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How to grow an investment portfolio with limited Equity

Discussion in 'Property Finance' started by Corey Batt, 22nd Jun, 2016.

  1. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

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    A common issue that a lot of early investors can find in their starting their investing journey is a lack of equity to draw to make their second, third (and so on) purchases.

    The standard options for those early investors are either:
    • Save for their next deposit (again)
    • Wait for equity to gain in their existing property (time consuming)
    They may have a deposit in which they have saved for a number of years and the thought of having to go through the process of savings these funds all over again for their next purchase can seem daunting. Likewise waiting for equity to increase in an existing property has no definitive timeline (unless you have a crystal ball), leaving many investors feeling they aren’t progressing as fast as they would like to their goals.

    There are other options, the most common I’d like to touch on is renovating. This innovative technique certainly isn’t for everyone, but it can allow those early investors a means to leapfrog quickly into follow up purchases. Through carefully selecting the right properties, planning a suitable renovation and keeping to a set budget many early investors can grow a substantial property portfolio from relatively low savings. Here’s an example:

    Let’s say we have a first time investor, her name is Sally. Sally has spent the last two years saving $50,000 to buy her first investment property. She isn’t interested in buying her own house at this time, but instead wants to build an investment portfolio as quickly as possible. Sally can potentially make a purchase of $350,000 using these existing savings – however she doesn’t like the idea of having to then start saving another 50k before being able to make a similar purchase again. Instead Sally makes a purchase of a run-down property in the same area for $270,000, only needing a deposit of $38,000. Then with her remaining $12,000 savings, she then completes a minor cosmetic renovation (painting the property herself, updates the kitchen and replaces the fittings in the bathroom, fixing some minor issues and having the floors sanded etc). After the renovations are complete she then rents the property out and has the property revalued.

    Even though the property was recently purchased for $270,000, because the property has had significant renovations completed on the property the valuer is able to compare this property against the recent sales in the area – which based on the condition of the property has a new result of $320,000. This equity gain means that Sally can then top-up her existing investment loan to 90% LVR of the new valuation, allowing $45,000 to be released – enough to purchase another property immediately or supplement with future savings to purchase a higher value property whilst retaining the existing investment.

    There is no limit to this strategy, so long as the numbers for each purchase stack up, continual purchases can be made at an accelerated rate allowing substantial portfolios to be grown from humble beginnings. The ancilliary benefits of this strategy can includes potentially higher rental yields (from increased desirability of a renovated property), rolling equity gains and depreciation benefits.

    Some of you may be thinking at this time that there has to be a catch? Absolutely. There is a very limited number of properties in Australia which can allow for such short term purchase and renovation strategies, so it’s incredibly important to make sure the numbers for each deal stack up from the point of purchase. Likewise it’s necessary to keep within a defined budget, which to be successful will include building a strong network of trades people and potentially DIYing a lot of minor work – which isn’t for everyone.

    To ensure you can successfully implement this strategy it’s imperative to have a strategic finance plan to reliably be able to repeatedly make rapid purchases and release equity from each deal, enabling you to move onto the next property.
     
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  2. MJS1034

    MJS1034 Well-Known Member

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    Totally agree with majority of what you said, but how would the long term capital growth be on the $270k property compared to the other more expensive property.

    Short term the cheap run down property may get you quick equity but long term I'd argue the more expensive property in a better area may outperform
     
  3. York

    York Finance Broker Business Member

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    In the context of the OP's post, a investor starting their journey does not have the available deposit to buy a property in an expensive area (and most probably won't have the income either). Their deposit is limited. They need to think of ways of 'manufacturer' equity and renovations are a way of doing this. This strategy can allow someone to grow their portfolio without having to save a deposit everytime. Of course, it's not easy. But if you do your DD and have a set budget as mentioned, you increase your chances of being able to extract equity and do it again.
    Also, no one knows which areas will out perform other areas everytime. Selected 'cheaper' areas on a growth percentage basis, have done just as well as more expensive areas in certain markets.
     
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  4. MTR

    MTR Well-Known Member Premium Member

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    Hi Corey

    I think a very good strategy for newbies trying to build equity, only works when accessing equity in a stable market. Don't try this in Perth, or falling markets, it won't work and if selling ...sales cost etc will kill the deal

    MTR:)
     
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  5. monalisa

    monalisa Well-Known Member Premium Member

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    Capital growth is compounding 10% on a $270k property is 27k vs 10% on a $500k property is $50k. Whilst the overall return is higher, I think going down the cheaper option means twice the rental income, which may help with servicing (though twice the holding costs as well).

    As York said above, no one has a crystal ball, but whether buying a $270k property or $500k, growth will ultimately depend on supply and demand, where people want to live, and where infrastructure is going in; is it conveniently located? or is it something out in the suburbia? Is there an upside with it?
     
  6. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

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    The good thing about this strategy is that it works across the price brackets, but of course the lower the price point the lower the deposit requirements. In general an area can have price swings 20%+/- the median, so you don't necessarily need to look at a lower priced area, but instead look for stock which is being discounted off the median significantly. (essential to this strategy for future revaluation potential)

    I don't necessarily subscribe to the argument that the more expensive the property, the higher the long term growth. Past performance will certainly show it if at a higher median - but the big growth drivers are through suburbs in transition as always. (gentrification, increased desirability, redevelopment potential)

    100% agree MTR - you will want to run this strategy in a stable to growing market - in general you want to avoid a downtrending market if capital growth is needed. :)
     
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  7. datto

    datto Well-Known Member

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    How about adding a granny flat to increase equity and cash flow.

    This is probably something a newbie investor could do a little later on as a GF may cost 100K.
     
  8. Elives

    Elives Well-Known Member

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    i've heard granny flats are great for cashflow but tie up your equity as they are generally undervalued. (can't get your equity back)
     
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  9. drg86

    drg86 Well-Known Member

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    I've used this strategy and it accelerated my portfolio growth, my last purchase was funded by the equity growth via renovating. I will say it is not for everyone, many people can get a false idea watching these reno shows and think it is easy, it isn't. My family has a construction company so it comes naturally to me and I have access to all types of tools and good rates with trades.

    As others have said it is all relative to market conditions. You still need a growing market and a good buy in price for it to work.
     
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  10. House

    House Well-Known Member Premium Member

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    90% LVR after a reval? Don't know where but sure I read that banks would only go 80% for a reval so did my strategy figures around that.

    If a reval came in at $100k more I could extract and reuse $90k as another deposit instead of the $80k I'm budgeting for? Happy days! :D
     
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  11. albanga

    albanga Well-Known Member

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    You really want to make this strategy work? Buy old houses that have ridicilously sized laundry and dining spaces. Conveniently homes in the 1950s were built with this rooms adjoining so by knocking down some walls and minimizing spaces which don't require so much you have done the biggest equity gain possible which is converting 2 beds to 3.

    Maybe subdivide the backyard whilst your at it = $$$
     
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  12. marioland

    marioland New Member

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    Serviceability will put the breaks on this strategy especially with tighter lending criteria.
     
  13. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    This is true - combining it with a sub-div to sell the yard and reduce the debt is more sustainable longer term.
     
  14. Corey Batt

    Corey Batt Finance Strategist Business Plus Member

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    Certainly possible with quite a number of lenders - it requires a lot more strategic timing and finesse, but definitely no hard and fast rule against it. :)
     
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  15. House

    House Well-Known Member Premium Member

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    image.jpeg

    Would this affect things like LMI?
     
  16. MTR

    MTR Well-Known Member Premium Member

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    This is correct.
    Also g/flats don't necessarily work well in every market, but investors don't understand this and could work the other way - in the red, because they take longer to rent out.

    Also need to have the right set up/configuration, tenants want separate entrances, privacy, works better on corner lots,

    MTR:)
     
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  17. MTR

    MTR Well-Known Member Premium Member

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    Also hard to sell the rear blocks if the front property is old and tired, they sit on the market and prices have to drop to sell. This strategy works well when it is an area where land is tightly held.

    MTR:)
     
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  18. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    Of course depends on area/market - could build on back to hold and sell front, too. Or hold both for cashflow. Lots of options. :)

    The reality is that ever increasing debt via buying and holding (regardless of whether you reno or not) is no longer going to happen no matter what your equity position looks like. It's limited now where before it wasn't, so if you want a large portfolio, having a strategy to methodically reduce debt during your acquisition phase has to be the key.
     
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  19. MTR

    MTR Well-Known Member Premium Member

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    I also think sometimes investors should consider selling as a way of moving forward, this can work very well.
     
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  20. Jess Peletier

    Jess Peletier Mortgage Broker - Australia Wide Business Member

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    With servicing constraints now, it's a must for most people who want a significant portfolio.