How To Create A Real Estate Portfolio

Like many things in life, the idea of a perfect portfolio is highly personal. It depends on your goals, your personal and financial situation, and how much risk you can handle.

This means that what works well for others may not be the right strategy for you. For example, some people may have made a fortune by buying older properties that they have renovated and flipped. Others may have made money by buying new houses and holding over the long term.

There are literally dozens of ways to build a property investment portfolio, but there's one strategy that trumps them all: balance.

Regardless of your situation, age or experience, balance is the one thing that can help you maximise your profit and minimise your risk. It's the one thing you need to factor into your portfolio if you want to succeed as an investor.

Achieving balance is crucial to long-term property investment success. Picture: Tom Rumble/Unsplash

What is a property portfolio?

A property portfolio is a collection of investment properties owned by an individual, a trust or a company. Individual investors typically live in one of the properties they own and rent out the others.

In some cases, the rental income they earn on a property is greater than their loan repayments; in others, it is less. When the rental income is greater than an investment property's outgoings, the property is said to be positively-geared; when it is less, it is said to be negatively-geared.

Most people get into property investment with the aim of setting up an income stream that steadily flows into their bank account whether they turn up to work or not, and so positive gearing is typically preferable to negative gearing.

But high competition among landlords means that it's not always possible to earn enough rental income to keep in the black. And current legislation allows investors to deduct losses made on an investment property against their taxable income, so negative gearing has some perks, too.

What does a balanced portfolio look like?

When it comes to property, most investors have a similar aim: build a portfolio that pays for itself each month, whilst consistently growing in value.

To achieve this, you need some properties that deliver high rental yields and some properties that promise high capital returns , as it's rare to find properties that offer both.

The former can typically be found in regional working cities such as Geelong, Ballarat or Bendigo, tourist meccas like Cairns, or in any other areas that attract large numbers of people to live on a short-term basis – and can offer yields up to 7%. The latter can be found in aspirational suburbs with long-term, family appeal, and can offer capital growth of up to 5-10% per annum.

Balance can also be achieved through pursuing a policy of diversification. Buying properties in different states will reduce your exposure to location-specific downturns, and investing in both residential and commercial property will help you weather storms in either market.

How do I build a balanced portfolio?

While all paths lead to Rome, each investor will need to chart a slightly different course to reach the promised land of positive cash-flows and long-term capital growth. And they'll need to take their time, as property is a long-term investment strategy, not a get-rich-quick scheme.

According to Ben Kingsley, co-host of the Property Couch and founder of financial advisory firm Empower Wealth, the steps you should take to get there ultimately depend on four factors: your income, your expenses, your wealth target, and the time you have to reach it.

"It's a game of money first, assets second – because your cash flow determines how much surplus money you can trap," he says.

"The more surplus you trap, the higher your borrowing power – and once you have that borrowing power, you can then finance a property."

1. Work back from an end goal

You need to set a target so that you have something to aim at. This will ensure that your investment strategy is focused and structured, and will give you something to refer back to when you need to make a difficult decision.

Which is why Kingsley says setting an end goal should be the first step in your investment journey.

This target could be a passive income of $2,000 a week, or $100,000 a year, by the time you retire. Or something more directly related to your overall wealth.

"You'd then ask yourself, 'how many properties do I need to achieve that?' And the strategies you adopt and how much time you have will determine which price points and property types you will need to invest in, as well as how much time it will take to get into your second or third property," he says.

2. Start by focusing on income

While the breadth of Australia's property market means there are investment opportunities at a wide range of price points, investors need a high enough income to put down a deposit and service the interest repayments on their loan.

This means that would-be investors either need to wait until they earn enough money to absorb rental losses on low-yielding, high capital-growth properties, or initially only invest in high-yielding, low-capital growth properties that boost their income. (You can find out which areas offer these types properties by looking through each suburb's median rents and yield on our neighbourhoods pages.)

That way, they won't struggle to service their loan, and can later leverage their increased income to borrow more from the bank.

"If we have really strong monthly surpluses in the household, then we would usually buy the stronger capital-growth assets first. One or two of those, and then when we get to our third or fourth property, we might move to a balanced asset for the third and a cash cow for the fourth, just to round out the portfolio and help retire the debt out," says Kingsley.

"Because ultimately the reason why you build a portfolio is to live off the passive income. So as you go through your accumulation phase and reach your peak debt, it's then all about trying to retire that debt, and live off the rent roll that you've created for yourself."

Properties with charm and character have plenty of owner-occupier appeal. Picture: realestate.com.au/buy

3. Buy properties with strong owner-occupier appeal

The logic behind this is simple: owner-occupiers make up 70% of the market, and so buying properties that only appeal to investors will greatly limit your capital returns, as demand for these properties will be lower.

According to Kingsley, properties need to have "character and charm", and be located in areas with "high status, good amenity and great liveability" to deliver really good capital growth.

"That's because people buy those properties with their hearts not their heads, so they really do out-perform investor stock in regards to stronger capital growth over time," he says.

What should be in your portfolio?

As mentioned, this depends on where you are in your investment journey, what your personal and financial situations are, and the goals you want to achieve and when.

If you're a beginner investor and on an average income, you'll want to buy cash flow-positive or neutral properties first to help ease into the game.

It's worth noting, too, that older houses in the outer fringes of capital cities generally achieve higher rental yields by virtue of their lower price points, and their typically older stock offers plenty of opportunity to increase value through renovations. Which means you might get to enjoy both rental income and capital growth.

Units typically offer high rental yields but deliver low capital growth. Picture: realestate.com.au/buy

What shouldn't be in your portfolio?

While the answer to this question largely depends on your personal finances and goals, Kingsley says it's generally advisable to steer clear of "investor stock, because there's really no appetite of asset in the re-sale market".

These are typically identikit units in hi-rise apartment towers, with few distinguishing features.

"If it's a unit, make sure that it's in a small block, it's well positioned, and that it's one of four or one of six," he says. "These have lower holding costs, higher demand, and are less exposed to oversupply".