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.
Just to be clear… positive or negative gearing is not an investment strategy – it’s just a result of your financing situation.
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.
The pros:
- 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.
The cons:
- 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.
3. Diversification
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?
Why?
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..
- Also read:The latest Corelogic Rental Market Report
- Also read:The Boom and Bust of our Property Cycles: A Journey Through the Investor’s Mind
- Also read:Perth housing market update | April 2024
- Also read:Latest property price forecasts for 2024 revealed. What’s ahead in our housing markets in the next year or two?
- Also read:Sydney housing market update | April 2024
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.
Buying a property which would only appeal to investors or tenants will greatly limit your capital returns because demand would be much lower.
To do this you need to look at the suburb, neighbourhood, local amenities, and liveability because its things which help to drive good capital growth.
In the long term, it's these properties which will outperform versus “investor stock.”
Tip 9: Start your process with ‘buy and hold’
Start off with the basic strategy of buying and holding property investments to get capital growth.
Capital growth is the ants’ pants of property investing so don’t look at making quick profits by flipping.
Over time you can introduce other investment strategies such as adding value through renovations or development
Tip 10: Identify when someone has a vested interest
The most noise in the property investment industry comes from people trying to sell you something.
While not all of them are sinister, you will encounter plenty of well-meaning individuals who are simply mistaken.
Then there is the new breed of property investment “gurus” who haven’t really got a track record but have built fancy websites and large Instagram followings from overseas paid “friends.”
Sometimes it’s hard to know who to trust and who to ask for investment advice, but being able to recognise when someone has something to gain from your investment decisions helps you know how to protect yourself and your investments.
Tip 11: Don’t just buy in your own backyard
Leave your emotional connection to your local suburb at the front door, the best investments are often further afield, not just in places we already know and are comfortable with.
Consider looking at growth areas in different property markets across the country to work out what the best investment is to suit your budget.
Tip 12: Buy existing, not new properties, preferably with renovation or development potential
As a general rule, don’t buy a new property.
New properties come at a premium and like driving a car out of the showroom, can drop in value soon after purchase.
Instead, you should look for existing properties, ideally with renovation or development potential so you don’t have to wait for the market to do the heavy lifting – you can “manufacture” some capital growth.
Tip 13: Target properties with character
If you can get an old period or character house, they usually make great long-term investments, because of their scarcity and wide appeal.
Tip 14: Think about neighbourhood
It used to be the case that the closer to the CBD, the more convenient the property will be for tenants and therefore those properties have a huge demand drawcard.
But if the Covid-19 pandemic has taught us anything, it has taught us the importance of the neighbourhood we live in.
Gone are the days where our ‘home’ was simply the place we rest our heads.
Nowadays, buyers are looking for properties which are a short trip to a great shopping strip, your favourite coffee shop, amenities, the beach, a great park.
Tip 15: Make sure you understand the market for supply and demand
Prices rise when demand exceeds supply, so you’ll want to make sure there is the highest demand-to-supply ratio in order to get the great returns.
And look for a market where there are is strong demand from a wide range of prospective buyers creating sufficient market depth to avoid the volatility we tend to see in small regional areas or country towns.
6 tips on how to manage a property portfolio
So we’ve covered off how to build a successful property portfolio, but how do you then manage it?
I’m sure you’ve heard it said that you should treat your property investments like a business.
But what does this really mean when it comes to the long term management of your asset?
Here are six top tips on how to manage a property portfolio.
1. Be business-minded
When you fail to plan, you plan to fail as the old adage goes.
In order to succeed in property investment, you need to have a detailed strategy mapped out and keep sight of your long term goals.
Meanwhile, when it comes to managing your property portfolio, you should think like the owner of a business, because that’s essentially what you are!
Employ the best people in your team, take an active interest in all aspects of what they’re doing and communicate with them regularly because at the end of the day, it’s your asset and you need to make sure it’s being looked after effectively.
2. Don’t get emotionally involved
Allowing your emotions to get in the way when it comes to your property investments is a huge mistake.
To avoid getting too emotionally involved and rather than imagining yourself in the property you’re looking at, think about the type of tenant you want to attract and whether they would be interested in living there.
By knowing your target market you can help to avoid extended vacancy periods and are more likely to achieve top rental dollar.
3. Keep your property pristine
One way to make sure you get the best tenant to look after your asset, whilst at the same time ensuring it retains its long term value, is to conduct regular and timely maintenance.
By keeping up appearances with a fresh coat of paint as required, attending to any necessary repairs, or even installing an air conditioner or dishwasher to take that bit of extra care for your tenants, you will reap the rewards with a top rental price.
And let’s face it, a well-maintained property will be a money-spinner for the long term as it continues to grow in value, rather than losing value due to untended wear and tear.
4. Stay on top of rent reviews
To maximise the return on your investment, it is essential to keep on top of where the rental market is heading.
Ensure your property manager conducts annual rent reviews to ensure you achieve market rentals and therefore the best returns on your asset.
Often, by increasing your rent in line with the market, you can decrease the divide between your monthly mortgage repayments and the contribution your tenant makes each month.
But it can also mean your tenant ups sticks and leaves for somewhere else.
So you need to weigh up whether gaining a bit more in the short term could see you lose out in the long term because your property is overpriced and remains vacant for longer.
Of course, your property manager should be informing you of the appropriate rent to charge and when you should be increasing your rent.
5. Don’t make it personal
Getting too cosy with your tenants can cause a world of pain for landlords.
Firstly, there’s more chance of complications when it comes to the tenant paying their rent in a timely manner, as they might feel they can take advantage of your personal relationship.
Secondly, if you stretch the friendship and pop around to visit too frequently, the tenants might end up accusing you of breaching their legal right to quiet enjoyment of the rental property.
Again, this is where the benefits of employing a business management attitude toward your property investment and have a proficient property manager look after your asset as opposed to getting personal, is invaluable.
6. Hire great help
To manage your properties effectively, you need a good team of professionals to help.
Employing an experienced property manager who knows the area your property is in intimately, will be a great benefit in the long term - and they do more than just collect the rent for you.
At Metropole, we help you build your wealth by offering the best property management services available because we are a different breed of licensed estate agents. We do not sell real estate.
We lease and manage residential properties throughout Melbourne, Sydney and Brisbane concentrating all our resources on ensuring that your specific management needs are fulfilled.
