It takes time to build financial freedom, but if you only have a short timeframe ahead of you to build your nest egg, all is not lost.

A number of years ago I was asked by Your Investment Property Magazine to devise a strategy for success to help readers James & Elizabeth.

Here’s what I said:

INVESTOR SCENARIOCouple carrying boxes

James and Elizabeth are a married couple both aged in their mid-50s.

James is a public servant and Elizabeth is a school teacher; between them, they earn around $130,000 a year.

They have two adult children and owe $115,000 on the mortgage on their home, which is worth around $550,000.

They have no big debts, other than a $3,000 credit card limit, but they also have no big assets either – and with retirement just a decade away they’re starting to worry about their financial future.

What can James and Elizabeth do now to start planning for their future retirement?

Firstly, James and Elizabeth should be congratulated for starting to consider their financial future – unfortunately many people don’t do this until it’s much too late to change the outcome.

That said, it takes time to build financial freedom and they only have about 10 years or so ahead of them before retirement, which does make it a little more difficult compared to if they had started planning when they were in their 30s or earlier.

The scary fact is that the vast majority of Australians won’t retire with enough superannuation to see them through the remainder of their lives.

This is because the average male’s superannuation balance is about $200,000 at retirement in Australia and a woman’s is about $100,000, and because we’re all living longer our super nest eggs need to financially provide for us during some 20-plus years of retirement.

So, if they are to enjoy financial freedom during their twilight years, James and Elizabeth will need to grow a significant quality asset base over the next 10 years, which will include their home, superannuation and investment properties.

Needless to say, the number of properties they have in their portfolio on retirement won’t be anywhere near as important as the net value of those assets and the total rent achievable.

The thing is, to achieve financial freedom, they will need to do things differently from how they have done them in the past.

They will need to invest in high-growth properties that generally have negative cash flow, as they don’t have a lot of time on their side to see the wonders of compounding growth work their magic.

This means James and Elizabeth will have to budget and sacrifice a little now so they can enjoy their retirement later.

If they don’t, the alternative is that their golden years will be defined by money worries as they struggle to make ends meet on their pension and their inadequate superannuation balances.

Financial freedom is a goal for many people, but it is something that very few achieve. property investment

In fact, James and Elizabeth will need to do things differently from the majority of Australian property investors.

Statistics show that of those who buy an investment property in Australia, 50% end up selling their property within the first five years, and of those who retain their properties, close to 90% never own more than one investment property.

And of course, one investment property is not enough to gain financial freedom.

So, with only a decade ahead of them, how can James and Elizabeth create a better financial future?

Let’s consider some options for them…

Taking steps towards financial security

The first step for James and Elizabeth is to gain a sound education in investing, tax, superannuation, and property.

In particular, they must understand the power of leverage because it will be leveraging the equity in their home, and borrowing to buy high-growth properties, that will help them secure their financial future.  Property-Investment-Checklist-300x199

Secondly, they should gather a team of professionals around them who can offer sound investment advice. 

Their advisors should be independent and unbiased and not salespersons or marketers trying to sell whatever shoddy, second-rate property they’ve got on their stock list.

This team should include an independent property strategist who can project manage their investment strategy, as well as the other consultants; a finance broker to help them through the maze of lenders; a financial planner who can discuss concepts such as self-managed superannuation funds (SMSFs) and insurance with them; and a property-savvy accountant.

Early in the piece James and Elizabeth will need to gain a better understanding of their current financial position – money warts and all!

Questions that they need to know the answers to include:

  • How much spare cash do they have to fund investments?
  • What is their borrowing capacity?
  • How can they improve this?

“Because they’re starting their investment journey late in life, they don’t have the luxury of time to make mistakes”

James and Elizabeth will then need to (with the assistance of their property strategist) build a strategy to accumulate the assets they will require to work towards financial freedom.

They will need to take the following actions:

  • Prepare a comprehensive budget so they can see where they can increase their cash flow to help them invest. property mortgage finance money
  • If James and Elizabeth are going to take on debt during the accumulation phase of their game plan, they’re going to have to focus on their incomes and spending so they don’t get into financial difficulty.
  • They’ll need to set up the right loan structures, including a financial buffer and an offset account, which is where it’s likely they will deposit extra savings to help minimise interest repayments on their home loan.
  • James and Elizabeth could also consider filing for a PAYG variation. This way, rather than receiving a tax deduction at the end of the year, they will have more cash flow throughout the year to help finance their investments. They may put these extra funds into their offset account, which will again minimise their interest payments.
  • I would recommend they make interest-only payments on their home loan and use the savings in repayments to fund investment loans – this way they can earn 10% (6% capital growth plus 4% yield) on their investment rather than paying off their home loan and saving, say, 4% in interest payments.

Wealth-building: the 3 phases

Before we go any further, it’s important that James and Elizabeth understand the three stages of building wealth, which are:

1.     Accumulation phase
This is the stage James and Elizabeth can’t afford to get wrong.

Because they’re starting their investment journey late in life they don’t have the luxury of time to make mistakes, therefore they must ensure that they own the right assets, meaning investment-grade high capital growth properties.

2.    Consolidation phase
The consolidation phase involves slowly reducing the debt on their properties, which conversely increases their cash flow when they need it the most – in retirement.

3.    Lifestyle phase
The lifestyle phase is all about enjoying their golden years, as well as managing and protecting their assets to make them last the distance.

Begin with the end in mind

In order to make realistic plans, James and Elizabeth must begin with the end in mind.house property

Questions they must now consider include: what do they want their life to look like after they retire?

They also need to decide how much income they would like to have after-tax, and then determine what size asset base they will need to fund their end game.

It’s important that they understand that it’s not about the number of properties in their portfolio.

I’d rather own two investment-grade properties than four or five secondary ones.

Successful property investment is about the net value of your properties and the cash flow that the portfolio can ultimately yield.

Part of this process must also include an assessment of their current financial position:

What can they expect from their superannuation?

  • How much have James and Elizabeth got in super today?
  • How much are they likely to contribute over the next 10 years, and what will their super balance be when they retire? This will give them an idea of the gap between where they are now and where they would like to be.
  • Do they have the ability to move some of their super into an SMSF and then leverage it to buy a property in an SMSF? (They will need to see a financial planner before deciding whether to go down this investment route.)

What is their borrowing capacity for an investment property?property purchase money

  • Learn the value of their home.
  • Understand how the banks will calculate their available equity: the value of their home minus the existing loan($550,000 x 80%  = $440,000 – $115,000  = $325,000.
  • This means they could borrow up to $325,000 against their home as a deposit for their first investment plus some extra for a ‘rainy day buffer’.
  • A professional mortgage broker will look at their other debts, but other than a small credit card limit there doesn’t appear to be anything to be concerned about.
  • From these calculations, it’s likely James and Elizabeth will be able to borrow around $700,000 in today’s stricter lending environment.

What are their financial habits?

  • James and Elizabeth have two good incomes, but it’s not really about how much they earn as it is about what they do with their income.
  • Do they budget?
  • How much cash do they have left over each month?
  • James and Elizabeth should set aside at least 10% of their income to invest (and to service the new debt).

It’s also key to understand their risk profile, but I assume James and Elizabeth are risk-averse because they haven’t invested up until now and haven’t taken on much debt.

What are their options?

The financial options for James and Elizabeth include:

1.  Do nothing – They could just keep going as they have been, slowly paying off their home and contributing to super.Property-Game

They will retire with no debt on their home and a few hundred thousand in super, but that’s not an overly pleasant financial outlook.

2. Contribute more to super – They need to see a financial planner to understand what the end result could look like, but it’s unlikely to give them adequate returns to secure their financial future.

3. Invest – They could use the equity in their home and their steady incomes to borrow and invest in a number of properties over the next decade, with the aim of lowering their LVRs near retirement so they can live off the cash flow or increase equity in their properties.

They may not necessarily need to sell their properties when they retire because they should have significant equity and reasonable cash flow.

The game plan for James and Elizabeth

Given the limited information I have about their financial situation, but knowing their desire to get closer to financial freedom, I propose a ‘buy, renovate and hold’ strategy, which will allow them to speed up the journey by manufacturing some capital growth, then use the magic of leverage, compounding growth and time to build their assets.

Year 1

In the first year, they should buy a blue-chip investment-grade property in Sydney or Melbourne with the intention of manufacturing capital growth and rental income through renovation.

This will serve as the foundation of their future property portfolio.melbourne

They should draw equity against their principal place of residence (PPOR), not by increasing their current home loan but by securing a separate equity release loan to the maximum 80% loan-to-value ratio (LVR).

This new loan would be tax-deductible, even though it is secured by their PPOR, as the purpose of the loan would be to buy an investment property.

Their $700,000 budget would allow them to buy an apartment in a high-growth location for, say, $640,000, and give them a $60,000 renovation budget.

They should borrow at 80% LVR against this investment property and keep the balance of their home equity release loan as a buffer in an offset account or line of credit, to help them sleep at night!

If done well, their property would likely be worth about $750,000 after the renovation, so they would have already manufactured significant capital growth, plus they would get a higher rental return and depreciation benefits.

However, it’s unlikely the bank would allow them to refinance their investment property for 12 months or so.

A common reason why many first-time investors never get to their second property is that they make a poor first purchase – one that hasn’t delivered capital growth that they can use for the deposit on their second property. bank reserve interest rate save money finance loan




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