The best way to fast-track your portfolio and acquire more properties is to maximise your borrowable equity
Often property investors refer to “equity” as the difference between a property’s current value and the mortgage balance(s) secured by it (i.e. what they owe). This definition is meaningful in that it is a good measure of wealth but arguably it’s purely academic if you never intend on selling the property. Perhaps a more meaningful measure is borrowable equity. I define borrowable equity as the amount of money a bank will lend you using a property(s) as security.
Why borrowable equity is more important
Leveraging against assets to invest is a time-tested investment strategy that can work fantastically well (as long as you invest in quality assets of course). Maximising the ability to borrow can assist you with many things including upgrading your home, buying another investment property, investing in the share market, funding short term cash flow challenges (i.e. supplementing living expenses for a few months when you expect cash flow to be tight) and so on. Therefore, maximising your borrowable equity is key to ensuring you maximise your financial opportunities. The sooner you can invest in another property, the sooner you will build wealth.
The main factors that determine your borrowable equity include:
- The bank’s assessment of a property’s value
- The bank’s credit criteria (i.e. the percentage of the property’s value they will lend you)
- The bank’s borrowing capacity (i.e. how much you can afford to borrow).
I’m going to discuss some strategies that active investors should consider employing to maximise borrowable equity.
Strategies to maximise bank valuations
Property valuations can differ between lenders by large amounts. From personal experience, valuations on some of the properties I own have differed (between different banks) by 10% to 20%. Switching to a lender with a higher valuation has allowed me to invest in another property whereas if I didn’t refinance, my investment journey would have stalled.
There are a few valuation strategies that you can employ:
- Make sure your loans aren’t cross-securitised (inter linked). The reason for this is you need to have the ability to select which properties you would like to revalue at which times. If your loans are cross-securitised, the bank will revalue all properties at the one time and you may not want that to happen (in case a lower valuation on one property offsets higher valuations).
- Realise that revaluing all property at the same time might not be best. Of course different types of property and locations improve at differing rates at differing times.
- Follow the market so you can keep track of comparable sales. Valuers will look for 3 or more good comparable sales in the last 6 months to influence their opinion. A property is comparable if the location, land size and accommodation are similar. For example, assume you own a single-fronted Victorian cottage that was valued by the bank 1.5 years ago at $700k. You have followed the sales in the area and know that two similar Victorian cottages have sold in the same street – one for $800k and one for $830k. Another, two streets away, sold for $850k recently. It’s likely that you can expect a bank valuation to come back at more than $800k if you get a new valuation. Therefore, once you have 3 or more good comparable sales, request a bank valuation.
- Speak to your mortgage broker and see if they think it’s worth ordering more than one valuation. Some banks allow mortgage brokers to order valuations on properties (sometimes at a small cost to you). If another bank revalues your property for materially more than your current lender, it might be worth switching to allow your investment journey to continue.
- Make sure your property is clean and well-presented when the valuer inspects it.
- If you disagree with the banks valuation, request a copy of the report to check that the details about your property (e.g. land size) are correct.
- Realise that valuations can be unpredictable at times. Sometimes you can be unlucky and get a conservative valuation. It is difficult to successfully challenge the valuers opinion once it has issued its report (i.e. get the figure revised). Therefore, typically, your only two options are to switch lenders or live with the low valuation.
Be careful with the type of property you buy
The great thing about unique properties is that they have more scarcity value. Scarcity value should translate into good capital growth. For example, I know of a property in Prahran, Melbourne that consists of two, two-bedroom, single-fronted Victorian cottages joined together to make one, four-bedroom home. It is in a blue-chip location and I suspect that if it was ever put onto the market it would fetch a healthy price. However, when bank valuers assess the property, it is difficult for them to find comparable properties. There are few 4 bedroom properties of this nature in that location. In this situation, valuers are more likely to be conservative – and conservative valuations don’t help active investors. In this situation, buying a unique property theoretically helps the investor as they have a scarce asset that will likely enjoy strong capital growth. However, this is only relevant if they ever sell the property and realise the value. If they consistency experience conservative bank valuations (because of the property’s uniqueness), the property might not help the investor grow its portfolio (compared to a less unique asset). This is a good illustration of the difference (and importance) between theoretical equity and borrowable equity.
Use different lenders in a strategic order
Different lenders use different models for assessing how much a person can afford to borrow. Often it is possible to maximise your borrowing capacity by using certain lenders in a certain order. Therefore, sitting down with your mortgage broker (that is hopefully experienced in developing financing strategies) and planning ahead (maybe up to 5 years ahead) could be a very valuable thing to do. It will allow the broker to consider using certain lenders first – leaving the more generous lenders to use in the future.
I need to make one important caution here. Achieving financial independence is a journey, not a race. You absolutely must always borrow well within your capacity taking into consideration the impact on changes to income, interest rates, allowing for buffers and so forth. Borrowing too much, too soon could result in large financial losses and it’s not worth the risk (and stress). Mortgages make great servants but very bad masters. Borrow safely and know that a slow and a safe strategy wins the race.
Borrow when you don’t need it
The best time to approach a lender for more borrowings is when you don’t really need it. Arguably, the worst time to approach a lender for more borrowings is when you are desperate for it. With this in mind, I have coined the phrase “borrow when you don’t need it”. By this I mean revalue your properties strategically. When you get a higher valuation, increase your lending limits to 80% (or more) of the new valuation. You don’t have to draw the funds so you don’t have to pay interest. But the money is “locked in” and available for a rainy day (or your next investment).
If there is one thing that never changes in people’s lives its change itself. People move homes, relocate for work, become self-employed, get retrenched, start a family, change careers, come across the “investment opportunity of the century” and so on. Making sure you maximise your flexibility (like locking in access to more equity) is key to accommodating the inevitable changes that life brings us. So whilst you might think you have no need for higher credit limits now, if they are available, active investors should lock them in.
Maximise borrowing power
The nature of compounding returns is very powerful. The difference in equity in 20 years between investing in a $400,000 property today versus waiting 12 months’ before making the investment is over $127,000 (in equity). That is, a delay of 12 months will make you $127,000 less wealthy in 20 years’ time. Investing more sooner (assuming it’s safe to do so) will help you achieve your financial goals.
After over a decade of advising property investors, I appreciate how important it is to maximise your borrowable equity. It is key to achieving success as an active property investor. You need to educate yourself about the above strategies and develop a trusted relationship with an experienced mortgage broker/advisor who can actively help you maximise your borrowable equity.