Deciding whether to hold or sell an investment should involve careful consideration of whether the property will pay off better now, or in the long run.
Most investors use property to reach one common goal – to create financial freedom. While financial freedom may mean different things to different people – travel the world, generate a $100,000 passive income for life or retire early – whatever the end goal, you’ll want to have a clear exit strategy in place. When it comes to property investment, like many other endeavours in life, it’s critical that you begin with the end in mind.
Not having a clear view of the outcome you’re trying to achieve can potentially derail your efforts: you’ll more likely be distracted and may stray from your path of systematic investment.
Remember to ask yourself from the get-go: what is my vision?
Get that clear, then it’s time to meet with your accountant to ensure you create the correct investment ownership structure. It’s important you do this before you start investing. See, you’re already starting to think long term!
There are common exit strategies that are popular among professional property investors.
Sell your Portfolio to Pay Down Debt
There are some pros and cons to this strategy. Some people feel they must be debt-free, that their only financial goal in life is to pay off the family home.
But here’s the thing: trying to achieve this goal using earned income – that is, paying off the family home over 25 or 30 years using savings from your work salary – is a tough call. Indeed, I’d go as far to say it’s a waste of time. I can appreciate why people think this way; we’ve been conditioned to this way of thinking by our parents, and society as a whole. But just because it’s something that our parents told us doesn’t mean it’s something I’ll encourage you to do.
The good news is paying off your own home can be a lot easier than you think if we work smarter.
I’ll make this a very simple example, with very basic figures to show you how it’s done.
Let’s say that you only ever make three property purchases: two well-chosen investment properties, purchased at $500,000 each plus the family home, also purchased at $500,000. This is what our portfolio will look like:
- Value of x2 investment properties – $1,000,000
- Value of the family home – $500,000
- Total property value $1,500,000
For simplicity, we will assume the total loan amount is also $1,500,000.
Remember you will have the help of the government’s taxation laws around negative gearing plus your tenants will obviously be contributing to the repayments of this substantial loan amount.
As a general rule, experience tells us a well-chosen property will double in value approximately every 7–10 years. This being the case, all that’s required to be debt-free on the family home is to hold the investment properties through one full growth cycle, and then sell them at a profit.
This will mean your two investment properties will increase in value from $1,000,000 to $2,000,000, remembering that the total debt on all three properties is only $1,500,000.
Again very simply, if you were to then sell the two investment properties at this point for $2,000,000 you would incur capital gain tax of 25% on the profit from the sales (25% rather than 50% as these properties will have been held for a period longer than 12 months). The remaining amount available to reduce debt after tax therefore will be $1,750,000.
You are now able to pay back the entire debt on the investment properties and also the debt on your own home. This also leaves an additional $250,000 for you to play with. I’m sure you’ll think of something to do with the extra money!
Pay off one Property after the Other
If you don’t plan to hedge your bets on the “sell-and-pay-down-debt-strategy”, what other options do you have? One other possible exit strategy that requires you to pay down debt is to change one of your investment property from interest-only into a principle and interest loan. You than focus on trying to pay off as much of the principle as you possibly can. You may also want to attach an offset account and lump any additional rent into an offset account.
As the principal owing decreases, the interest on the property will decrease and thus create a domino effect. Once you pay off one property, you move on to pay down the next property in your portfolio, and the one after that, until you’re debt free.
Live off Rent and Equity
If paying down debt isn’t an option, you may want to review your portfolio and see if you can live on rent.
This strategy requires a buy and hold strategy and is suitable for mature couples, low income earners or if you started building your portfolio in your 40’s – see our article about investing while having a family or at a later stage in life. With a young family and other financial commitments, you will probably have less money and experience even fewer boom cycles.
The idea is to buy property that is neutral to cash flow positive, with the aim of increasing your future rental yields to 7-8 per cent.
This strategy will allow you to keep on adding more and more property to your portfolio. The additional rent should cover the interest on your mortgage as well as provide additional equity to keep on investing. Over the years, rent should continue to rise in keeping with inflation and give you an additional source of income for you to live off.
With this strategy, you don’t have to pay off your mortgage if you’re able to live off the passive income and pay off your home loan. You can even combine this strategy and refinance your home loan to access the additional equity gains in your investment property if there is a shortfall. You would only do this if your portfolio value increases faster than your yearly living expenses.
Hand over your property investment portfolio to your children
This final strategy involves handing over your investment properties to your kids (if they are smart enough not to lose them!). This may be in conjunction with any of the above strategies.
Transferring control of your portfolio, if held in trust, is simply a matter of appointing a new company director. The actual asset never changes hands, so no tax is incurred. You are simply signing across control of the asset’s holding entity.
With any exit strategy, the right trust ownership structure is very important. This is why, as we stressed at the beginning of the article, it’s critical you start with the end in mind.
Remember, your portfolio will be equity rich and positive in cashflow by the time you have to make an exit. An exit strategy is all about minimising tax and maximising returns.
How can we help?
If you have any questions or would like further information or you are seeking property tax advice, please feel free to contact our office via email –info@investplusaccounting.com.au or phone 02 9299 7000 to either speak with someone or arrange a time for a meeting so we can discuss your requirements in more detail. You can arrange a free 15 minute no obligation chat to discuss your options. Please arrange an appointment with our office by clicking here
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