Property Investing/ Property Advice: Series 2 of 7; Series 2: Tailored Plan: Part 5
I believe you must engage a Buyers Agent with every property purchase, Using a Buyers Agents/Buyers Advocate and Property Advisor is key to more property investment success. These are extracts from my latest book “The Australia Property Investment Handbook 2018-2019″. In all good book stores now. Also Read Property Finance Made Simple and Property Investing Made Simple.
With every plan there are also three stages
- An acquisition phase:
This is the period of time over which you acquire the required properties. It can be as short or long as is practical, but needs to suit your current situation and all the elements of what makes up your current situation discussed in chapter 1.
- The holding phase:
This is the period of time that you hold your properties. The longer this phase, with a buy and hold strategy, the more time the properties have to grow in value. Many property-marketing companies will tell you that property has doubled in value every 7-10 years and whilst this is true in many areas, what these people do wrong is imply that property will continue to double the next 7-10 years. They may not say it explicitly, but they often lead you to believe the chances of it are very high.
This I disagree with, the past is not a reliable indicator of the future. To be more reasonable with timeframes and in order to manage expectations, it is more reliable to allow 15 years, or even 20 years is better. Not everyone has this much time, and it is a sad fact of life that people leave it too late in life to take action for the betterment of their future. What can be done for people who are young enough, is to consider starting now if your current situation allows it. For those people who have left it late, they could also consider whether they should start now, to at least try and improve their situation, and seek advice at least.
The older someone becomes, the more conservative they should consider being. They have less time to try and mitigate any financial mistakes they make.
- Exit phase:
There are five main exit strategies. It is best to seek advice from a property advisor for a tailored approach.
- Sell some and pay off the debt on the rest leaving the remaining properties hopefully unencumbered. This works when there are more than just a few properties, and some with a capital growth focus. You may or may not have reduced some of the debt. The less debt you want to reduce, the more confidence you would need with the market.
- Reduce your debt, assisted by an offset account and principle and interest (P & I) repayments on any mortgage against your principle place of residence (PPR). Firstly focus on the debt not providing any tax benefit. Once non-deductible debt is paid off, then consider an offset against the deductible debt against the principle place of residence, or investment property, originally used for deposit and costs of a property purchase.
- A blend of 1 and 2 is probably optimal unless all debt can be paid off from personal endeavour (working for a living).
- Live off equity in retirement. Prior to retiring, apply to refinance all properties, setting up redraw or line of credit against some or all. Using equity to live off is different to earning income to live off, as it is not taxed.
- Sell all properties. Hopefully walk away with two million in equity, then purchase a few properties with really high yield, for example 10% and live off the rent.
Example: If your home, or preferably an investment property, had enough equity to establish a line of credit/redraw against it of $400k (could be more, but let’s say $400k), just before retirement, while still earning assumedly sufficient income to service this amount. The undrawn equity could sit in the loan not incurring interest. It could provide $40k pa to live off for 10 years, which would put the borrower in the top percentage of retired income earners in Australia. Let’s assume superannuation and any additional shares provide an income of $15k pa. Only $25k needs to be used from the line of credit/redraw to earn $40k per year, meaning the $400k in redraw could last for 16 years. Imagine having a couple of properties with access to $400k equity in each.
Note: the point number four is one some others promote. It has, as a concept, been around for 20 years, but often these people fail to adequately explain the mechanics and downside of it. Some reasons it may be problematic are:
- Accessing equity after retirement is very difficult and unlikely possible, as lenders will need the borrower to have enough income to service an increase in the existing debt level, and an acceptable exit strategy.
- Lending policy may inhibit further borrowing; you cannot rely on what lenders will do in five, or 25 years. Additionally, it is not always so easy to refinance just when the borrower wants to.
- You will eventually die, leaving all the debt-covered properties to someone else. This would be unfortunate and not considered a welcomed legacy.
- Some elderly decide on a reverse mortgage, and this does have serious consequences. It’s one of the most expensive forms of debt, may leave the person unable to afford aged care, and it may affect pension eligibility.
In summary: The type of property strategies and the number of properties of each strategy will impact on location choice, and therefore outcome. Between 5-7 well purchased properties is better than just choosing a number like 10 as a naïve goal for your portfolio. Property advisors do have software to model outcomes using conservative assumptions of growth and yield figures.
It is important that you don’t just buy and then sit and wait. You need to review your plan, portfolio, goals based on any changes to your circumstances, and the performance of the property and the market which it’s in. Using conservative figures will manage your expectations. It means that if the portfolio performs better, you may exceed what you had planned for. If it does not perform as well as you might anticipate, at least you have been conservative. Also review your risk tolerance.
Reducing debt that provides tax deductions is not the best approach if you have debt that does not provide you tax deductions, but it does have other benefits, which need to be weighed up. Whilst any applicable depreciation on the dwelling is on a straight-line method at 2.5% each year over 40 years, depreciation on fittings and fixtures, if applicable, does diminish over the short term, so the cost of debt will increase accordingly. To help mitigate this rise in cost of debt (to help weather the storm of rising rates) especially on interest only and investment loans, and to maximum the difference between the value of the property and level of debt, and make it more cash flow positive (if you can afford to), a debt reduction strategy is generally wise.
The bigger picture is the focus here, in a managed manner of course, but if you significantly reduce your debt over time, it will lessen the debt ultimately against your properties and perhaps reduce the number of properties you may need to sell. It’s very important to consider principle and interest repayments on the properties.
Rule: Please remember you will probably have to convert your repayments to principle and interest at some point, which in turn will reduce your debt. The more debt you do reduce, the better the outcome in the end, as long as you can afford to do this.
You need capital growth for wealth creation. This can provide the equity which may be accessed to use for the deposit and costs of buying more properties, paying off debt on other properties nearer retirement leaving a final number unencumbered. Paul Clitheroe from Money Magazine proposes a multiple of 17. Work out what you need in retirement, and then multiply it by 17, this is what you will apparently need. He suggests that 17 is the years you will live beyond retirement. If you live beyond that, well, you are in trouble. If you retire too early, then you may also be in trouble.
A plan’s focus is to acquire an appropriate number of properties for your specific needs, over a given time, at a given price, to achieve a desired passive income – all within an appropriate risk tolerance and level of affordability throughout the entire process.
It is worth reiterating that a plan is better than not having a plan at all. If you fall short, well, you would have achieved more than not having a plan to begin with.
My next book will go much more in-depth and provide examples of tailored plans, so stay tuned.