Understanding your loan to value (LVR) ratio when property investing is important – and this figure will change over time.
Unless you’re one of the lucky ones who comes into money, or is a share-market expert, building an investment property portfolio can be a great way to fund your retirement in Australia. Your loan to value ratio is a key figure to understand and manage carefully as you progress in the business.
In order to do this effectively, you need to know how to borrow money sensibly, and use it along with your equity effectively over time, to build the wealth required.
Normally the questions are around how much should you borrow at this stage of your life – along with how much you are comfortable with borrowing, and what can you genuinely afford.
In today’s changing landscape, there are now more and more opportunities and lenders who can help you get organised to access investment related capital. Keep in mind though that serviceability requirements have become tougher after the financial crisis, and with necessary tougher bank and industry regulations.
In order to maximise your opportunities with your cash balance and income combined, you will need to have all of your documentation in order. Even to borrow against your existing equity requires exacting paperwork and a variety of documents as security for lenders.
There are two main approaches to property investment..
There are those looking for positive cash flow
..in the hope that after paying the mortgage and other related costs, there will still be some money left over as profit. This can sometimes be achieved by buying cheaper properties in regional Australia, but these also often return less capital growth.
It is possible to get a positive cash flow from a high growth property, but this will usually occur when borrowing less, lowering your loan to value ratio, but requiring more upfront money or equity, so that your property costs are lower than your rental returns.
Other investors invest for capital growth
..where generally they can negatively gear the costs when they exceed the rents received. This can happen when the rental yields are lower in areas often expecting higher capital growth.
It tends to be when we start our investment journey, that we have a higher loan to value ratio, as our deposits are smaller – perhaps 10% of the loan value – meaning our repayments are higher. This is when negative gearing is often used.
Selecting the right property as your first investment is critical of course, as you will need strong capital growth in order to make up for the negative cash flow, given your normally higher loan to value, consequentially higher mortgage repayments and ownership costs, such as insurances.
As we move up the property ladder and get more established, we aim to reduce our loan to value ratio, as we gain more equity, and can provide a higher percentage of deposit for our next property, such as 20%. This level of gearing provides a more comfortable equity buffer in case the market slows down but still offers the benefit of some leverage.
As we get closer to retirement, it becomes more important for us to start earning an income from our property investments, rather than continuing to grow our asset base. This is when it’s about funding our lifestyle with sufficient cash flow from our net worth – and if you still have loans against your property portfolio, you want to get to a point where your costs should be lower than the net returns. With a big enough asset base, you are more likely to be closer to a loan to value ratio of 50% or even less.
Successful property investors have to go through the stages of asset growth, then lowering their loan to value ratio, and increasing their profit, as their returns become progressively higher than the cost of managing their portfolio.
Usually it’s property investors that don’t have a big enough asset base and don’t build this asset base quickly enough, who are unable to retire from the profits of their property investments.
Hence building this asset base by leveraging into new properties and managing your portfolio effectively, with good advice around optimising your strategy, is critical. Considering cash flow, negative gearing, capital growth and ultimately profit, it’s important to manage this professionally in order to maximise your end result.
Picking the right properties in the right locations and with the right strategies and tax arrangements, and starting sooner rather than later, is the way that most successful property investors reach their retirement goals.
In order to grow your asset base, you need to stick with proven models such as established properties in great locations, especially initially, where the capital value of the property is at least stable, and where there are various growth drivers in place such as growing populations and new infrastructure.
Looking for areas for example with strong economic prospects for its population, such as new industries opening up, or developing potential for income, means that people in those areas will look to improve their properties, bringing the value of the area up collectively, and increasing the likelihood of stronger capital growth.
Where infrastructure and amenities are good, and the right signals for growth of the local population in an area exist, such as transport developments, this gives you the right signals which we have explored in more detail in another of our key advice articles on buying well.
Considering the right gearing at the right time, having a close eye on your portfolio management, dealing with the right professionals, and optimising your tax structures, are good ways to ensure your success in the longer term and towards financial freedom and retirement. As you progress your loan to value ratio will change, your cash flow scenarios will change, your positive or negative gearing strategy will change.
Having a professional property team including the right accountant to demonstrate the best way to manage your loan to value ratio to maximise returns, is a great start for any property investor.
Engaging an independent property adviser, to give you information, data and options around the best opportunities, locations, property types along with expert insights, will always lead to better results throughout your property investment career.
Get in touch with us, and fill out our confidential and detailed questionnaire, so that we can take a look at your particular set of circumstances, and make sure that your short, medium and long term strategies are relevant and appropriate – not just for you, but aligned with the current market, and strategic best-practice.