Investing in Real Estate 109 (How to Start a Property Portfolio)

Reading Time: 7 minutes 

RnB music pumping:

“….She’s so dangerous
That girl is so dangerous,
That girl is a bad girl, yeah”

Oh!

Hi there – how’s it going?

Sorry for being distracted, you see – I’ve had an old school RnB binge this weekend.

Poor MrsFrugalSamurai had to put up with my dance moves and random bursts of song.

She doesn’t mind, tests our marriage she says, makes it stronger.

Today’s article is in response to a question from one of her good friends Bane-san, a well-renowned medical physician based in Melbourne, who originates from the Indian sub-continent but has a Japanese name.

#Winning!

Bane-san asks:

How to start a property portfolio (and how to get/ structure loans for this), how to prepare for inevitable increase in interest rate.

Hey Bane-san that’s cheating! That’s 3 questions…

How to start a property portfolio.

Hm. The first one is always the hardest.

I’ve talked about this in depth with the property series which I wrote on earlier (read the first part here). The mindset required, the action needed and also what to look out for.

Buying a property, any property is actually really easy.

Anyone can call up an estate agent, inspect a property, sign on the contract.

If the bank can give you financing, hey presto – you’re pretty much set.

But how do you build on that, how do you create a portfolio through leveraging into more and more properties?

Yeah, how?

Traditionally the methods used are to either:

a) Access the equity built up in the first property for a deposit into the second.

For example: purchase property A for $200,000. Wait until values reached $250,000, refinance and access the $50,000 equity.

Use the $50,000 equity as deposit on property B to purchase for another $200,000.

Wait until property B reaches $250,000 (hopefully by then property A reaches $300,000, a further gain of $50,000).

Refinance and use the $50,000 equity from property B + additional $50,000 equity from property A as deposit on property C… and so on and so forth.

b) Use cash savings for a deposit into the second.

For example: purchase property A for $200,000 with cash savings of $50,000. Continue to purchase properties as soon as you have the savings to do so.

Back in the good old days when property values were substantially lower compared to income levels, and rental yields higher – a combination of the two worked nicely.

As long as the banks could lend you money – and they usually did, you kept on going.

Their rationale being – property values will always go up, an investment property will have tenants, and wage incomes will grow.

BUT these days, unless you’re living under a rock – you would have realized that the lending environment is much, much harder.

Gone are the days of 105% loans (banks lent you ALL the acquisition costs), 100% gross yields being applied for servicing, nil buffers, self-declared living expenses.

With the APRA crack-down and Banking Royal Commission – there is even less inclination for banks to lend.

Which is why recycling equity/savings done previously is SO much more difficult nowadays.

So what to do?

Well, if you want to leapfrog into a portfolio – the first property is the most crucial.

This is because if you max out your borrowing capacity with the first one – you can pretty much kiss buying the second one goodbye… until either your income, the property value and/or yield increases substantially.

So, buying the right asset the first time is KEY.

What is the right asset then?

Judging by what the old timers say to this, there are a number of recurrent themes as to how they go about it:

• The first thing is to always have a plan. It doesn’t have to be the most detailed or even the most insightful – but having a plan allows you to progress in a direction which suits your situation. If you don’t know how to create one. Find someone who does. Start to build your property team (read here) and leverage from people who are smarter than you.
• Research, which is absolutely paramount – is crucial for selecting the right asset. Understanding the supply and demand factors, demographics, infrastructure, jobs growth and council rules are just some of the things to look out for.

• Positive Gearing, Negative Gearing or Both? Know your strategy. Is it a yield or capital growth play (read here for the difference) or a combination of the two? Capital growth allows equity to grow and be utilized, but yields increase your servicing capacity – understand which one you’re comfortable with.
• Buying below intrinsic or market value. This requires understanding values, but it speaks for itself. If you purchase for $500,000 when you know the value is closer to $600,000. Then BOOM – instant equity.
• Add value. Oooo, I love this one. Basically it’s about renovating or making structural improvements. It doesn’t have to be crazy – a tired, run-down property can look pretty smick with a fresh coat of paint, new flooring and manicured garden. What can cost a couple of grand can add twice, triple or more in terms of value post-renovation.
• Something special. This relates to something a bit different with your property compared to others. For example, if your inner-city apartment has a designated parking spot whilst others don’t have one, yours will always be in demand – and values will reflect that.

That’s all fine and good TheFrugalSamurai, but what about the second and third part of Bane-san’s questions? I mean, yes we can pick the right first asset, but how can we structure our finances to obtain further loans for more lending to buy the second, the third and so on? And what about when interest rates rise???

WHAT DO I DO?!?!?!

Whoa, whoa, take it easy – it’s not that intense to get worked up over.

Look, I’ll just go through it… so what you do is… hey… are you still with me? Are…are you OK?

Listen, we might stop there for the moment… things are becoming too heated.

Go on, take a break – drink some water and come back as I’ll take you through the next parts to Bane-san’s question!

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