Positively Geared – Accelerate growth with granny flats

The primary goal of any savvy property investor is to generate a sustainable passive-income that creates the freedom to escape the rat race. Getting to this goal as quickly as possible requires a good strategy and a little bit of luck. Seeing as hope is not a strategy, we’ll stick with the tried and true methods of building a positively geared (self-funding) property portfolio.

As an investor, there are several levers we can pull to increase the income generated, and hence reduce the paydown period, by our property portfolios. Firstly, we can find and invest in properties that have a higher than average rental yield. Secondly, we need properties with strong capital growth. The combination of these two elements will see you pay off the asset much faster and generate a higher level of income once it is finally unencumbered.

This is illustrated in the example below. Here we have three unique scenarios all starting with a property purchased for $300,000. However, the individual characteristics of each property determining their capital growth and rental yield differ greatly among the three.

The first property (represented by the blue line) has a rental yield of 3 per cent and capital growth in the underlying value of the property of 5 per cent p.a. The second property (orange line) is generating a 5 per cent yield while growing at 7 per cent, annually. The third and final (grey line) delivers its owners a yield of 7 per cent and sees the value increase by 9% year-on-year.

Please note that for the purpose of this exercise these rates are averaged out over 10 years.

Figure 1. Capital growth in property value over 10 years

Figure 2. YoY annual rental income growth over 10 years

At the end of the ten years, the difference between option 1 and 3 is $392,020. More than enough to self-fund another investment property. With the average Australian rental yield and property growth rate at 4.1% and 6.8%, respectively, it is definitely attainable to achieve this in the current property market.

So, what value add strategies can you use to create a wealth-generating machine?

Adding a granny flat to an existing property is a relatively simple undertaking and can deliver a significant uptick in rental yield, and capital growth. By either creating two properties to rent to two separate tenants or one larger property for one tenant, rental and resale value should see a significant jump.

The increased rental income from having the additional dwelling can then improve your level of debt serviceability. Making it faster and easier to progress to your next property or project.

Here are some things to know before you embark on any subdivision project, including the addition of a granny flat.

  1. Get Approved – work with your broker and financial adviser to ensure your finance is pre-approved from your lender. Competition is fierce among properties appropriate for granny flat additions.

  2. Extension Financing – not all lenders are keen on financing renovations, including subdivisions and granny flats. Make sure that yours is one that will allow later construction finance.

  3. Full Borrowing Capacity – ensure that you have sufficient borrowing capacity to executive on phase 2 of your strategy – building the granny flat.

  4. Rules + Regulations - understand the planning and zoning rules of the area you are looking to purchase in. Not all councils and municipals advocate the subdividing of existing properties or the construction of additional dwellings.

  5. Know Your Market – get a gauge of who the renters in your area are and what type of renter might be in the market for a granny flat. This will determine how and what you build – a simple studio up to a large two-bedder.

  6. Build the Best – work with a reputable builder, preferably one that specialises in designing and constructing granny flats and other extensions. There are some nuances to getting this strategy right. For example, some builders will push for mounting the granny flat on stilts as a more affordable option. Most lenders and valuers, however, will then view this as a transportable dwelling and hence not count it towards your property valuation.

While the process can be simple, effectively executing a granny flat addition strategy can have its hurdles. Knowing what, where and how big you can build, lining up financing approval and securing a property can often be quite a juggling act. So, seek out experienced professionals that can assist in making the exercise a smooth and enjoyable one.

Click here to view some of our subdivision case studies.

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