If you’re a budding investor looking to build a property portfolio, welcome to the club. Australians have a long-found affinity with building wealth through property. Building a property portfolio is a long game and the key to building your portfolio is ensuring you have a clear strategy from the outset.
We know we say this a lot, but have a strategy in mind
When it comes to property investing, it can be challenging to begin with the end in mind as there are so many factors and unpredictability involved when it comes to suburbs and areas. What you can do is determine whether your end goal is around net wealth or income generation.
Income is a stream of money that a person receives from different sources such as their wage, rent, interest, profit, etc. If your strategy is income generation, your goal may be to own an investment property (or multiple) outright by the time you retire so they generate an income for you.
While income can assist with the creation of wealth, wealth is a different thing. Wealth is referred to as the total market value of all assets possessed, stored, or saved by a person for future use. The major difference between the two is that income generates money immediately as opposed to wealth which grows over time.
You’ve borrowed once, how do you build enough equity to borrow again?
When it comes to building a staple of properties, people cap out because of their income level vs the debt level. Each property acquisition makes it more challenging to get the next property as you’re accumulating more debt.
Inovayt Managing Director, Nick Reilly, says banks ‘stress test’ your income when they look at what you can comfortably repay. Often, they will look at your interest repayments and if they were to increase by 2 per cent, they will reduce your rental expectation by 20 per cent. Essentially, they’re only factoring in 80 per cent of your income when they consider how much you can afford to repay.
By having a clear strategy in place, you should be able to work backwards. For example, if you know you want to purchase another property in two years’ time, you should be able to have a rough idea of what kind of equity position you need to be in to be able to trigger another purchase.
When it comes to building equity, you might choose a debt-reduction strategy or potentially find ways to increase your income, for example, through dual-income property. Dual income properties provide two separate, self-contained dwellings, usually on one block of land, giving an investor two streams of income.
You might also be able to undertake minor renovations that can help to increase the rental returns on the property. Sometimes, inexpensive updates like fresh paint or new carpet can make a world of difference when it comes to the attractiveness and desirability of a space, which we know impacts the cost people are willing to spend.
Ideally, you want to create positive cash flow. This means the rental income you receive from each of your investment properties will easily covers the cost of servicing the investment. If you find yourself in this position, your disposable income has increased which, in theory, puts you in a better position to be able to purchase again.
It comes down to what you want to do with your property portfolio
Let’s look at a hypothetical example to help drive home the impact of having a clear strategy when it comes to building a property portfolio.
You could purchase in Carlton for a million dollars and get $500 per week in rental returns. Alternatively, you could purchase a property in Ballarat for half a million dollars and get $400 per week in return.
It would be challenging to add another Carlton-type purchase to your portfolio as the gap between your repayments and the rent is significant.
However, Nick points out that hypothetically, Carlton would increase more in value over time. If the property goes up by five per cent, you get five per cent of a million dollars in capital growth. But, if you don’t get that capital growth, it’s so much harder to hold that property due to the gap between the rent you receive and the debt you must repay.
Tax implications to consider when building a property portfolio
Building a property portfolio requires careful consideration of the tax implications of property investment. The Australian tax system offers several incentives for property investors, but it’s important to understand how these can impact your overall financial position.
Income tax is levied on rental income received from your property portfolio, and you can claim deductions for expenses related to the property, such as property management fees, insurance, and repairs. The government also offers a depreciation schedule for investment properties, which allows you to claim deductions for the wear and tear of your property over time.
Capital gains tax (CGT) is levied on the sale of an investment property, and the amount of CGT payable is based on the difference between the purchase price and the sale price, adjusted for inflation. The CGT discount, which is currently available for individuals, allows you to reduce the amount of tax payable on capital gains if you hold the property for more than 12 months.
Negative gearing, where the expenses of your property investment exceed the rental income, is a common strategy used by property investors to reduce their taxable income. However, it’s important to understand the potential risks of negative gearing, as it may not always result in a tax benefit.
In addition to these tax implications, property investors should also consider the stamp duty and land tax implications of acquiring and holding property in Australia. These can be significant costs, so it’s important to factor these into your overall investment strategy.
The wrong strategy
Having the wrong strategy can be just as detrimental as having no strategy.
As indicated above, the property game is long-term, and you need to be prepared to weather a property cycle or two to build capital growth over time.
Building a property portfolio can have complexities and tax implications that shift and evolve like the market. It’s essential to seek regular advice from a financial advisor to ensure the strategy you have chosen is the right one to help you achieve your end goal.
To recap, the key to building a property portfolio is to develop a sound strategy and seek financial advice. Knowing what your goal is will help inform which steps to take to build a solid portfolio.