Long Term Strategy - Critique Please

[Asheam]

Hey All

As I'm now starting to progress through my property journey, I thought that I should document my property related goals to keep myself accountable. For all of you experienced Somersofters, I would appreciate your feedback on the feasibility of the below outcomes and strategy involved.

My main reason for investing in property is to ascertain financial freedom, to feel financially secure and to be able to spend more time doing the things I love, be it with friends, family or even by myself.

I?m currently 24 and have set the following goals to achieve by ages 30 and 40.

Age 30: To hold an asset base of at least $4m.
Age 40: Net passive Income of $100k which is roughly $140k pre tax.

I have broken my strategy down into two phases, the residential accumulation phase and commercial accumulation phase which will be used to meet the above goals.

Stage 1 - Residential Accumulation

To hold an asset base of $4m by the time I am 40 I will be looking to purchase 10 properties at approximately $400k each. Targeting the lower quartile of the market allows me to keep yields high to assist with cash flow.

I currently have one investment property worth $350k and after the construction of my second property by my 25th birthday my Assets will be $710k and my loans will be $590k with cash on hand of $45k.

By drawing down on the equity in my 2nd IP and using cash on hand I will be able to purchase two additional IP?s for around $350k each giving me $1.4m of assets with 5 years to reach $4m.

Each year I will be able to save approx $40k, maybe a little less in the early years and more in the later years. From my savings I will be looking to purchase a $400k property each year for 5 years. Total Assets = $1.4m + $2m = 3.4m.

From purchasing well and any increases in value I am aiming to be able to draw down another $100k to be able to purchase additional one or two properties at $400k for total assets of $4.4m at age 30.

Any comments here on my ability to service these 10 / 11 properties in the banks eyes? My income is currently around $70k and should be increasing to about $120k by the time I?m 30. I am aiming to have the properties at least cash flow neutral after any depreciation benefits.

If I have not experienced many capital gains at this point in time I will have approximately $300k in equity with assets of $4m. Quite a high LVR but hey, I'm young and all properties will be purchased with cash flow in mind.
If the properties appreciate at around 5% then equity would be approximately $800k (Assets $4.2m - Loans of $3.4m).

Stage 2 - Commercial Property (Assuming $4.2m Assets and $3.4m Loans)

The second stage of my plan is based around accessing the equity from my residential properties to purchase commercial property with strong yields.

For the purpose of these calculations I have estimated that the residential properties will grow at 5%. Growth may be lower or may be higher, the strategy will have to adjust accordingly.

Assuming 5% growth, at age 32 Assets will be $4.6m and loans $3.4m giving me equity of 1.2m. If I am able to draw to the properties to 90% LVR I can cash out $780k as a deposit on a $1.8m commercial property and use savings for the closing costs.

Commercial Property 1 = $1.8 million with an 8.5% yield.

Cash flow at age 32 based upon interest rates at 6.5% = $36k pa.
Cash flow at age 40 assuming 4% rent increase pa = $92k pa.

Commercial Property 2 = $2.5 million with an 8.5% yield.

At age 35, equity in the residential properties will be enough to cover a $1m deposit + costs for a $2.5m property.

Cash flow at age 35 based upon interest rates at 6.5% = $50k pa.
Cash flow at age 40 based upon 4% rent increase pa = 96k pa.

Age 40 - Statistics
Assuming the above 5% growth in the residential properties and 3% growth in the commercial properties my assets and liabilities would be as follows:

Assets = $12m
Loans = $7.6m
Net Assets = 4.4m or a LVR of 63%

Cash flow from the two commercial properties at age 40 = $188k pa gross.
Reducing this for 3% inflation per year works out to be $120k pa in current dollars and additional rent from the residential premises should cover the remaining $20,000 required for my goal.

At this stage the aim would be to let inflation do its job with the rent increasing by at least 20k per year and even at 3% capital growth, equity of $360,000 per year.

Possible choices at this stage would be to sell a couple of residential properties to reduce any headaches and purchase a few more commercial properties as the loans are paid down.

TLDR : Buy many residential properties to build up a solid asset base and then leverage the equity in these properties to purchase high yielding commercial properties to provide a passive income stream in the future.

Thanks to anyone who managed to read through the whole thing. Any questions or points you would like to make are much appreciated

 

[HD_ACE]

Looks pretty thoroughly thought out. Just rember life will always throw things at you be it good or bad, change of job, family/kids, relocation etc etc.

Be prepared with all your insurances incl income protection.

Have you thought about developing to build the asset base cheaper and faster? 1 can become 3 or 2 become 4 etc.

Best of luck

Cheers

 

[Singo]

Detailed plan. As HD_ACE pointed above developing or other value adding will make it faster. You don't have to wait for the market to move by 3% or 5%. Instead you can create your own asset growth. Best of luck!

 

[Asheam]

Thanks Guys,

The plan is for marriage etc after 30, hence I would like to get a solid foundation set up before then.

At what point did you guys start developing? I've always thought that I would not have enough equity / deposit for quite a few more years, otherwise that would be a way I'd like to go.

The numbers are set how I would like them however the types or properties to purchase / developing / adding value etc are all ways in which the strategy can be tweaked to get the desired result.

 

[Rickardo]

Asheam,

A well thought out strategy. It is certain to change over the years but you've got a good starting point.

From my own experience the biggest blockers I see in the early years in trying to align your strategy to it's practical application, will be your ability to find properties with an appropriate yield/CG mix to allow you to continually purchase and keep holding costs down, while growing enough to redraw equity for future purchases.

The key really is to save and inject as much cash as you can, especially if the growth doesn't eventuate over the next 5-10 years. Good luck!

 

[Aaron_C]

Strategy is fine at a high level but things happen along the way. I think it's just best to buy the best located real estate and once you have gained sufficient equity - you can choose what you want to do later on as most people struggle with equity, not cashflow.

 

[Deltaberry]

Set big, broad general goals (eg I want to make $50m by 40).

Then work out the 12 month steps along way. Planning too rigidly ahead will distract you from opportunities because you're too focussed on doing it one way.

 

[pinkboy]

Big goal.

Now do your models based on long term interest rates (especially for commercial stuff), and then for all your commercial stuff, base it on 15yrs P&I. What does your cash flow look like now??

Will you buy a PPOR within the plan, or after?


pinkboy

 

[Tonibell]

Great that you have a plan at such a young age - it is a great chance to build your asset base early.

Like has already been suggested - it is best if you can add value and cash flow yourself rather than just relying on the market to do it.

Renos, granny flats, developments etc are opportunities to create sweat equity. Unless you can get substantial income from other additional efforst it is a good way to get there earlier (although your plan already looks pretty ambitious).

 

[Asheam]

Thanks for the responses guys. All of the points will be taken on board.

In general the plan is to work hard for the next 6 years to create the largest asset base possible. Ill be on the lookout for ways to create the equity such as developments and renos in this time.

50m by 40 sounds good delta, I will be constantly looking for ways to expand my money, especially when im into commercial. Thought people might have laughed at me if i set such a lofty goal though!

Pinkboy, plan is to rent in the western suburbs, the yields around here are incredibly low. And ill be better off investing the difference. Ill do some modelling with the interest rates and PI for you later but I assume they would then be cash flow negative for the first 7-8 years.

Here's to being ambitious

 

[Asheam]

Pinkboy

I've done quick calculations for Comm IP#1 based upon a 7% interest rate with 800k at 7% interest only (Cash out) and 1m at 7% principle and interest.

The first two years would be a net cash loss of $11,000 and $4,880 with the third year approx neutral.

By the time I hit 40 the cash flow would be $40k a year and once the $1m is paid out at 47 cash flow would be $220k.

After about 5-6 years the cash flow from Comm IP 1 would be able to offset the loss from Comm IP 2 until that one becomes positive as well.

Point taken about the commercial loans generally being principle and interest over a short term loan. Are all commercial loans normally offered on this basis or are interest only periods still available?

 

[Rolf Latham]

Point taken about the commercial loans generally being principle and interest over a short term loan. Are all commercial loans normally offered on this basis or are interest only periods still available?

many comm loans have IO periods

generally though best to work on a max term of 15 years PI unless you know for sure you can refi back out to another IO term

ta
rolf

 

[DavidMc]

Asheam. Sounds like a great plan and very similar to what I'm doing.

Others have mentioned Development. I've looked into it many times however while very profitable always found it just takes too much equity and personal time.

The strategy you have outlined is a good mix of growth/yield and risk and still reasonably passive. This suits me personally. Developing will increase all of these dimensions (more growth, more yield, more risk and more activity).

I'd just try and buy one or two properties in your mix with development potential and you can decide to dev this later (perhaps after switching down from full time to part time work).

Everybody likes a different mix but I have enough hassle even getting a decent tradie to do minor work let alone develop.

 

[HiEquity]

Asheam

Nice to have a plan but I will challenge some of your assumptions. You assume capital growth of the CIPs to be lower than the RIPs. Where do you get that idea? It has not been the case in the past and is unlikely to be in the future. They just work in different cycles and the one to buy may be best determined by where each type of property is in its cycle where and when you want to buy it rather than how they fit your assumptions here.

You have outlined a path very similar to the one we have taken. However, if I had my time again, I would have jumped straight into CIPs ASAP. They are still available (albeit less attractive than the big ones but still better than RIPs) at lower price points and the learnings will be invaluable as you grow. I reckon your age 30 target looks pretty skinny on typical RIP yields on your likely salary. Maybe some of the brokers on here could stretch you to get the loans but that doesn't necessarily make it a good idea. You have to be able to cover the risks as well as expose yourself to the upside. This is not a one way elevator!

The only advantage that RIPs give you is high leverage - the ultra high leverages come at the not insignificant cost of LMI, which means we are really comparing 80% for RIPs with 70% for CIPs. At that spread, the better net cash flow from CIPs may be worth the reduced exposure, particularly if bought in the right time in the cycle... and if you can buy a CIP on a decent yield which is under market and has a review coming up - run some numbers and see how it looks. Remember you can also reinvest the extra cash flow. CIPs give you a lot more potential to play around and identify value that may have been overlooked by others and this can make up for the reduced exposure. RIPs are typically more "vanilla" and perform like the market in that area in the absence of the blood, sweat and tears involved in reno work.

I classify development as a job - great if you enjoy it but if you like your current job better you may want to stick with it. Buyer beware in all this of course - you may be buying a dog in CIP land - you have to educate yourself. It's just a matter of risk and return... most of the players in CIPs are self educated.

As others have said stay flexible - the good opportunities present themselves at odd times and may not fit your plan - you have to roll with the punches.

Good luck!

 

[Asheam]

Thanks for the great post HiEquity

To be honest, the estimated capital growth on the commercial properties was a non-event in my eyes. At the moment with little experience I'm unable to state what sort of growth is possible with commercial.

The aim was to grow enough equity through residential property so that I would have a large enough deposit for commercial property which would then generate the cash flow for retirement. Any capital gains on the commercial property at that stage would be bonus / used to further purchase more commercial property and shares. If I could get a higher capital gains from commercial then I can think about adding them into the portfolio earlier.

Point taken about the $4 mil of assets on my skinny salary , it is highly possible that a girlfriend at this stage would be bringing in an additional 80k+ but I wanted to keep my strategy based just upon myself for now.

Once I do have a few residential properties over the next couple of years I will definitely take your advice in looking at some lower level commercial properties. I guess the issue that Pinkboy state about the 15 year P&I loans for commercial would significantly put a damper on any cash flow from them in the early years however?

Thanks again for your detailed post

 

[Truly Exotic]

Planning is BS,
Strategy is KING

The future is always going to be uncertain,

what happens if you get divorced?
What happens if you have octuplets
What happens if you lose your job
What happens if you get a 100% payrise?
What happens if you break your back?
What happens if you lose interest
What happens if you become a gambling addict

etc. etc. etc. etc.

Have broad realistic goals and try to exceed them, or have unrealistic goals and try to achieve them and when you fail, at least you have acheived better then your realistic goals

 

[HiEquity]

Once I do have a few residential properties over the next couple of years I will definitely take your advice in looking at some lower level commercial properties. I guess the issue that Pinkboy state about the 15 year P&I loans for commercial would significantly put a damper on any cash flow from them in the early years however?

Thanks again for your detailed post

No. Pinkboy doesn't know what he is talking about.

In any case even if it were true you don't lose the principal you pay - you just get access to more equity for the next IP when it comes time to revalue / refinance.

 

[neK]

Planning is BS,
Strategy is KING

Planning is only BS when you create the plan without understanding the strategy.

Understand the strategy the plan can always be varied.

That said, I set a goal and the strategy in which is obtained. The plan is only there to make sure i don't deviate too far from the expectation.

Years ago i planned everything to a tee. My wife thought life was miserable. I thought life was fine.... i now look back and realised my wife was right.

 

[Greg Reid]

Asheam,
Good to have a written plan and long term goals with the reasons why you are trying to achieve them.
A few comments:

• Buy well.
• Diversify across different states to minimise land tax and tap into different property cycles.
• Think about structures and asset protection earlier than later.
• Look at opportunities to add value (granny flats in NSW has been suggested that will add cash flow and increase your borrowing ability).
• Make sure you always have a buffer or LOC facility in place for downturns or unexpected costs.
• Use different lenders as much as possible - to minimise lender risk, easier to use a revaluation and refinance strategy and minimise LMI costs.
• Choose which lender to use for each property, based on lower servicing criteria first, far more important than interest rate if you want to build a large property portfolio rapidly.
• Always keep in mind - to be able to obtain finance for the next IP, what characteristics does this current IP need.
• Your first CIP does not need to be $1.8m, it can be lower.
• Conserve your own cash/capital as much as possible and use OPM where you can, so have an offset facility somewhere in the mix to park your own funds.

Good luck with the plan and look forward to hearing an update.

 

[MTR]

Hi Asheam

I am really impressed with your strategy, I like it very much. Good for you

I will add having a positive attitude as an investor is very important, I have noticed over the years people who see their glass half empty struggle to achieve their end goal.

Never underestimate the importance of networking.

Never stop learning, step outside your comfort zone and develop skills that will enable you to make money regardless of what the property cycles are doing.

Keep reading SS posts.

MTR