Building wealth through investment property isn’t a simple endeavour. Just having one property under your control won’t generate wealth. You need to know how to build a property portfolio.
Very few investors start with even a basic property investment plan. They typically have their own homes and use the equity they build to buy an investment property, But that’s as far as they go.
They don’t know how to build a property portfolio. Instead, they assume the single property they’ve bought will generate high enough returns.
That’s rarely the case. Building wealth through property investment requires you to build a portfolio. You need several properties under your control.
Building your portfolio increases your rental yields, which means more money in your pocket. Also, a strong property investment plan allows you to build your borrowing power. This can give you access to even more promising opportunities.
Of course, there are barriers in place that may make it difficult to build a portfolio. Freeing up enough cash to make the purchase is often a problem. So too are the tight conditions that many lenders have in place.
Overcoming those barriers is the main focus of this article. The tips provided show you how to build a property portfolio. But first, let’s look at what one of The Successful Investor’s clients achieved with our advice.
Case Study – Alexander and Kari
Alexander and Kari had taken a smart approach to their finances. The couple listed some goals upon getting married. Buying their first home was chief among those goals. In the long term, they wanted to build $1 million in equity in their property portfolio.
They bought their first home, valued at $380,000, with a 20% deposit. Over the next five years, their property achieved 6% capital growth. They also continued to make their minimum repayments. This meant that they had $128,000 in equity and a remaining home loan debt of $285,000.
They chose this point to invest in their first property. But they added a caveat to their property investment plan. They wanted to have $35,000 in equity leftover in case of emergencies. This gave them $87,400 in useable equity.
They used The Successful Investor’s technique of leveraging equity based on the Rule of 4. This means they can buy a property worth $349,600.
The couple buys a $330,000 property. Coupled with their own home, they now have a portfolio valued at $838,000. Remember that capital growth raised the value of their own home.
Now, they have two properties that they’re building equity in. Capital growth of 6% also continues to benefit them. A mere two years later, they have built $129,600 in equity on a portfolio worth $942,000.
This gives them $94,600 to play with after subtracting the emergency fund. Again, using The Successful Investor’s Rule of 4, they determine they can buy a property worth up to $378,400.
The couple buys a $375,000 property.
After following our property investment plan for seven years, they’d achieved their goal of having a $1 million+ portfolio.
The couple continued to invest, barring some breaks from work to raise a family. Each time they built on their portfolio, they increased their borrowing power. They also built more equity, which means they could buy more expensive properties.
Using The Successful Investor’s techniques, the couple built a portfolio in far less time than they anticipated. They now own over $1 million in property.
Tips for Building a Property Portfolio
Alexander and Kari’s case isn’t unique. There are millions of Australians who can use a similar property investment plan to build a portfolio.
Here are five tips on how to build a property portfolio.
Rule #1 – Leverage Your Equity
Let’s start with the technique that brought Alexander and Kari such great success.
The average person doesn’t have tens of thousands of dollars laying around to invest in property. Instead, they must rely on the property purchases they’ve already made to make further investments.
It starts with your own home. As you repay your home loan, you build equity in your property. Capital growth also increases your equity, as do any improvements you make to the property.
After enough time elapses, you can access this equity to make other purchases. That’s how you get on the property investment ladder.
There are two important things to do when accessing your equity. Both lower the risk you take on:
- Determine an emergency fund
- Use the Rule of 4
Your emergency fund is a set amount of equity that you leave in the property when you invest. This covers you in case something goes wrong.
The Rule of 4 determines the maximum value of the property that you invest in. Simply multiply your usable equity or cash deposit by four to get this value.
You then use this equity to pay a 20% deposit while leaving 5% aside to cover the fees.
Now, you have two properties that you’re building equity in. After a few more years, you’ll have enough equity to make your third purchase. You can continue using this technique to build your portfolio over time.
This is a long-term property investment plan. But it’s one that will generate results. You slowly build a portfolio while minimising the risk that you face.
Rule #2 – Start Small
Your first investment property represents the greatest risk. Buying big at this stage can cause serious problems when trying to build a portfolio. The problem is that you’re more likely to make mistakes at this stage too. You’re new to investment, which means you haven’t experienced the pitfalls that more seasoned investors have.
The key is to start small so that you give yourself time to understand property investment. In our case study, Alexander and Kari’s first investment property cost less than their own house. They weren’t looking to make an immediate profit. Instead, they wanted to create an equity base from which they could build their portfolio.
Take your time, do your research, and work with the right advisors. You may still make mistakes. But with a cautious enough start, they won’t be so big that you’ll lose hundreds of thousands of dollars.
Keep it simple by buying a property in a stable location that has some strong capital growth potential. The larger purchases come a few years down the line.
Rule #3 – Start Early
While it’s not impossible to build a portfolio when you’re approaching retirement age, it does present more challenges.
Starting early gives you some time to make mistakes. It also means that you can build a property investment plan that lasts for several decades.
Again, it starts with the property that you buy for yourself. Start creating your plan as soon as you start building equity in that property. You can then focus your loan repayments on building the equity needed to achieve your goals.
You’ll likely have access to more equity when you’re older. But you also have less time to build equity in the investment properties that you buy. Starting early gives you more time and flexibility.
Rule #4 – Understand Cash Flow
Some experienced investors use negative gearing to their advantage. But poor cash flow can prevent the average investor from building a portfolio.
Focus on properties that will generate cash flow that works for your circumstances.
Negative cash flow means that the property doesn’t generate enough money to pay for itself. That means that you have to pull cash from other income sources to pay for it. But the key is that you buy a property with a cash flow that works for you. Otherwise, your portfolio-building activities slow down.
With the right advice, you may be able to use negative cash flow to your advantage. But place your early focus on properties that offer a balance between good cash flow and good capital growth. You’ll build equity faster, which means you can build a better portfolio.
Importantly, buying with the right cash flow in mind means you’re not negatively affecting your current lifestyle.
Rule #5 – Increase Your Yields
Higher rental yields mean that you have more money available for portfolio building.
The simple tip that many forget is that rents naturally increase over time. The market evolves, yet many new investors don’t raise their rents in accordance with it. Even without making improvements, you can often increase your rents by a small amount each year.
This means more money in your pocket with which to fund your portfolio building.
Keep an eye on the market and what other investors do. You’ll be fine as long as your rents stay in line with those of similar properties.
Buy a home owner quality property, this will make the property more desirable as a rental and when you sell. You must also buy in a home owner quality location, not a suburb filled with investment properties.
Those who own an older property may have to consider major improvements. Renovations modernise your property and make it more desirable to tenants. Better yet, they typically increase the value of the property. This means you increase your rental yield while also increasing the equity available to you.
Simply put, if you add value to your property you generate a stronger cash flow. This can help you to build to your ideal portfolio size.
Building a property portfolio is the key to building wealth through property investment. Don’t rest on your laurels once you’ve bought your first investment property. Build a property investment plan that revolves around the tips in this article.
Leverage your equity and take steps to add value wherever you can. Target properties with good cash flow and growth potential in the early years of building your portfolio. You can buy properties that offer high capital growth with poor cash flow later.
Most importantly, recognise that this is a long-term endeavour. You can build a portfolio worth a million dollars or more as long as you take your time and follow a strong plan.
Michael Sloan is the author of two books, The Formula to Successful Property Investing and Cracking the Real Estate Code. His articles appear on the National Australia Bank (NAB) website and he is regularly quoted in the media. Michael is the Co-Founder and Director of The Successful Investor, a national property advisory firm. With over 20 years in the industry, he has helped hundreds of people safely establish and grow successful property portfolios. His app the_formula is available from both Android and IOS.