The four stages of property investing
Hi everybody, my name is Jacques Fouché, I’m the CEO and founder of the IGrow group of companies, South Africa’s number one real estate investors group. We teach real estate investors, business owners and entrepreneurs how build a multi-million rand property portfolio by leveraging other people’s money, time, effort and experience, so that they can retire financially free and leave a legacy to their loved ones.
The way you get there is by strategically going through these four stages in your investment career:
STAGE 1 – Accumulation phase: build an asset base
Very few investors realise how important it is to focus on building an assets base first. Assets will make your rich, not the income. So, your focus must be on buying a substantial, high capital growth asset base.
Remember that our ultimate goal is passive income.
How do you get there?
- Buy high growth properties that create capital growth
- Capital growth creates equity
- Equity creates passive income
- Passive income crates financial freedom
Smart investors know they need to create capital or equity and later convert the capital to cash flow, namely passive income as they move towards retirement. (You can also see one of my other videos where I explain my very simple Triple R principal of investment investing in property.)
I have said it a million times: you can’t save yourself to wealth with income. But you can grow your way to wealth through investing in high capital growth assets.
So your first objective should be to build up a high-growth portfolio of A-grade investment- properties. Buy where the disposable income of tenants is adequate to justify rental increases and where salaries are rising faster than in other areas because affordability and the aspiration of the tenants are driving demand. Demand creates growth and growth will make you money.
This asset accumulation phase it can take anywhere from 7 to 15 years depending on many factors and at least one or two property cycles. During this phase your aim should be to build your property portfolio tax free until retirement and not worrying about earning an income over the short term form your portfolio.
Income or profit is taxable, but capital growth is tax free. Beautiful…
So, what’s an A-grade investment property?
- a property that outperforms the market in terms of capital growth and rental income because of the demographics of the suburb
- a property that has a proven track record in the suburb, delivering above average capital growth in the past.
Generally speaking, past performance is a good predictor of future performance.
I often hear inexperienced investor say, “I won’t live there so I won’t buy there.” But you don’t buy what and where you would like. You buy what your tenant likes. Successful investors buy where their tenants want to live, not where they want to live themselves, because as an investor you are never going to live in your investment properties.
The smart investors know it’s about their tenants’ needs, not their own. And they know that this is a business and not something we get emotional about. Cater for your tenants because they are the clients of your business.
So, where will you find these A-grade investment properties?
Look for areas in close proximity to all the amenities like shopping malls, hospitals, schools, sports fields and public transport. Or buy properties close to your tenants’ place of work. Tenants don’t want to travel an hour to work and back.
Generally we target suburbs with their own economy, where there are multiple economic drivers within the suburb and province. So, I prefer suburbs close to the major CBD of the major provinces.
How do you go on to build your asset base tax free until retirement? By implementing my Triple R principal of investing:
- Retain your asset – don’t sell it
- Refinance your asset – unlock the equity
- Reinvest- the equity and roll it over tax- free, into the deposits, shortfalls and acquisition cost of more assets you buy.
This way you build your portfolio, tax free.
Once you have accumulated sufficient assets (through applied leverage, compounding, refinancing and tax efficient investing) your net asset value will be substantial enough for you to transition to the second stage of the process, the Consolidation phase.
STAGE 2 – Consolidation phase: reducing your loan-to-value ratio
During the consolidation phase you need to lower the loan-to-value ratio in your portfolio. This is to reduce your risk and your debt levels in your portfolio, which in turn will increase your cash flow.
These are the four main methods whereby you can reduce your loan-to-value ratio and increase your cash flow:
- Do not add more properties to your existing assets base. Your loan-to-value ratio will naturally reduce as the capital growth in your portfolio increases the equity and value of your asset base.
- When your retirement savings products mature, use pension fund money, a provident fund pay-out, retirement annuity lump sum or any alternative investment to pay into your portfolio.
- Consider selling some of your properties to reduce your total bond debt, and by your loan-to-value ratio.
- You can use extra cash and disposable income payments to reduce your loan-to-value ratio.
This will streamline your portfolio to a more secure and conservative level, which will allow you to progress to the third stage of property investment career: the passive income phase.
STAGE 3 – Passive income phase: your properties pay you a salary
By the time you reach this phase you will be able to live off the equity and cash flow that will be generated monthly by your property portfolio. Your earned income from your day-to-day job will be replaced by your passive income from your property portfolio.
You have options here:
You can choose to pay off all the debt and only live from passive income. (If you choose this option, you will forego the benefits of leverage and taxation because there will be no debt to reduce your income tax lability with. This is a very conservative option, but still a fantastic position to be in.)
You can choose to pay off a large portion of your portfolio and achieve a comfortable level of risk and loan-to-value ratio.
The aim is for the cash flow to be enough to live from while still allowing you access to your equity so that you can refinance regularly and live from the equity, tax free. The income in your property portfolio should be enough for you to show a consistent, regular income to the banks and thereby refinance equity in your portfolio.
This equity you roll out of your portfolio is tax free, it’s a loan. The tenants pay the loan because your rental income rises every year and the growth on your portfolio will be more than the equity you have refinanced to live off.
So, while you are cleverly living from income and tax free equity at retirement, your loan-to-value ratio is still reducing because of the growth of your portfolio. This means that although you created debt by refinancing, your loan-to-value ratio is less at the end of the year than at the beginning. So you are wealthier than before.
The rule is to never take out more equity than the speed at which the capital growth is appreciating on your portfolio.
STAGE 4 – Preservation phase: leaving a legacy
In this final phase you prepare your wealth legacy for your family or institutions you wish to support. This is when you can look back at your life and know that you made a difference for generations to come, and you can feel proud of your life and your accomplishments.
This is your time, this is your moment, make every second count. Invest strategically, invest intelligently, become financially free and leave your legacy.