WHITEBOARD DEMO: USING EQUITY FROM YOUR HOME TO INVEST IN PROPERTY
If you have purchased a principle place of residence over the past ten years, you may be sitting on a gold mine and not even know it. There is potential to make money buy using equity to invest.
Most homeowners have enough equity to build an investment portfolio and don’t even realize it!
However, because they don’t have the cash saved as a deposit, they assume that building a portfolio is next to impossible, when really it is well within their reach.
USING EQUITY AS YOUR FIRST DEPOSIT
If you have purchased a principal place of residence within the past five or ten years, chances are it has gone up in value. If it has, you may be able to tap into the equity from your capital gains and use it as a deposit for your first investment property.
Even better, you may have enough equity available that you can use it for two or three deposits in order to get the ball rolling.
If you are going to be useing equity from your home, you need to ensure (as with any property investing) that you make smart purchases, based on a well-informed strategy while taking every step possible to minimize risk.
HOW TO MINIMIZE RISK
The three keys to minimizing risk in property investing are to buy below market value, with an upside for growth and with a strong cash flow.
• Buying below market value gives you a buffer if you need to sell due to unforeseen circumstances. This will cover closing costs and help you come out with a clean slate. It also helps you withdraw equity again sooner.
• Buying with an upside for growth minimizes the risk that your investment will turn negative. Metropolitan areas are the best to invest in because they generally have greater population growth and therefore more consistent renter demand. This helps to minimize the risk of a prolonged vacancy or earning below market rent.
• Having a strong cash flow will ensure the property takes care of its own costs. This means if you lose your job or suffer any unexpected financial hardship, it is less likely you will need to sell your properties.
HOW TO USE EQUITY TO BUILD A PORTFOLIO
Using a hypothetical example, let’s look at how quickly you could build a portfolio using equity and the three keys to property investing mentioned above.
Say you purchased a property in Sydney for $500,000 during the 10 years from 2004 to 2014. It is now worth near to $800,000.
Assuming you still owed $500,000 on the loan after purchasing with a 20% deposit, you may have around $140,000 of equity.
WHAT CAN YOU DO WITH $140,000 OF EQUITY?
That $140,000 in equity could be used as 3 separate $40,000 deposits of 20 per cent on some investment properties.
If you purchased three investment properties worth $250,000, under market value, for $200,000 each, you would then have $150,000 of equity from the deal at the end ($250,000 – $200,000 = $50,000 x 3 properties = $150,000).
In order to access this new equity (assuming you chose the right broker who will design your borrowing according to your needs as a portfolio building investor), you will probably be able to get up to 80% of it to buy another round of properties.
$150,000 x 80% = $120,000.
With this $120,000, you could purchase another two properties worth $250,000, below market value, for $200,000.
This would give you another $100,000 of equity on the deal that you could use to purchase another one or two properties.
By using equity from your home and buying below market value, it is possible to build a foundation portfolio of six properties without even waiting for the properties to go up in value.
Once they do go up in value, you may be able to access this equity to purchase a few more properties.
And, since you have purchased with a good upside for growth, it is likely they will go up in value rather than stagnate or go backwards.
THE IMPORTANCE OF A STRONG CASH FLOW
All of this would not be possible if you were negatively gearing your properties. Having a negative cash flow would affect your serviceability, preventing you from borrowing as much.
If you were putting your own income into holding your investment properties, you probably wouldn’t be able to afford to build a portfolio of two or three, let alone six.
PURCHASING IN THE RIGHT ORDER FOR YOUR GOALS
To be successful in property investing, it is essential to purchase the right kinds of properties and in the right order for your financial goals.
Someone close to retirement, for instance, will have different financial needs to a young family with another 30 years of work ahead of them.
Some properties deliver more in capital, while others deliver more in cash flow. In order to know what to buy and at what stage of your investing, it pays to have the right team of property investing professionals around you.
NOT ALWAYS SMOOTH SAILING
While the example above makes property investment seem easy, it’s not always so straightforward. The real world is full of many variables and changing conditions.
Having the right team will help you design, tweak and re-asses your strategy and prevent you from making mistakes along the way – especially if they are all on the same page.
Your accountant, financial planner, lawyer, mortgage broker and buyer’s agent need to have a thorough understanding of your goals and financial capacity, as well as be in contact with one another in order to give you the best service possible.