Equity empires

Equity is for everyone – it’s a tool that, provided you use it responsibly, can enable you to continue growing your portfolio, even in the absence of cash savings.

Sam Saggers, CEO of Positive Real Estate, says investors with multi-property portfolios use equity to create a domino effect with their property acquisitions.

“Let’s say we’re just starting out and we’ve got $35,000. We put that $35,000 in the bank. After a year the bank calls us and says ‘Well we’ve still got your $35,000, but things have gone really well here at the bank, so here’s another $35,000’.”

“Now that’s pretty unbelievable – but if it were to happen you’d put all your money in the bank. Of course the banks don’t do that, but property does and your job as a property investor is to choose an asset where you’re going to put your deposit into the deal and after a period of time – usually one, two or three years – you recycle your deposit, in this case the $35,000, in the form of equity.

“You’re looking to put your cash into a deal and pull it out. The number one reason why a lot of property investors become successful is they choose properties where they can grow equity. And by growing that equity of course they create a nest egg to invest in other assets. Equity is the key to being a great property investor.”

Mr Saggers explains that a lot of Australians over the past few decades have been fortunate enough to create accidental equity, but if investors know how to use it properly, they can surge ahead of the pack and create a self-sustaining portfolio.

“More people create equity through luck. They buy a property – they don’t know where they’re buying, they just buy it because they like it. They then hold onto it for long enough that it creates equity.

“Unfortunately in Australia today, there’s a lack of financial responsibility and more people spend their equity on the wrong things – they buy a car, they go on a holiday. They don’t invest it wisely.

“So you need to care for your equity, because it’s actually your nest egg for the future. If you can work out how to move it around the markets, and make it work for you, I can tell you, equity will become your best friend.”

Structured for success

If you want to make the most of equity in your portfolio, the first thing you need to do is structure your finances correctly, director of Right Property Group Victor Kumar says.

He says a lot of investors get sucked into the idea of using their principal place of residence to invest in property, but can get themselves into trouble when cross-collateralisation goes wrong.

The number one reason why a lot of property investors become successful is they choose properties where they can grow equity

“If you’re just aiming to build a one- or two-property portfolio, cross-collateralisation isn’t too much of an issue,” he explains. “But if you are trying to build a multi-property portfolio and you have all the properties tied to each other, then you become really dependent on every single property in your portfolio stacking up when you’re coming back to sell down or top up your loans.”

Mr Kumar warns that cross-collateralisation often doesn’t work in investors’ favour when they’re trying to access equity to buy more properties. They may have one property which has grown in value by $100,000 and another which has decreased in value. If all the properties are tied together, investors may not be able to access the equity they’ve accumulated in their better-performing properties.

Elaine Chase, property mentor at Positive Real Estate, says investors will also be able to access their accumulating equity more easily if they spread their loans between different lenders.

“You want to have your portfolio with different banks as much as you possibly can,” she says. “If you give one bank the power over your portfolio it can stop you from releasing equity.”

Lisa Montgomery, finance specialist and consumer advocate at Resi, says having your property debt tied together in one facility can also make it difficult to measure the different properties’ performance.

“If you’re building a multi-property portfolio, you want to understand how your properties are performing. If you have all your properties under one loan, it’s very difficult to identify which properties are performing and which ones are not performing.

“For that I do suggest a more lineal or more individual strategy or structure which means that you’re going to have a loan per investment property. Now a lot of people think ‘Well, that’s a lot more administration’, but I think over time it’s going to give you more information and more power than it is going to give you administration.”

In addition, Ms Montgomery says if you have a non-performing property asset, it’s much harder to unwind and sell it off because it’s tied to your other property loans.

Mr Kumar says instead of cross-collateralising loans, investors should set up separate facilities and aim to always transfer their debt back onto their investment properties, which is more tax effective than having a highly leveraged principal place of residence.

He says the best way to avoid over-leveraging and putting your home, or one of your other investment properties, at risk is to ensure you’re only tapping into a finite amount of funds.

“You need to start off with finite capital and not get carried away,” he says. “So you start off by tapping into $100,000 equity in your home and you use that to fund your deposit and your closing costs for multiple property purchases. Once you’ve exhausted that, the ideal way to proceed is actually to go and tap into the new equity of the investment properties you’ve acquired. You then pour that money back into your owner-occupied property, then tap into it again.

“That way you’re not over-leveraging. You’re giving the capital amount that you’ve committed to your investment business and keeping it at a finite level. That way, you won’t go into negative equity.”

Mastering your finances

Getting your finances right is actually the unsung hero of effectively using equity, says Ms Montgomery.

“It’s interesting. People don’t think as positively about equity as they should,” she says. “It really is the gateway to property investment because it opens up opportunities. The more equity you’ve got in your own property, the more opportunity you have to invest into property and also other asset classes if you want to.”

Ms Montgomery says investors can wait around for capital growth to increase their equity, or they can take matters into their own hands.

“You’re going to build a multi-property portfolio a lot faster if you increase your repayments on your principal place of residence and pay that loan down. It can be quite surprising how quickly you can get that equity through pre-payment. Even just $10 a week will make a huge difference.”

In addition, Ms Montgomery says investors will build up equity much more quickly if they improve their overall financial wellbeing.

She says a mortgage is the lowest interest and most flexible credit facility available, and if investors are hampered by other debts, they should consolidate these payments into their mortgage.

“The mortgage interest rate is so much lower than most other debt facilities, so you’re actually going to create that equity a lot more quickly by consolidating your loans into your mortgage.”

Ms Montgomery says it’s also important to understand the tax implications of your debt structures and ensure your portfolio is as tax efficient as possible.

She explains that the more you know about the financial implications and growth opportunities associated with accessing equity, the more quickly you’ll be able to grow your portfolio.

“You can’t undervalue equity in property. It’s a funny thing. Some people find they really don’t want to borrow on their existing place of residence. They don’t feel comfortable borrowing money and using that as security for something else – whether it be for consolidation or for buying another performing asset like property.

“So it’s really about moving through that mentally because the equity in your property is really the tool to help you create wealth because it allows you to get that next property and the next one. Equity really is the key to good property development.”