Greg and Mary are a young, high-income couple that decide to use property to create wealth and help them retire. Greg and Mary earn $100,000 gross each, have no children, rent at $400 per week, have minimal expenses and no other debts.
At the outset, they are clear in what they want and decide that they want enough funds to retire in 20 years. In 20 years, they will reallocate their capital grown to income driven assets.
Keys to building their portfolio
1. Planning & Strategy:
Greg and Mary begin by making an investment plan, a finance plan and a risk management plan. These plans set the tone for what they are trying to do and guide their purchases and decision making over time. Importantly, they work together to build, grow and protect their portfolio over time.
Greg and Mary will maximise their borrowing capacity by using a structured and ordered approach between foundational lenders, aggressive lenders and then calculated risky options to grow their portfolio. They have matched lender selection with their properties, which helps balance finance risk over time.
2. Investment Plan:
Greg and Mary want to build an investment portfolio as large as sustainably possible that grows in value over the next 20 years. They plan to aggressively acquire assets as soon as possible and let time work in their favour.
Yield will only pay for their properties, not lifestyle. They want an average 5% yield across their portfolio, so as to not impinge on their lifestyle.
They are flexible with the number of assets they plan to acquire, but instead focus on quality assets that will grow over time. This includes some lower yielding assets and some higher yielding ‘cash cows’.
They will invest across Australia, to diversify their investment risk.
3. Finance and Risk Management:
Greg and Mary want to have a plan to be buffered for changes in interest rates, finance risks, property risks. The intend on being prudent to cover 6-7% interest rates at P&I repayments over the course of their journey.
They will seek 80% LVR’s across the board given their large cash position and as a method of managing finance risk. They will not seek to re-access any additional equity to continue purchasing.
Financing their purchases
Greg and Mary have their mortgage broker test their serviceability with a range of different lenders across the market. This analysis produces the following results:
Phase 1 – Foundational lenders
Greg and Mary use these borrowing capacity calculations to start planning out their investment journey. To start, Greg and Mary should look to use lenders from the more conservative end of the spectrum that also have useful loan features for investors.
This will allow them to maximise their borrowing capacity later in their investment journey and grow a larger portfolio than they otherwise would be able to. The lenders Greg and Mary should be looking to use should have features like:
Greg and Mary look to use up their full borrowing power with a suitable lender fitting these criteria. Typically, 1 or 2 of the big 4 banks will be highly suitable. Greg and Mary borrow their first $2.2 million of debt to fund their portfolio from their chosen foundational lender.
Phase 2 – Mid-tier lenders
Greg and Mary have now reached their borrowing limit with foundation lenders. They no longer pass servicing under the more conservative calculators to continue taking on additional debt.
In order to continue borrowing, Greg and Mary need to go to a more aggressive lender. However, it’s important they consider this lender choice carefully, as they need to map out a path to future portfolio growth. Borrowing with the most aggressive lender at this point could be detrimental unless absolutely necessary, best to save the most aggressive lenders till the very end when you really need them.
At this point in their investment journey, Greg and Mary and looking for a mid-tier lender that has:
Greg and Mary borrow their next $1 million from a suitable mid-tier lender, until their borrowing power with this lender is exhausted.
Phase 3 – Aggressive lenders
Greg and Mary have now reached the point where they no longer have any remaining borrowing capacity with mid-tier lenders. To continue borrowing they now need to use the most aggressive lenders. They have this option because they have correctly structured their loans over time, borrowing from the right lenders at the right time.
To continue borrowing Greg and Mary will have quite limited lender options. At this stage the only real criteria are lender’s servicing calculators. Greg and Mary will likely only pass servicing with 1 or 2 lenders so they will just have to accept the offered interest rate and other loan features if they want to continue borrowing. At this point in their investment journey it is very important to consider whether each additional investment will generate the returns necessary to compensate for the higher borrowing costs and increased risks at this highly leveraged stage.
Greg and Mary find the right investments to continue growing and can borrow another $1.2 million. Greg and Many have now reached their maximum borrowing capacity with $4.4 million in debt. By structuring their lending correctly over their investment journey they have been able to borrow an extra $2.2 million than if they went to the wrong lender at the start and got stuck at the conservative lender stage. As you can see the correct financing structure allows you to just about double your borrowing capacity. This is why it’s so important for property investors to have an understanding of the finance game so you can make it work for you, rather than getting stuck before you’ve achieved your objectives.
At the end of the day, property investing is a little like a business partnership with the bank, you need their assistance to grow. Being with the right partner at the right time opens up your possibilities and allows you to grow a large portfolio.