Planning to retire one day?

Are rental properties part of your retirement plan?

For many Australians they are, yet will their rental properties be enough to provide a reasonable standard of living?

Research by the Australian Bureau of Statistics (ABS) in 1995 reported that 78% of rental property investors only own one property.

Will one property be enough to live on?

Short answer – NO WAY!

So how many rental properties will you need to own to retire on comfortably?

To answer this question, we first need to work out how much money a single rental property generates.

The Perth median rent is currently $395 per week, and the vacancy rate 5.6%.  Combine those two numbers and we get an annual income of $19,400.

Rental expenses that an average Perth property would incur are outlined in this table:

Rental Property Expenses
Item  Amount 
Council Rates  $     1,800
Insurance  $         900
Land Tax  $         500
Management fees  $     2,000
Pest control  $         200
Repairs & maintenance  $     1,500
Sundry expenses  $         300
Water Rates  $         800
Total Expenses  $     8,000

We are talking about cash flow here so I have not included the non-cash costs of depreciation, capital works allowance or borrowing cost amortisation.  Those items are extremely useful in managing taxable income, but less important for assessing cash flow in retirement.

Annual income of $19,400 less annual expenses of $8,000 gives us a cash income of $11,400 per year, or $950 per month.

How much money will you need in retirement?  ASIC has suggested that for a couple who own their own home, retire at 65 and live to 85, an amount of $34,216 will give a modest lifestyle while $59,160 is comfortable.  In rental property equivalent terms, three rental properties will give modesty and five to six properties comfort.

Rental Properties  Cashflow p.a. 
1  $              11,400
2  $              22,800
3  $              34,200
4  $              45,600
5  $              57,000
6  $              68,400
7  $              79,800
8  $              91,200
9  $            102,600
10  $            114,000

From the table above, three rental properties is the minimum that any home-owning couple will need for retirement purposes.  The net cash flow from three fully-owned rental properties of $34,200 is equivalent to:

  • ASIC’s ‘modest’ retirement indicator of $34,216;
  • Full aged pension for a couple of $34,382;
  • Minimum adult wage of $34,980;
  • $1 million earning 3.5% (yes that is higher than current bank rates and may not be easily achievable).

So at a minimum, a couple will need to own their own home and three debt-free rental properties to provide a modest retirement.  Five rental properties gets our couple very close to ASIC’s comfortable retirement.  Six or more houses and we can start to relax a little.

Please note that we have not included any expense here for capital replacement.  Repairs and maintenance cover the small ongoing maintenance costs but do not include major capital expenditure.  Some investors tend to forget that their house is slowly deteriorating and will ultimately be demolished.  Many investors try and play “pass the parcel” with their properties, and hope that some future owner will end up paying the bill for the roof replacement, deteriorating boundary fence or crumbling stumps.  Capital expenditure on residential properties tends to be lumpy, for example termites are discovered and a portion of the roof timbers need replacement.  But if we wanted to provide a long-term estimate of capital expenditure, simply get the replacement cost of the entire house and divide it by the anticipated life of a new house.  A new finished 4×2 home in Perth will cost around $240,000 and last for around 40 years.  A quick calculation gives $6,000 per year average capital cost, which will certainly eat into your free cash flow quickly.

Capital expenditure requirements are not uniform over time.  New houses will have very little money required to be spent on them, with many items in the property covered by warranty.  On the other hand, a house that is twenty plus years old may have suffered years of deferred maintenance, which some future owner will eventually have to pay.

Plan your portfolio to anticipate these capital expenditures.  Simple strategies include having your properties well-maintained during their lives rather than letting repair items build up and compound.  You might also develop a strategy of owning older houses and re-developing them when you are getting close to retirement, so that you have a portfolio of new houses at that time.

Our calculations so far have been about debt-free houses.  You can carry a lot more debt while working than when retired.  While you are working you are earning income from your occupation and paying income tax.  The negative-gearing loss induced by your rental property loans is offset against your employment income and results in a tax refund.

Effective Interest Rate on Housing Loans for Rental Property Investors by Marginal Tax Rate (including Medicare Levy)
Interest Rate Tax Rate for annual incomes over
$0 $18,200 $37,000 $80,000 $180,000
0% 21% 34.5% 39% 47%
4.0% 4.0% 3.2% 2.6% 2.4% 2.1%
5.0% 5.0% 4.0% 3.3% 3.0% 2.6%
6.0% 6.0% 4.7% 3.9% 3.7% 3.2%

For example, if you are working and earning over $80,000 per year, an interest rate of 5% only costs you 3% in after-tax dollars.  This enables you to carry higher levels of debt than you might otherwise choose to.  But once you are retired and the work income ceases, your interest rate is felt at its actual rate of 5.0%.  Suddenly your property portfolio is much more sensitive to interest rate increases and interruptions to income.  You will need to develop a plan for your property debt as you approach retirement.  Some options include converting any interest-only loans to principal and interest ten or more years prior to retirement; selling some properties and using the equity to repay debt, or using lump-sum superannuation payouts to make principal payments.  Each of these options has taxation implications and you should run the scenarios past an accountant experienced in property investment.

Can you go into retirement while still carrying debt on your rental properties?  Yes, as long as you have established both an equity and a cashflow buffer.  You need an equity buffer to allow you freedom of movement with your property decision making.  If you are highly-leveraged, an unexpected fall in house prices could restrict your ability to sell an individual property (as the remaining properties may have insufficient security value for the loans).  You will also need a cashflow buffer so that you are safe from rising interest rates, extended rental vacancies or capital expenditures (such as replacement of a roof or central air-conditioning system).

Note that in all but the most severe economic downturns you will be able to ride out a fall in house prices as long as your cashflow is positive so that you continue to make your loan repayments.  Remember that after retirement you will not have any wage or salary income to plug the gap from vacancies or expenses.  Some of the heaviest casualties in warfare occur during an unplanned retreat or rout.  In the same way, some of the biggest financial losses in property occur when owners are forced to sell during a downturn.  Ensure that you build the twin buffers of equity and cashflow so that you remain in control of your property portfolio and never have to take orders from others.  In the same way, protect your assets from external interference during absence or incapacity by having an enduring power of attorney nominating a trusted person registered at Landgate and a valid and current will.

In conclusion, you will need to own your own home plus at least three debt-free rental properties to have a modest retirement.  Beyond that point, each additional property will add to your comfort and when you have six or more rental properties you can start breathing easily.

Are three or more rental properties achievable?  Yes, but it is not easy.  A large debt-free rental property portfolio takes design, intention and hard work.  Most Australians do not get beyond one rental property.  But if you have made it through to the end of this article, you have the potential to do it.

 

 


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ronald-reagan-meme

The nine most terrifying words in the English language are, I’m from the government and I’m here to help.’ according to Ronald Reagan, the fortieth president of the USA.  And he should know, since he helped a bunch of mujahideen in Afghanistan with Stinger missiles and other paraphernalia of war in Operation Cyclone.  That worked out well for everyone…

Which brings me to the National Rental Affordability Scheme (NRAS) which commenced on 1 July 2008 with the legislated aim to “encourage large‑scale investment in housing by offering an incentive to participants in the National Rental Affordability Scheme so as to:

                     (a)  increase the supply of affordable rental dwellings; and

                     (b)  reduce rental costs for low and moderate income households.”

I like how the Department of Social Services refers to the NRAS in short as “the Scheme”, evoking memories of other schemes.  Remember the Home Insulation Scheme?  Who could forget the flood of newly-minted installers chasing the government cash, the four deaths from electrocution, the shonky installations and outright fraud, the abrupt termination of the scheme, the compensation fund and finally the Royal Commission.  What a bumpy ride but at least some people got a softly-padded landing.

So let’s take a look at the latest Scheme to Make Rental Properties Great Again.  Did you notice that the Australian Government administering this scheme is the Department of Social Services (DSS)?  Yes landlords of Australia, with NRAS you are going onto Centrelink benefits.  Seriously.  Those of you who own low-income housing are probably thinking “Well it cuts out the middle-man!”.  Jokes aside, what is the issue here?

You are entering a world of regulated income.  Of rent by decree.  That can change with the stroke of a pen.  Which it did.  The Government announced in the Budget on 13 May 2014 that it would not proceed with Round 5 of NRAS, announcing “The money that was set aside for Round 5 will be returned to the Budget and contribute to Australia’s savings”.  Did you notice the return of those savings?  Same here…

So why would anyone invest in an NRAS property?  To receive the NRAS incentive payment of course.  The NRAS incentive is an annual amount, indexed annually provided to approved participants for each approved dwelling which complies with the conditions of the allocation of incentive for the dwelling. The incentive comprises:

  • An Australian Government contribution per dwelling per year for up to 10 years as a tax offset.
  • State and Territory Governments may offer approved participants a contribution per dwelling per year as direct payment or payment in-kind.

I have put in bold the key words I would like you to focus on – complies, and may offer.  In other words, if circumstances change, your property may not comply, and you could lose your incentive payment.  For example, your tenant may get a pay rise and no longer qualify for NRAS assistance.  Which could certainly lead to a preserve incentive for tenants to keep their income below the prescribed limits, or alternatively earn income in ways that do not pass through the normal reporting systems.

Speaking of tenants, as a newly-minted NRAS owner you will be targeting low income tenants.  The income limits are generous, for example in 2016/17 a sole parent with two children can earn up to $83,233 and still qualify.  Yet NRAS properties are not built in isolation, but rather in large group developments.  So you will be grouping together large numbers of low-income tenants.  This strategy has not worked well for Government housing departments around Australia, many of whom have abandoned the concentration model and now disbursed their tenants around the suburbs.  For example in Western Australia the awarded New Living program  “aims to reduce high concentrations of public housing…”.

The NRAS has also created a high concentration of financial advisers, promoters and salespeople eager to cash in on investor interest in the Scheme.  As fellow schemers, they will waive the shiny incentive payments before your eyes and seek to entice you to buy their newly-developed properties.  And like other Schemes, fraudsters abound, so much so that the DSS has issued formal warnings alerting investors about cold-callers promoting NRAS.  Investors please take note – capital accumulates slowly from your hard labour, and can be burned very quickly by a wrong decision.  Do your due diligence.

Take a step back and think for a moment.  You are looking to buy property.  Which is a long-term investment.  The NRAS incentives will be all gone in 10 years (or earlier if the Scheme is cancelled).  You will then be left with a decade-old home that has suffered the wear and tear of low-income tenants.  In a cluster of properties all tenanted, with owners all thinking about selling at the same time.

So forget the fiscal favours and focus on fundamentals.  Land appreciates and building depreciate.  In general.  In the long-term.  Perhaps not in Perth 2016.  So what should you buy?

As an investor you want your rental property surrounded by owner-occupier neighbours.  And certainly not positioned in the centre of a large group development surrounded by other rental properties.  When grouped investment properties are all chasing new tenants in a quiet rental market, the only way to differentiate a property is by price, so rents will be going one way, down.

My stock standard suggestion for investors is to buy an ordinary house on a potentially subdivisible block of land within a reasonable distance of the city centre.  And only buy when you can afford to make the loan repayments and other holding costs.  Without a tenant.  For some time.  If you budget on that, every rent payment is a bonus.

And when your property is tenanted for some time, and your bank balance is still rising, consider buying your next.

Many years down the track, develop your own properties.  Then rent them out.  To ordinary tenants.  That’s my scheme.

 

 

 

 

 

 


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REIWA President Hayden Groves said, “A number of factors contributed to the sharp upturn with falling prices the main catalyst.”

Based on the SQM Research, rental vacancy was dropped. Western Australia is showing an increase in rental activity. Therefore, no pressure on the rental prices. Tenants tend to lease for shorter period of months and after look for another property. Vacancy rates fell nationally but there are suburbs drives the rental market especially in unit. Rents are started to stabilise nowadays as there is no new stock coming into the market.


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