Brett Alegre-Wood shares with you the 6 key factors in deciding the correct leverage ratio when building your portfolio.
Brett's unique portfolio building strategies are popular because he simplifies what is normally a very secretive and overhyped part of the property industry.
His direct and no BS approach teaches you not only how to build an investment property portfolio but also how to avoid the many pitfalls, misconceptions, myths and deceptive practices.
Over-leveraging is perhaps the biggest killer of people's portfolios yet it's an area that is easily avoidable using Brett's investment strategies.
If you want more clarity on how to map out a plan with all these factors taking in consideration when building your portfolio, watch this video.
As always, the team are here to talk you through anything you need, we’re here to support you through whatever is happening in the market. Do not hesitate to give us a call on +44 (0)207 923 6100
Here's a copy of the video Transcription:
Hi guys, Brett Alegre-Wood, Chairman of Gladfish and author of the best-selling book, The 3+1 Plan.
Okay, so today the question is, how much leverage should I use to build my portfolio? And it's one of my webinar questions. And basically, it's actually a really good question because it's not something that most people think about. Because if we are honest, most people starting off in investing, they may have their own home, they may have one buy select property which may be the property they lived in. And for most people starting out, it's not a big issue.
You look for the maximum mortgage you can get, okay? Because you're trying to take that, use as little money as possible and keep that money in your account that you've got. So at that level, it's a pretty simple answer. Okay, so most people go for the maximum amount. And that, depending on the country you're in, could be anywhere from 65 percent to 95 percent, okay?
But realistically if we're talking about building a portfolio, all right, and at the end of the day we all have to, okay? If you watch other videos that I've done on how many properties you need and you've read the book The 3+1 Plan, but realistically, there's a number of factors that affect the answer to the question, okay.
So let's have a look at each of these. Now, my general answer would be 60 to 80 percent loan to value. So how much leverage? Well, you should be putting 40 to 20 percent in for each property. And there is a range of factors. So, let's just have a look at them each in turn. Because if you can understand the factors, you start to get a sense for how I build people's portfolios, and why I put certain restrictions, and why we place certain provisions off to the side and why we can't when we use mortgage cost averaging. In other words, we jack up the mortgage rate a bit on the cash flow worksheets and make sure we've got some tolerances in there.
So, look, the first one is the experience. Obviously, if you've got very little experience then that will tend to move you down from the high loan to values to the low loan to values, okay. Now, not so much in your first one. Your first one as you're starting off investing, that's going to be much more about getting the maximum mortgage.
But as you start to build, because if you're talking now you've got two properties or five properties or ten properties, or fifty properties, okay? Then you need to change things. Because if you're still at 50 properties and you're taking 80, 85 percent mortgages, well I can tell you, you're going to be in for a shock. Because if you look at, I've got my latest book that's coming out, I've got five stories of five different gurus, okay, all of whom stood on stage and went “You know, we're wonderful, we built this up, 150 properties in two years, 18 million worth in three years”, all these sort of stories.
And when I looked at them actually at the height of the market, it looked good, looked impressive. But actually, I was sitting there going that's dangerous because I could see they've used massive amounts of leverage. They've got very little equity in those properties. So realistically they may have lots of properties, a big ego attached. But the bank owns most of them. All right? As we build bigger, we've got to lower our loan to value, okay. In other words, we're going to get more equity in that property, okay.
Now the reason I say 60 percent is because quite simply, at 60 percent I think whatever the shocks in the marketplace are, whatever the market cycle's doing, whatever interest rates are doing, 60 percent is going to get you a cash flow positive property through the whole market cycle, okay? As well as that, prices aren't necessarily going to drop more than 40 percent. Now this assumes that you've bought well and you have not bought overpriced and you haven't inflated the value and don't do these sort of ridiculous cash back and all that sort of stuff. If you've done that, then it's a different story. You'll probably never going to be at 60 for a long time.
Okay, so that's the reason I chose 60 because pretty much, you're insulated from all the shocks even if the worst happens. Now if you think about it, the U.K., in particular, let's say, about 20 percent prices dropped. In some areas a bit more, it could be 40 percent. But 40 percent is pretty much the extent, that's the maximum extent to a drop really we're seeing, all right. So at, even at that level, you still would've been able to sell your property if you had to, okay. Now obviously we don't want to, but if you had to, you could do that. And that's why that sort of 60 percent barrier is there as the minimum, okay. Up to 80 percent, and look if it's 85 or 95, it's the same. In Australia or some other places, you can get 95 percent when you're first starting out, fine.
Now experience, the first one is experience. If you're highly experienced, you know what you're doing, you know what all the risk factors are, you've taken them all into account then fine, okay. Go for your high loan to values, go for your 80 percents, okay. Now, the other factor is age. All right, if you're young, you can afford to take a bit more risk. All right? So obviously, you can borrow more so the high loan to values are fine. If you're getting older and say 60 plus, in fact, probably 55 plus now, you need to be start considering that if your whole portfolio, hopefully, you've got a portfolio by now, is at 80 percent you need to perhaps look at dropping that down.
And all that means is rather than taking money out, rather than spending money, you either need to sell some property and pay some of the other mortgages off or you need to just sit around and let them sit for a while and let the capital values grow. Now obviously, it's market dependent and all that sort of thing. But effectively the older you are, the lower your loan to values should be, the more equity you have. Because you don't want to take as much risk because if the worst happens it all falls over, you have no real time to rebuild back up, all right. So the older you are, the less risk you want to deleverage effectively.
Okay, so number of properties makes a big difference. That's the third factor. So there's experience, age, number of properties. If you've only got one property, that's not too much of a problem. You can factor in all the provisions and increases and interest rates, drops in prices, all these sort of things.
If you've got five properties, now it's a very different story because a one percent raise in interest rates on that portfolio could mean a significant increase in your mortgages. So now you need to think of things like not only your leverage in terms of deleveraging a bit more, so moving from the 80 down towards that 60, okay, but also you need to factor in interest rate increases. So you might want to put away a bigger provision, okay? Or you might want to fix half your mortgages and let the other ones variable so you get that balance.
So, experience, age, number of properties, stage of cycle. There are times in the cycle where property is sitting around doing nothing. In those times, and especially if interest rates are going up, you don't want to be highly leveraged. The lower the leverage, the better. So, if the prices are shooting up then you can probably leverage a bit more.
You've got to remember that stop sign in my property cycle, and if you haven't seen that just watch the video on the property cycle and it will explain that all to you. But it's fine if the market's shooting up to perhaps go more towards that 80, whereas the market's sitting sated, you want to get down towards that 60. And ideally, while it's still going up, you want to start to deleverage towards the end of that. So use the first half of it to build your capital, build the number of property, build your portfolio. But then toward the end of it you need to deleverage because if you do that then as interest rates increase, you're okay.
So experience, age, number of properties, income. If you've got, and this is not necessarily a question about income, it's more about disposable income. Because we all know the more money you earn, the more money you tend to spend. And if a lot of that spending is fixed expenditure, in other words, it's not discretionary.
Now if it's discretionary, fine. But we're talking disposable income. How much of effectively interest rates going up or things like that happening, can I actually provide for? Now, if you are lower income, you probably want to go more toward that 60. If you're on high disposable income, then actually you can more toward that 80 because you can afford to have interest rates go up by a percent or two percent or three percent or whatever it is and still sit there and hold the portfolio throughout. Because at the end of the day, this is a game of buying and holding.
If you think you're going to make huge money out of buying and selling and buying and selling and buying and selling, all that's going to happen is you're going to move from one job to another job. And most people when the become a professional investor or full-time investor, they think that that means they have to work full-time. So all they're doing, they're trading one job for another.
Maybe a bit more freedom, a bit more ego, you can sit around the dinner table and talk about how great it is. But in actual facts for me, property investment doesn't take a lot of time and that's how I would say most of the people I speak to, most of the clients I deal with, they don't want to become full-time property investors.
In fact, becoming a full-time property investor would probably be the worse thing for them. Because you're at home twiddling your thumbs. Eventually, your wife or your husband kicks you out of the house and says “go get a job”. Because it's not that glamorous. It's not that wonderful. Doing full-time investment, passive investment, now that's a different story. Because then I can choose to do whatever I want with my life while my portfolio's in the background working away for me.
So the final factor is a risk appetite. Look, if you're the type of person that stresses out when someone goes boo, or worries about things a lot, then perhaps you want to move more toward that 60. If you're someone who brazenly just wants to go out and conquer the earth, well then you move maybe towards that 80. But remember, risk appetite is not actually a symbol of a good portfolio or that sort of thing.
So that final one, and I left that final because I don't want you to take that just because you're prepared to take the risk doesn't mean you should. Doesn't mean that it's going to come off. Doesn't mean that it's going to be a safe thing to do. All the previous ones, they are true effects on that 60 to 80 percent. The final one is much more a bit of ego because actually the risk appetite.
Now look, I'm not saying that's a bad thing but what I'm saying is just because you think you can go out there and buy 10 properties and there's no, you're not worried about the risks, you still sleep at night, all that doesn't mean you should. The other five ones, the experience, the age, the number of properties, and the stage of cycle and the income, those five things they're the key. The risk appetite is the bit of the red herring for the sixth one.
But guys, hopefully, that gives you a bit of an idea of the type of factors that we deal with when we're talking about portfolio management because all of those come into play. And when you factor in all of them, actually you can build a large portfolio safely, securely, not having to worry about interest rates rising, prices dropping, all these sort of things.
You can hold the portfolio throughout with minimal stress. Because after all, property investment comes down to one test. And I call it the sleep test. If you can't go to bed, sleep a full night, wake up feeling refreshed then perhaps there's something you need to change about your portfolio. If you can, fantastic.
You're probably building your portfolio at the right pace, with the right leverage, that sort of thing. Unless the risk appetite and the ego side of the risk appetite gets involved, in which case you think you're indestructible.
The interesting thing is at one stage of the cycle when prices are shooting up you can be forgiven for thinking that you are indestructible. What you've got to realize, and this is the key to building a portfolio, is making sure that even though times are good now, you're looking onto the horizon and working out where the market's going and making decisions now whilst you can still make the decisions and you can structure the portfolio so that when the horizon does appear to reality and becomes the present, that actually whatever that is, you can face it and still sleep at night.
Okay, guys, have a great day and live with passion.