Be the master of your money
Money management is the foundation to building a large property portfolio and should be implemented before starting your investment journey. Here’s what you need to know to be the master of your money.
The first thing that many start-out property investors will do is begin their search for a suitable investment property, whether by trawling property web portals, attending home opens or brushing up on market insights.
However, this is typically useless if you don’t have adequate money management systems in place that will show you how much cash you can allocate each week to servicing (i.e. repaying) a loan for an investment property, after allowing for the income on a property. Most higher growth residential properties have negative cash flow in the first few years if you borrow around 80% or more, so understanding what it costs is vital.
When it comes to building a property portfolio, your personal cash flow is critical because this will allow you to hold your investment properties by meeting your loan repayments, and subsequently capture the capital growth of the assets over time.
This is why every investor should create a household budget that will detail their income and expenses to determine how much surplus money (i.e. cash flow) they have left over at the end of each month.
What should my budget include?
In short, your budget should detail all of your income and all of your expenses – whether on a weekly, monthly or annual basis.
Your income will include your salary from your job as well as any government payments, dividends from shares, rental income or interest accumulated from savings deposits.
Your expenses should comprise an estimate of all your outgoings including household (utilities, groceries, council rates, mortgage repayments, insurance etc), transport (fuel, car registration, repairs, public transport etc), health (gym, doctor, dentist, cosmetics, haircuts etc) and personal expenses (clothes, entertainment/eating out etc).
Your budget should also set aside money for holidays and funds for upgrading your car, as well as any other expenses you might have.
By allocating a certain amount of money to ‘entertainment’ you don’t have to account where every dollar is spent, such as $17 per week on coffee or $40 per month on movies, for example.
The money allocated to ‘entertainment’ can be treated as your weekly pocket money that can be spent on any discretionary items.
In addition to helping you manage your money, a budget will also alleviate any guilt or buyer’s remorse you might feel when buying a new leather jacket, booking a holiday or purchasing your morning cup of coffee. If you’ve allocated money to these things in your budget, then you know the funds have been set aside and are there to be used, while you’ve also allocated money for ‘savings’.
When making a budget, you obviously have to be sensible about how much money you allocate to ‘non-essential’ items, and perhaps make some compromises. For example, if you have Foxtel which you rarely use, it might be worth considering stopping your subscription. Instead of buying a coffee every day, perhaps start buying it every other day.
It’s all about finding what works for you. You don’t want to make your budget so conservative that you have to live on baked beans for the next 10 years, but if there is room to make some savings then try and make them.
With your budget set, you will know your surplus cash flow and can allocate part of this as repayments for an investment loan.
Finding a property that suits your cash flow
Depending on the type of property you buy, the rental income will help you cover either part or all of your investment loan repayments. Typically though there’s likely to be a shortfall that you’ll have to cover.
However, you can target different types of properties that will suit your cash flow circumstances.
For example, if you have limited cash flow available, you can target properties that are neutrally or positively geared, meaning the rent will cover all of the repayments.
Typically these types of properties will be villas or apartments and are generally more modern builds. Generally, the downfall of these types of properties is they will deliver lower capital growth.
On the other hand, if you have a high cash flow then you can target properties that are higher growth and lower cash flow, meaning the rent won’t cover the loan repayments and you’ll have to cover the rest from your own pocket.
Typically these types of properties will be older houses on larger lots. Generally, the benefit of these types of properties is they record higher capital growth.
However, by mastering your money management by creating a budget, you’ll form the foundations needed to build a large property portfolio and help avoid financial distress from buying the wrong type of property.