What is the best way to balance your investment property portfolio to protect against market downturns? When buying investment properties, it’s easy to get caught up hoping for the highest rental yield possible or focusing solely on areas with good capital growth. However, something you may not have considered is ensuring you have a diversified and balanced property portfolio just like you would with other investments (like shares or your super).
We heard from some fantastic buyers advocates at our recent Melbourne Property Outlook event held here in Richmond, and all of our experts agreed – having a properly balanced and diversified investment property portfolio will ensure you have protection throughout all market cycles.
Developing your investment property strategy
Here are some common terms you might hear when it comes to investment strategy:
- Capital Growth is the increase in the value of your property over time. If you purchased the property for $500,000 and 5 years later, it’s worth $750,000 then you’ve seen $250,000 or 50% capital growth (less expenses).
- Positive cashflow is a strategy used to generate profit after expenses on a property. You’ll usually aim to purchase a property with low vacancy rates and a high rental yield. Sometimes the property may continue to appreciate so you’ll also experience a capital gain, but this isn’t always the case. Typically a cashflow positive property exhibits lower capital growth.
- Rental yield refers to the amount of income an asset produces relative to its underlying value. To calculate the gross rental yield you take the weekly rent x 52 and divide by the property value, then multiple this number by 100.
- A property worth $500,000 being rented for $450 per week would look like this:
- $450 x 52 = $23,400 / $500,000 * 100 = 4.68% gross rental yield
- This is gross rental yield and doesn’t take into consideration the outgoings on the property. It is important for investors to be familiar with outgoings, as they can vary greatly for some property types.
- Negative Gearing occurs when the income you generate from the property doesn’t cover the expenses attached to holding the property such as interest repayments and outgoings like rates and insurance. Some people will use this loss to offset their taxable income however this can have an impact if you need to use this same income to service new loans or grow your portfolio. Negative gearing benefits should never be a reason to invest, merely a bonus.
- Renovate and sell is a very popular strategy in Australia right now thanks to reality TV shows like The Block. This occurs when you purchase a property that needs a bit of work. After completing the necessary renovations, the investor then relists the property to make a profit.
- Development is another path some people choose to walk. That is, they buy a parcel of land or existing properties and gain approval to develop the site for residential use, often units, townhouses or apartments. Developments can range from small to large scale and require a lot of time, energy and know how to execute profitably.
- Land banking is a scheme whereby you buy large blocks of undeveloped land and hope to sell it for a profit to a developer or investor at a later stage. The issue is here is whether the land will ever be developed or is appropriate for development and is something ASIC suggests you be very careful about if considering.
Ok, so now we’ve got that out of the way – what should you consider when pulling together your own investment property portfolio strategy?
Balance your investment property portfolio with income and value growth
Cate Bakos of Cate Bakos Property recommends a mix of positive and neutral cashflow or higher yield properties coupled with properties that are owned for capital growth purposes. The reason behind this, is when lending criteria becomes tighter, you’re going to need positive cashflow assets to help support your servicing.
Lenders are currently accepting a lesser amount of rental income (just 80%) and are basing your on a principal and interest rate at double what your actual interest only rate is (think around an 8% assessment rate).
Having deductibles in your tax return is one thing, but generating cashflow during periods of tighter lending will allow you to maintain and grow your portfolio during challenging lending and market conditions is important. The last thing you want to do is have to sell a property you’ve purchased for capital growth during a slowing or downward shifting market and having to wear a capital loss.
When the market is slowing, your capital growth is also going to be slowing so having those cashflow positive or neutral properties are going to prop up the rest of your investment property portfolio. Then during times of growth, you benefit from those properties geared for capital growth allowing you to realise your profit gains without pressure when the market is in your favour.
Diversify your property portfolio across different markets
Another consideration is to invest in different markets across Australia, similar to investing across different sectors when buying shares. You wouldn’t just buy shares from 20 companies all in the energy sector, you’d diversify across a range of sectors that aren’t going to be affected by the same market changes – and the same applies to property.
Having an investment property portfolio spanning different regions, all experiencing different market conditions, can ensure when one area is booming you are reaping the benefits. Or if another market is sliding, you can buffer any potential losses by having property in other markets who might still be gaining. A great example right now is the easing in the Sydney markets but continued high performance in Hobart markets.
Renovating for profit
People looking to renovate and sell properties need to do their due diligence on the location, the property and likely gains after stamp duty, renovation costs and capital gains tax is deducted. All contingencies and risks should be considered.
Adding value to a property over the short term can be challenging, in some instances the intrinsic or underlying value of the property is mostly apportioned to the land and not necessarily the building. Particularly in many blue-chip suburbs where land size is tiny but the value is huge – think $1M+ properties with the cost of the building coming in around $400k. Making an upgrade to the building may not give you the result you’re hoping for compared with a longer term growth strategy.
Using this strategy, you need to watch your budget like a hawk. Any overspending or over investment can mean the difference between profit or loss. And just remember, any value you add is going to be taxed on the way out at your marginal tax rate. Especially if you sell within 12 months of buying – you are required to pay the full CGT rate. If you hold the asset for at least a year then you can generally expect to see a 50% discount on the CGT payable.
The right balance in your property portfolio
We’ve looked at a few different options when developing a strategy for an investment property portfolio. Ultimately how you balance your investment property portfolio is going to come down to your finances and the amount of debt you can comfortably service. Whether you are going to benefit most from a negatively geared property or positive cashflow investment is definitely a question to have with your accountant before diving in.
We would also strongly recommend speaking with a Buyers’ Advocate or other property professional who can assist you in making the best asset selection. They can support you in selecting property in the areas that are going to suit your strategy.
Get in touch with Entourage and we can connect you with a quality Buyers’ Advocate in your area.