Many investors buy their first rental property with the goal of purchasing more and more investment properties throughout their lifetime to build their wealth. They build up equity in their property and then use that equity to purchase another one and so on. This strategy can work quite well, where property prices are on the rise. There are many people who have grown invest property portfolios using this exact strategy.
The basic principal of this working is that you buy a property, the value of the property goes up and you use that equity as a deposit on a new property. If you are purchasing the right property with solid capital growth this works well.
The other process to get this working well is to make sure this property isn’t costing you too much out of pocket each week. There are many benefits of negative gearing but that doesn’t mean you need to buy a property where you are losing money each week. If you buy the right property and get your structuring correct, you could have a property that may cost a small amount per week, or in some cases, be cashflow positive. To do this, you need to have good depreciation claims. The newer the property, the better the depreciation.
The strategy of using property equity to buy your next property may not work if you have not structured your loan correctly. A term named “Cross-Collateralisation” may be something you have heard of. This is when the banks pool all of your property together and all of your loans together. On the surface, it may look as though one loan relates directly to a property and the other loan relates to another. But in the background the bank may have “Cross-Collateralised” your loans.
Like any investment property valuations can go up and down. If your properties have been pooled together by the bank then if 1 property doesn’t increase in value, or even drops in value it may mean you don’t have the equity to buy another property.
Let’s say you have a house in Melbourne that has increased by $80,000 since buying your investment property, but you investment property in Perth has gone down in value by $80000. If the property has been cross-collateralised then you will have no available equity. If they have not been cross-collateralised, then you would be able to draw the extra $80,000 out of your Melbourne equity to purchase another investment property.
By getting the loans structured correctly, you will be able to be better placed to purchase additional rental properties if that is your strategy. Speak to us about getting the loans right. If you have any property investment questions, give us a call to discuss.
Article Written by Paul Wineberg
Paul is a member of the Institute of Chartered Accountants
and a Director of South East Accounting.