The 5 golden rules of property investing

Property investment provides a path to wealth like no other. It’s open to just about everyone, regardless of your age, social status or employment. The rewards can be substantial and the risks, while both present and real, can also be controlled and mitigated.

The key is not to blunder blindly into investing but understand the fundamental rules of the game and how they work together to create hugely successful portfolios.

Why? Because you will be playing with big numbers in real estate and while the potential upsides are excellent, there are downsides, too.

A lack of education could see you miss an extraordinary opportunity that would have paid handsome dividends.

Worse still, you could purchase the wrong asset at the wrong price and be left substantially out of pocket. But fear not!

Once the rules have been explained, and you apply them effectively, you’ll have the right foundations for building an outstanding cache of holdings.

RULE 1: EQUITY IS YOUR FRIEND

Grasping the concept of equity and how it’s best utilised is essential, because it’s the building block that lets you grow a portfolio without having to continually save up for deposits.

Equity is simply the difference between the market value of your investment property, and the unpaid loan against it.

So, for example, if you have a property worth $400,000 and the outstanding mortgage over that property is $300,000, you have$100,000 in equity.

It’s like a stash of “stored wealth” that’s locked away as part of the property’s overall market value.

Why is equity important? Well, your equity increases as the value of your investment rises. i.e. increasing more stored wealth that can be reinvested into your portfolio.

A great example was Cam McLellan’s lightbulb moment. Cam, my colleague here at OpenCorp, often tells of his first investment – a modest home that rose in value by $40,000 in the first year he owned it. Best of all, he was only earning $22,000 a year stacking shelves at the time.

Equity was a vehicle that delivered him the deposit for his next home – an amount he could never have saved by putting away a percentage of his modest wage.

RULE 2: USE OTHER PEOPLE’S MONEY

One of the major advantages real estate delivers as an investment vehicle is the ability to use more of “other people’s money” to increase your personal wealth position.

What we're talking about here is leverage.

You see, unlike shares, lenders will allow borrowers to access high loan-to-value ratios on their property holdings.

For example, you can borrow money to invest in the stock market through margin lending, but often the financier is only willing to approve funds at around 50 per cent of your share portfolio’s value.

But property lending is far more generous, with some financiers usually approving 95 per cent of your asset’s value to fund real estate purchases.

The key is to realise this is good debt, not bad debt like a credit card or personal loan.

As long as the interest amount you are paying on a loan is less than the wealth and income generated by that loan, you will be ahead.

Let’s say you buy a $400,000 property and are able to borrow 100 per cent of the purchase price.

Let’s assume you’ve borrowed the funds at four per cent interest and over the course of a year, that property increasing in value by six per cent while also generating a rental return of three per cent.

Under this scenario, you are paying $16,000 a year in interest, but during that period your rental income is $12,000 and your property’s value has risen $24,000.

So, by owning that asset you have improved your net position by $20,000 – and it was entirely on the back of using someone else’s money.

This is how powerful good debt is in the wealth-building field of real estate.

RULE 3: CAPITAL GROWTH IS KING

(BUT CASHFLOW MATTERS, TOO)

During your time as an investor, you’ll hear varied opinions about whether capital growth or cashflow is the superior metric for investment success.

There will be entire strategies built on one or the other, and they’re often pushed by “advisors” with a vested interest.

Maximising capital growth should be your primary objective, but cash flow must also be factored in or you risk losing grip of your valuable assets.

You see, capital growth builds empires. Owning a portfolio of property that increases in value by a modest six per cent every year means you are on track to financial freedom – particularly as all the other rules of investment like duplication and compound growth come into play.

But choosing capital growth alone will be pointless if the cashflow (i.e. rental return) generated by your investment is so low that you can’t afford to service your loans or pay all other holding and maintenance costs.

You must select assets that have excellent value-gain upside for 10, 20 or even 30 years.

To enjoy those benefits, you must be able to retain possession of the asset, because if you can’t service its debts you’ll be forced to sell prematurely and will lose out on all the upside.

When you choose an investment property, you want it to be as close to neutrally geared as possible when you buy it, and you want it to flip into positive cashflow territory soon after.

This relieves the stress of ownership and delivers that most valuable of wealth building tools… time in the market.

RULE 4: DUPLICATION MULTIPLIES THE RETURNS

You can see from some of the examples above how holding just one property investment creates a wealth path.

Now imagine what those returns would look like if you controlled two, three, five or even 10 investments?

Successful portfolios aren’t created by buying one or two high-priced assets and waiting for the gains.

You need to diversify your holdings across multiple, price-accessible investments. This sort of purchasing allows for flexibility and manageability.

You can offload one or two if needs be without dramatically impacting your overall portfolio value too much.

You are agile, will see better rental returns, and can pivot as needed in response to opportunities or threats.

Duplication is also a factor of time. You must progressively ramp up your asset number because the first investment builds equity which allows you to borrow and acquire the second.

Then, the equity gains in those first two combine to help you get into a third a bit quicker, and so on.

The more you acquire, the easier it gets.

RULE 5: COMPOUND GROWTH IS THE EIGHTH WONDER OF THE WORLD

Compound growth is a magical figure recognised by one of the world’s greatest scientific minds.

It was Einstein who stated compound growth was the eighth wonder of the world, and said “He who understands it, earns it. He who doesn’t, pays it.”

Here’s a great example of compound growth – imagine you had a magic one cent piece that progressively doubled its value every day. How much do you think you’d have at the end of one month?

On day zero you have one cent, on day one you have two cents, on day two you have four cents and so on.

By the end of week one, you’d have $1.28. Enough for a bag of mixed lollies!

But continue to hold that magic coin because by the end of week two, it’s at $163.

Wait another week and the calculation sees the figure rise to $20,972

By day 28, you’d have over $2.6 million and by the end of the month (just three days later), it elevates to $21.47 million.

You know what this tells me... never sell a growth asset!

Legendary American investor, Warren Buffett, once said the best investment holding period is forever, and he was right.

We all know the two biggest regrets of the average investor are, “Why didn’t I buy sooner?” and “Why did I sell so early?”

And compounding doesn’t just apply to capital value. Rent compounds as well, building on itself over the years to create more and more positive cash flow from your investment.

Once the property is bringing in passive income for you, then really the power is with you as an investor, because you can choose what to do.

You might sell it, if your lifestyle circumstances are such and you want to transition to retirement.

On the other hand, you can retain the property and continue to enjoy the power of the compound growth moving forward.

THE POWER OF COMBINED EFFORT

As mentioned earlier, the strength of these rules is in the way they work together to build an extraordinary investment path.

By using equity and borrowing money you can build a multi- property portfolio of assets with excellent capital growth potential and solid rental returns that allow you to hold on for multiple property cycles.