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How exactly is the property going to be used as a stepping stone to the next property?
Here are some two simple examples:

1. Capital growth- say I purchase a $1,000,000 property (for simplicity’s sake). If my strategy is to purchase this property anticipating that the market will appreciate by 7%p.a., then next year it will be worth $1,070,000. Then I would be able to draw that extra $70,000 to use it as a downpayment for the next property
2. Fixer-upper – say I purchase a beat-down $430,000 property which is in bad shape. I buy it thinking that it should be worth at least $500,000 if it was in top shape, given other property prices in the area. I spend $20,000 on renovations, meaning my total money spent is $450,000. Then i get a revaluation on the home, and its After Repair Value (ARV) is $500,000. Then I’d be able to draw that $50,000 on a downpayment for the next property

These are just two simple examples of how a property can be used as a stepping stone. But you may be thinking – why do I need a long term plan of where I want to go if I can just do any of those two and rinse and repeat?

There are other factors in play which you need to think about when considering the ‘stepping stone’ concept – one factor in particular is your financing.

Here’s an example of Bob and Jane, who both work T-mart. Compare the pair. They both have the same savings, same salary, same superannuation and are looking to buy 2 identical properties next to each other. However, Bob has a low risk tolerance and Jane has a high risk tolerance. Let’s see how their plans will differ…

Property Deal: $500,000
Projected capital growth: 5%

Investor 1: Bob
Savings: $100,000
Downpayment: 20% ($100,000)
LMI = $0
Savings per year = $25,000
Goal: To buy a property every 2 years
Loan Type: Principal + Interest with Fixed Interest

In this scenario, Bob has put down his entire savings as a 20% downpayment for the property, which saves him money on the LMI. He also decides to go with the P+I loan so he is paying off the principal off the mortgage too. He opts for a fixed interest rate since it is the cheapest.

In one year, Bob would have the $25,000 appreciation and $25,000 from his savings, leaving him with $50,000 in total. He would need to wait another year before he can invest in another property using his strategy.

Investor 2: Jane
Savings: $100,000
Downpayment: 10% ($50,000)
LMI:$10,000
Savings per year = $25,000
Goal: to buy a property every year
Loan Type: Interest Only, Split loan (fixed + variable) with Offset Account

In this scenario, Jane goes with the lower downpayment, and incurs the $10,000 hit with the LMI. She goes with the interest only loan, meaning the interest portion of the payments will remain consistently higher than the interest payments of Bob’s loan which is decreasing as he pays off his principle. Jane also has more interest paid on her variable part of her loan.

Now this may sound like her option isn’t favourable, but Jane has set up her loan in this way to align with her overall strategy, which is to acquire properties at a quicker rate than Bob. Here are Jane’s justifications for her strategy:

• Although she has enough money for a full 20% downpayment and avoid the LMI, she takes the hit for the opportunity to have the remaining $40,000 liquid and not trapped in the mortgage principal. She then puts this in her offset account.
• Interest only – Jane chooses an interest only loan so she has better cash flow and more money in her pocket (which would go in the offset account)

In one year, Jane would have the same $25,000 appreciation, $25,000 savings, but the extra $40,000 sitting in the offset account and approximately an extra $5000 from not paying the principle. After a year, Jane would have almost $95,000 which is ready for the next purchase. Jane is better financially positioned than Bob after year 1 to go her next property investment.