Ever dreamed about quitting your day job sooner rather than later? You’ve come to the right place as Todd Polke shows you a detailed road map to property riches you probably didn’t think were possible
Five-part strategy process
- Life design
- Finding your story
- Allocating assets
- Right strategy, right market, right time of the market
- Making it happen
Here’s a reality check: 99% of investors who start out investing in property to secure financial freedom for themselves and their families will never achieve the results they want. It is a sad fact but unfortunately true.
I could go into multiple reasons why most fail: no education, ineffective structuring, running out of cash flow or serviceability, no team around them, buying in the wrong locations at the wrong time of the market cycle, paying too much for property, ineffective due diligence...the list goes on. However, after working with tens of thousands of property investors over the last decade, I believe the primary reason people fail is that they don't have a strategy. If they do, it is buy and hope.
They buy property and hope it goes up in value, which is not a strategy for financial freedom. It is a strategy that keeps you tied to your job and a lifetime of working, to retire at 65 or 70 and hope you have enough to scrape by in your glory years.
What are you going to do about it?
Strategy is like piecing together a puzzle. We take aspects from your personal situation, including your personality, your financials and family situation, and create an amazing picture of your dream life. All these aspects are in a constant state of change and so your strategy has to evolve with you, being adjusted so it stays relevant to who you are, where you are in life, the marketplace and your goals. Although I would love to give you the magic 10-stage step-by-step guaranteed formula for financial freedom, I can't and don't believe anyone who says they can. Life changes and your strategy is dependent on that.
What I will do is walk you through my five-stage process, which I go through when setting the strategy for my personal portfolio and for each of my mentoring clients. Take this information and apply it in your life and get ahead of the game. Leave the 99% behind and join the 1% of investors who free themselves financially to live the lives they want to live.
How the strategy works in real life
As we go through these steps on how to create an effective investment strategy
, I am going to use a real case study of a couple I began working with about 18 months ago. This way you can understand the method and see how it applies to a real-life scenario. This describes the process I used during my initial strategy session with them and what has transpired over the last 18 months of us working together.
Here is a brief snapshot of their situation:
Meet Paul and Anna (names changed for privacy reasons)
Putting theory into practice
Their financial situation is as follows:
- Paul is 42 years of age and Anna is 38
- They have two children under the age of 10 and live in Western Sydney
- Paul is employed full-time earning $81,000 per anum
- Anna is employed part-time earning $30,000 per anum
- Principal place of residence in Western Sydney valued at $590,000 with a current mortgage of $285,000
- Investment properties: 0
- Savings: $8,000 in the bank and they are depositing $500 extra each month
- Superannuation: Combined balance of $150,000
- CURRENT LIABILITIES
- Personal loans: $38,000 for two cars
- Credit cards: Two with a combined limit of $15,000, completely paid off each month
What does financial freedom mean to you? The key principle of achieving success is to start with the end in mind. Everybody wants financial freedom, but what does that really mean?
I've had clients whose version of financial freedom was to create #35,000 per year passive income and then travel around Australian in a caravan renovating properties. I have others who say they need $200,000 a year in passive income before they can even think about feeling free and secure.
Most people overestimate how much income they actually need to retire with. Once you are clear on your ultimate life, you can calculate your expected living expenses as a weekly figure. If your home loan and all personal debt were paid off, how much income would you need to live your dream life?
Start by asking yourself what time of life you want to live (see box below). I asked these questions of Paul and Anna, and helped them decide on the following five main goals.
What type of life do I want to be living?
Try answering these questions:
- Where do you want to live?
- In what type of home?
- What do you want to spend your time doing? With who?
- What legacy do you want to leave?
- How do you want to contribute to your friends, family and charity?
- What objects do you want to own – fancy cars, a boat, a shoe wardrobe or just your own home?
- How much spare cash flow do you want to have each week?
- What choices do you want to have?
- What experiences do you want to have?
Take the time to answer these questions. You now have a blueprint for your ultimate dream life and a destination for your life journey.
MAKING IT REAL
- Paul and Anna don't want to reply on their superannuation for their retirement, as it isn't performing the way they need it to.
- Paul does not enjoy his job and doesn't want to have to work until he is 70. He'd like to create a passive income within 11 years, when his children finish school. He will then be 53.
- They are paying the maximum amount of tax at this point and want to reduce this with legal deductions.
- Anna wants to eliminate the debt on their home over the next seven to 10 years.
- They want to take a two-week overseas family holiday every year.
- They are concerned about how their two children are going to enter the property market when they hit their twenties, and want to assist them with their first property purchase.
These are relatively specific goals but we don't have tangible numbers to create a strategic plan. How do we turn these ideals into a clear target?
Once you've designed your ultimate life, it's time to cost it. This is when we go through each component and put a dollar figure on it.
What does it look like after costing?
- Goal 1: Replace Paul's current income with a passive income of $81,000 Deadline: 11 years
- Goal 2: Create $15,000 per annum in savings/profit to take a holiday Deadline: Two years
- Goal 3: Reduce debt of $285,000 Deadline: Seven to 10 years
- Goal 4: Eliminate tax Deadline: Five years
- Goal 5: Gift $100,000 to their children when they turn 21 Deadline: 13 years
We now have tangible goals. It's time to create a plan on how to achieve them.
Whatever it is for you, get clear on your outcomes and figures, as without this you are just taking a shot in the dark.
Using property to get rich
There isn't just one way to get a result, which is particularly true for property. There are three ways you can achieve financial freedom through property investing.
1. Positive cash flow portfolio - Living off your rental income
- Conservative (depending on where your properties are).
- Passive strategy. Once your income is rolling in, your involvement can be minimal.
- Reliable. With a solid portfolio and skilled property managers, this strategy is more reliable than others.
- You pay tax on the income
2. Living off equity - Drawing down equity to live off
- Income is tax-free.
- Flexibility on how much you can draw down.
- Lenders are not a fan of this and in most cases won't allow it.
- Unreliable. You are relying on your portfolio to continually rise year after year to ensure your equity goes up faster than your debt.
- Prone to massive fluctuations.
I highly recommend against this in this market and lending environment. It can be very risky.
3. Trading for cash flow - Buying and selling to live off profit
- Gratifying. Living off pure profit feels pretty good.
- Adaptable. Ability to increase activity to increase income.
- Costs of the buy and sell can be expensive.
- Lots of variables can impact on your profit level.
- Very active strategy.
- Relying on constantly making a profit.
- Lending can become challenging if this is your primary income.
These all work in different ways and some are a higher risk than others and subject to many variables. My recommendation is number one, especially in our current marketplace, lending environment and economy.
This is the strategy we will be focusing on.
SO HOW MANY PROPERTIES DO I REALLY NEED?
This is the wrong question. A lot of would-be investors get caught up in the romantic idea of owning 10 or 20 properties, which is just for their egos or a good conversation starter at a barbeque. I have met people with big portfolios of 15–30 properties who are simply not getting the results they want.
I review their properties, asking, “How is this one serving you? What about this one? Why did you buy that one?”
Most can’t answer – they just felt they had to keep accumulating properties because that was going to make them successful. Why own lots of properties if they aren’t giving you the results you want?
Owning 10 or more properties is a lot of work! I’d prefer to own four to five good-quality, debt-free properties that are diversified across major metro areas in great locations that will provide $100,000 passive income without all the stress. This is what my clients are working towards.
Let’s rephrase your question. Instead of how many properties do you need, ask, “What value of net assets do I need to create this income?”
Coming back to Paul and Anna, we are working to replace an income of $81,000 per annum in net cash flow. In order to the answer the question above, we need to work it out using two figures: the first is the income goal (which is $81,000 for Paul and Anna) and the second is the average rental yield of the portfolio.
I use a figure of 5% gross yield,which is typical of capital city locations. We then need to calculate our costs.
THE COST OF INVESTING IN PROPERTY
For each property we own outright, we still have approximately $5,000 in costs per year for council rates, body corporate (if a unit) and property management fees.
The average price of the properties in our portfolio is $500,000 (we tend to stay in the ‘meat and potatoes’ price range because this is where the majority of the demand is when it comes time to sell). We calculate this by $5,000 in costs over $500,000 in value:
($5,000 / $500,000) * 100 = 1%
If we take this 1% from the 5% gross yield, we have a net yield of 4% of the value of the property.
4% of $500,000 - $20,000 p.a. rental income of $384.61 p.w. per property.
Now we reverse engineer the goal of replacing Paul's income of $81,000:
$81,000 income / 4% net yield - $2,025,000 of property owned outright.
This is the value of net investment assets you need to own outright, renting at a 4% net rental yield.
I want to leave a larger buffer in Paul and Anna’s portfolio. Once we create this foundation portfolio that is producing steady income, we want to lock this portfolio away and not touch it. We can still continue investing with other equity.
To replace Paul’s income and ensure Paul and Anna can continue investing afterwards, they need five properties each valued at a minimum of $500,000. These properties need to be owned outright. We strategise to reduce personal debt through organic means and create some cash profit; to reduce tax through strategic purchases; and to ensure enough cash for a yearly holiday.
We decide to focus on the $100,000 gift for the children after we achieve these initial goals.
Adjust these figures based on your own assumptions and scenarios.
Paul and Anna have to buy and sell a number of properties to get the results they need.
THE THREE PHASES OF YOUR PROPERTY JOURNEY
Owning five investment properties debt-free might feel like a long way off and seem unrealistic for you, but remember that everyone has to start somewhere.
Property investors experience three
distinct phases in their portfolio:
- Acquisition – Accumulating properties to build our leverage in the market.
- Consolidation – Debt reduction phase.
- Lifestyle – Funding our lifestyle through property portfolios.
In the acquisition stage, the key things we want to focus on are:
- Continually growing our capital base (cash and/or equity)
- Supporting our serviceability and day-to-day cash flow to stay in favour with the banks for lending purposes
- Legally reducing tax so we can reinvest that cash to compound the portfolio
- Organically reducing debt through the use of offset accounts
This is exactly what I went to work with Paul and Anna on.
Mapping it out
We now explore the guts of our investment strategy and map out our next steps.
As I mentioned earlier, creating a strategy is like piecing together a jigsaw puzzle, and every person’s puzzle is completely different. There are key principles that are consistent for every person; however, how we apply those to each situation is completely different.
Here is the list of what I personally consider when mapping out a strategy for clients. It consists of four main areas: personal history, financials and market.
You as an individual and your unique situation:
Impact on strategy
- Age and stage of life
- Marital status and family situation
- Personal goals and timeframes for achievement
- Personality and risk profile
- Work situation and available time
- Personal interest in property
Past experiences and knowledge
- Your age, stage of life and family situatioon are going to significantly impact on the timeframe to achieve your outcomes and your borrowing.
- Your personality, risk profile and family situation will impact on the types of deals you do and the locations you invest in.
- Your general interest in property and available time are going to impact on the types of strategies you employ. If you have no interest or no time, then you won’t be doing renovations and will focus on a passive accumulation of property instead.
Impact on strategy
- Financial and property knowledge
- Preconceptions (eg land always goes up faster than units – not true)
- History of investing – successes and failures
- Personal investing experience (novice or professional)
- Skill sets (eg being a builder, electrician, good with your hands or a master negotiator)
Personal financial situation
- Your knowledge, skill sets and experience will obviously impact on the sophistication of strategies you employ.
- If you have had bad experiences in the past, then you may approach your accumulation more cautiously as you build up your knowledge and confidence again.
• Employment status (PAYG or self-employed or company)
• Buying power
• Tax situation
• Savings ability
• Current portfolio
Impact on strategy
- Employment status, income, buying power, serviceability and existing structures will impact on the type of lending you can qualify for. LVRs, price points and yields impact on the types of deals you can do.
- Your employment status, tax situation and existing portfolio can definitely impact on on how you hold real estate – whether it needs to be bought in a trust, company or personal name.
- Your tax situation may impact on whether we should focus on newer properties to maximise deductions.
Impact on strategy
- Global and local economy
- Market strength
- Market position on the property clock
- Strength of various industry sectors
- Lending environment
- Rental yields
- Available stock
- Supply and demand variables
All of these factors are going to impact on where you invest and what strategies you employ. As you can see, there is a lot to consider, and each can alter your strategy. Be aware of the impact of each stage.
Allocating assets is such an important part of the strategy process. This will help you decide what money is set aside for buffers, for personal life and for investing.
Following are the two main variables you will need to use when assessing your portfolio, and how you will allocate your assets.
This is the maximum amount a lender is willing to lend you based on your situation, income and expenses.
This is the maximum amount of real estate you can afford to buy, based on how much cash or equity you have for your deposits.
These variables affect everything moving forward and will be a constant juggling act throughout your entire investment journey. To calculate your serviceability, you’ll need to speak to a specialised property investment mortgage broker.
Back to Paul and Anna. We run through all of their financial information with a specialised property investment mortgage broker. He advises us that they have serviceability of up to $1.2m, as long as all future purchases have a minimum average gross rental yield of 5%.
Your buying power will depend on how much cash and equity you currently have available.
Paul and Anna have a home in Western Sydney valued at $590,000 with a mortgage of $285,000. That’s $305,000 of equity in total ($590,000 – $285,000). Unfortunately, they can’t access the whole amount. We decide to release up to 80% of the value of the property, as follows:
80% maximum loan = $590,000 x 80% LVR = $472,000
Available equity = $472,000 – $285,000 = $187,000 equity release
Paul and Anna also have $8,000 in cash savings, which gives them a total of $197,000 to utilise.
We set aside three brackets of savings:
- Personal buffer or the ‘sleep at night’ factor – this is the amount of cash we need kept aside to cover any family emergencies such as health issues, loss of jobs or income.
- Property buffer – an investment portfolio is a business and it needs to be treated that way. It should not impact on investors’ personal lives. A property buffer is there to cover your property portfolio’s expenses so that ultimately your property business is separate from your personal lives and your portfolio is self-funding.
- Play money – this is the fund for future investments such as deposits and buying costs.
Total amount: $197,000
Personal buffer = $10,000
Property buffer = $15,000
Play money = $165,000 available for deposits and costs for future deals
Holiday fund = $8,000 (the original cash savings)
Now that we have allocated the assets, we can calculate buying power. We have decided to do future purchases at 90% LVR. If we can be approved at 95% for one of them, we would consider it.
We work out our buying power by taking the ‘play money’ fund – in Paul and Anna’s case, $165,000 – and we divide it by the deposit and other costs for future deals. At 90% LVR, they will have a 10% deposit and 5% for costs (such as stamp duty, legal fees, lending fees, etc.). This is a total of 15% for future property purchases.
$165,000 / 15% = $1.1m
The limiting factor
When it comes to serviceability and buying power, one is always limited compared with the other. This limiting factor will hold your portfolio back more than anything else, so this plays a key role in our strategy.
For Paul and Anna, they were relatively similar. With their serviceability at $1.2m and buying power at $1.1m, we were able to move forward with a fairly balanced strategy.
There are three primary strategies I use:
Column one (Growth Column)
shows our long-term buy-and-hold assets. These are blue-chip properties in good-quality (usually capital city) locations, which tend to have stronger capital growth than the rest of the marketplace and are a safer asset. These are the ones we will want to own outright when consolidating our portfolio.
Column two (Support column)
represents our supporting assets. These are the positive cash flow properties designed to increase the income of the portfolio so that you can break even. Cash flow properties also support your serviceability so you can continue to borrow.
Column three (Accelerate column)
shows our assets that accelerate our portfolio. These are trading properties that we buy with the intention of redistributing their equity into more purchases or to reduce debt on better-quality properties. These are usually sold within three to five years of purchasing. This is a very important part of a strategy.
Paul and Anna’s strategy
Before I tell you, what strategy would you devise for Paul and Anna based on all the information provided?
Remember, Paul and Anna’s buying power is $1.1m and serviceability is $1.2m, meaning we can move forward on a relatively balanced strategy.
The first two purchases are to be completed within the initial six months; the third will be later on when more capital is available. The order of the first two property purchases important, as Paul and Anna’s position is strong enough to do both regardless. If we try to use the strategy for purchase number three earlier on, we risk seriously impacting on our ability to move forward with our portfolio. The focus is on newer properties so we can maximise depreciation to rapidly reduce tax.
1. STRATEGY: Equity builder – house and land strategy
Strong growth area (property clock position 6.30–9.30), eg Newcastle
, Southwestern Sydney, Toowoomba, Townsville
This property is designed to deliver an equity result within one to two years. We will put approximately $70,000 of equity into this deal as deposit and costs, and we want to use this equity for the next deal. I have targeted areas with a strong capital growth prospect and places that valuers are confident about so we can get favourable valuations. I have chosen a house and land strateg because it is working effectively in the current market and we can often way into the deal, which gives us more certainty. However, if this is an existing property purchase in a solid growth area it will be fine, as long there are market fundamentals working in our favour.
2. STRATEGY: Cash flow and growth
Dual income (build or granny flat) or fully furnished option
7% gross yield
The purpose behind this property is cash flow so the location is less important than the rental yield. However, we want to secure a decent equity result if we can.
The location will depend on the dual-income purchase we choose. If we build a house with a conjoining flat then it will tend to be in a major regional location with flexible council planning laws and a market for this product.
For a granny flat, we will tend to focus on major regional locations – Central Coast, Toowoomba and Wollongong
If we choose a fully furnished option, we can head closer to metro areas and target a unit closer to a CBD and furnish to increase rental yields – for example Brisbane or Townsville CBD.
Due to the low interest rate environment and recent strong capital growth in property, rental yields have compressed across the country. Securing a 7% rental yield in strong areas is not possible unless you go into mining areas, which I am not comfortable with. We need to manufacture our rental yields to create yields suitable for the purpose of this property.
Once we have completed steps one and two, we will reassess to fine-tune our third step. At a minimum, we will look to do this in approximately nine to 12 months, as we need to focus on further savings to do this deal.
3. STRATEGY: Blue-chip buy and hold
5% gross yield
15km from Brisbane CBD
This is the foundation of our buy-and-hold portfolio, which freedom. We are targeting units due to their price point, and our ability to get closer to better infrastructure, population growth and various other investment fundamentals in central Brisbane. We are targeting Brisbane because it is the only major capital city offering a value-buying proposition in relation to the property clock. This property is designed to grow over the short, medium and long term in the Brisbane market and to leverage for the continual expansion of our portfolio.
Final notes and implementation
Alongside this property strategy, you need a solid financial and loan strategy, which must be working in harmony. In addition, I would create a debt reduction strategy for the home mortgage through effective use of money and loan structures.
There are actually four strategies running side by side and working in conjunction:
- Property strategy
- Finance strategy
- Debt reduction strategy
- Tax reduction strategy
Investing is a systematic process. It has to run through a funnel:
- Goals and dreams.
- Strategy (designed to begin moving towards your goals).
- Market to suit the strategy (match the market with the right conditions to maximise the outcome behind the strategy).
- Product (choosing the right product to suit the market and the demographic; buy a property with who you are going to sell it to in mind).
- The deal (be meticulous in your due diligence with your numbers – the numbers make the investor).
Paul and Anna complete the first two purchases within the first six months as expected They follow a house and land strategy in Newcastle to create equity and create $60,000 in equity during the build timeframe and then pull this equity out when construction is completed. This is a 100% cash-on-cash return within nine months.
Strategy two is an off-the-plan purchase in Townsville CBD with a rental agreement guaranteed for three years by a short-term letting company at a yield of over 8%.
The awesome result in Newcastle means Paul and Anna get into their third deal at the 12-month mark, securing a blue-chip property in Brisbane, which they will furnish to increase serviceability.
We are now in the process of reassessing to go for deal number four.
It is possible, and you can do this too. Strategy is everything. Knowledge of the markets, how to do exceptional due diligence, and getting involved with a team to support you will always lead to success.
Final key points
Todd Polke is Positive Real Estate’s head property investment coach for the NSW team.
Right strategy, right market, right time of the market. Never forget it.
- Always reassess your strategy after every property purchase and whenever something changes in your life or the economy. When life changes, your strategy evolves with it.
- An investment strategy is an absolute must if you want to create financial freedom.
- Pigeon-pair your strategies to create overall wealth systems.
- Focus on the purpose of each property and how it is supporting the overall portfolio.
- Don’t look at individual deals; look at the portfolio performance overall and how each part is supporting it.
- Never get caught up in the deal; get caught up in the result.
- Every property you buy needs to have the next two purchases (minimum) in mind.
- Never invest purely for tax reasons. Tax minimisation is a key consideration, but it is just a benefit of a quality, well-planned portfolio.
This feature is from Your Investment Property's August Issue. To read more, you may purchase the issue or sign up for a subscription.
Can you afford to buy in this suburb? Find out how much you can borrow