Whether your property portfolio is already taking your real cash to new heights, or you’ve only recently felt the pull towards finding out how real estate can help you reach your retirement goals, it’s never too late to create your strategy for financial success.
It's important to always begin with the end in mind, says director at Metropole Property Strategists Brett Warren.
“Most people start at the beginning. They start by thinking, ‘Let’s buy a property and let’s buy another one’, and they don’t have the end in mind,” Warren says.
“Rather than starting with the number of properties [you will need], start with the income you want, then that gives you a bit of a guide as you can work backwards from that. What’s most important is the value of your asset base and how hard your money works for you.”
Speculation does come into play when you’re laying down the foundations for the largely unforeseeable future, and people tend to change their preferences over time. Still, Warren encourages investors to start by considering the amount of money they are currently spending on their living expenses and make adjustments from there.
“It’s likely that you will have fewer mouths to feed once your kids leave home – but don’t count on that. Adult children still seem to get themselves into trouble and need help,” he says.
“Also, it’s probable that you’ll want to holiday more often or pursue certain hobbies or pastimes that you don’t currently have. And unfortunately, there will be medical and other expenses you’re not having to pay today.”
While accounting for the number of retirement years is impossible, Warren says many Australians will live well into their 80s or 90s.
“You’re likely to have to fund 25 years or more of living expenses in your retirement phase,” he says.
Chasing a round number
When Warren meets with clients and asks them how much income they think they will need to fund their retirement plan, he says “nearly everyone says $100k per year after tax”
To provide broader context as to the position an investor would need to be in to be able to attain $100,000 in property income each year, Warren works off a 3.5% average gross rental yield – gross meaning before any expenses, such as council rates or income tax, are taken into consideration – which he says is “the yield for welllocated properties in Australia”.
“If you eventually own $1m worth of properties with no debt, meaning you’ve paid off all the mortgages, you’ll receive $35k rent each year. But you’ll still have to pay rates, land tax, agents’ commission and repairs, leaving you with something like $30k a year. And then you’ll have to pay tax on this income,” Warren explains.
He adds that you would need a fully owned property portfolio worth several millions of dollars in order to earn $100,000 per year after tax.
Director at Results Mentoring Brendan Kelly – who has also often heard $100,000 per year pitched by clients – points out that since your annual income has provided you with a lifestyle that you have become accustomed to, adding a little bit more on to it could indicate how much you will need in your retirement years.
“It’s probable that you’ll want to holiday more often or pursue certain hobbies or pastimes that you don’t currently have. And unfortunately, there will be medical and other expenses you’re not having to pay today”
“If you are on $60k a year, you might want $70k; if you are on $120k, you might want $130k – that becomes a target,” he says.
Another way to calculate the amount you might need is to start from a ‘zero base’ approach.
“It’s a more scientific approach when you sit there and figure out all the things that you want to do in a year,” Kelly says.
This involves the investor asking themselves a multitude of questions to drill down to the kind of lifestyle they will want to sustain in retirement, such as how often would they like to travel, how often would they like to go out each week, and how often would they like to host social functions.
Once you work out how much you want to earn in retirement from your investments, whether that figure is $30,000 or $300,000, you then need to work out the value of the assets you’re aiming to accrue.
“The answer to how much money you need to live off comes from how big you are able to make your net asset or net capital base,” Kelly says.
“I might have $10m worth of residential property but with a debt of $8.75m. If I was in this position, then the costs associated with holding this volume of residential property with that much debt would likely wipe out any possibility of a meaningful cash flow in retirement.
“But if I held $1.25m of higheryielding property without debt, then I’d be in a much better position to enjoy a desirable cash flow from my property in retirement.”
The magic figure: $100,000 per year
For an income stream of $100,000 per year to be obtained through property, Kelly explains that, based on a conservative, average annual gross residential rental yield of 3%, the investor would need about $3.33m in net income-producing assets.
“This is a significant amount of money to be holding in property for $100k of rental income to live off,” he says.
On the other hand, if an investor were able to obtain, say, a 10% net yield from property held in more regional areas, and/or commercial properties, then they would only need a portfolio valued at around $1m in net assets to produce the same income, Kelly explains.
“This amount of net assets is a much easier and faster target to achieve than the original $3.33m. The art of your success here is in the yield that you are able to create for yourself,” he says.
“Accumulating a mass number of properties is not the answer; accumulating properties that have a great return with no debt is the answer.”
The number of properties that are required to retire wealthy then also becomes a question of the strategy the investor sides with.
As an investor moves closer to retirement, they will want to shave down as much debt as possible on their property portfolio. To speed up the process, investors will sell properties to be able to shift equity out of those that aren’t generating a strong yield into properties that are yielding.
However, Kelly says investors need to keep learning about the different ways they can generate a higher return.
“They agree that they need to get rid of debt, so they settle down, but the yield that they end up with often isn’t great,” he says.
“The dilemma most investors face is that they are emotionally attached to their accumulated properties, they find it hard to let go, and they don’t sell their residential properties in favour of commercial.”
Commercial property allows an investor to obtain a higher yield and sign into a longer lease agreement, on some occasions stretching out to 10 years. However, if the property becomes vacant, the dry spell can last for months or even years, which is a significant amount of time to go without an income.
“If you have a blend of residential and commercial properties, you might get a 4–5% yield on something residential and a yield of 9–10% on your commercial properties,” Kelly proposes.
“The net effect is a higher yielding portfolio with a lower targeted total net value of, say, $1.5m with managed risks.”
While the residential properties will likely have more frequent but shorter-term vacancies than commercial properties, Kelly says: “If your commercial property does go vacant for a period of time, you will have enough money [coming in from your residential] to continue to eat and live during the period the commercial property remains vacant.”
What about superannuation?
Propertyology director Simon Pressley believes superannuation can be used as a vehicle to grow wealth and buy property assets, but says accruing assets outside of superannuation has more advantages.
“We’re heading towards not being able to access superannuation until age 70, but what if you want to retire beforehand? And governments are forever changing super rules,” he says.
“While it requires more discipline, I enjoy the control of asset ownership outside of superannuation; opportunities for leveraging are far superior, and I can do what I want when I want to.”