Building The Perfect Property Portfolio

Your Investment Property Magazine
by JoeyJ

Investing in property at random will only get you so far. Your Investment Property magazine discovers there are careful strategies involved in building a strong portfolio that will ultimately deliver you financial freedom.

A portfolio is a case used for carrying loose papers or drawings. It serves to organise the disparate sheets of paper into a unified set with a single overall purpose.

Similarly, a property portfolio must be seen as more than a mere collection of different investments. It is an entity unto itself. Each investment in your portfolio is an element of the whole, working in harmony with all the other elements to achieve a single outcome – your financial goal.

There are, of course, factors beyond your control. Rising interest rates, worsening economic conditions and imperfect tenants can conspire to confound your best-laid plans. The point is to look long-term and be prepared to change your strategy along the way.

Getting started
In order to start building a property portfolio, you actually have to begin at the end. What is it you ultimately want to achieve? Do you want a quiet, comfortable retirement? Do you plan to lead a very active and expensive retirement? Do you want to retire early? How many more years do you envisage earning an income?

These are among the essential questions each investor must ask themselves before devising their portfolio strategy. “You must know a lot about yourself – your attitude to risk, time till retirement and cash flow needs today,” says Margaret Lomas, director of Destiny Financial Solutions.

Building a portfolio is most certainly not a get-rich-quick scheme. “There aren’t any shortcuts,” warns Stuart Wemyss, director of ProSolution Private Clients. “It’s about developing some goals and then developing a strategy that meets those goals.”

If you have already been through the process of buying your own home, it may have been quite an emotional experience. Investing is the opposite. It requires a certain level of detachment, which can be quite difficult to achieve.

“You must learn how to research so that you buy according to a property’s investment potential, rather than whether you like or dislike it,” says Lomas.

One way to practice decoupling emotion from investment is to look into a town or state that is far away from your own. Researching the fundamentals of an unfamiliar locality will give you the discipline to look only at the numbers. Your particular aversion to tiled floors or galley kitchens is irrelevant.

“With property [investment] we tend to be really myopic and look within a few k’s radius of our home,” says Wemyss. “The first thing a property investor should do is come to terms with the fact that they’re investing in something, not to get too emotional about it and to see the benefits of building a wider portfolio outside their domicile state.”

Strength in diversity
Once you have decided what your investment goals are, it is time to build a strategy. One very important aspect of portfolio strategy is diversification.

“A lot people will tend to buy within 2–3km of their local area because that’s all they know,” says Pino Tedesco, managing director of property strategists Capital 360. “If you’re in an area that takes a bit of a dive, then it’s probably not a good thing to do.”

Lomas reiterates the importance of geographical diversity in your portfolio: “Property behaves in different cycles everywhere,” she says. “When you diversify, you will always have something in your portfolio that is in its growth phase while others are in their plateauing phase.”

At the moment, for example, Sydney is quite strong, while Adelaide and Hobart are sluggish and Brisbane and Perth have almost ground to a halt. These are, of course, generalisations, and you will have to research specific suburbs within your chosen city in order to get a better idea of what is happening street to street. As a guide, though, it is useful to understand where different cities are in their cycle. Your Investment Property publishes detailed price guides and state-by-state market analysis every month.

“The other main consideration is land tax,” says Wemyss. “If you own four properties in four different states, it’s possible to get away with paying no to minimal land tax. If you have them all in one state, you’ll be paying more tax.”

Wemyss notes that diversity does not just relate to geography. Diversity of architectural style might also be useful, as different styles go in and out of fashion. Also, it is worth thinking carefully about dive rsifying in terms of property type: your portfolio should eventually contain apartments, houses, two-bedders, three-bedders and possibly larger family homes.

Growth vs yield
“First we must understand that growth doesn’t mean you compromise yield, and vice versa,” says Lomas, busting the old myth. “I have proven, and so have most of my clients, that you can buy property that gives you both, as long as you don’t try to sell too soon.”

Holding for the long term is one of the hallmarks of a strong property portfolio. ‘Flipping’ and short-term profit chasing will ultimately prove fruitless. Chasing so-called ‘hot spots’ is also potentially dangerous, as they can be incredibly unstable. Look for areas that will deliver stable growth and, eventually, good yields.

“What a lot of people do is they chase one or the other [yield or growth]. I think that can be fundamentally a mistake in the long term,” says Tedesco. “If you concentrate just on [the yield] path, you basically create yourself an occupation of being a property manager. You end up accumulating a lot of properties in sub-regional or mining-type areas or coastal towns, where you get those high yields, but you’ll find yourself managing a lot of properties, and the tax applicable on that income does take away a lot of the upside.”

Tedesco prefers a strategy that begins with buying in areas with historically high capital growth. Next, look at high-demand areas that are undersupplied. In these localities, there is little or no land available for development and properties spend very few days on market. These suburbs are always close to major employment or education hubs and demand for rentals is red-hot.

Don’t leave it on autopilot
As your portfolio grows, you may be in your 40s or 50s, perhaps with a family and one eye on providing a more comfortable life for yourself and your family once you retire.

“It’s never too late to do a bit of planning,” says Wemyss. Take stock, examine the markets and realign your strategy. Are you still on track to reach your target? Which type of property can you buy next to complement those already in your portfolio? “You don’t need to labour over these things for months and years,” he adds. It is important, however, to ensure that your portfolio is continuing to work hard and grow.

Access to finance is, of course, crucial to building a healthy portfolio. However, experienced investors are very disciplined about their gearing strategy. They don’t borrow against their equity to buy consumer goods and other expensive liabilities. Equity is strictly for feeding into the next property purchase. “You can extract that equity and you can utilise that through refinancing without actually selling and incurring capital gains tax,” notes Tedesco.

In consultation with your lender or mortgage broker, you will be able to decide when is the right time to acquire another property. However, remember not to cede responsibility for your borrowing to anyone else. Just because a lender says you can service a loan doesn’t mean it will necessarily suit your lifestyle requirements. If your portfolio is still cash-flow-negative, calculate how much money you can afford to devote to servicing each month and don’t exceed that, no matter what your lender offers.

Gearing up early and remaining disciplined about using your equity will help you get through the acquisition phase of your portfolio sooner. “The quicker you can acquire [your properties], the better off you are. If the timing is right and the cash flow is right, gearing up sooner rather than later will make a big difference,” says Wemyss. “Capital has a compounding nature, so it really needs a few years to get going. The sooner you can do it, the better off you’ll be.”

Eventually, you will hit a limit in terms of acquisition. “There’s a financial glass ceiling,” says Tedesco. “The banks basically say serviceability is out the window. You’ve got this income, your property portfolio’s grown, but unless your income grows, there’s no more finance.” That’s when you can really focus on the value-adding phase of your strategy. You are now building cash flow and getting ready for financial independence.