How many properties should I buy to retire?
When it comes to investment property – one or two will normally do.
I’ve been a financial adviser for over fifteen years, eight of which have been specialising with property investors and their wealth creation plans, and I’ve now seen pretty much every property strategy there is, several times over.
What I’ve learned from this experience is that the most consistently successful property investment strategy is usually the one which just focuses on buying one or two blue chip assets and holding them over the journey for as long as possible.
I know this sounds boring and slow and of course I’ve seen several people be successful adopting all sorts of alternative strategies, but it can be a more consistent, relatively low risk strategy.
The reason for the success of this no fuss approach is due to many factors include compounding; opportunity to diversify; growing rental income; opportunity to reduce debt and the minimisation of buy/sell costs, including tax.
Let’s look at these factors all in isolation.
If you are reading this article, then I’m going to assume you like property as an investment and have or are thinking about buying investment property as part of your wealth creation strategy. I like property too for many reasons, which we’ve explored in other pieces throughout the website. For the purpose of this blog though, let’s just focus on the assumption that you buy one property in line with the Melbourne median at September 2016 of $740,000. We’ll assume you are age 35 and hold it until at least the age you retire, which today is generally age 65.
Most people have heard of compounding and Albert Einstein has reputedly said “Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it”. In essence compounding is growth upon growth and even if you only get the same rate of growth each year, if it is applied to a higher valued asset, then the return is said to be compounded.
Looking at this example:
$740,000 x 4% growth p.a. for 30 years (until you reach 65), your property could be worth $2,400,114. Increase the compound growth rate to just 5% and this increases to $3,198,237.
By simply holding a good quality asset over time, your rate of return is increased exponentially and this is one reason this strategy is often so successful.
Opportunity to diversify
I’m sure you’ve heard of the phrase ‘don’t put all your eggs in one basket’, right? Well when it comes to property, it’s hard not to. It’s such a large resource that it ties up a lot of capital and if the property is negatively geared, then cashflow is tied up too. Given it is very difficult to avoid concentration risk when property investing, it is extremely important to diversify as best you can into other assets and by keeping your property purchases to a minimum, it is freeing you up to do just that.
Property is in the end just an asset class, like shares or cash for example, and depending on the year, all asset classes will have their time in the sun and be the best performer of the lot. Holding a diversified portfolio therefore smooths your return over time and improves your investment flexibility to make your investments work for your ongoing needs. In effect, reducing the risk that you become a victim of being too heavily overweight in any one asset class.
Growing rental income
The longer you hold your property, the greater amount of rent you will be able to charge. Like with growth, your income return is essentially compounded as it increases exponentially, when measured as a percentage of your original purchase price. This growing income increases your cashflow in time for future investing, including debt reduction, and could become a fabulous part of your retirement planning strategy to meet your retirement income needs.
One of the great things I see with clients who buy and hold quality property is that by the time they come to retire, their properties are often largely unencumbered. It always pays to focus free cashflow on reducing home loan debt before investment, but once this is extinguished, offsetting investment debt increases free cashflow for other investing and your lifestyle. The large majority of Australian’s I meet do not want debt in retirement and therefore having an unencumbered property or two by retirement, gives increased flexibility that one or more properties can in fact be held, to help meet retirement income needs. Remember that the longer the property is held the more the compounding benefits apply, though taking a very good strategic look at whether holding is the right strategy around retirement is always the right thing to do, rather than to just assume.
Reduce buy/sell costs including tax
One of the biggest factors to overcome to make property a successful wealth creation strategy is to achieve a good return above costs. Property has such big upfront costs, when you factor in stamp duty, legal fees, bank fees etc. and it has big selling costs, when you factor in agent fees, marketing and then capital gains tax to finish it off. Time and compound growth is the best way to achieve the desired investment outcome and minimising property turnover is paramount to this. So many property investment strategies involve buying and selling property, but often this will not deliver the best long term outcome and if you value your own time in most of the strategies that involve a quick buy and sell, then the comparison in favour of simply buying and holding is even better.
Want to better understand your property investment plans? Contact us to arrange a free no obligation meeting.
Written by James McFall – Financial Planner and founder of Yield Financial Planning.
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The content of this presentation is intended to be general information only and has been prepared without taking into account any person’s objectives, financial situation or needs. Each person should consider its appropriateness having regard to these matters or obtain relevant professional financial advice before making any financial decisions. Examples are illustrative only. Each person should obtain any relevant professional financial, taxation and social security advice before making any financial decisions.