Can property investment really fund your retirement?
Will this really be possible at a time when the banks are being stricter with their lending making it harder to grow a significant portfolio and at a time of lower capital growth?
That’s what we’re going to discuss in today’s episode as I have a chat with Pete Wargent.
We’re going to look at how you can take control of your financial future, why many investors fail, and the strategies of debt in retirement and how to reduce debt before you retire.
What you need to know about self-funding retirement through property
Over 2 million Australians invest in property.
You’re probably one of them.
These investors are looking to take control of their financial future and hope to one day live of the rents of their property portfolio.
But is this still possible in today’s more restrictive lending environment – how many properties do you need to live off your property portfolio and how do you handle your debt when you retire?
Most property investors fail
- They never build a sufficiently large property portfolio to be able to live off its fruits – why is that?
They start too late
The don’t buy the right assets – they don’t get sufficient capital growth
They don’t stay in the market long enough – it takes 20 and more likely 30 years to grow a big enough asset base
We don’t know what the future holds
- The rules have changed since the global financial crisis with more restrictive lending and the world will change again in the future.
- We don’t know if there will be a pension, what the superannuation rules will be, whether you will be able to negatively gear
- One thing we do know: if you have a substantial asset base, you’ll have options
The 3 stages of wealth creation
- Asset growth – requires leverage
- Transitioning to lower LVR
- Living off your property portfolio
How are you going to repay all your loans before you retire?
- Part of successful investment is having a strategy – a strategy for property purchases, a strategy for asset protection, a finance strategy and an exit strategy knowing how you're going to repay your debt before you retire.
- You don't need to fully pay off your debt before you retire, but you must assume that the banks will not be comfortable extending you further debt unless you can prove serviceability.
- In my mind, it's not necessary to repay all your debt before you retire but debt serviceability is very dependent upon interest rates and therefore it is important to go into your retirement years with the level of debt that is easily manageable and there would not choke you financially if interest rates changed.
- With that in mind how I like to structure our clients’ portfolios is that when they go into retirement, they have a mixture of assets:
- Their home with no debt against it
- Superannuation which should be bringing them income
- A property portfolio that is no longer negatively geared, and if it does have debt against it the LVR is such that the portfolio generates income. This does not need to be a lot of income but needs to be sufficient so that your property portfolio is not draining your cash flow.
- Having no debt may not be an optimal strategy as a conservative amount of leverage going into retirement could work well for some people
- Often our clients will live off their superannuation for the first 10- 15 years of their retirement years allowing their property portfolio to once again double invaluable and therefore naturally lowering the loan to value ratio allowing the portfolio to spin off cash flow.
- Other clients achieve their cash flow in retirement through the dividends from shares or from the positive cash flow of commercial property investments.
Strategies to reduce debt
During the investment journey stage where you lower your loan to value ratios, the following strategies can be used
- slowly lower your loan to value ratios by not buying further properties and allowing the natural increase in the value of your well-located assets to keep growing and at the same time lowering the LVR's
- paying principal and interest
- replacing growth properties with cash flow positive properties, but not secondary properties – instead of adding commercial properties which have strong cash flow and still some growth to the portfolio
- renovating or redeveloping properties in the portfolio to increase cash flow
- selling one or two properties – remember capital gains tax and bank repayments of existing mortgages will be required meaning you won't end up with this much money as your equity may have suggested.
- Selling assets in your SMSF which would not attract capital gains tax and then distributing the proceeds tax-free to help pay off debt outside the SMSF.
Strategies to be used during retirement
- Downsize your home – this doesn't often work as well as some would expect as selling up and buying a good apartment, townhouse or villa unit in the same location may not give you much change
- Withdraw some funds from super - after 60 you could withdraw funds tax-free, either to live off or repay debt. Of course, in retirement, super is a zero-tax environment (if your balance is less than $1.6 million), so it’s wise to keep as much money in your super account for as long as possible.
Does Living off Equity still work?
- This is very hard nowadays because you need to prove serviceability and to do that you need strong cash flow which would mean you'd have to have a very low LVR and probably a number of commercial properties in your portfolio which would produce substantial cash flow
Links and Resources:
Some of our favourite quotes from the show:
“You can’t save your way to wealth, so you’ve got to borrow and buy income-producing capital growth assets.” – Michael Yardney
“You’ve actually got to have debt that’s at a level that’s going to be manageable and not choke you financially if circumstances change.” – Michael Yardney
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