The simple mathematical formula for wealth creation … that your 13 yr old already understands!
The simple mathematical formula for wealth creation… that your 13 yr old already understands!
Most people dream about financial freedom or at least having sufficient wealth not to have to worry about their day to day needs or their family’s future. The thought of doing something about it, however, is often very daunting. For most of us the idea of amassing $1 million in superannuation before retirement or saving a deposit for our first house (even outside of Sydney) seems likes a huge task. But it doesn’t need to be – read on to see how principles taught in year 8 maths could change your financial future!
We hear a lot about housing affordability, with house prices in Australia some of the most expensive in the world, and how difficult it is for first home buyers to get a foothold in the market. When I bought my first property in 2006, prices were considerably lower than they are now but it still took me a very long time and a lot of sacrifices to save a deposit. The task has only become more difficult due to higher prices and stricter lending criteria. The idea of saving a $100,000 deposit to buy a $500,000 apartment is daunting enough, let alone wealth creation by building a $2 million or $5 million portfolio.
What can we learn from year 8 maths?
This is where year 8 maths and the secret of compounding, or what I like to call the snowball effect, comes in. Compounding is the ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings, snowballing over time. Compounding is such a powerful force in finance and in our lives in general that Albert Einstein call it the 8th wonder of the world.
The power of compounding can be demonstrated by looking at a sheet of paper – if we took a sheet of paper, one thousandth of a centimeter thick (0.001 centimeters), how many times do you think you would need to fold it in half before the stack of paper was higher than the Eureka Tower in Melbourne? Go on, have a guess! Would it surprise you if I told you that after 25 folds you would have a stack taller than the Eureka tower, even taller than the Q1 tower on the Gold Coast – which is Australia’s tallest building?! Don’t believe me? Whatch this fascinating Ted-Ed video How folding paper can get you to the moon.
How do we apply these to property investing?
Exactly the same principles can be applied to property investing. When you start out investing, it is very difficult to build a portfolio. Your first purchase is a mammoth achievement and at the time a second seems near impossible. In time, however, you build some equity in your first property and you are able to leverage that equity to purchase your second – now just stop for a moment to think about what you’ve just done – you’ve folded your paper, you’ve only increased your portfolio from one property to two but that is a 100% increase in the size of your portfolio! If you fold you paper again, you will increase your portfolio from two properties to four. Folding two more times, you will double your portfolio to eight and then from eight to 16 properties. Now to most people a portfolio of 16 properties seems like the stuff that dreams are made of!! But if you understand that owning 16 properties only requires to you to double your portfolio four times (and that doubling from four to eight or from eight to sixteen takes exactly the same amount of energy that it takes to double from one to two) it seems so much more achievable. This is a lightbulb moment for many investors who want to grow a portfolio but who have felt overwhelmed with the size of the task.
Now the amazing part about building a portfolio is the increasing wealth generation potential as the size of the portfolio grows. If we assume, for the purpose of this calculation, that property grows at 5% per year, if you own a portfolio of two properties each valued at $500,000, your portfolio will grow by $50,000 in the first year. If you double your portfolio twice, first to four and then to eight properties, again each worth $500,000, your portfolio will be worth $4 million and will grow at $200,000 per year. Double again and all of a sudden you portfolio is growing at $400,000 per year! Unbelievable!
Do the numbers really work?!
You’re probably thinking, well I understand the maths but doubling my portfolio – is that really achievable? Well, the answer is yes. Now, markets never perform the same over time and you will find that there are often markets within markets, so growth can never be guaranteed and you should always seek advice from an independent, unbiased adviser (such as a Qualified Property Investment Advisor – who has met Property Investment Professional Australia’s (PIPA) education requirements and subscribes to PIPAs code of conduct), however, well located, quality, residential property has historically grown at something like 7% per annum. Using our previous example, if you hold a $1 million portfolio for three years and it grows at 7% per annum, at the end of year three it will be worth approximately $1,225,000. In theory, the additional equity of $225,000 could be drawn down and used to purchase additional properties. If you were to use $150,000 of your $225,000 for deposits on new properties (retaining the other $75,000 for closing costs and a repayment buffer) and borrow against the new properties at an 80% loan to valuation ratio, you could purchase new properties to a value of $750,000, giving you a total portfolio value of $1,975,000, almost double your original portfolio value. This process can, assuming consistent growth in your portfolio, be repeated again and again.
Now, as we discussed earlier, growth in your portfolio is never consistent, some properties will underperform and others will overperform and they may do so as at different times as different markets respond to different growth drivers – so you must build your portfolio slowly and as your overall circumstances allow. It is important also to note that the example requires high overall leverage and should only be considered by experienced investors after obtaining appropriate property investment advice – but it demonstrates that it is possible to double your portfolio in a fairly short space of time, without the need for large amounts of additional capital.
Much of the work may already be done!
The power of compounding allows many investors to understand that in acquiring their first investment property or building a portfolio of two or three properties, they have already done much of the work required to build a significant portfolio that is likely to deliver them the financial freedom they desire.
Are you building a portfolio? Do you have an investment plan? Are you currently harnessing the power of compounding?
Why not get in contact with Real Estate Wealth for a free and completely independent strategy session and find out how to take your first steps or how to take your portfolio to the next level! Contact us at info@rewealth.com.au.
5 simple steps to improve your rental property return – that your agent won’t tell you!
5 simple steps to improve your rental property return – that your agent won’t tell you!
Have you ever wondered what makes the difference between an average property investment and a great one?
We have seen lots of people who have taken the leap to become property investors and who have done everything right: they have researched their target markets, inspected lots of potential investments and ultimately purchased quality assets at great prices. But their property investment journey still isn’t smooth because their investments under perform or sometimes even perform downright badly. So, why does this happen?
Typically these investors are in the first 5 years of owing their investment property and, like most of us, have borrowed to fund part of their acquisition. The reality for most investors is that the returns available on quality, capital growth assets mean that their investments are negatively geared for the first 5 years, if not longer. During this period, careful cashflow management is required to minimise the shortfall amount required to contribute from other income sources.
So, what is the difference between an average property investment and a great one? Well, assuming you have purchased a quality asset at the right price, the answer is often very little! It is often the little decisions you make, often without realising it, that makes the difference. Hearing this often a lightbulb moment for many investors – for the first time they realise that it is not their investing or their choice of investment that is the cause of their investment stress, it is the way their investment is being managed – something that is usually easily fixed by implementing the 5 simple steps outlined below!
But first, why won’t your agent tell you about these things? The answer is also simple – because these simple steps will significantly increase the cashflow from your investment and decrease the amount you pay to your agent!! Additionally, they will require your agent to spend more time and be more precise in the way that they price, market and manage your property. We bet you’re thinking ‘that’s what I thought I was paying my agent to do!!”. We agree!!
So what are the 5 simple things you can do right now to increase the cash flow from your investment?
1. Ask your tenants for 12 month leases
Agents won’t generally suggest longer leases because they charge you a reletting fee, usually equal to one to two week’s rent, to relet your property at the end of each lease. If you enter into six month leases, you are generally accepting a reduced return on your property equal to at least four to six week’s rent each year (a reletting fee of at least one week’s rent, twice per year, at the end of each six month lease and some vacancy in between each lease (even if your agent is doing a great job, a few days or a week in between tenants is often unavoidable)). If you ask for 12 month leases, you cut that vacancy period in half, at least, and you avoid the possibility that your property is vacant for longer periods in between shorter six month leases.
Another advantage of 12 month leases is that your tenants generally become more settled after a year in your property, reducing the chance of them moving on at the end of their lease – this will further reduce your losses from vacancy.
2. Mid term rent increases
One of the major arguments made by agents against 12 month leases is that the market might change and you will loose the opportunity to increase your rent. Well that is true, you will not be able to increase your rent during a 12 month lease – unless the increase is written into your tenancy agreement. So include a clause in your tenancy agreement that after six months the rent will increase by a small, fair amount. By using longer lease periods and automatic increases you will will not only reduce costly vacancies but you will lock in a rent increase over the lease term!!
3. Have happy tenants
Investors often give us perplexed looks when we mention this one – some even tell us that as long as their tenants pay the rent and look after their property, they don’t much mind whether they’re happy! But we have a different view – as investors, we have always done everything we can to keep our tenants happy – which can be as easy as responding quickly to maintenance issues or agreeing to extra picture hook to installing air-conditioning or ceiling fans – but more on that later.
The only thing better for your cashflow than a tenant who signs a 12 month lease is a tenant who signs a 12 month lease year after year, after year! Long term tenants are the very best way of eliminating costly vacancies and avoiding reletting fees on your property. And when coupled with regular mid term rent increases, long term tenants can significantly alter the performance of your property.
A word of warning – unless your agent is conducting regular rent reviews on your property, there is a risk that long term tenants can result in your rent falling behind the market – so make sure that each time you renegotiate a lease with your happy long term tenant, you know exactly what the market rent is for your property.
4. Offer your tenants extras
Often tenants will love a property but need something extra to make it really work for them – common requests are ceiling fans, air-conditioning and kitchen and bathroom makeovers. We have seen landlord’s reject these requests out of hand due to the cost and concerns about how it will affect their investment performance. However, these requests will usually represent an opportunity to increase the return on your property!
For example, we recently received a request from a tenant to move the laundry from the kitchen to the garage of a rental unit. We priced the work at $1,500 and proposed to the tenant (who was at the beginning of a 12 month lease) that we would do the work if he paid an extra $20 per week rent – which he happily agreed to do! The extra rent over the course of the 12 month lease was $1,000 and the tenant was very happy and more likely to sign up for a further lease. Additionally, the extra rent will pay for the cost of the work in 18 months and the unit will have increased in value and will continue to rent for more into future, thereby increasing our overall return on investment well into the future.
5. Price your property correctly
Do you know exactly what your property should rent for in the current market? No? Well it might surprise you to find out that your tenants do! Your current and prospective tenants have every property currently available in your market at their finger tips, thanks to the online real estate portals. Additionally, it is much easier these days to view and apply for properties, so your tenants are in the market looking at properties all the time. If your property is incorrectly priced, prospective tenants will discard it quickly in their search for value and your current tenants will move on to get a better deal. If your agent is not giving you a formal written rental appraisal every year, or perhaps more regularly in the current market, you may not know exactly what your property is worth and you may find your property vacant for much longer periods than correctly priced properties.
Is your property performing as well as it should be? Has your agent advised you to implement any of the above strategies? Do you know exactly how much your property should be renting for in the current market?
If the answer to any of these questions is ‘No’, give Real Estate Rentals a call or ask us for a quick, independent and completely free rental appraisal and get your investment working for you today!!
3/21 Derby Street, Highgate Hill QLD 4101
This two bedroom ground floor unit is positioned in a quiet leafy cul-de-sac within the state high school catchment area.
Features include:
– Two bedrooms both with built-in robes
– Open plan living and kitchen
– Front entertainment area
– Carport for one
Easy access to Southbank, green bridge, West End and only 2kms to the city makes for a very easy lifestyle.
Please note that Derby Street is located at the end of Roseberry St in Highgate Hill. Should you not be able to find the property please contact our office for assistance.
