How do I build a property investment portfolio?

If you’ve been considering investing in property for a while – you might be wondering: “How do I actually plan out a property portfolio?”

That’s a great question and one most property investors start out asking. That’s because there’s a lot to decide.

You’ve got to figure out what to buy and when to buy. You’ve also got to calculate how much you have to spend.

So, this article is going to “pull back the curtain” and show you:

• The three fundamental principles of building a property portfolio
• And then, we’ll dive into a case study and show how a regular couple can go from owning one property to owning 4 in just 3 years – and the results of it.

Creating a self-funding property portfolio

The first two principles are based on building a diverse portfolio.

I get that sounds boring … so let’s put it a different way.

You want to add properties to your portfolio that complement one another.

This is often called a wealth wheel. What’s a wealth wheel?

It’s where you might buy a few properties that have poor cashflow and then complement it with properties that have good cashflow.

Here’s an example. Let’s say you buy a property that has great capital growth potential. But, over the long term, it might lose $50 a week once interest rates rise.

This sounds manageable, so you buy another one.

You’ve now got 2 investment properties that you expect will increase in value. And they cost $100 a week in total to hold.

You then decide you want to buy a few more. But you can’t afford to keep putting in an extra $50 a week per property. Or, maybe the prospect of keeping on buying negatively geared properties sounds a bit risky.

That’s when you might purchase a high yielding property – like a dual-key apartment – which might earn $150 a week in cashflow.

You take that cashflow and use it to pay for your other two properties.

So the apartment earns $150 a week. The two growth properties require a $100 a week top-up. That leaves $50 leftover.

You can then use that to subsidise the purchase of another growth property.

In this wealth wheel, you bought 2 growth properties and then a yield. That’s what we call GGY. Because your wealth wheel is 2 growth and a yield.

As you're building your wealth wheel, you can keep this little acronym in mind, so you know what you’re due to buy next.

For instance, if your plan is to buy 3 growth properties before adding a yield property, your acronym would be GGGY.

If you can get your properties to complement one another in this way, you’re more likely able to hold them for the long term. That’s because the cashflow supports one another.

In simple terms – properties that work together – stay together.

Buy properties around New Zealand

The second fundamental principle is – to use a cliché – don’t put all your eggs in one basket.

To put that in property investment terms, you don’t want to put all your properties in the same housing market.

Why’s that? Well, property prices go up, sometimes they come down. And for long periods, they’ll stay the same.

But here in New Zealand, each region’s property market ­tends to operate independently.

That means that property prices in Auckland can be skyrocketing while Wellington is flat. In other times, Wellington will be booming while Auckland prices are going backwards.

Take a look at this graph –

Auckland prices increased 86% between January 2010 and mid-2015. Over that same timeframe, Wellington was up only 6%.

But then what happened between September 2016 and April 2020?

Auckland was up 6%, whereas Wellington house prices were up 43%.

What’s the message? It’s not to buy in either Wellington or Auckland. But instead to invest in multiple property markets, so it’s more likely that you’ll have at least one property in a booming market.

Project when you will next be able to make a purchase

One of the big questions early-stage investors ask is – “after I buy my first investment property … when will I be able to buy the next one?”

At some point, investors tend to get tapped out of equity in the early part of their investing life.

They’ve bought properties and now don’t have the deposit to go and purchase another one.

If you’re following a passive buy and hold strategy – focussed on New Builds – then the two main ways to increase your equity are:

• capital growth (your property increasing in value) and
• paying down debt.

This is where you can use a spreadsheet like the below to project when you might have the equity to purchase another property.

You can then also test whether paying down debt more rapidly will help you grow your portfolio sooner. Download the spreadsheet here.

Setting the scene

Ok, let’s now get into a case study of how a couple might plan out a portfolio and how the portfolio might meet their long term goals.

Our example couple is Bill and Jean. They live in Wellington and are aged 47 and 48, respectively. They’re happily working and plan to retire in 20 years. They want to build a passive income in retirement to supplement their savings.

They are in a healthy equity position. The couple’s family home is worth $800,000. And since they’ve been paying down their mortgage over time, they’ve only got $200,000 left to pay over the next ten years.

These numbers mean that Bill and Jean could purchase up to $2.2 million worth of New Build properties without having to touch their savings.

Now that we have a goal (build passive income), the resources to achieve that goal (equity in the home) and a time horizon (20 years), we can create a portfolio.

Building Bill and Jean’s portfolio

Here’s what Bill and Jean might look to do:

• The couple has $440k of useable equity within their owner-occupier home. This useable equity can be used as a deposit to buy investment properties.
• This useable equity gives them purchasing power of $2,200,000 if buying brand new properties, which are exempt from the 60% LVR cap.

It is usually best to begin your portfolio by investing in properties that will likely achieve good capital growth.

These properties may require the investor to ‘top-up’ the mortgage each week (i.e. be negatively geared), but they will increase in value more quickly.

You would typically start with these capital growth properties for two reasons:

1. you want to hold these properties for the longest time possible, so you get exposure to the market for capital growth
2. The banks may change their lending criteria. If new borrowing rules stop you from buying additional properties, you'll want to have your growth properties already since they’ll usually have the most significant impact on your long term plan.

Let's look at a basic portfolio strategy:

• Year One: invest in a brand new Auckland property for $850,000, using 100% lending (borrowing against your own home). This property is forecast to grow in value at 6% per year and will cost $50 a week over the long term.

At this point, the couple has $370,000 of mortgages secured against their home. That’s because the $170,000 deposit for the investment property is tagged against their own equity.

At this point, the couple will still have the ability to purchase another $1.35 million of investment properties.

They have the equity to purchase another property straight away. However:

• first-time property investors may decide to hold off for a year since they may feel a bit nervous, and
• the bank may also be hesitant to lend on two new investment properties at once, depending on the couple’s income level.

So the couple might wait, and then over the next few years, they might:

• Year Two: invest in a second property geared for growth. They may want to diversify their risk and buy a property for $650,000 in Hamilton, with a forecast capital growth rate of 5% annually.
• Year Four: invest in a high yielding apartment in Wellington for $700,000. Forecast the annual house price growth at 4%, but provides weekly cashflow of $125 a week.

Let’s assume the Hamilton property will also be negatively geared and also requires a top-up of $50 a week. So the portfolio will need a $100 a week top-up across both the Hamilton and the Auckland property.

Because the Wellington property earns $125 a week, it can pay $100 top-up for the other properties. That means that the portfolio is no longer negatively geared.

So, at this stage, there is $440,000 worth of investment debt secured against their home. However, the rent from the investment properties will cover these interest payments.

Bill and Jean's results

• By the time Bill and Jean get to retirement, the three investment properties are projected to be worth a combined $5.7 million with $2.2 million worth of debt secured against them.
• That means the couple is projected to have just over $3.5 million worth of equity.
• That allows them to transition the portfolio from high-growth over to high-yielding properties. This might earn them a net yield of 4% income annually.
• In today's dollars (i.e. accounting for inflation), that would give them a passive income of $95,000 every year for the rest of their lives.

By investing in high yielding property, Bill and Jean’s wealth would increase as the properties slowly rise in value. This ‘inflation-proofs’ their retirement strategy, making them set for life.