Design a property portfolio that can weather the inevitable storms
Friday, May 26, 2017/
If you’re hoping to gain financial freedom through property, your investment journey is likely to be a long one.
And over the next 10 to 15 years, you’re likely to encounter some good economic times and some tough ones; some periods of low interest rates and spells of high interest rates; and some booms in the property markets as well as slumps.
And one day we’ll have another recession (Australia hasn’t had one since the early 1990s) and maybe even a depression.
If the last few years has taught investors anything it is to expect the unexpected.
That’s why I suggest you should prepare for the worst, while hoping for the best. In other words, maximise your upside while at the same time covering your downside.
Here are some of the ways you can prepare for the inevitable storms ahead.
Correct asset selection
To see you through the ups and downs of the economic and property cycle, you need to own the types of properties that are strong and stable.
By strong I mean your property should outperform the averages and increase in value at wealth producing rates of return.
By stable I mean the value of your property should not fluctuate much when the property cycle slumps.
This is why you must only own investment grade properties; the type of property that will be in continuous strong demand by a wide demographic of owner-occupiers and one that is situated in the big capital cities of Australia, because these locations are underpinned by multiple pillars of economic support.
It’s what I call investing in “deep markets” — locations where there is a significant turnover of property because there are always a large number of owner-occupiers wanting to buy and sell as they upgrade or downgrade their homes.
This is very different from owning a property in a location where there are few buyers around and at times it’s hard to sell a property even at a bargain price (think small regional or mining towns).
The lesson from all this is that if you own the right type of property in the right location, it is likely to be less volatile in difficult times. There will always be tenants for it and its price is likely to be more stable.
Even at the worst of times, in the downturn after the global financial crisis, there were buyers for well-located properties in our major capital cities. This is because even though the markets slowed, most people were still getting on with their lives; some were changing jobs, others were getting married or divorced or having babies, and this meant they were looking for accommodation.
As your portfolio grows it makes sense to own properties in various states, so that when one market is flat, you’ll benefit from the growth of your properties in another state.
It’s also worth remembering that at the slump stage of the property cycle when fewer people are buying property, more people are renting. This usually increases rentals and is good for your cashflow.
Don’t speculate or overcommit financially
Have a financial buffer
Rather than gearing to the max, strategic investors take a more prudent approach by building an emergency financial buffer to buy themselves time to ride through the storms.
Another strategy I recommend is not paying down your mortgage — be it for your home or investment property. Instead consider taking an interest-only loan and place the funds you’d use to pay down your mortgage into an offset account. This will have the same net effect on your interest payments, but you’ll be in control and have access to your funds should you ever need them.
And if you are currently in a position where you have a nice little pool of equity built up in your property portfolio, then you are already ahead of the game. Maybe it’s time to think about establishing a line of credit (LOC) using your existing equity?
In fact, I would go so far as to suggest some investors consider drawing as much equity as the bank will allow, and stash all of it away as a cashflow buffer.
Of course, you shouldn’t use these funds to speculate in the options market or spend on a holiday.
Your LOC should be viewed purely as a buffer that will give you consistent financial stability, regardless of the ups and downs of world markets and local banks’ funding vagaries.
Build a buffer or buy a bargain
The other beauty of being financially prepared is that when everyone else puts the brakes on and competition in the housing markets dries up, you will be in a position to nab the bargain priced opportunities that abound by using some of your LOC or the funds in your offset account as a deposit on your next property investment.
Remember, you need to be proactive with your financial strategy and be in control of your situation before things turn sour.
By doing so, you will ensure that you remain sheltered from the storms ahead and avoid the panic that many will feel when one day again, the local or global situation worsens.