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Investing made easy: Working backwards

In order to build a substantial portfolio, having the end goal in sight is the best place to start.

Friday, December 4th 2009, 10:47AM

by Sonia Speedy

There are no hard and fast rules when it comes to moving from small-time property investor to property tycoon extraordinaire. But what is required is a solid plan that will get you into more serious property investment - particularly if you want to build a robust property empire rather than a house of cards.

The key to moving from small to medium or even big-time property investment is all about working backwards: establishing your "end game", or objective, before you start. Then it is a matter of planning how you address the fundamental issues of building equity and maintaining loan serviceability in order to reach the finish line in one piece.

Craig Moffat, ANZ general manager of specialist distribution says: "It's taking a step back and saying: in a few years time, or depending on my age, I really want to have a certain amount of income set aside that I can live off and not have to realise any of the capital investment."

Investors need to establish just how many properties "unencumbered" with debt they need to achieve that income goal and how each step in their investment process might build on the two magical investment cornerstones of equity and cash flow.

"If you need say $100,000 of income (per year) to retire on, then you would need something like $2 million of unencumbered property to generate that revenue from them, using a 5% yield basis," Moffat says.

Building equity and your portfolio
Ben Duflou, director of Wellington-based business advisory and chartered accountancy firm All Accounted For, says investors should target properties making at least a 7% return and invest in different areas to minimise the effects of area "desirability slumps".

Meanwhile, Richard Evans, principal of Rotorua Rentals, says the key is to find out what the market wants in a particular area - not what you think it wants - and then sticking to a tried and true investment formula based around that.

"I have one landlord who will only ever buy Lockwoods, because they're low maintenance. I have another one who will only ever buy free-standing houses on a fully fenced section with a fireplace, a garage and near a primary school. He never deviates from that formula," he says.

Typically investors will need to continuously build equity in their portfolio in order to shoehorn themselves into their next buy, whatever formula they use.

Banks generally require a minimum equity input of 20-25% and with capital gains likely to be subdued over the next few years, investors need to create that equity themselves - through getting the property at below market value, adding value by improvements and building up rents.

Another way to raise equity quickly is to join forces with friends or family and make use of any funds they might have to inject. Duflou says it is wise to create separate legal entities to use when doing this to protect those involved, such as loss attributing qualifying companies (LAQC) and partnership structures.

Increasing serviceability
Ensuring you have enough cash flow available to handle all the mortgage payments is the second key fundamental underlying serious portfolio building, whether this cash flow comes from rents, or your day job.

Duflou says lenders will typically discount the rents you receive by 25% when they consider you for a loan, to allow for things like rates, insurance and any periods the property is vacant. Improving the rent you receive for a property helps reduce the reliance on outside income sources. Bear in mind that lenders will only consider money from outside income streams that is uncommitted - ie. after tax and expenses.

Moffat says doing things that other landlords are not doing is a great way to add value, increase the rent a property brings in and keep the tenants sweet. He suggests things like heat pumps, alarm systems and even getting a lawn mowing contractor in to keep the place looking neat and tidy, can all make a big difference.

Duflou adds that investors should always have a financial buffer on hand to dip into should they need it. It does not have to be savings, but could be something like a flexi-facility with the bank and should ideally cover two to three months' worth of cash flow.

Playing well with others
As your portfolio expands, investors need to be in regular contact with their real estate agent, property manager and accountant, Duflou says.

"Your real estate agent will be able to keep you briefed on new opportunities; the property manager will provide insight with regards to maximising rental yield; and your accountant can prepare or check your numbers," he says.

Duflou suggests aligning yourself with two or three real estate agents and using the bigger firms to make sure you cover as much of the market as you can. This way you can try to get to the good deals before everyone else does.

Peter Holmes, realty manager at Crockers, says new investors should identify themselves with a company and an agent that almost exclusively deals with investment styled properties, as the average residential consultant might not be equipped to offer the range of services that a specialist can.

He suggests that the effectiveness of an investor's portfolio is directly related to the importance they put on building strong relationships with their consultants.

"This involves patience and commitment. Successful investors recognise this, and build up their portfolios slowly, but with very strong foundations," he says.

Property managers can play an equally important role, helping to minimise vacancies and maximise rents. Evans suggests using property managers who are not involved with sales and hence "don't have an axe to grind" and that are also landlords themselves.

Moffat points to the importance of using a well reputed valuer - try to use someone the bank is comfortable with. He adds that banks like well organised investors and stresses the words research, analysis and planning.

Knowing your limits
Duflou says too many people get themselves into hot water by thinking they are "onto a good thing" and so keep buying properties ad hoc until they find themselves overcommitted.

"That's where having your team of good advisers and keeping them in the loop when you're looking at other purchases is critical," he says.

"There are a number of examples where people have built those 30-plus portfolios and had two or three of them vacant for a couple of months and then all of a sudden, the whole lot unwinds."

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