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Why Your First Property Should Never Be a Cash Flow Play: Stop Getting This Backwards · The Follio Property Podcast

• 0:00
  your first investment is arguably your most important, right? Because that will dictate the length in time you can make a second and third and the fourth. And like I said, in my personal world, my first asset that I purchased, regional Victoria off the planned townhouse, put me back five years because it was the wrong asset selection. And that, you know, five years is a long time, half a decade to then exit, you know, pretty much at the same price as what I paid. So a really good learning exercise.
• 0:29
  So when I look at that, your first asset has to be with the mindset of capital growth. Has to be. So if you're out there chasing the yield, chasing the yield, chasing the yield, there is a place for cash flow. Don't get me wrong. It's important.
• 0:41
  And typically later in the portfolio piece, we go heavily cash flow through commercial. We spoke about that with Cal Doggett and the ability to generate a passive income from commercial property. A hundred percent. A lot of our clients that are getting close to retirement, that's the strategy we endorse. But early in the portfolio, we need to get equity. We need to get capital growth into that asset as soon as we can because that's going to set you up for your second purchase. Once we get to two to three, three to four, then we start to have to manage cash flow a little bit more, you know,
• 1:11
  Then we have to start to manage cash flow across the portfolio because you're going to hit a cap on your borrowing capacity, not because of your equity levels, because of your serviceability. But certainly for your first investment, you can service it. The banks wouldn't give you the debt unless you could service it. So we don't want to go high cash flow, low capital growth strategy. And everyone's like, I want high cash flow, I want high capital growth. Just get comfortable with the fact that that doesn't exist. There's a world where that doesn't exist. Yes, there's exceptions. Yeah.
• 1:40
  Like I'm sure a lot of the assets, maybe Perth as well, where the yields were good, had that growth. But that was just the market. We have purchased assets that have 6% yields. These regional markets we've participated in and had 15% year-on-year capital growth.
• 1:55
  So it has happened, but I'm not going to go out there and say, there's a market in Australia where you're going to get this consistently longer term. Let's under-promise and over-deliver, right? So let's assume for the moment that it doesn't exist. It's either higher capital growth and then you're going to take a haircut on yield, or it's going to be lower capital growth, but you're going to get higher cash flow. So that, let's assume, the long-term compounding growth rate of most of the markets we participate in is between 6.5% and 7%.
• 2:24
  And that's the average, obviously, in a rising period of time when the cycle is on the rise, it exceeds that. When it's on the decline, it's subbed that. But on average, over 30 years, it's six and a half to seven.
• 2:37
  If we want assets to outperform that long-term compounding growth rate, we're gonna look for higher land component assets. And to do that, you pay more for the land, less for the house. The tenants are gonna pay less for those improvements, therefore you're gonna take a hit on your rental returns and your yield. So that balance needs to play out. And my advice for first-time investors is be only focused on capital growth. Find a way to service it.
• 3:04
  Find a way to make sure the cash flow means you can survive. You're not eating two-minute noodles. You can get by. Like I said, the banks won't give you the debt if you couldn't anyway, so you're pretty well safe from that point of view. If you've been assessed and improved, they know you can cover the debt. So that's a really good safety net.
• 3:19
  But there's various ways which we've spoken about value-add renovations to increase the capital growth. But let's keep the eyes on the prize. In the first 12 months, how do we get equity? Because then we can look at the second asset. And then I'm okay to look at cash flow assets for the second and third. It's a completely different conversation. Without equity from the first, we're not going to get to property two or property three. Yeah. And just going back to the debt reduction strategy, so...
• 3:41
  pretty clear that I guess in terms of the strategy in terms of what you want to be buying, what type of assets to be buying, high capital growth, potentially trading at least ones where you can activate some of that equity and put it back onto the principal place. I'm just thinking in my head, if someone comes to you, early 30s, late 20s, maybe that's their first home that they're aiming to pay off, they're gonna upsize in a period of time. So maybe their strategy is always just to be paying off that principal place, they get it down to a,
• 4:09
  you know, pay off that principal-based debt, but then they go, actually, no, I want that house in the better suburb next to us that's an extra six, 700K, so we go again. Is that kind of what you see from time to time? Absolutely, you see the debt reduction strategy play out multiple times throughout a life cycle. If I had to, you know, in every client situation is different depending on when they come to us, where they're at their journey.
• 4:28
  But if you look at the masses, if I had to give you the timeframe, it would be first purchase isn't an investment property, right? It becomes an accidental investment, as you say. So they go into a home, wherever they can afford, and they get into that property.
• 4:43
  then they will look to upgrade at some point in time, two to four years, maybe five years down the track, and then they upgrade into that investment property, the property they were living in, just becomes an investment property, your favorite saying, accidental investing. Accidental landlords. Yeah, accidental landlords.
• 5:00
  a scenario that plays out so commonly. But if you can actually control that a little bit better and have some pre-thought that, hey, that probably will happen to me. So let's put some, you know, a strategy into place to make this work better for us. Because what happens in that scenario is they paid off a lot off their home,
• 5:15
  Then they move, they upgrade, they don't change the debt. They've got high leverage on their prime place of residence now and they've got low leverage on their investment property. It's exactly what we don't want to do, but I say it all the time. And a broker may not be sophisticated to provide that advice.
• 5:30
  So let's plan it out. Where you live now at 30, is that where you're gonna probably wanna live at 35 or 40? What's your dream location? It's not, yeah, and they're gonna go, oh yeah, we're probably gonna have kids one day. Okay, so this two bedroom villa that you're in, will that be enough to have the three or four kids that you hope to have? No, okay, so let's plan for that. How can we get the debt down to this as quickly as we can? And this may inevitably become a trading strategy. So we buy one to two investment properties, that $600,000 debt on the villa,
• 5:57
  We get that down to zero within the five to seven year period. And then we sell down the villa to upgrade and have as little debt as we possibly can on that upgraded property. And then we start the debt reduction strategy again. We buy two, three properties and over the course of five to seven years anticipate to pay that debt off. And then you'll find there may be a third.