Thank you for tuning into The Buyers Guide Podcast where we talk all things property and finance. My name is Peter Mastroianni the founder of The Buyers Guide and in today’s cast I’ll be outlining four key exit strategies to consider when you want to cash in your property chips. So let’s get to it…
There are three distinct phases property investors are quite likely to go through over their lifetime.
During the acquisition phase, cash will be king as you try to maintain a steady cash flow against the backdrop of your ongoing personal commitments. Your challenge in this phase is demonstrating to lenders that you are a safe set of hands, and that you have the security and capacity to repay debt. Tax deductions will be an important consideration in your decision-making, together with taking full advantage of the leverage.
Characteristics of the consolidation phase relate to streamlining, reducing debt and maximising cash flow. During this stage, the appropriate structures you initially established will start to pay dividends.
Finally, when you’re sitting on the beach with an umbrella in your drink, you can be thankful that the plans you put in place years before are providing you with rewards. In this phase, you could start a new venture, retire early, invest more or do whatever you like.
Before you start pouring the pina coladas you’ll need to have the foresight to consider what you exit strategy is. Now, I believe their a four main strategies to consider. There are others but they mainly involving combining one or more of these main strategies.
Four key exit strategies
The truth is that your investment journey won’t be clear-cut. The exit strategy you choose will depend upon the phase you’re in being acquisition, growth or lifestyle. Importantly, your exit strategy is all about minimising tax and maximising returns. The four board options are:
- Never sell and pass assets on to the next generation
Creating generational wealth is an aspirational and an incredible achievement. If your structures are set up correctly, you would just transfer control of the portfolio, held in a trust, by appointing a new director. In this scenario, the asset never changes hands, so no tax liability is incurred. You’re just signing across the controlling assets’ holding entity. It’s a straightforward dusting-off-the-hands type scenario.
- Live on the equity gains and income
The second option is the simple process in which you would make interest-only payments on your borrowings and live off the equity gains and increases in rental yield from your properties. Once there has been an increase in the property’s value, it can be revalued and drawn down by using a line of credit facility. You could then live off those funds. This is a good option to consider, as long as the value of the assets grows faster than your living costs. Advice should be sought from your accountant relating to this strategy because there will be tax implications to consider.
- Sell and pay off debt
This may sound simple in its application, but there is a lot to consider.
When you sell and make a gain, there will be tax to pay, selling expenses, loans to be discharged but you will be secure in the knowledge that you are debt free – or financially free as some like to call it. Remember, though, not all debt is bad and maintaining a level of investment debt could be beneficial to your overall structure. As with all things in life, if you’re drawn to a debt-free lifestyle, go for it, otherwise, keep walking. It is possibly the simplest of the strategies to apply, it just may not be the most efficient.
Disadvantages of selling
- Capital gains tax
- Legal fees
- Sales commissions
- Marketing costs
- Opportunity cost.
Selling does allow you to access any gains, reduce debt and importantly it can give you the chance to cut off dead wood and create a liquid position to fund your lifestyle and the other choices you may make.
- Domino effect – knock them over one by one
Start working on reducing the principal component of one of the loans with excess cash flow. Once this loan is paid out, your cash flow will improve again and you can concentrate on paying off the subsequent loans. Just like dominoes, your loans will fall over one by one. This is a decent strategy to use while you’re still working full time in the lead up to retirement, and it will produce a steady and consistent rental income from the properties when you retire from your job.
Depending on the initial structures you establish, your ultimate goals and wishes will largely dictate the exit strategy you choose. There are other considerations, but they are largely a play on one of the four above and vary in complexity and risk. Importantly, seek advice from your legal and accounting team to help decide on the best pathway forward.
Reaching the lifestyle phase can seem like it is a distant future. And if you method of investing is through speculation, shots in the dark and relying on luck… well, it might just be. Might not even happen at all.
Speculation though, whether we like it or not, will always play a part in the property industry. Primarily, I feel the blame sits with the investors themselves and their property choices. The finger should be pointed directly at emotion and ill-informed decisions, people can all too easily get caught up in the bright lights of ‘incredible returns’, losing sight of the associated risks. Property investment should not be left to chance, decisions should be made after careful consideration of underlying fundamentals of the chosen asset.
‘Hotspots’ are definitely in vogue and I can understand the attraction of wanting to unearth that next shining investment location poised to boom. Crowds follow ‘hotspots’ which means the growth there is quick and steep to begin with, as more people jump on board. When the area falls out of favour with the crowd, the decline is just as steep, and if you haven’t jumped ship already, you’ll be left with a dud investment that you cannot offload because it’s no longer in vogue.
Hotspots make me think about Moranbah or Port Hedland, two locations which were riding very high during the coal and iron ore booms, but are now done and dusted. These so-called ‘hotspots’ have been pummelled, with values falling by circa 70% in a 12-month period.
Property investment decisions should be based on proven long-term performance, rather than short-term speculation. In fairness to investors in those mining regions, the belief was that the boom would last – some thought forever. Like all good things it did come to an end and unfortunately, holding property in remote areas reliant on one industry or employer is a risky strategy.
Money can be made by hot-spotting, but it is reliant on timing, getting in low and cashing out at the top, which is possible in theory but difficult in practice. Property investment success typically is dependent on the proven long-term performance of consistent above-average growth.
Alternatives to ‘hot-spotting’
Don’t ignore the need to set long-term goals and develop strategies to achieve them. The following factors avoid the need to rely on ‘luck’ or making a ‘shot in the dark’, or hot-spotting.
- Growth trends
When a market has experienced strong growth – 15%+ for two or more consecutive years – it may be best to avoid investing there. The reason is that housing in that market may have been in short supply, causing high growth and high development activity to meet the demand. By the time the new stock hits, the demand may have been filled, resulting in a price correction and a flat market that could last for 12 to 18 months, or more. In this scenario, it is wise to find another market to invest in.
- Population and employment
Look for areas with population growth and low unemployment statistics. Don’t immediately look for the biggest ‘pop’ or spike in recent years, look for long-term and ongoing growth of more than 1% per annum. The same applies for employment, don’t immediately look for the lowest unemployment rate. If the general business sentiment is pessimistic, then owner-occupiers will batten down the hatches and won’t be buying new houses. And owner-occupiers are the ones who drive growth.
With employment look for areas that are employment ‘generators’:
- Those near the CBD or a major urban area
- Industrial areas
- Major activity areas with commercial offices or industrial/technology parks.
You don’t necessarily want to buy next door to one of these areas, but in close enough vicinity away from the hustle and bustle will probably serve you best.
One last warning about mining towns: don’t be fooled by regional mining centres, because property values peak in the boom due to construction activity and fall sharply when the boom is over. Plus, mining operators employ fly-in-fly-out (FIFO) workforces, who are usually aware of the risk of investing in property located in regional mining towns. Overall, it’s probably best to avoid centres that are reliant on one employer or industry. One-trick ponies rarely impress further after that trick is completed.
- Watch for oversupply
When demand exceeds supply, naturally prices and values will rise. Developers are in the business of moving stock, moving it quickly and starting on the next project. Therefore, in their project feasibilities, they factor in stages and bring the new stock to market in a flow that ensures competitive pricing. This allows them to draw the punters in, or they can undercut to achieve sales targets, or even ‘top drawer’ the later stages to profit from dwindling stock. In short, they tweak the demand and supply. A 15,000 to 20,000 lot development will take 10, 15, 20 years to sell. And that only indicates one thing, oversupply. It may be best to avoid areas with any signs of oversupply.
Areas with good schools (both primary and secondary), in convenient proximity to shops, transport and public spaces are always winners. Excellent amenities mean good prospects of future returns on property in that area.
Quick rules of thumb to apply to property selection
- Less than 7km from a train line
- Less than 1km from a bus route
- Within 3km of a local primary school
- Within 5km of a high school.
- Misjudging cash flow requirements
Not maintaining a property balance sheet to track your cash position leads to misinformed numbers. And as you should know by now, you need to know your numbers! It is imperative to know your incoming and outgoing cash flows. Your properties will experience periods of vacancy when you will need to cover all the costs associated with that property out of your own pocket, until new tenants can be found. By knowing your numbers, you can accurately forecast cash flow through these periods.
Include all outgoings in your estimates and add in a 10% additional margin to cover unaccounted for expenses – and these will certainly pop up! You should have cash on deposit that you can access when the unexpected happens.
Yes, bargains do exist, but you are much better off finding the right property instead. Bargains are a bargain for a reason. The vendor probably knows that ‘reason’ but isn’t willing to share it. Bargains are part of speculating. Your focus should be on making the right decision, taking the time and having the patience to do so.
- Pricing the property to the market
If you over-price your property you won’t attract tenants. Price it under and you’ll be leaving money on the table. Therefore, be aware of the local rental market, what’s renting and for how much.
- Stick with the fundamentals
As we have discussed in the previous pages:
- Define a property investment strategy aligned with your goals and timeframe
- Be tactical in deciding when and where to buy
- Get the right financial structure in place for long-term rewards
- Effectively manage the property and be disciplined in all matters relating to cash flow
- Get a good team around you and maximise all the benefits that are available.
That’s my 8 tips to put some more precision into your property search. If you would like to review these points again check out our blog at www.thebuyersguide.com.au and be sure to subscribe to not miss out an any future episodes. Have a good week everyone and on our next few episodes we have a property inspection expert sharing their insider secrets. And we speak to town planner who is set to revolutionise the town planning industry. All of that is to come so stay tuned in. until next time though… bye bye