Your Investment Property asked Jeremy Sheppard to share his time-tested finance strategies, guaranteed to boost your profit and reduce your risks
1. Knowledge is power: Invest in your education
Don’t be frightened to spend on your education. Start off reading a book or magazine each month on a variety of topics about property investment. They are cheaper than seminars. Keep building your library until you start seeing the same things being repeated and a particular strategy resonates with you. Then carefully pick out reputable educators and attend a few seminars. Focus on education and make sure you get your questions answered at seminars.
2. Budget cash flow
Make sure you have a realistic budget in place for your lifestyle and stick to it.
Get good with forecasting the balance between income and expenses. Your budget helps you save for a deposit; it highlights how to tight cash-flow might get it; it forces you to think forward; and to consider everything. Don’t set a budget that is too tight to enjoy your life. Remember, property is a long-term investment. If a bank rejects your attempts for finance, heed its warning, and get busy reducing debt or improving cash flow; don't find sneakily workarounds as these may land you in cash flow trouble.
3. Budget equity.
Allow a 5% equity margin for unexpected expenses. Accurately calculate how much it will cost to enter the market, just as accurately as you calculate how much it will cost to stay in it. If you’ve calculated it will cost you $100,000 in deposit, stamp duty, legal fees, etc to buy an investment property, then you need $105,000 in equity or savings to cover things like a hot water system going bung or a tenant taking off in the middle of the night.
4. Assess both risk and return
All investing comes down to only two things: risk and return. You must be able to assess an investment opportunity looking only at risk and return. Risk is ignorance. You don’t know if a property will fall down a sink hole, be vacant for months at a time or stay stagnant in
terms of growth. Knowing as much as you can reduces the risk, so do your research and ask questions.
5. Know when to chase positively geared properties
As a rule, you’re looking for the best return on investment (ROI) for the least risk with each
investment. You need to consider capital growth as well as income and tax, too. That may mean
buying a negatively-geared property.
If it is the best ROI with the lowest risk, then it is not stupid to buy negatively-geared property. What is stupid is choosing an investment with either a poorer ROI or higher risk profile simply because it is cash-flow positive.
But there may come a time when you’re unable to service more debt because your cash flow is too low. You need to know in advance how lenders will view your position after you’ve bought the next property. You don’t want to be stuck after you’ve purchased.
If your cash flow is looking a bit tight, aim for positively geared property. Not properties that are cash-flow positive after tax, but properties that have you paying more tax. That is, the income exceeds all expenses related to that property before tax is even considered.
6. Don’t fix your interest rate to try and save a buck
Choose fixed over variable to reduce risk, not to reduce interest expenses. Banks will offer a rate not knowing exactly what will happen with interest rates in the future – they’ll factor in a margin for that risk. For the marginal perceived improvement in interest expense you think you’re going to get by fixing, you lose the ability to refinance or sell without incurring a break cost.
7. Maximise your leverage
A high loan to value ratio (LVR) is one of the most important factors in maximising the profitability of an investment.
A good investment is made so much better by leverage. Without attractive finance, I wouldn't even bother investing in property. The lowest interest rate is not the most important part of your financing.
Not all low interest rate loans will allow you to buy in any entity. You may prefer a company or trust ownership structure, for example.
Not all loans will be interest only. Paying principal & interest will hurt cash flow terribly. Choose a loan that offers interest only for as long as possible.
8. Use available stats to your advantage
Rapid capital growth is all about imbalance in supply against demand. Prices change according to the law of supply and demand. When demand is high and supply is low, prices rise. This is a market out of balance. It will need either high price growth or sudden supply to restore balance.
As an investor you should be looking to capitalise on markets that are out of balance. Locate markets with growth potential by examining the supply and demand for property there. A number of indicators can help including rental vacancy, days on market, stock on market, discounting rate and rental yield. You can get this information at the back of Your Investment Property
magazine or at dsrscore.com.au.
Along with the demand to supply ratio (DSR) data, check for recent price growth. If there has been significant price growth in a market with a high DSR score, the price growth remaining
may not last for too long before the demand is subdued. To maximise your capital growth potential find markets that have a high DSR as well as lack-lustre recent growth over the last few years.
9. Check out the market fundamentals
Do both ‘statistical’ and ‘fundamental’ research. Statistical research is pretty quick and objective, you just look up the property data published by the data providers such as RP Data and DSR score. But unfortunately, it doesn’t tell you the whole story. That’s where fundamental research comes in. It is more time-consuming and subjective than statistical research.
Examples might be checking private and public spending in the target area. The most valuable single piece of quick fundamental research you can do is to check development applications on the local council website to gauge how much future stock is about to come onto the market. This represents the supply side of the equation. Low supply is a good thing. A new development is not a good thing.
10. Find out what will trigger a price growth spurt in the suburb
Positive change affects capital growth. Proximity to existing schools, shops and transport sounds positive, but doesn’t translate directly into capital growth. For example, if a train line is extended into a suburb, property prices in that location will rise as the new infrastructure benefits residents making the place more desirable to live in. But after 10 years, the value of having a train station is already well and truly factored into the price of properties. The rapid price change occurred when the new train station was built.
Positive change is what is needed to keep a property market growing above the national average growth rate. Locations with the least infrastructure are the ones that can change the most if that infrastructure is added. Markets that have already can't experience the same level of change.
Don’t be afraid to spread your wings interstate. Investing interstate gives you diversification of property markets, ensuring you have at least one property growing in your portfolio somewhere. You can also reduce land tax liability by investing in other states since it is a state tax, which kicks in once a threshold is exceeded.
Although it is advisable to visit wherever you plan on buying, it is not essential so long as your online research is top notch.
12. Pick your property manager carefully
A good property manager versus a bad one can be worth thousands a year for only a $300,000 property.
Picking a good property manager usually comes down to researching their policies concerning operation and seeing how many properties they have to manage.
Be prepared to change managers until you find one that provides the level of service you expect. Make sure your property manager feels appreciated to get them onside – they are the closest thing you have to an employee for your ‘property investment business’.
13. Beware of depreciation deception
Don’t be fooled into thinking that depreciation is a nice little bonus for property investors. Sooner or later you are going to have to pay for the repair or replacement of a fixture or fitting related to your investment property.
Imagine you have spent $5,000 on some carpet and assume it depreciates by 10% per year for the next 10 years. After six years you then spend $8,500 replacing the carpet. You can’t claim that full amount. The depreciation you were claiming has already gone into that. You have already claimed $3,000.
14. Find a pedant to do your bookkeeping
You want your accountant’s time to be spent on strategy and your bookkeeper’s time to be spent on compiling data for your accountant to make decisions with. Scan and store all correspondence you receive from insurers, councils, tradesmen, property managers, etc, so you can easily share this data with your accountant and/or bookkeeper.
Have your bookkeeper create a spreadsheet for each financial year that lists every transaction related to your property portfolio.
15. When it comes to retiring on property, lower LVR is the key
Obviously you can't retire on a portfolio of negatively geared properties. But you also can’t retire on a portfolio of cash-flow positive properties if they're only cash-flow positive after tax. High cash-flows areas are quite often high-risk areas. These are not locations to hold a ‘set and forget' property. The relaxed cash-flow portfolio is one with a low LVR.
Fifty per cent LVR should be more than enough to make a property cash-flow positive. That's your target...