hills and still an element of capital growth.
Meanwhile, high capital returns, which is simply the return on investment, are more likely in aspirational suburbs with a long-term family appeal or areas which are ‘up-and-coming’ and gentrifying.
A balanced portfolio is a portfolio which is a mixture of the two and which also has enough diversification (as we discussed earlier) to reduce exposure to any location-specific market downturns.
What shouldn’t be in your portfolio?
I’d generally advise that any property investor steer clear of what I call “investor stock” – you know ….those cookie-cutter-style units in high-rise apartment towers, with few distinguishing features.
These have a long history of poor capital growth.
This may at first sound counter intuitive…
Why avoid “investor stock”, but these properties which are typically built by developers to make a quick profit and sell on to investors are very different to “investment grade” which are properties that outperform and deliver wealth producing rates of return.
15 tips to start building a property portfolio
Attaining wealth doesn’t just happen, it’s the result of a well-executed plan. Planning is bringing the future into the present so you can do something about it now!
You see… building a strongly performing property portfolio is a process that takes begins with education, and then building a strategic plan to get you to your end goal.
So here are 15 tips which should help cover off everything that you need to think about for how to build a property portfolio.
Tip 1: Know why you’re investing in property
The first tip to help you on your property investment and property portfolio building journey is to answer this question: Why are you choosing to invest in property rather than any of the other investment asset classes such as shares?
Because most investors know why they want to invest in property but some do it for the wrong reasons.
Property investing is not a competition – buying an investment property just to keep up with friends is not a good enough reason to take the plunge.
Tip 2: Understand all the risks involved when investing in property
Just because prices have been growing consistently for a number of years doesn’t mean they’ll go on indefinitely.
The truth is, growth in value is rarely consistent and linear.
Some years you get growth spurts and in other times it’s stuck in the mud.
In short, capital growth is hard to predict.
You could also face vacancies or tenants that default and destroy your property.
While there are ways to reduce these risks, they, unfortunately, do remain a part of property investing..
Tip 3: Be prepared to be in it for the long term
Investments don’t rocket overnight.
Even if you bought in the right area and picked the right property, there’s no guarantee that you’d see growth come through quickly.
While some areas may experience rare short-term surges, the majority of suburbs go through periods of slow to no growth before values rise.
Therefore, you’ll need to be prepared to hold your property for at least one cycle of around 7 years if you want to make a solid gain.
This means you need to ensure you have a solid enough cash flow to maintain the property in the meantime to avoid selling prematurely.
Tip 4: Learn everything that you can
While you’re building your deposit, continue to learn everything you can about property investing.
Buy a few books from a range of authors to get a variety of opinions but be cautious of expensive courses which promise to teach you everything, it’s often not true.
Tip 5: Get your finances sorted as soon as you can
Property investing is a game of finance with some houses thrown in the middle, so make sure you create a budget to help you live well within your means – stretching yourself too thin puts your whole portfolio at risk.
Tip 6: Set an end goal
You need to set an end target so that you have something to aim for.
Whether your target is a passive income of $2,000 per week or $200,000 per year by the time you retire, or whether it’s something more directly related to your overall wealth.
You can then work out how to achieve it and pick strategies, properties and budgets to suit.
By setting an end goal you’re helping to ensure that your investment strategy is focused and structured.
It will also give you something to refer back to when you need to make a difficult decision.
Tip 7: Focus on your income
To build a property portfolio you’re going to need to leverage and gear by borrowing from the bank.
While banks love to see that you have equity in your home or other investment properties they will require you to prove serviceability to borrow more funds.
This means you’re going to need to have a secure day job and strong income to make the banks comfortable in lending you more money.
Overtime you won’t have to go out to work because your properties will be working for you bringing in cash flow, but again, this will take time.
Tip 8: Only buy properties with strong owner-occupier appeal
Remember…owner-occupiers make up around 70% of our property market, so it makes sense for investors to only buy properties that would in demand from these buyers.
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