CHAPTER 15
Turning up the volume
As time goes on, returns amplify. If we turn up the volume on your bulletproof investment strategy (for simplicity, we will use the same assumptions for growth rates as previous chapters), by year 5 property 1 (from the previous chapter) would be worth $700 000 and you'd owe $530 000 (I've assumed you haven't paid back any of the loan amount, which would be the way to go if you still had debt on your own home). Property 2 would be worth $600 000 and you'd owe $450 000.
Take a look at table 15.1 (overleaf) for the year 5 numbers.
Table 15.1: equity position — two properties, year 5 (90% LVR)
| Year 5 | ||
| Property 1 | Property 2 | |
| Value | $700 000 | $600 000 |
| Debt | – $530 000 | – $450 000 |
| Equity | = $170 000 | = $150 000 |
Borrowing 90 per cent
As we've seen already, you can borrow up to 90 per cent of a property's value. In the case of property 1, that would amount to $630 000 (90 per cent of its year 5 value of $700 000) less the amount you currently owe ($530 000). For property 2, you could borrow up to $540 000 (which is 90 per cent of $600 000) less the debt amount of $450 000.
So, if you wanted to buy more properties, in year 5 you could potentially borrow $100 000 against property 1 and $90 000 against property 2. Table 15.2 sets out this information.
Table 15.2: available equity — two properties, year 5 (90% LVR)
| Property 1 | Property 2 | |
| 90% of today's value | $630 000 | $540 000 |
| 90% of purchase price | – $530 000 | – $450 000 |
| Available equity to invest | = $100 000 | = $90 000 |
Properties 3 and 4
This means in year 5 things could really start to snowball. This year, you'll borrow $80 000 of the $100 000 in available equity against property 1 and $80 000 of the $90 000 in available equity against property 2.
Just to recap: the $80 000 consists of $50 000 to pay for your 10 per cent deposit plus $30 000 for your purchase costs (which are conservatively 6 per cent of the purchase price).
You use the equity to buy not one, but two additional properties. For simplicity, let's assume you spend $500 000 on each of properties 3 and 4 and borrow 90 per cent of the purchase price, as detailed in table 15.3.
Table 15.3: equity position — four properties, year 5 (90% LVR)
| Year 5 | |||||
| Property 1 | Property 2 | Property 3 | Property 4 | Total | |
| Value | $700 000 | $600 000 | $500 000 | $500 000 | $2 300 000 |
| Debt | $610 000 | $530 000 | $450 000 | $450 000 | $2 040 000 |
| Equity | $90 000 | $80 000 | $50 000 | $50 000 | $260 000 |
Behold Einstein's Eighth Wonder of the World! You now have four properties growing at a rate of $50 000 each per year. Assuming all properties grow at the same rate, you would achieve $200 000 in growth in one year. Remember, all of this is the result of your original investment of only $80 000.
Check out table 15.4 to see the power and effect of 10 years' growth.
Table 15.4: equity position — four properties, year 10 (90% LVR)
| Year 10 | |||||
| Property 1 | Property 2 | Property 3 | Property 4 | Total | |
| Value | $950 000 | $850 000 | $750 000 | $750 000 | $3 300 000 |
| Debt | $610 000 | $530 000 | $450 000 | $450 000 | $2 040 000 |
| Equity | $340 000 | $320 000 | $300 000 | $300 000 | $1 260 000 |
Borrowing 80 per cent
If you had a bit more equity to begin with — say you put in $120 000 at the start (and borrowed 80 per cent of the purchase price, instead of 90 per cent, thereby saving on LMI) — you would have properties worth $3 050 000 and owe $1 960 000. In this scenario, you would be able to buy property 2 in year 4 (versus year 3 in the 90 per cent scenario), and properties 3 and 4 in year 7 (versus year 5 in the 90 per cent scenario).
And to top it off, instead of turning $120 000 into $600 000 with one property (as we saw in table 12.5), you'd have converted $120 000 into $1 090 000 (i.e. $3 050 000 less the debt of $1 960 000), as you can see in table 15.5.
Table 15.5: equity position — four properties, year 10 (80% LVR)
| Year 10 | |||||
| Property 1 | Property 2 | Property 3 | Property 4 | Total | |
| Value | $950 000 | $800 000 | $650 000 | $650 000 | $3 050 000 |
| Debt | $640 000 | $520 000 | $400 000 | $400 000 | $1 960 000 |
| Equity | $310 000 | $280 000 | $250 000 | $250 000 | $1 090 000 |
Time is your best friend
Remember, compound growth magnifies a return over time, or put simply, it turns up the volume! The longer you allow for compound growth to take effect, the greater the impact. Apple didn't go from selling 5.94 million iPhones in its first year straight to 194 million iPhone sales the next year. It built up gradually over time, with the biggest leaps coming in the past few years. The more patient you are, the greater the reward; time becomes your greatest ally.
What happens if we're even more patient, allowing our friend — time — to work even harder for us, beyond the 10-year period?
We know that the median house price doubles roughly every 10 years — using the figures from our example in this and previous chapters — from $500 000 to $1 million. Logically, from year 10 to year 20 it doubles again, from $1 million to $2 million. This goes to the heart of Albert Einstein's enthusiasm for the maths.
Based on the figures in table 15.4, the 90-per-cent borrowing option would grow the total value of the four properties from being worth $3 300 000 to being worth $6 600 000, while the debt would remain the same ($2 040 000). Your $80 000 investment would increase from being worth $1 260 000 in year 10 to being worth $4 560 000 in 20 years ($6 600 000 less the debt of $2 040 000). You can see these numbers at work in table 15.6.
Table 15.6: equity position — four properties, year 20 (90% LVR)
| Year 20: 90% LVR | |||||
| Property 1 | Property 2 | Property 3 | Property 4 | Total | |
| Value | $1 900 000 | $1 700 000 | $1 500 000 | $1 500 000 | $6 600 000 |
| Debt | $610 000 | $530 000 | $450 000 | $450 000 | $2 040 000 |
| Equity | $1 290 000 | $1 170 000 | $1 050 000 | $1 050 000 | $4 560 000 |
If we go by the figures in table 15.5, under the 80-per-cent borrowing model, the properties would grow in value from $3 050 000 to $6 100 000, while the debt remains the same ($1 960 000). Your initial outlay of $120 000, which is worth $1 090 000 in year 10, amplifies to $4 140 000 in year 20 ($6 100 000 less the debt of $1 960 000). See table 15.7 for a snapshot of this scenario.
Table 15.7: equity position — four properties, year 20 (80% LVR)
| Year 20: 80% LVR | |||||
| Property 1 | Property 2 | Property 3 | Property4 | Total | |
| Value | $1 900 000 | $1 600 000 | $1 300 000 | $1 300 000 | $6 100 000 |
| Debt | $640 000 | $520 000 | $400 000 | $400 000 | $1 960 000 |
| Equity | $1 260 000 | $1 080 000 | $900 000 | $900 000 | $4 140 000 |
There's no disputing that these numbers are impressive! That's the power of compound growth. But, as I've emphasised already, you need to buy the right investments to achieve this sort of growth — in other words, you need to know what you're doing.
In the past couple of chapters I have used some assumptions to explain the concept of compound growth as simply as I can. The key message is that you can achieve significantly better results if you can find a way to access repetition and compound growth once your initial investments have started to grow. It’s not an overly complicated concept to understand, but it’s not necessarily easy to do — or commonly practiced — because it takes a great deal of discipline and focus, no matter the type of asset you’re investing in. As I said earlier in the book, there’s a reason 90 per cent of property investors only own one investment property. It’s got little to do with the property they buy and lots to do with the discipline and focus required to access compound growth.
It is also why John says, ‘cash flow is like oxygen’. The key to keeping things bulletproof when you have a debt of $2 million is to make certain you manage your cash flow.
And you can't do it alone. There's a team of people you'll need in your corner if you want to achieve this sort of success. And that just happens to be the focus of the next chapter.