"How do people finance so many investment properties and service the shortfall of the loans? Example if a person has 10 properties even with the rental income you would need to service the shortfall for 10 properties."

This is an excellent question, one that I'm sure is on the minds of many property investors (or potential property investors) who are wondering how to keep on investing and not run out of money to cover their shortfall every month.It is a little difficult to provide you with a personalised answer to your question without knowing your current financial situation such as your income, how many properties you have or whether you are able to take advantage of any negative gearing benefits etc.Therefore, for the purpose of this exercise, I'm going to assume that you don't have any other income apart from rent received from investment properties.This is by no means a far-fetched assumption either, as many of our clients who are successful investors have reached a point where they are able to choose whether they want to continue working a full-time job or not.

Before I started coming along to Investors Direct seminars (you see I was actually an Investors Direct client first before I was a staff member), your question was one that I was also asking. I'm sure that if you walk into the local branch of one of the major banks or spoke to a mortgage broker and ask this question, who are supposed to be experts in this field, the answer you would probably get is "Well, you can't!".How do I know this?Because I was one of those staff members at a major bank for 10 years prior to my involvement with Investors Direct, and Lee a Bank manager and then a mortgage broker prior to Investors Direct.

You have used the example of a person with 10 properties and wondering how you would service the shortfall for those 10 properties.My personal experience is that many "conventional" financial institutions already start saying you can't borrow any more money (in other words you can't service the shortfall) long before you get to 10 properties.I still recall 10 years ago when I was working in the bank and tried to borrow money to buy a second investment property, being told that I would have to sell my own home first before I could borrow any more.Of course I didn't want to do that and that lost opportunity has cost me a lot of money.

Enough said about how "conventional" lenders would look at the servicing of the shortfall of a growing property portfolio, because a lot of people would have already experienced this for themselves.

At Investors Direct we pride ourselves in finding creative ways of doing finance, and also believe that utilising finance is the key to wealth creation rather than the actual accumulation of properties.Obviously, the two must go hand in hand.Without the properties, you can't have the finance as all lenders need the peace of mind that the money they lend out is backed by what they consider to be "safe" assets.

There are four ways that a property investor can ensure the shortfall between their rental income and interest payments as well as holding costs can be serviced.These are:

1. Positive Cash Flow Properties

Only purchase properties that have neutral or positive cash flow (i.e. rental return is the same or higher than interest payments).The disadvantage of this strategy is firstly that this type of property is becoming increasingly difficult to find nowadays but most importantly, they tend to be located in regional areas for which history has proven may not have consistent capital growth.We believe that capital growth is the key to creating wealth and achieving financial independence through property investing, so this is not a strategy we normally recommend to our clients.

2. Income

Make sure that you earn enough income from your business or job to always cover your shortfall.The disadvantages of this strategy are very obvious – there will always be a point where you simply can't afford to cover another property shortfall. It would be very stressful if you are solely dependant on your income to service your debt as many circumstances may be beyond your control e.g. inability to keep increasing your income as your property portfolio grows, redundancy or economic factors that may affect business income.As with anything that we do, if it's too stressful or not enjoyable, it's unlikely that you will succeed at it and keep doing it for the long term.Don't get me wrong, having a good income can certainly be an advantage when it comes to finance however we have learned that the reality is there are many sources of income, rather than just what you on doing your day job!

3. Borrow less or use different loan structures

Take out loans where the monthly repayments are at or near the amount of rent received.

One way of doing this is to only borrow the amount of money that will give you a repayment equal to the rent you receive (eg. rent equals $1000 per month and the Interest Only payment on a $100,000 loan @ 8% also equals $1000 per month) This assumes that you have sufficient equity or cash to cover the balance of the property and cover purchase costs when you bought the property. However, it is also a dreadful use of your own money and would have minimal tax advantages!

One of the loan products that we sometimes recommend to clients is the Cash Flow Mortgage™, which is designed to help investors manage their monthly cash flow, at least for the first few years of owning an investment property.The concept behind this type of loan is that you can defer paying some of the interest by having it capitalised onto the loan balance. This in turn will reduce your monthly loan repayment figure. It has the effect of turning negatively geared properties into ones that have positive cash flow.More information on this product can be found on our website.

4. Build in Interest Cover from your Equity

This is by far the most important strategy and is used widely by our clients who are successful property investors. Investors Direct always recommends that our clients continue to grow their property portfolio in a safe and stress free manner. This strategy involves structuring the finance and using equity in such a way that there is always a "buffer" to cover shortfall in monthly repayments for a certain period of time.

The Cambridge Advanced Learner's Dictionary defines "buffer" as "something or someone that protects from harm" which I think is a very appropriate way to describe our finance strategy (and perhaps our finance strategists?).To put it simply, having a buffer means putting aside a certain amount of funds from a loan or loans for the sole purpose of servicing the shortfall for a period of time.

When you borrow 75% using margin lending to buy a blue chip stock in the share market, the lender doesn't check your serviceability. They know that the dividend you receive is not enough to service the interest.The reason why they are happy to lend you the money, knowing that you may not be able to service the debt with your income, is that they are betting on the equity you have in the stock as their 'buffer'. They can sell the stock to get their money back if you failed to make the interest payment or the stock falls below their allowable threshold.

This is an example of using equity rather than income to service debt in the stock market. It is very similar to concept of 'debt servicing debt' in the residential property investment market.

One thing you need to be very careful about with this strategy is to make sure you select a property that you know will have strong capital growth. Why? Because if your property doesn't go up in value and you run out of 'buffer' to pay the interest, then you'll be forced to sell the property to repay the debt. That's if you cannot find funds from elsewhere.

This is no different to a margin call in the stock market except that you have to do it yourself. Hopefully you can sell before the price of the property drops below the threshold which allows you to pay out all your debt.

The best way to explain this is by way of an example. Let's assume:

·You currently own a property (property # 1) valued at $650,000 and you own the property out right.

·You also want to buy an investment property (property # 2).

·You want $100,000 a year to live on and

·You want your interest payments and income covered for 2 years.

So what could you do?

First thing would be to access the equity you have in your home.

You take out a loan at 80% against property # 1.

$650,000 Property # 1 value
$520,000 80% LVR loan

And you want to buy an investment property (property # 2). So:

$400,000 purchase price on property # 2
$320,000 80% LVR loan
$80,000 required for deposit
$24,000 covers associated purchase costs
$104,000 your total contribution

Now we work out interest cover:

-$41,600 interest payments on loan for property # 1 of $520k (even though you haven't used it all yet, I've planned for the worse)
-$25,600 interest payments on loan for property # 2 of $320k
-$4,000 holding costs on property # 2 (rates etc)
+$16,000 4% rental income
$55,200 shortfall per year

$520,000 available equity from property # 1
$200,000 Kept aside for living ($100k x 2 years)
$110,400 2 years interest cover for your both loans
$104,000 used for deposit and costs for property # 2
$105,600 left over

At the end of 2 years, both properties will have grown in value which means you would actually access to more equity and you still have $105,600 left over from your initial $520,000. You could even buy another property!

How much to put aside will depend on a number of factors, such as how quickly you want to grow your property portfolio, your comfort level with debt, how much is the total amount of debt, the growth potential of the properties etc.

Our Finance Strategists are able to tailor a finance strategy to suit each individual's needs.In other words, they can help clients to take the stress out of property investing.If you had a way to cover all of your shortfall for the next few years, even if you continue to purchase more properties and even if you did not have any other source of income apart from rent, is there anything stopping you from taking action right now to start or continue investing in properties?

The last two strategies I have described are considered by most people to be "unconventional" hence the title of our next series of seminars "How to Leverage Yourself into More Top Performing Properties" - Unconventional insights from industry insiders".If you have never been to one of our seminars before, or even if you have, I highly recommend that you come along to hear for yourself how you can use finance to your advantage, as well as learn about many other aspects of property investing such as property selection based on proven strategies and property related tax and asset protection strategies. I hope that I have been able to answer your question for you, however, if you would like to know more information about our finance strategies that is more catered to your individual needs, please do not hesitate to contact our office.

Regina Looi is an Investment Mortgage Strategist based in Melbourne. Regina has an in depth knowledge of the finance industry having been with Investors Direct for 3 years and prior to that spent 10 years working at a major bank. She is a passionate and experienced investor. She has been investing for 6 years and owns 6 properties.

Lee Dittmer is an Investment Mortgage Strategist based in our Melbourne office. Lee worked for various banks for 23 years and has been a broker for 4 years. She is an active investor and has assisted many of Investors Direct's clients maximise their investment potential. www.investorsdirect.com.au

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