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Thursday, January 3, 2008

How to Build a Property Portfolio

If your long term strategy is to build a portfolio of investment property then it is important to have a long term finance strategy to match.

Investors frequently hit a brick wall with their lending and can't move forward to the next property. It is often their current loan structure that is holding them back. Incorrect structuring usually results from short-term planning with a focus on completing the immediate purchase rather than asking "How will we do the next one?"

Understanding lender differences
As you acquire more property you also acquire more debt. In most cases lenders will be looking for evidence that you have the capacity to meet this increased commitment. Where you are acquiring high growth property that may be cashflow negative in the early stages this becomes more challenging. Each additional property will effectively eat into your income reducing the loan capacity.

Each lender has their own method of assessing serviceability. This means the amount you can qualify for can vary significantly from lender to lender. Even between the major banks there can be significant variations.

eg. across a panel of over 30 lenders, a couple earning $75,000 per annum could potentially borrow anywhere from $308,879 to $522,124, based on the same information. Therefore you can actually rank your potential capacity across these lenders from lowest to highest.

In building a portfolio you would start by using the lower rank lenders first. As you reach capacity with these lenders you then place your next purchase through the next lowest lender where you can qualify. And so on moving up through the rankings.

Avoiding cross-securitization
Cross-securitization is where more than one property is used to secure a loan. If you have a property with a lender and buy another property, in most cases that lender will secure the new loan against both properties.

This can present a number of complications going forward:
1) By linking all your properties together you have probably limited your loan options to that lender. As highlighted above if this lender has a more restrictive servicing test then your future investment plans may be slowed

2) The lender will generally assess any future borrowing plans on the aggregate value of the properties. Let's say one of the properties experienced strong price growth but the other property was located in an area that was experiencing a down turn in value. The loss on one would cut into the gain on the other, reducing the amount of additional equity that could be released. If the properties were separated then you could take full advantage of the property with the gain to release additional equity and acquire further property.
3) If you want to change things with either property or the loan structure it is likely to involve more costs in terms of additional documentation and valuation fees.

4) Having your properties separated gives you greater flexibility. It means if you need to make changes to your portfolio or your loans going forward you can do so without significant complication. If you find that there is a better option for you with another lender you can move one of your properties without disrupting the rest of your portfolio.

It must be remembered that these are general principals only and will not be practical or apply in all situations. The range of options available to you will depend on your specific situation.

This article is not a substitute for independent professional advice. Marquette Turner does not warrant the accuracy, completeness or adequacy of this information. We disclaim liability to all persons or organisations in relation to any attraction(s) taken on the basis of currency or accuracy of the information or material, or any loss or damage suffered in connection with that information or material provided. You should make your own enquiries before entering into any transaction on the basis of the information or material provided.

Where The Smart Money Will Go in 2008

With so much happening around both Australia and the world – wars, sub-prime financial crisis, changing governments, assassinations and very unforgiving stock market investors, where is the hot money tipped to go?

On the domestic front we have just come through to our 17th year of consecutive growth. We defied the Asian economic crisis and continued building and growing as demand for our natural resources reached record highs. The resilience of the Australian economy will again be tested to some extent if predictions of a recession in the United States come to bear. Decreased US demand will affect Asian manufacturers including China however their domestic demand for Australian resources and products has every chance of shielding our economy and seeing yet another year of continued growth.

So the big question is where will the HOT (or smart) money go in 2008?

Typically we would be asking – shares or property? We have seen some of the property trusts like Centro take major hits on the stock market which is now extremely watchful and cautious.

We’d expect a flow of money into property with any stock market wobble and I am hoping that will occur in 2008. Prior to the Federal election I predicted that interest rates would continue to increase regardless of which party won and with inflation at current levels The Reserve Bank is likely to increase rates further.

The last property cycle came to an end in 2003 and historically property has doubled in price every 7-10 years depending on location, so we can reasonably expect that Sydney prices would have doubled by around 2013 as compared to prices in 2003. With that in mind property yet again looks like being a winner for those fortunate enough to capitalize on the current situation. Mortgage foreclosures in 2008 will create opportunities for investors with rental demand outstripping supply, increased yields and an excellent outlook for long term growth. Our population has now reached over 21,000,000 and people will inevitably continue to invest in Sydney.

The hot suburbs for me are those in the typical hot spots like Surry Hills, Darlinghurst, Potts Point and now Redfern. Rental demand in these suburbs is enormous and there are still some great buys for those willing to look and wait. And of course, sydney luxury homes continue to do well.

The surprise suburbs for 2008 will be those that have an inherent cultural need like Lakemba and its surrounds. The Muslim Mosque creates a natural need for accommodation around the area and the Eastern Distributor and M5 have now made it very easy to reach the city from that area.

Suburbs like Penrith, Glenmore Park and Kellyville are much further from the city and will hurt as interest rates increase.

My tip for 2008 is to invest in property where you know that demand will be constant – especially where a cultural need exists. Many of these suburbs are undervalued and provide enormous opportunity for those willing and able to look outside the square.