We get to see a number of ambitious young investors looking to rapidly grow their fledgling portfolios. The challenge is that accumulating properties has become tougher in the past 4-5 years with tighter bank credit rules and lower capital growth. Although it feels like banks have loosened a bit, as soon as investors rush into the market they'll tighten up again. It is a bit cat and mouse.
Banks want to retain market share but they don't want to write too much perceived "higher risk" business. I say "perceived" as sometimes it is near impossible to even do good business outside of bank credit policy. For lower income clients the first roadblock we typically see is their income. Lenders do not like you having more than 50% of your income coming from rentals unless you have a great job and/or a high proportion of equity. Otherwise you are considered “rent reliant” which is a nice way of saying no and no and no! For most young investors, they don’t have tons of equity, so their income will initially limit them to 3-5 properties.
I had a young client wanting to buy this week at 95%, which just won’t happen beyond a first property. However, she had two other lowish value properties at 75% we could leverage against. We pursued this option. Unfortunately one of those properties was a non-standard apartment (only 39sqm), which chewed up all of her spare equity in the other property. This left us nothing to work with. We have managed to get her approved at 80%, so for her to continue the non-standard apartment really needs to go. The lesson here is that if you’re in growth mode be careful with non-standard properties (apartments less than 45sqm and properties with more than 3 incomes.) Banks will typically only lend between 50% and 70% of the value on these types of properties. They might be cheap and have good yields, but they can also be a trap for your equity.
When you first start out investing you really need to have strong capital growth. It takes too long to save the deposit for one house let alone a portfolio. You need to add value to your properties and then recycle the equity gain into the next purchase. This is relatively easy to do. Banks will allow you to recycle your equity after 6 months, sometimes sooner. In a slow market, capital growth won’t happen by fluke. (Despite what agents will tell you, I don't think you'll see overall property prices go up over the next 5 years.) That is "on average." Within the market some places will go down and some will go up. So capital growth relies on finding the right properties. Personally, I look for rundown properties where I can add value through creating a second income, subdividing, and/or renovating. There seems to be enough around, even in this market.
As an example, a business partner, and myself are currently subdividing a property in Mt Albert and putting a relocated villa on to the site. The project will cost around $900,000 with an end value of $1,200,000. We should get 25% equity into it and the yield (on cost) is ok for the area at around 6.50%. This one will be a long-term hold. I'll do a separate blog on this project in the coming weeks giving you the details of what we've doing. We also buy, renovate and sell properties in Auckland and would readily get 15%-20% equity growth in them but the yields are crap. In this regard we have two projects nearing completion: one at 5 Himikera Ave in Avondale Heights (awesome area and house) and 5 Cowell Place (off Moana) in One Tree Hill / Onehunga. Both of these properties will go back on the market in February/March and we will give Squirrel clients first dibs if you're interested. We leave a bit of value in them for the buyer, so the longest one of our properties has been on the market is 1 hour (first open home.)
If you’ve got the income then you might sacrifice a bit of yield in the short term to get some equity. Some canny clients manage to find properties that achieve capital gain and yield. In the past few months I’ve seen Auckland clients secure 8% yields in the likes of Ellerslie and the North Shore. Not surprisingly, each time it has involved a renovation and a dual income property.
To grow a big portfolio in the next 5 years my view is that you need to be extremely selective and objective about the properties you keep. There is no value to be had owning properties for the sake of owning properties. Real successful comes from making the tough calls. I still find clients reluctant to sell properties that have had a good run of capital growth, but in reality have peaked out with poor yields. Personally I’d sell them and get my money working harder in a new property, but everyone’s different.
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