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The key to your financial future

Monday, 1st Sep 2014
Categories: Finance, Newsletter

Many people have been led to believe that they can casually buy one or two investment properties and eventually live off the rent.

While this may be true in principal, to truly set yourself up for a comfortable financial future, you need to do two things. Firstly, you need to build up a substantial portfolio of high-growth properties, which will provide you with the necessary leverage. Then, you need to let the power of compound capital growth do its thing. Once your portfolio has achieved sufficient growth and you want to retire, there are many ways to configure your portfolio for income-generating purposes, such as by selling down your debt or by drawing from your equity.

What’s important is that while you are able to invest, you accumulate enough properties to eventually fund your desired lifestyle in retirement.

How many properties do you need?

Clearly, it’s not the number of properties that’s important, but rather the value of your asset base. Ultimately, it will be the amount of equity you have in your portfolio that will determine your level of property-funded retirement income.

If we assume a net yield of 3.5%, $1 million of equity will generate $35,000 of annual income. And working in reverse, if you want to retire on $105,000 per annum (before tax), you’ll need equity of at least $3 million.

Realistic example adjusted for inflation

What does it take to build $3 million of investment equity? Let’s run through a realistic example of how a financially-disciplined investor could achieve such a feat. We’ll look at 3 scenarios, where our investor buys either 2, 3 or 5 investment properties within the first 10 years of a 20-year journey.

In our example, our investor makes smart investment decisions (based on sound advice) and purchases properties that increase in value, on average, by 8% per annum, starting with a value of $450,000 in Year 1 (by Year 9, an investment property costs $832,919).

For the record, our investor pays market price for each property and borrows the full amount for the purchase, including purchase costs. Although our investor owns a home, we’ll exclude it from this analysis.

While you may have heard others give examples of this sort, they often don’t factor in inflation, which effectively reduces the value of money over time. Our analysis does include an inflation rate of 3% pa, making this a very practical example.

 

Number of investment properties

In the first scenario, our investor buys 2 investment properties (in years 1 and 3). At the 20-year mark, our investor has amassed equity to the tune of $1.416 million (in today’s money).

Based on our rule of a 3.5% net yield, this portfolio could generate just under $50,000 pa in income (before tax). This isn’t terrible by any means, but not what you would call ‘comfortable’ considering most people’s retirement plans.

In the second scenario, our investor buys 3 investment properties (in years 1, 3 and 5). As you can see in the graph, just one extra property has resulted in the equity jumping to $2.061 million after 20 years. With a 3.5% net yield, this equates to over $72,000 income pa (before tax).

In the third scenario, our investor accumulates 5 investment properties (in years 1, 3, 5, 7 and 9) and the result is quite dramatic. After 20 years, our investor has amassed equity of $3.175 million (in today’s money). Based on a 3.5% net yield, this equates to over $110,000 pa (before tax).

If you’re curious about the figures when inflation isn’t considered, the third scenario results in equity of $5.8 million with a portfolio worth almost $9 million.

Conclusion

There are many other matters to consider of course, such as how to deal with any residual debt and whether or not commercial or other higher yielding property should be added closer to retirement. If you would like more information about securing your financial future or to discuss your specific circumstances contact us at info@momentumwealth.com.au or on 08 9221 6399.