The ultimate goal of most investors is to create a stream of income that allows them to retire without having to worry about money.
Depending on individual life-experience everyone will have a different idea of what ‘retiring comfortably’ means. For example, high earners, living in expensive suburbs and enjoying the freedom of what their income brings will want to continue that as long as possible, so they need to create a retirement plan with big returns. More modest earners, with less outgoings, will have a very different view regarding what they need to live on in later years, and their plans will reflect that. It’s simple: ideally, in retirement, everyone would like to maintain, as far as possible, the level of lifestyle they have been accustomed to – or as close to it as is feasible. In any case my notion of “retiring comfortably” is far from the ASIC guidelines of $43K for a single person.
Knowing your numbers
Property investing is not about focusing on property itself; it’s about concentrating on the numbers involved in making your deals work. Education, understanding what you’re doing and creating realistic goals are key, because every investment decision you make has the potential to change your life – either positively or negatively.
Calculating your ultimate portfolio
Three main ingredients contribute towards creating wealth:
- Strategy: Forward planning, and setting milestones, is the basis of all wealth creation.
- Leverage: You need to borrow from banks to leverage your return on investment. Therefore, your income level is vital as it dictates how much finance you can secure, and, ultimately, how many properties you can buy.
- Time: Compounding is the key, and you need time for your investment to grow. So your age is an important factor.
Looking at strategy – Let’s start at the endpoint. As an example:
- You want to retire on an annual income from property of $100K before tax (you will also have some superannuation to add to this).
- You do not want to eat into your capital as, at some point, you will run out of money.
- An unencumbered property (purchased 15 years ago) worth $500K today should generate 5% cash return before tax. This yield assumes steady rent increases over time.
In this scenario, to retire today, you would need a capital base of $2million generating 5% income per annum, equating to about 4 unencumbered properties at $500K each.
If you sell your properties, and invest the proceeds in a term deposit at a rate of 5% (currently the return is lower, but the long term average is about 5%), you achieve your goal of $100K per annum.
Alternatively, keeping your property portfolio will generate similar returns and, in addition, they will continue to be exposed to capital growth. You can gradually sell them as you age, and cash in on this growth.
The key word here is “unencumbered”. In practice you will probably still have some debt on at least one of your properties. Depending on how much loan principal has been repaid when you retire, you may need more than 4 properties in your portfolio, so you can sell some to pay off the debt on the remainder.
Obviously other factors come into play. Although starting investing early is advised – so there is time to purchase and hold several properties long-term – it’s not always easy. Those wanting to invest may be fresh out of university or on the lower rung of employment and believe they are simply not earning enough to maintain a property as, even when rented out, there are always costs to be met by the owner. This is where parents often step in and help their children get started.
At the other end of the scale, investing when getting older, edging towards mid/late 50s, can also be an issue as banks become more reluctant to lend to those closer to retirement.
Structuring finances properly is probably the most important investment aspect as most people usually have deductible and non-deductible debt, and the structure needs to optimise the tax consequences of having both.
And, finally, whatever your situation, when building a property portfolio, it’s good to work with an investment team including professionals such as a property advisor, a finance broker and an accountant.