One of the great debates in the property world is which path is the right one for investors to take to lead them towards their much sought after financial freedom. Thinking that there is only one correct answer is actually what resulted in one of my biggest property mistakes – its something I see repeated a LOT by investors still to this day.
You see, whilst there is only ONE way to build true WEALTH from property investing, there are often two schools of thought on how to achieve financial freedom. What I’m talking about here is the ‘buy negatively geared property and pursue growth’ camp and the ‘only buy cash flow positive/yielding’ approach.
Remember, a negatively geared property is where the costs of having the property are greater than the income earnt from the property. Ie the rental income doesn’t cover the mortgage and bills so you need to put your own cash towards the costs each month. A cash flow positive property is where the rental income not only covers the mortgage and bills but leaves you with leftover cash.
Before I bare my soul and talk about my own life lesson, lets talk through a simplified example. Keep in mind this is general information only.
I want to keep this as simple as possible so there are some generalisations in the numbers, but if we use a National median house price of $800,000 (rounded) and assume that the house doubles in value after 10 years, ie a 7% per annum year on year return. By 2030, that house would be worth $1,600,000, meaning the owner has an on paper asset or wealth increase of $800,000. According to rent.com.au, the July 2020 National median rent for houses was $450 per week, so we can assume a rental yield of around 3% pa. Gross rental income of around $235,000 would have also be earnt during this 10 yr period, assuming full occupancy. So after 10 yrs of ownership, and excluding costs and tax, the owner has an increase in their financial position (equity and cash combined) of $1,035,000.
On the flip side, a good cash flow positive property might grow in value by 4% per annum but achieve rental yield of say 6% pa. Lets assume someone buys a house for $350,000 today which rents for $400 per week (6%). After 10 years at an average growth of 4% pa, this property is worth just under $520,000. An increase of wealth of $170,000. Gross Rental income of $210,000 was also earnt – so after 10 yrs excluding costs and tax a change in financial position (equity and cash combined) of $380,000.
So, hearing this, you might be thinking that chasing cash flow positive properties is for dummies. Who wouldn’t want the $million dollars over the $380,000?
And that my friends is where I went wrong when I first started out building my portfolio.
Because, I ONLY CHASED negatively geared, high growth properties.
The problem with this approach is two fold:
- If your income decreases…. recessions hit, or you want to leave paid employment (for example, to raise a family or to change careers) but you can’t because you have NEGATIVELY GEARED properties with COSTS to cover
- The banks refuse to lend you more money to continue to build your portfolio because you fail the servicibility tests and consider you overexposed.
So the solution is actually quite simple and its to make sure before you start your property hunt and ideally before you commence building your portfolio, that you have mapped out your investing plan. That you know what your end goal and timeframes are and you work backwards from there. That way you can work out how many investment properties you actually need in order to achieve your financial goals and whether those properties should be a growth property, a yielding property or a balanced property for each property purchase. The answer to this differs for each person and depends on many factors, such as years until retirement, lifestyle costs, investor type, risk appetite, etc
Growth properties ultimately are what will create real WEALTH but you NEED Yielding properties to facilitate building a portfolio and achieving that financial freedom so many are chasing.
We introduce this concept to our students and our Property Investor Lifeline activity during our Buyers Bootcamp course and I encourage you to really spend the time to do something similar, so you don’t scattergun your portfolio build without having a clear plan of attack . That way, you will avoid getting stuck in a job you don’t LOVE or at the mercy of a property firesale when a pandemic strikes and your income is slashed.
Finally, be sure to check that every purchase you make will improve your chances of getting finance for your next purchase and make sure that your portfolio offers the right balance of growth and yield for ultimate risk minimisation.
If you want to learn how to create financial freedom through building a better property portfolio, you’ll want to sign up for our Buyers Bootcamp course. Be sure to follow us on our social pages or for more information click here -> https://buyersacademy.com.au/