Hi there. My name’s Ben Everingham and in today’s video I’m going to talk about passive income versus equity growth and which one may be better for you.
Hi there. My name’s Ben Everingham and I’m the director here at Pumped On Property and in the last 12 months, we’ve helped over 120 clients buy over $40 million dollars worth of property. In today’s video, I’m going to talk about the benefits of passive income versus equity, or capital, growth and so this is a conversation that I have with a huge amount of investors and I don’t think there’s one size fits all for style strategies to which one’s best for you.
I think at different times of your portfolio there might be benefits of chasing capital growth and benefits of chasing cash flow. For any of you that have been watching some of my videos, you’ll begin to see a pattern where I believe that it is achievable to get passive cash flow, to get great long term capital growth, and to actually add value to one property.
The old days of just buying a high growth inner city property or just buying a regional block of units to get cash flow or your commercial property are completely over and there’s some great options available in the market now for those of you that are savvy enough to go out and find them for yourselves, but today’s video is primarily going to focus on some of the pros and cons associated with passive cash flow and some of the benefits associated with equity growth.
Let’s start with passive income and the positives associated with it. From my opinion, I’m an extremely, extremely low risk investor and so a lot of the way that I invest is basically putting myself in a comfortable position for the future and this can mean a lot of different things to different people.
The reason I like to buy passive income style investments for myself and my own portfolio is because it provides a bit of a buffer between myself and the market place. It reduces my risk if interest rates go up. It reduces my risk if I lose a tenant because I’ve been receiving passive income from the asset for a period of time and hopefully you’re parking some of that excess money into an offset account against the property so that if that rainy day comes or you do lose your tenant, there’s a surplus of funds there to carry it without you having to pull money out of your own pocket.
It could also be great to have a neutrally or positively geared property if you do lose your job or if the market turns and we go through a period of decline in terms of capital growth prices or a period of stabilisation and it just sits flat because in that type of market place it can still generate income, it can still pay for itself, and while you may not be making growth on that property at that time or you may even be losing money, at least it’s not costing you money week in, week out from your portfolio.
There’s a huge amount of benefits associated with passive income. Another one of them is the ability to walk away from your job or walk away from your current business and actually live the lifestyle that you’d like to live or replace that income through the properties or the rental income that’s coming through.
I’ve talked to a lot of people about this and for some reason, they think they need to get to a certain number of properties, each producing a certain amount of passive income per week.
Let’s say you bought 10 $200,000 properties and they each gave you $100 a week. That’s fine if it’s $100 a week passive income at a 5% interest rate, but what happens when interest rates get to 7%? You’ve got a dud property in a crappy market that’s never going to grow in value and you’ve lost all of that income, so the property’s actually doing nothing for you and in a bad market potentially even going backwards.
I think a much, much more sustainable way to get long term positive cash flow would be to buy a number of assets, at some point sell half of those assets to pay off the remaining debt, so that you’ve got a couple of properties that are generating great income owned completely outright, and at the end of the day, that is truly passive income and that’s the type of income that we like to support our clients to work towards.
Income that can’t be touched by banks, that can’t be touched in bad market places, that gives you the type of lifestyle that you want to live, so you can spend more time with your family, you can spend more time starting businesses or doing the things that you love or enjoy. You can volunteer, you can spend more time on health. You can do the things that are actually meaningful to you because at the end of the day, property is just an investment class, or an asset class, that helps you get closer to where you want to be medium and longer term as opposed to trying to save your way there, which is very difficult.
Some of the negatives associated with passive income, or passive income property, as a strategy or targeting positively geared properties is the fact that, like I said before, interest rates can rise and so if it’s a dud property in a dud area and it’s not also growing in capital, you might be stuck with something that’s losing you money and when interest rates rise, that passive income that you’re receiving from the property is going backwards and that means that you’re stuck in a situation where your money’s not working as well as it could be for you.
For the average Australian that’s earning less than a couple hundred thousand dollars, it’s all about making that money work for them in the right way.
Each time we invest in a property, it’s either getting us closer to where we would ultimately like to be in the future or taking us further away from where we would like to be. So often I see people that have spent $300,000/$500,000 and they’ve gone and bought a property in some hot spot or some regional market place that’s just doing absolutely nothing for them, but they’re emotionally tied to this property and for some reason, they feel like they can’t let go of it, they can’t sell it, and they don’t have any options.
If you look any sort of spreadsheet sort of calculating the future values of properties over time and there’s some assumptions associated with all these spreadsheets, but you can play with those assumptions and you put in a $500,000 property purchase today consistently growing year on year at a 4% to 5% capital growth rate, you can see the trend over time of that money and that compound effect of in year 1, 5% of $500,000, but in year 2, you’ve got the 500K that you bought the property for plus the 25 grand of capital growth you made the year before, so the next year you’re getting 5% on $525,000 and it’s stepping up year on year.
This is why properties snowball and I think Warren Buffett said best when someone asked Warren, “What would you do differently if you were ever starting again,” and then he said, “Instead of starting at 14 years of age, I’d start at 13 years of age.” Crazy, dude, because that compounding effect over time would have doubled his net wealth over that 50, 60, 70 year period that he’s had in the market place.
It’s extremely, extremely important to choose the right type of property and to get the right result and to make sure your money’s working as well as it can be for you.
Some of the other negatives associated with positive cash flow is that for some reason people believe just because it’s a positively geared property, it’s a great property because it’s paying you this surplus money each week and it’s right type of asset to own right now, but it couldn’t be further from the truth.
You really need a clear strategy and you need to know how each of the properties that you buy is supporting that longer term picture so that you can get from where you are right now to where you want to be.
Positively geared properties, I’m a massive fan of. Passive income, I’m an even bigger fan of, but making sure that you’re thinking about the bigger picture at the same time when you’re acquiring those properties. Chasing crappy regional properties that give you a little bit of income or chasing commercial properties in regional market places that absolutely get smashed by every downturn in the market place or change in the wind in those local markets might not be the best thing for you. Really sitting down and getting real with yourself and mapping out a strategy’s a smart thing to do.
There’s also some positives and negatives associated with equity growth and so the positives associated with it is equity, or capital, growth is really what makes you wealthy longer term. The cool thing about buying a property at $400,000 10 years ago in Sydney and now that property’s worth $800,000 today is that’s $400,000 you haven’t had to work for.
Equity, or capital growth can be a very, very powerful thing. You’ve got to be careful that you don’t believe that just because you buy in Sydney, Melbourne, or Brisbane that the property is going to double every 7 to 10 years like it has in the past. I’m very conservative with my predictions for the future based on a huge amount of wide reading that I do.
I probably think, over the next 10 years, 4% to 5% capital growth rates in Sydney are probably more realistic with maybe 4%/4 1/2% growth rates in Brisbane. Make sure that you’re planning your future correctly and you realise that just because something’s happened in the past and that’s what people preach doesn’t mean that it’s going to happen in the future.
The other positives is, like I mentioned before, you could buy let’s call it 3 or 4 really high quality properties today and in 15 or 20 years time, when you get to a point where you don’t want to do anything anymore and that you want that passive income through your portfolio, hopefully those properties over a 15 to 20 year period because you bought well, because the market increased in value, because you added some value to property through a manufactured growth strategy, has doubled over that 15 to 20 year period and then you can effectively sell a couple of them to repay the remaining debt on the properties that you are holding or own outright.
That can be a very, very powerful way to actually replace your income and get to a true position of positive or passive income.
Another positive associated with equity growth, or capital growth, is the ability for you to actually refinance or revalue that property, release some of the equity, and use that equity to go out and buy more property. This is something that I’ve done many times in the past and an example might be you buy at $400,000, the property’s now worth $600,000, you borrow a little bit of that difference between the $400,000 of debt and $600,000 worth of value and that can be your deposit plus your holding costs to buy another property to speed up the real estate cycle for yourself or your own journey.
It can be a very, very powerful way to move forward and it’s extremely difficult to save deposits. I don’t know many people that consistently save the $50,000, $100,000, $200,000 a year that they need to buy the properties that are going to enable them to achieve financial independence. That equity, because it’s leveraged money and because you’re getting consistent returns if you’re buying in the right time of the market and the right type of property, you can be using that money to leverage forward.
Some of the negatives associated with equity growth is this old school concept that you can only have capital growth or your can only have passive cash flow and so that means that a lot of people buy million dollar properties now in Sydney or Melbourne hoping that they’re going to continue to rise in value. Whether they do or not is anybody’s guess, but they buy these million dollar properties that only rent for $500 or $600 a week, which means they’re extremely negatively geared and very hard to hold.
There’s nothing wrong with chasing capital growth properties in high quality markets like Sydney and Melbourne, but you’ve got to make sure that that $20,000 plus per year that you’re losing just in interest rate payments plus holding costs, the property’s growing by at least that amount of value year on year for the next 5 or 10 years so that you can achieve what it is that you’re looking to achieve.
It can be a shocking thing, and from experience and from the people that I’ve read, when the GFCs do occur and the bad times do come to the market, it’s generally those people who are reliant on their jobs that have these extremely negatively geared properties that suffer the worse because it doesn’t take you long if you lose a job to eat through your savings if you’ve got a couple of properties that you need to pay $20,000, $30,000, $40,000 per year or a negatively geared position. It can really mean that you can come unstuck pretty quickly.
A lot of what the strategy that you have for buying property needs to be about reducing your risk. You need to have that exit strategy in place and you need to be conscious that you’re making the best possible decision that you actually can.
From my perspective, I think that both positively geared, or passive income, as well as equity growth, or capital growth, are very important in different times of the cycle. I think chasing those capital growth oriented properties earlier on in the accumulation phase and setting down a solid foundation can be a great starting point and then transitioning to properties that get you capital growth plus a much better rental return and they would effectively be the ones that you hold after you sell some of the capital growth oriented properties down the line in the future.
Both have their pros and cons. I personally believe that you can actually achieve both. A good example of this at the moment might be to buy a house 10 kilometres from Brisbane, say by day, in some very specific suburbs and so because it’s 10 kilometres to the city, it’s a high quality type of property, it’s already got good cash flow. Like let’s say you pay $500,000 for it.
The property in the right market should rent for between $420 and $500 per week in the right suburb if it’s the right type of product and then maybe you hold that property, you do a cosmetic renovation on that property in the future, and then you buy a property with a nice big open backyard where you can legally build and rent out a granny flat and in the future at some point, when you want that passive cash flow as well, for $115,000 you build yourself a really cute little two bedroom granny flat and you get $320 a week rent for that plus your let’s call it $420 to $500 a week rent from the house and you’ve got this really nice property that’s continuing to grow in value that is also giving you a surplus of passive income.
Owning something like that outright long term in the future would be amazing because 320 bucks a week plus 420. You’re kind of looking at $740 to $800 a week in rent return from one property or between $35,000 and $40,000 a year in income. If you own a couple of those outright, that’s a pretty bloody easy way to get your $80,000/$100,000 a year in passive cash flow on a good property that’s going to grow over time as well.
In today’s market, hoping that you just buy and hold and it all works out in the future just doesn’t work anymore. Buying in crappy market places and getting a little bit of passive income because interest rates are low isn’t going to work in the future. You really have to take your strategy to the next level, learn off people that are already applying these strategies, and before you waste your money or your time, really understand what’s important, where the opportunities in the current market lie, where your condition is, and where you would like to be and then be confident in your ability to move forward in the right suburbs with the right type of properties.
I know we’ve talked about a lot of different things today. I really appreciate the opportunity to talk with you about these things that I’m so passionate about. Everything that I personally buy for myself now ticks both of these boxes. I don’t own a single property that doesn’t grow buy 4% or 5% per year minimum and I don’t own single property that doesn’t have at least a 7% rental return now.
I practise what I preach and if any of you are interested in learning more about these types of strategies, I’d love to offer you a one on one strategy session with me. You can do that by going over to www.PumpedOnProperty.com and on the top of the homepage clicking Strategy Session where you can book a session directly in there.
Alternatively, you can have a look at the bottom of this video and click the link straight to the Strategy Session page, but in that session, we can help you work out where you are, where you would like to go, and the steps that you need to take over the next 10 years to achieve financial independence and what it is that you’re looking to do.
Thank you so much for your time. Until next time, stay hungry. Thank you