A reader of this magazine emailed me the other day and asked how they should go about building a property portfolio. I thought it would be useful to share the advice I offered them.

1. Start with a basic idea of what you want to achieve After emailing back and forth, I discovered this couple want to become property investors so they can earn a passive income in retirement.

2. Look at the resources you have to make it happen The couple are in a good equity position. They have a home worth $600,000, with an $80,000 mortgage, with five years left on the term. This gives them purchasing power of $2.4 million, even without digging into their savings.

They also have time. The couple is 47 and 48, and want to retire in 20 years.

Now that we have a goal, resources to achieve that goal and a time horizon, we can start building a portfolio.

3. Plan out your portfolio Here’s what I would typically recommend to someone in their position.

• The couple has $400,000 of useable equity within their owner-occupier home. This useable equity can be used as the deposit to buy investment properties.

• This useable equity gives them purchasing power of $2,000,000 if buying brand new properties, which are exempt from the 70% loan-to-value ratio cap.

I’d recommend they start by buying properties that are likely to achieve good capital growth. These properties may require the investor to top up the mortgage each week (negatively geared), but they’ll go up in value more quickly.

You’d typically start with capital growth properties for two reasons.
• You want to hold these properties for the longest time possible, so you get the capital growth.
• If the banks were to change their lending rules thereby prohibiting you from buying additional properties, then you’ll want to have the ones that are going to grow in value the fastest. Let’s look at a basic portfolio strategy.
• Year One: invest in a brand new Auckland property for $700,000, using 100% lending. Forecast growth at 7% per year. Note: The couple will still have purchasing power of $1.3 million. Typically, I wouldn’t recommend pulling the trigger straight away, since they’re first time property investors and have time to build their portfolio.
• Year Two: invest in a second property geared for growth. They may want to diversify their risk, and buy a property for $600,000 in Hamilton. Forecast capital gain at 5% annually.
• Year Four: invest in a high yielding apartment in Wellington for $700,000. Forecast the annual house price growth at 4%. Assume it will provide enough cashflow to offset the negatively geared capital growth properties.

At this stage, there will be $400,000 worth of investment debt secured against their home. However, the rent from the investment properties will cover the interest payments. As the properties go up in value, they can refinance the lending back against their investments. Based on these growth rates, this could happen in years six, nine and 13. In year 14, their personal property would not secure any investment debt.

The results

• By the time they retire, the three investment properties would be worth a combined $5.5 million with $2 million worth of debt secured against them.
• The couple would have just over $3.5 million worth of equity. At this point, one strategy would be to sell the three properties, invest in a managed fund and earn an average of 5% income annually.
• In today’s dollars, that would give them a passive income of $118,000 every year, for the rest of their lives. However, if they do this, the equity would depreciate at the rate of inflation. So there are a few things the couple could do. These include:
• Buying more property earlier, building more equity.
• Maintain exposure to the property market in retirement.

There are a lot of numbers in this article, so if you would like the spreadsheet I used to build this scenario, email me at andrew.nicol@opespartners.co.nz