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Balloon

The Balloon is a buy and hold property strategy. The idea of the Balloon is to let inflation do the dirty work for you. While in the short term relying on capital gains is foolish, in the medium to long term we can rely on at least inflation pushing up house prices. So the idea of the balloon strategy is to buy twice as many properties as are needed to be financially free. The investor then waits until their price has doubled (You can use the rule of 72 to figure this out). If they count on inflation alone at approximately 3% per annum it takes about 23 years. If they add 2% for capital gains (a conservative long term average on top of inflation) it drops to about 14 years. They then sell half of the properties and use the money generated to pay off the other half. Leaving them with enough income from their mortgage free properties to be financially free.

This plan obviously suits the better capital gain areas (Auckland, Wellington, Queenstown etc). However, this does need to be traded off against the increased holding costs, there is no point paying 2% extra to get 1% increased profit. It probably best suits neutral or positively geared property in reasonable neighbourhoods.

Example

Suppose an investor needs $1000 a week to live on. So they purchase 8 properties which are cashflow neutral but once they are paid off will in present terms return $250 net a week each. They each cost $200000. The growth (including inflation) over the next ten years averages 7% so in ten years their properties are worth $400000 each. they sell 4 of them, becoming financially free. (Note selling costs would also need to be taken into consideration).

Part of the Property Cycle it best suits

The beginning of a boom, since on average properties will rise faster through the boom meaning you can become financially free sooner. On the other hand during a boom it can be hard to source cashflow positive or neutral properties. This strategy is likely to take 10-20 years depending on inflation and capital gains.

Advantages

Requires (if using positively or neutrally geared property) little or no actual input other than the deposit from the investor in terms of money. Reasonably safe, due to the long term nature of the plan.

Disadvantages

Relies on the market and property prices rising with inflation. In the long term this is probably a safe assumption in the short term this is not. As such this suits a longer time frame. The holding costs could add up if negatively geared properties are used. Does rely on being able to find and hold quite a few properties.

Optimising the strategy

There is a trade off between properties being easier to find and purchase that fit the cashflow positive or neutral criteria if the mortgages are interest only, and the speed at which properties may be paid off. If it is possible to get properties that are cashflow neutral (or positive) on a 25 year principal and interest mortgage then these will be able to be sold down to pay off much sooner.

Buying more properties will also make this faster, so for example if the investor bought three times as many properties as they will ultimately need then they could sell 2 thirds of them off when they had increased in value by 50% and still pay off their remaining mortgages. --Monid 08:41, 31 December 2007 (NZDT)