Here are the links to part one and part two, for those who missed them.
In Bulletproof Investing I provide a template for turning between $80,000 and $120,000 into a net wealth of between $4,140,000 and $4,560,000 over a 20-year period (the amounts differ based on whether you choose to put down a 10 per cent or 20 per cent deposit).
But what then?
At some point we will want to enjoy the fruits of our labour.
Let’s say you were wanting $80,000 per annum for living. You would need an exit strategy to transition from having growing assets to having income.
In part one, I discussed the fact that rents increase over time. They typically increase at a rate of 2 per cent above inflation. As a result, the above property portfolio would give you $57,121 per annum in income.
If you’re wanting to get $80,000 per annum, you’d need to find another $22,879 per annum.
How do we bridge the gap?
The two ways to get more income from a property portfolio are:
- Consolidation (this was covered last week in part two); and
- Growth to income conversion.
Consolidation is the ‘traditional’ exit strategy method and deals with paying down debt. In part two we looked at how selling ‘Property 4’ in the above example would increase your cash flow from $57,121 per annum to more than $70,000 per annum.
Growth to income conversion
An alternative to consolidating a property portfolio, is to keep the properties and, instead, increase the income generated from those properties.
This can be achieved in a few different ways, the most common being to build additional dwellings on the block of land.
Because we have a critical undersupply of one- and two-bedroom dwellings in Australia, a lot of councils allow Granny Flats and Fonzie Flats to be built in backyards, or on top of garages in the case of the Fonzie Flat.
For example, let’s say you were to build a granny flat in the backyard of ‘Property 1’ in the above example (you would generally target the property that has the most space, and highest rent).
The Granny Flat would cost about $120,000 to build and you would be able to collect an extra $400 per week in rental income.
That means an extra $20,800 per annum in rent. Sure, you’re potentially taking on an extra $120,000 in debt, but that debt would cost you $4,800 in interest. Even after all the other associated costs, you’d still come out with $10,800 in additional income each year:
Using the original example above, your cash flow would increase from $57,121 per annum to $67,921 per annum (i.e. an extra $10,800 per annum):
You could go a step further and build a second Granny Flat or Fonzie Flat on another property.
It would cost another $120,000 but, like in the previous example, you would be able to collect a further $400 per week in rental income – or $10,800 per annum after expenses and interest costs.
Across the two Granny Flats, you would have an extra $21,600 in rental income each year, increasing your cash flow from $57,121 per annum (without any Granny Flats) to $78,721 per annum (with two Granny Flats):
You could even combine the consolidation and growth to income methods and increase the cash flow even further.
The other option when it comes to increasing income would be to renovate or redevelop (e.g. knock the house down and build two or three houses in its place). Both options contain a little more risk, however, so it’s important to be careful.
With these methods it can be easy to overcapitalise because spending money doesn’t always translate to additional rent.
When we start out building a property portfolio, the focus is necessarily to aim for accumulating land in high population growth areas, then build the bear minimum house on that land to cover the holding costs.
The reason for this is that the land is the only part that grows in value. Everything built on top of that land depreciates in value over time.
However, once the assets have done their job and grown in value, the priorities can change.
If you’ve done the first part right, accumulating a land bank in areas with high population growth, you will have so many options open to you down the track when it comes to working out your exit strategy.
