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Regardless of your ambitions, one financial goal shared by every Australian is to retire in comfort and to not have to worry about working ever again, preferably sooner rather than later. But if you’re planning on using your rental income to fund your retirement, have you ever sat down and worked out how many properties you need to retire? All you need is a calculator and a few spare minutes, so let’s look at what you need to do.
If you want to use your investment property portfolio to fund your retirement, there are two main ways to go about it:
The strategy you choose is entirely up to you and depends on your financial situation and the lifestyle you plan to lead in retirement.
This article focuses on the first strategy of using rental income from your investment property portfolio to pay for your retirement.
But before you start hunting for suitable investment properties, it’s important to take a closer look at your retirement plans.
Before you can calculate the number of properties you need in your portfolio, you first have to work out how much income you require each year. How much money do you need each year to be able to live the retirement you want?
Unfortunately, there’s no set method for working this out. It’s up to you and the lifestyle you want to lead once you leave the workforce. One way to look at it is to think in terms of the income you currently earn. Would that amount be enough for you in retirement, covering not only your everyday living expenses but also eating out, regular holidays and any other experiences you might like to spend your money on?
The answer you decide upon will be crucial to determining how many properties you need in your portfolio. A budget of $100,000 per year is a common target for many investors, but your figure could be lower or higher based on your personal needs.
To give you a rough guide as to how much you might need, the Retirement Standard from the Association of Superannuation Funds of Australia (ASFA) provides an estimate of the annual living costs of retired Australians. As you can see in the table below, according to the standard, a couple that wants to enjoy a comfortable lifestyle in retirement has annual living costs of almost $60,000.
ASFA Retirement Standard | Annual living costs | Weekly living costs |
---|---|---|
Couple – modest | $34,560 | $663 |
Couple – comfortable | $59,619 | $1,143 |
Single – modest | $23,996 | $460 |
Single – comfortable | $43,372 | $832 |
The next factor you need to take into account is when you plan to retire. After all, an investor who plans to retire in five years’ time will have very different financial goals from someone who doesn’t anticipate retiring for another 20 years. Take some time to consider how much longer you want to keep working and how long that leaves you to start building your portfolio as it usually takes time to save the funds you need to purchase your next property.
You also need to remember the effect of inflation during this time. If you want to retire on an income of $100,000 a year in today’s money, the rising cost of living means that figure could be much higher if you don’t plan to retire for another 20 years.
Finally, you also need to consider the costs associated with acquiring and maintaining your portfolio. Each property attracts a range of costs, including insurance, rates, property management fees, maintenance expenses and more. If you adopt the rental income strategy (Strategy 1), then you’ll need to manage these costs throughout your retirement. Multiplied over several properties, these expenses can be sizable.
There are two more important factors you need to take into account: loan repayments and tax. In a perfect world, you wouldn’t have to borrow money to buy your investments, but the vast majority of property investors need help from the bank to grow their portfolios. Even interest-only repayments can add up to a substantial amount each year, which you will need to cover with your rental income.
And don’t forget that you’ll also need to pay tax on any income you receive, reducing your total earning power. You need to factor all of these expenses into your equations to get an accurate guide to the amount of income you will be able to generate.
By now, you should have a target figure in mind for your annual retirement income, so let’s take a look at how many investment properties you need to generate the income you want.
Let’s assume your goal is to earn $50,000 in rental income a year. One rental property worth $1 million, returning a rental yield of 5%, will deliver $50,000 in income per year. Of course, this 5% figure needs to be the net rental yield, which takes into account loan costs, property management fees, maintenance expenses and strata levies.
Unfortunately, affording a $1 million investment property is something most investors can’t do, so a more realistic option might be to acquire several more affordable properties over a period of time.
For example, let’s say you own four rental properties worth $350,000 each. After acquiring the first property and spending a couple of years paying off your loan, you then use the equity in that property to buy your second investment, and so on. If each of those properties had a net rental yield of 5%, you would generate rental income of $70,000 per year.
However, remember that you’ll need to pay tax on that amount, a total of $14,297 at 2016-17 marginal tax rates, resulting in an annual income of $55,703.
Number of properties owned | 4 |
Value of each property | $350,000 |
Net rental yield | 5% |
Before-tax income | $70,000 |
Income tax payable | $14,297 |
Annual income | $55,703 |
An annual income of $100,000 is a figure many investors aim for, but some fail to grasp the amount of rent they need to earn this much. Some people make the mistake of assuming that five rental properties producing $20,000 of rental income per year is all they need. They fail to take into account not only tax but also the many costs of acquiring and maintaining properties.
Let’s assume you have five rental properties, each worth $500,000 and returning a net rental yield of 5%. After tax, this portfolio produces a rental income of $91,118, well short of your goal.
But what if those properties experience capital growth of 5% every year for the next three years? By the time 36 months has passed, each property is worth (approximately) $580,000 and produces $29,000 each in net rental income. This means that, after tax, you’ll have an annual income of $103,718.
This shows why it’s important to consider capital growth and not just rental yield when choosing your investments.
Number of properties owned | 5 |
Value of each property | $580,000 |
Net rental yield | 5% |
Before-tax income | $145,000 |
Income tax payable | $41,282 |
Annual income | $103,718 |
If you’re planning on using your investment property portfolio to provide income for your retirement, keep the following tips in mind:
The answer to this question is the subject of much debate amongst property investment experts. Some put the figure at more than 10 properties, while others say the magic number is somewhere in the 3-5 range.
But as the calculations above show, the number of properties you need to retire really depends on your own personal circumstances. Only by considering your financial goals and how you plan to live during retirement can you work out a realistic number of properties to target for your investment portfolio.
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