Getting value from your property portfolio

Christine St Anne  |  21/01/2014Text size  Decrease  Increase  |  

Christine St Anne: It's my greatest pleasure to introduce property expert Margaret Lomas to talk to us about how to effectively manage a property portfolio. Margaret, welcome.  Margaret Lomas: Thank you.

St Anne: Margaret, firstly, how many properties should an investor hold in a portfolio?

Lomas: It's a really good question and very often people either over think it or under think it. So you get people who might buy one or two and think that they are set for their retirement, which of course they're not. But then you get other people and it's probably perpetuated by the fact that people write books about hundreds of properties in portfolios, who think you just have to keep going and going. I think it depends on, first of all, how much time you've got until retirement. But if you're starting early enough, and early enough would be somewhere around 40 or maybe a little early up, then if you have 15 years available to you, 10 properties will create for you pretty good return income and be enough to also then grow, so that you've got a good asset base behind you.

St Anne: Margaret, of those 10 properties, what about an underperforming property? Your latest book did mention a lemon. So can you explain that?

Lomas: The old lemon. Look, if you buy enough properties, you're going to get a lemon. There is no two ways about it. One of the things that often holds people back from even buying their first property is this fear that it will be a lemon and very often people are looking for that perfect property. So for every day they are waiting to find the perfect property is another day that that fair to middling property could have been sitting in their portfolio and probably performing okay.

But if you get to the point where you do buy lemon and it could be your first or your tenth or your fifth property, then you got to have a look at that property and work out the extent of its poor performance. Is it really a real lemon? Is it doing things like holding you back from buying more property, because it's taking up spacing your equity position? Is it costing you a lot of money in cash flow? So you don't have the money that you need to continue to pour into debt repayment, because debt repayment is very important to create additional equity.

Is it the kind of property that maybe fails to get tenants? Is it the kind of property that's situated in an area where you are continuously doing repair work, because you tenants are not caring for the property? Is it bad enough to get rid of it? If it is, then you have to sell it. Very often people might not want to sell, they are holding and hoping that it's going to improve or to sell it they might take a short-term loss. But you've really got to be able to project that forward and very often that short-term loss is far better than the overall loss that it could create staining that portfolio too long.

St Anne: Margaret, a lot of the investor puts together their portfolio of properties. What about in retirement? How do they sell down those assets? In other words, what's an effective exit strategy?

Lomas: Whenever people start their property portfolios, they always believe that they know exactly how they are going to finish off that strategy. I think it's more important that you don't have firm plans around that until you get a little closer. That for many reasons so much can change – capital gains, tax regimes change. You don't know exactly what that portfolio is going to be worth. You don't know what your personal position is going to be in terms of whether or not you're going to be getting any government assistance, whether you are going to be self-funded?

However, having said that, in the main, most people think that when they get their portfolio of 10 properties, they will get to retirement, sell half of them, payoff whatever debt is there and that's based on the presumption that they all would have doubled in value by then and then leave on the remaining five. But it's interesting that once you start building that portfolio, you begin to realize that perhaps you don't need to do that when you get there. When you get to retirement, your property portfolio is going to actually be worth the smallest amount that it's going to be worth from then on, presuming that property in the main will grow, providing you bought some good properties into that portfolio.

You could hang on to that and its' worth at 70 is going to be more than its worth at 60. This all depends, of course, on what kind of cash flow you're getting out of it. But a property of 10 portfolio – a portfolio of 10 properties should be giving you a reasonable income of retirement presuming that you have no personal debt left. There is no reason why you can't sit on that and continue to borrow and continue to add to it, if you like, knowing that the income on it will grow as you get further into retirement.

St Anne: Finally, Margaret, what about capital gains? It's an issue that many people still grapple with.

Lomas: Unrealized capital gain is worth more to you than realized gain, which is another reason why I am not necessarily in favor of the sell-down strategy once you hit retirement. What you have as an asset is worth more to you than it would in cash because once you liquidate, you are going to lose some of it to capital gains tax.

The capital gains tax isn't always quite as big as people think it's going to be. Let's remember that there is 50 per cent discount. So, once you get to retirement and you do sell a property, you will charge capital gains tax on only half of the gain and that's only your marginal rate of tax. So, whatever you are earning at that time determines the tax rate on that gain. So in reality most people are going to end up with something like 20 per cent or so capital gains tax.

But having said that, it's better not to incur it. So if the property portfolio is already giving you a fairly good cash flow, then there is no reason to liquidate. If you do liquidate though, you have to understand that there will be capital gains tax and there are some strategies around that too. So, just selling them one at a time in different years, so that they are nowhere being sold together and quite often you can take advantage of those lower tax thresholds every year if you do need to sell down that portfolio.

St Anne: Margaret, thanks so much for your insights today.

Lomas: You are more than welcome.

 

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