It’s important to acknowledge that this is not a financial plan and this property strategy is only available to wholesale investors as defined in section 761G of the Corporations Act.
For the purposes of this article, we are going to assume that you have paid off your principal place of residence, which is worth in excess of $4m, and your income is above $750,000.
Risk: This portfolio has been designed to be low risk. We do, however, have to take on a large amount of debt to make this work. This debt will peak around year 13, and there are a number of strategies we can discuss (upon request) in greater detail around how we manage this.
The time frame: Unless you have money coming in from a business sale or from an inheritance, building a large property portfolio takes time. This is largely due to the fact that we need to allow enough time for each property to go through at least one growth cycle. In this case, as we do with most of our property portfolios, we have assumed a minimum timeframe of 20 years.
Capital contribution: For the purposes of this strategy we are going to ask the investor to contribute $100,000 per annum, totaling $2m over the 20 year period.
Like all the property portfolios we build, the core principles are the same:
- Buy property in the value or momentum stage of the cycle;
- Buy quality, A-grade property, and;
Setting up the portfolio:
- Access line of credit (LOC) from PPOR - in order to kick off this strategy we are going to require a LOC against the PPOR for around $2m. This will cover deposits and upfront costs for the next 10 years.
- Buy 5 residential growth assets - over 6 years, we will be buying 5 properties across a number of states. This allows us to take advantage of different market cycles, all whilst helping us minimise land tax which is critical as the portfolio increases in value. The total residential investment will be $5m
- Buy into 10 PPA Commercial Funds - buying into 10 PPA commercial funds over a 10 year period allows us to diversify across a number of geographic markets, different asset types, and importantly, a range of tenants. Staging the money into the market over 10 years will help even out market cycles. The total commercial investment will be $3.5m.
Paying down debt;
- How much debt - now the portfolio is built the focus shifts towards paying down debt. As you can see above, we have purchased $8.5m worth of property, financing everything including upfront costs. Therefore our starting debt is roughly $9.2m.
- Use the 100k per annum - this $100,000 per annum that you contribute will be used to pay down debt - starting with the LOC we used against the PPOR. This will pay $2m debt over the 20 year period.
- Sell 1 residential asset - As we move closer to retirement and we want more income, selling 1 residential property not only helps pay down debt but will also improve the overall yield profile of the portfolio. This sale will contribute approximately $1m towards paying down debt.
- Use property income - we have modeled in such a way that it generates positive cash flow in around year 8. It is at this time that the commercial property investments will start to become a meaningful percentage of the portfolio. Over 20 years the positive cash flow (after assuming 30% tax rate) will roughly pay an additional $1m off the debt.
- Rollover commercial funds - PPA funds have a fixed life span at this stage of 10 years. The model assumes you pay the CGT at a 30% tax rate and roll these funds over into new PPA commercial funds.
- Refurbishments & Renovations - the residential properties will require refurbishments and renovations. On average there are minor refurbishments every 7 years and major renovations every 20 years.
- Do nothing - other than rolling the PPA funds over from year 13 & minor refurbishments - there is not much to do as this portfolio has been set up to be passive.
If you follow these basic steps your property portfolio net of debt in year 20 will be in excess of $10,000,000. The modelling shows a portfolio value of $15,000,000, against debt of $5,000,000. All the key assumptions have been provided in the table below.
The key to a low-risk portfolio is the consistency of income despite all adverse circumstances. This would include extreme circumstances such as the current pandemic. As you can see, this portfolio has 14 different income streams, roughly 50% coming from residential and 50% coming from commercial. Commercial investments are an essential part of the portfolio as the high net yields balance out the low net yields from the quality residential properties. Our focus when buying commercial assets is long-term, ‘defensive lease covenants’ - i.e. tenants that will still pay rent in economic contractions. These could include government tenants, supermarkets, medical centers, hospitals, or blue-chip, key supply chain businesses.
Economic contractions should be expected, recently in Australia they have occurred in 1972, 1982, 1989, 2001, 2007, and now 2020 - roughly every 10 years. These economic contractions have always been felt differently across the country and as such, geographic diversification ensures that if some rents fall, others across the country may rise. All our strategies have been designed to withstand these times, as well as other adverse circumstances, of which we can provide further detail upon request.
Finally, our view on land tax. Unfortunately, this tax you can’t avoid if you want to have a $10m portfolio. You can, however, minimize it quite significantly through diversification. At a portfolio value of $10m, your land value would be approximately $6m. If you have your entire portfolio in Victoria, for example, your land tax bill would be approximately $90,000 per annum. If we diversify just the residential portfolio across numerous states, most people can reduce this bill down to around $10,000 per annum. Having a quality accountant with experience in property is crucial for the tax guidance around this.
There is obviously much more detail, but these are the broad strokes that you need to be aware of. We have over 20 years of experience building these types of portfolios - for ourselves and for our clients Australia-wide.
This article is intended as general information for wholesale clients (as defined by the Corporations Act) only.
The article includes economic and market commentaries based on proprietary research, which are for general information only. The author believes the information contained in this presentation to be reliable, however its accuracy, reliability or completeness is not guaranteed. Any opinions or forecasts reflect the judgment and assumptions of the author on the basis of information as at the date of publication and may later change without notice. Past performance is not a reliable indicator of future results.
Any advice in this article is general in nature only and does not take into account your personal objectives, financial situations or needs. Before making any investment based decision, carefully consider the appropriateness of the advice in light of your financial circumstances and seek independent personal financial, legal and tax advice.
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