Variables to Consider when Modelling a Property Portfolio

In this advanced “How to…” session, I want to talk to you about all the sophisticated cash flow variables that any good cash flow management and property portfolio planning tool should have.

So let’s start from the top in terms of cash flow management. Naturally, we need to do our budget, and we need to assume that value of the money will increase over time. We call that Indexation. 3% is the figure that we use in terms of wages and also costs growing at 3%. So that’s number 1.

Number 2, we are also looking at Interest Rates. The cost of money is influenced in terms of how we borrow money and the cost we have to pay that back. So in any good sophisticated modelling tool, you should assume a higher variable. In Empower Wealth’s models we use 7.25%, so even though interest rates are a lot lower at the moment, it’s important to make sure that you can afford it, not only today but into the future.

Now when we start to get into the property side of things, we need to start looking at the variables associated with the property. So next would be acquisition costs. For anything under $750,000, a good rule of thumb is 5% to acquire that property. That is going to be your cost base. Anything above $750,000, say to $1.2 million, you should start to use 6%, anything above $1.2 million, you’re probably around 6.5 – 7%, if you’re getting up to anything above the $2 million acquisition stages. That’s the cost of acquiring the property.

The next phase we need to look at is ok, what about occupancy rates? What’s an appropriate occupancy rate? Well, we’re conservatives so 92% which effectively reflects four weeks of every year that the property is going to be vacant. We think that’s quite conservative.

What about the ongoing holding costs? The ongoing holding costs we use is 1.5% of the value of the property indexing at 3% per annum. So you work out the value of the property and you add 1.5%. Now what should that cover? That should include things like rates, maintenance, holding costs and body corporates as well. It’s really important if you do get a property that has high body corporates, that you adjust for that. But you really want to focus on trying to get the holding costs as low as possible because at the end of the day you don’t want your rent, which really is the income that we want to live on, to be just the servicing of the costs of holding that property.

The other areas are property management. Now property management fees vary around Australia and it can go as low as say 5 to 5.5% including GST right up to around 10% when it comes to looking at Western Australia as an example. At Empower Wealth, we use 7.7 to 8.8% depending on which state or area that we are looking in. So it’s crucial to understand that.

Those that I mentioned earlier are the main variables. The other thing you will also need to factor in, don’t just look at your property portfolios and factor in isolation. At the end of the day, it’s part of the overall wealth building strategy that you do. Although we don’t advise on superannuation and other investments, we do want to factor in some growth rates and also some income that’s coming from that. As a rough rule of thumb, we use 6% growth rates for superannuation, and then depending on the type of investment strategy you might have with your management funds, you need to decide what sort of growth rate and what sort of income rate you want to put when modelling a property portfolio. So they’re the moving parts associated with all the variables and we are talking about a very sophisticated model here in trying to understand the future value and bringing that back into net present value. Yes, it can be rather complex. It’s not going to be an easy model to build, but we are in the advanced “How to…” session here, and that’s why I wanted to share that. So if you wanted to build out these sophisticated models, that’s a great place to start. Thanks for watching.