Your five-year plan

By
Helen Collier-Kogtevs reveals practical steps you should take to ensure you achieve your investment goals in the next five years.

 

Many property investors have a broad idea of their plans for the future. You might know that you want to own five properties by a certain age, for instance, or that you wish to retire on your property portfolio in 10 years’ time.

But to be a truly successful property investor, you need more than ‘big picture’ goals and ideas. They’re a wonderful place to start, but you also need to know the steps you should take to turn your dreams into reality. You need a plan. And the best place to start is by covering your short-terms goals with a five-year plan.

 

Failing to plan is planning to fail

We all know or have heard about real estate investors who have been forced to sell some or all of their properties, particularly in recent times.

It can happen for a range of reasons. Some investors were overextended or highly leveraged, and they didn’t count on finance markets drying up so quickly – they were used to refinancing and gaining fast access to lending, and when they couldn’t get finance, they had no back up.

Others lost their jobs or income sources due to the slowdown in the economy and found that they could no longer afford to pay for their investments. Others still are impacted by situations that completely catch them off guard, such as divorce and family illness.

These kinds of situations can occur at any time, and if recent times have taught us anything, it’s that the biggest mistake we can make as investors is to fail to plan. I know it’s a cliché, but failing to plan really is planning to fail, particularly when you’re dealing with large amounts of money.

With the right preparation and risk mitigation strategies, you can protect your investments and ensure that you keep moving forward, regardless of what the market is doing. You need to prepare for the worst, while hoping for the best – and to achieve this, you need a plan.

 

Know your intentions

Far too frequently, property investors make decisions based on emotions, reactions, and even well-argued facts – but they do it without analysing their own personal situation.

A perfect example of this is interest rates. Many people thought about locking in their mortgage interest rates in the early months of 2009 when fixed rates were as low as 5%. That’s easy to see why now. March 2009 was the best time to lock in your interest rates. Often, however, investors have no idea what their own specific investment goals or intentions are when making these kinds of decisions. If you don’t have defined goals, it’s like trying to decide whether to book your upcoming holiday by train or aeroplane, before you’ve even decided on your destination – you obviously need to know where you’re going before you figure out how to get there.

In this example of fixed or variable interest rates, for instance, you would be better off asking yourself, ‘What is my primary goal, and how will a fixed rate or variable rate help me get there?’ We all want to save money wherever possible, and a fixed rate might deliver that, but it might also cost you more money in the long run. So in relation to a fixed interest rate, there are several specific criteria you should consider for each property that you own:

 

  • How long do I plan on holding this asset: short-term? Long-term? Unsure?
  • How much equity do I hold in the property?
  • How much do I owe on the mortgage? Is the loan principal and interest or interest only?
  • Will I need to carry out any renovations in the next five years?
  • Do I have a stable tenant? What are local vacancy rates like?
  • In the next few years, if I end up in a position where I need to sell one of my properties, is it likely to be this one?

 

The answer to these questions should help you to form the basis of your five-year plan. You now have an idea of how long you wish to hold your properties for, and you know how each piece of property relates to one another – so that if push comes to shove, you know which will be the first one you put on the market. You also have an idea of how leveraged each property is, which is important when you’re wanting to refinance, to access funds to renovate or use as a deposit on another property.

 

Now that you’re armed with all of this information – does a fixed rate still make sense for each of your investment properties? Or does the flexibility of a variable rate sound more appealing? If there’s a chance that you might sell a piece of real estate, I believe that you should avoid a fixed rate on that particular loan, as the exit fees you’ll be charged to get out of the loan will more than cancel out any savings you’ve enjoyed in the meantime. But aside from that, there’s no right or wrong answer in regards to fixed interest rates – it completely depends on your goals or aspirations.

 

Match your goals to your actions

Recently, I was speaking with a client who wanted to buy another investment property. She already had two properties and was excitedly telling me about a deal that was almost too good to be true – hence why she wanted my opinion.

It was a brand new, one-bedroom, one-bathroom apartment with a study located in the Sydney CBD. The building was new and very high-end, with amenities including an on-site gym, 24-hour concierge and rooftop garden. It had been sold off-the-plan since 2007, but as the building was almost complete, the developer was offloading the remaining few apartments at heavily discounted prices – almost $120,000 less than the asking price 12 months earlier.

 

With the projected rents and depreciation, my client’s 10% deposit, and the relatively low fixed-rate interest rate that her bank was offering, the property was going to be positively geared to the tune of around $150 a week. There was also a rental guarantee in place for the first two years. “Even if rents drop for some reason after two years, I’m still going to be ahead, because I’ll have the $20,000 I’ve earnt in the first two years with the rental guarantee,” she told me.

I looked into the deal, and the projected rents were on par with what the market could support, so the estimated returns were quite accurate. So what was the problem?

 

The problem was my client. She’s an accountant. Her partner is a lawyer. They’re a young, professional couple with no children, and I recall her telling me of their plans to move overseas next year, to gain some international career experience and do some travelling. They plan to be away for at least two to three years, before they return to Australia to settle down and have children.

 

While living in the UK, they’ll pay UK taxes, and all of the Australian tax benefits of this deal will fly out the window. Suddenly, a property that was returning $150 a week would return nothing, as the tax savings – most of which was generated by high depreciation – relied on them being Australian taxpayers. In fact, we worked out that if she wasn’t in Australia, she’d end up out of pocket by around $2,500 each financial year, without accounting for unexpected repairs or maintenance.

 

I believe that some of the tax deductions could be held over until she returns to Australia and earns income here again, so the tax could be offset against income earnt down the track – I’m no tax expert, so this would need to be verified by an accountant! But if my client intends on cutting back at work to start a family when she returns anyway, her offset-able income will be lower, so these future offsets will be less valuable in any event.

 

This is a perfect demonstration of why you shouldn’t make investment decisions based purely on the tax benefits, and it’s also a great illustration of how one deal could be perfect for one person, but not appropriate for the next.

All in all, you can see this deal was not suitable for my client, in light of her future plans. We worked out that she and her partner would be best off investing in a house that had lower outgoings – ie, no high building management and body corporate fees – and one which was and was excitedly telling me about a deal that was almost too good to be true – hence why she wanted my opinion.

It was a brand new, one-bedroom, one-bathroom apartment with a study located in the Sydney CBD. The building was new and very high-end, with amenities including an on-site gym, 24-hour concierge and rooftop garden. It had been sold off-the-plan since 2007, but as the building was almost complete, the developer was offloading the remaining few apartments at heavily discounted prices – almost $120,000 less than the asking price 12 months earlier.

 

With the projected rents and depreciation, my client’s 10% deposit, and the relatively low fixed-rate interest rate that her bank was offering, the property was going to be positively geared to the tune of around $150 a week. There was also a rental guarantee in place for the first two years. “Even if rents drop for some reason after two years, I’m still going to be ahead, because I’ll have the $20,000 I’ve earnt in the first two years with the rental guarantee,” she told me.

I looked into the deal, and the projected rents were on par with what the market could support, so the estimated returns were quite accurate. So what was the problem?

 

The problem was my client. She’s an accountant. Her partner is a lawyer. They’re a young, professional couple with no children, and I recall her telling me of their plans to move overseas next year, to gain some international career experience and do some travelling. They plan to be away for at least two to three years, before they return to Australia to settle down and have children.

While living in the UK, they’ll pay UK taxes, and all of the Australian tax benefits of this deal will fly out the window. Suddenly, a property that was returning $150 a week would return nothing, as the tax savings – most of which was generated by high depreciation – relied on them being Australian taxpayers. In fact, we worked out that if she wasn’t in Australia, she’d end up out of pocket by around $2,500 each financial year, without accounting for unexpected repairs or maintenance.

 

I believe that some of the tax deductions could be held over until she returns to Australia and earns income here again, so the tax could be offset against income earnt down the track – I’m no tax expert, so this would need to be verified by an accountant! But if my client intends on cutting back at work to start a family when she returns anyway, her offset-able income will be lower, so these future offsets will be less valuable in any event.

 

This is a perfect demonstration of why you shouldn’t make investment decisions based purely on the tax benefits, and it’s also a great illustration of how one deal could be perfect for one person, but not appropriate for the next.

All in all, you can see this deal was not suitable for my client, in light of her future plans. We worked out that she and her partner would be best off investing in a house that had lower outgoings – ie, no high building management and body corporate fees – and one which was positively geared without accounting for depreciation. She ended up finding an established house that returned $60 per week before depreciation, and $110 after depreciation, so it was a much more comfortable fit with her future plans.

 

As an investor, it’s important to make sure that your actions match your intentions – and having a five-year plan will help you do just that.

 

Your five-year plan

So precisely what does your five-year property investment plan look like?

Think of it as your personal road map to help you make all of your property-related decisions, from buying and selling to renovating and refinancing. If you don’t have one, it’s time to make one – now! If you do have one, now is the perfect time to revise it.

 

It should be a flexible working document – one that can be changed and updated to reflect changes in your lifestyle and situation – and you should aim to review it every six months or so, to ensure you’re still on the right path. Most of all, it should be tailor made to you and your financial position, so that you can be sure you’re making every last dollar work for you.

 

When you’re creating your five-year plan, you need to consider all of these things from the perspective of: where do you want to be in five years’ time? Once you’ve sorted out your goals, you work backwards. For example, say you currently own two investment properties, and in five years’ time, you want to own five properties. This means you need to acquire three additional properties in five years; your five-year plan should then spell out just how you can achieve that.

There are many factors that will influence your five-year plan, and they can loosely be grouped under three headings: finance, family and lifestyle.

 

Finance checklist

The ‘finance’ arm includes external influences such as interest rate movements, and internal factors, such

as your income and your ability to gain loan approval.

The major point here is serviceability. Rents are likely to rise slightly each year, which will offset some increases in interest rates, but rates could also be up by 2-3% higher in a few years’ time.

 

Consider:

  • Do you and your partner have steady jobs?
  • How much do you have in savings as an emergency buffer account?
  • Currently, how leveraged is your property portfolio?
  • If rates go up 1%, will you still be able to afford to maintain your investment properties?
  • If rates go up 2-3%, will you still be able to afford them?
  • If you plan to buy additional investment properties, where will the deposit come from?

 

Your answers will help shape your financial goals for the next five years.

If your goal is to buy three more properties, for instance, you may decide that you need around $40,000 in savings or accessible equity to purchase each property, to cover a small deposit and acquisition costs. That means you need to save around $25,000-$30,000 each year, or your current property portfolio needs to grow in value by that amount. Once you’ve worked out your financial goal, you can work out how to achieve it.

 

Family checklist

You might be able to afford your portfolio now, but how will you cope when your mortgages cost you an extra $1,000 a month due to rising interest rates – and your two-income household just dropped to one income, because you’ve just had twins?

 

Consider:

  • Do you plan to have a baby or expand your family in the next five years?
  • Will adding to the family impact your income stream? If so, how do you plan to replace that income?
  • How will you cope with the extra expenses that expanding your family brings with it?

 

Your answers to these questions will feed into your financial decisions and will help you work out a more realistic budget.

 

Lifestyle checklist

This group covers all of the factors that we often forget about when we’re making plans and working out our finances, from health and wellbeing through to travel and lifestyle choices.

 

Consider:

  • How often do you travel for leisure, and how do you pay for it?
  • If you increase your investment portfolio, could that have an impact on your future travel plans?
  • Do you plan to upgrade your car in the next five years?
  • Do you have savings set aside to cover health issues such as undergoing major dental work, which can cost thousands of dollars?

 

If your goal is to buy another three investment properties, and you’ve worked out that you need $25,000 per year to achieve that, is it still possible for you to go on that European vacation next year? Keep in mind that financing your travel plans via credit card is not the way to move forward!

 

I’m a big believer in enjoying your lifestyle, and I don’t think anyone wants to get rich by living off baked beans, but you need to make sure that you’re living within your means. If you’ve got your heart set on that European holiday, perhaps you need to revise your end goal, and aim to acquire two more properties in the next five years rather than three. Whatever you decide, the most important thing is to prepare and budget ahead accordingly, so that you don’t overextend yourself and your finances.

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