Have you ever read articles or heard people declare the number of investment properties they’d like to buy as a target?
Commonly they will say something like “I want to retire on ten investment properties”.
We love working with ambitious, optimistic people that have aspirations like this and we would never wish to dampen anyone’s enthusiasm. However, an important part of our role as property advisers is to provide perspective and maintain realistic expectations. These big goals are great and most are achievable over time if the right planning is in place.
Our concern is that this focus on how many investment properties we need to buy is flawed, because it doesn’t have any financial clarity.
In some parts of Australia, you could own ten investment properties with a total value of less than $2 million, whereas in Sydney or Melbourne you may end up with only two properties (or less) for that value. While focusing on the number of properties can appeal to our imagination (and egos), it probably does more to cloud our vision.
What we really need to ask ourselves is how much annual income we would like to have as a sustainable revenue stream from our investment properties, then reverse engineer the numbers from there.
In financial terms, this revenue stream would generally be calculated as a realistic percentage return on your net worth.
Here’s an example of how to calculate the value of net worth required to have your desired annual gross income, based on a 4% gross income return. This is sometimes called the rule of 25:
Desired annual gross income: $100K
$100K multiplied by 25 = $2.5M
In this example, a net worth of $2.5M (i.e. unencumbered investment property value) is required for a sustainable gross retirement income of $100K, based on a 4% annual return.
And how many investment properties would you need to get the desired outcome in this example? Well, that’s up to you. On average in Australia, it would amount to more than one or two properties, but likely less than ten.
By the way, this is how we define net worth:
Total value of income producing assets (not including Principle Place of Residence)
Liabilities (total loans/debt associated with income producing assets)
The retirement income example given above is just a suggestion, most people will have their own idea of what works for them. And yes, this income is taxable and there will be (tax deductible) property expenses. When we combine this with our projected superannuation income, shouldn’t it provide for a much better retirement?
While these are approximate figures that need to include some variables – such as your risk profile and exit strategy – it does give us a much better target than the usual, ‘how many properties’ question we often hear.
Using the above formula, why not be brave and have a go at calculating your own current net worth position?
While this exercise can be a bit confronting, it is a reminder of why you would start (or continue) investing now. Based on current median property values, you may soon find that it’s going to take more than one or two investment properties to get a decent income when you stop working.
It makes sense that the longer you hold an investment property, the more time it has to perform for you.
Therefore, if you can get finance, it may well be your best strategy to buy now with the right support, and not leave it too late, because once you leave the workforce it’s extremely difficult to get finance from a lender to enable you to invest further.