Steppingstone strategy: how to buy your dream home
If the recent property price growth predictions become reality over the next couple of years, more homeowners may become ‘priced out’ of their desired location. What might be affordable today, could quickly become unaffordable, as prices can rise quickly.
Sometimes it’s not possible to buy your dream home in one fell swoop. But do not despair. A steppingstone strategy could be the solution.
Buying a dream home has always been a struggle, embrace it
Property has always seemed expensive. I bought my first property 23 years ago for $150,000 and it was a big deal. It was a stretch, financially. It was a dump that needed renovating.
Getting onto the property ladder and buying your dream home will take work. Some sacrifices. A little bit of hustling. But that has always been the case. Focus on the solutions, not the problems.
Focus on building your deposit/equity
If you are income-rich but asset poor, you need to build equity to extend your purchasing power. That equity could come in the form of cash savings/deposit or equity in an existing property.
If your income earning capacity is limited, then accumulating more equity reduces the amount you need to borrow and as such, you are closer to being able to buy your dream home.
Either way, your sole goal should be to build equity.
How to implement a steppingstone strategy
A steppingstone strategy involves buying an owner-occupier property with the sole aim of accumulating as much equity as possible, as fast as possible. Then, selling that property and using the equity to upgrade to a superior property. And continuing to do that until you have attained your dream home.
There are three key steps to this strategy.
_Step 1: Pick a location that has attractive short term growth prospects_
Buying a property in a location that is popular and is enjoying rising property price momentum can do a lot of the heavy lifting for you.
The goal is to create equity as soon as possible. Therefore, it’s not as important to form a view about a given location’s long term growth prospects, unlike when buying a pure investment property. You just want to form a view about whether the price momentum will continue in the short term.
Typically, locations that are gentrifying will exhibit above average growth rates. Gentrifying suburbs tend to have similar themes such as a changing demographic, increased renovation activity, new infrastructure and/or amenities that enhance the community feel (liveability) of the location and so on.
Whilst it’s important to not buy at the peak of the market i.e. after prices have risen as much as they will, it is equally too risky to try to pick the next growth suburb, because you could be wrong. Essentially, you want recent evidence that the rising demand for the location is generating price growth. And that prices still have some future upside.
_Step 2: Buy an older house with scope to manufacture equity_
Often, but not always, it is best to buy a house instead of a townhouse, villa unit or apartment. Firstly, houses tend to have proportionately more land value. Secondly, houses tend to offer more scope to improve their overall value e.g. renovation of bathrooms and kitchens, landscaping, adding a room/living area and so on. This is called manufacturing equity when the property’s value appreciates by more than the cost of the improvements made.
Older houses (e.g. built pre-1970’s) offer better opportunities than newer ones, because there tends to be greater scope to make improvements, such as adding an additional bedroom, adding living areas or make it ‘open plan’. The risk of unexpected cost overruns is less likely if you stick to making cosmetic improvements i.e. no structural changes. It is also important that the finished product is aimed at the typical buyer in that location – it doesn’t have to appeal to your tastes – just have wide appeal to prospective buyers.
It is important to note that suburbs closer to the CBD tend to offer better growth prospects. Therefore, start with the blue-chip suburbs and then move further out until you find a location that allows you to buy a house that fits within your budget.
Sub-dividing a large block and constructing a second dwelling can also be a great way to manufacture (build) equity. It’s important to obtain tax advice from an experienced tax agent before you undertake such a project.
_Step 3: Occupy the property to avoid CGT_
Buying, renovating and selling property is not a costless exercise. You pay stamp duty when you buy and agent fees when you sell. The last thing you want to do is make a donation to the ATO, as it will eat into your financial gains. Therefore, if you can nominate the property as your main residence, it will exempt you from paying capital gains tax (CGT).
It might be difficult to occupy the property for the entire ownership period, especially if you need to complete significant renovations, but that should not prevent you from continuing to claim it as your main residence.
Buy a house that is located in a suburb that is growing in popularity, as close to the CBD as your budget will allow. Select a property that has plenty of scope to add value e.g. renovate. Hold it for 2 to 7 years (as short as possible) before selling and moving closer to your desired (dream) location.
Beware; this is a higher risk strategy
Warren Buffett says risk comes from not knowing what you’re doing. This strategy will require a lot of homework including speaking to various property professionals. You must upskill yourself so that you can identify the best property prospects. It is still worth engaging a buyers’ agent as long as they have experience in buying the types of property in the locations you are targeting.
In addition to upskilling yourself, you will need to assemble an experienced team including a mortgage broker, building inspector (you don’t want any nasty surprises), possibly a builder and maybe also financial advisor. Advice that makes money, pays for itself.
The key assumption here is that the market will move in your favour. Of course, there is a risk that this might not happen, and you could be caught living in this property for longer than expected.
Can your family help you?
If you have enough income but don’t have a sufficient deposit, and alternative to the above strategy is to use a family guarantee, which I have discussed previously.
Risk and reward
I acknowledge this strategy is more hands-on and won’t suit everyone. However, there cannot be any reward without taking some risk and working hard. It might take you a few properties (steppingstones) and years to get to your desired location, but once you’re there, you and your family will enjoy the benefits for decades to come.
 Of course, this is a generalisation, and you must obtain personalised tax advice.