Property investment for retirees
Investors seeking a better return on their money than bank deposits are turning to property investment in droves, spurred on by the fact bank interest rates are no longer keeping ahead of inflation.
Property investment provides two kinds of return – the income yield, which is the rent less expenses, and capital gain, which is the difference between the selling price and the purchase price of the property. As it stands, the income yield alone on many properties is higher than bank interest rates and there is the prospect of additional return through capital gain. It’s no wonder investment properties are being snapped up.
Investing in property is a popular means of building wealth for retirement and it works well in that regard. Property investment uses the principle of leverage, which is simply the ability to borrow money to invest. By using borrowed money, capital gains can be magnified if property values increase by more than the net interest paid. Typically, keen property investors will build a portfolio of properties using borrowed funds in the expectation that the increase in value of the properties over time will allow them to sell off one or two at retirement leaving a portfolio of properties with no debt. The plan is that the rental income from the remaining properties, less expenses such as rates, insurance and maintenance, will produce an income for retirement.
Broadly speaking, investments fall into two categories – growth assets and income assets. Property is a growth asset, as are shares and while growth assets do still generate income, their return comes mostly from capital gain which is accessed when the investment is sold. On the other hand, income assets such as bonds provide ongoing cashflow but little capital gain. As a result, property investment is a great way to build wealth up to the point of retirement, however there are a number of factors which make it a less than ideal source of retirement income.
Property is a long-term asset – it is not something you invest in for the short term. There is no guarantee that prices will keep increasing, so property investors need to be prepared to stay invested until they can sell at the right time.
Property markets have cycles just like any other growth asset - there have been periods when property prices have dropped or remained stagnant and times when property has been hard to sell. It’s easy to forget this when the market is buoyant. Also, investment property sold within a five-year period may attract capital gains tax through what is called the ‘Bright Line Test’. Your accountant can give you more information about this.
Many people live for twenty or even thirty years in retirement. Investment property held over that period of time usually requires expensive maintenance such as painting, roof repairs and replacement of floor coverings. Financial pressure can result unless provision has been made for these expenses.
Furthermore, income from property is not constant, as there are often periods between tenants when the property is vacant and occasionally tenants do not pay or cause damage to the property. Unemployment levels are expected to rise through the next year, and some tenants will undoubtedly find it hard to make their rent payments.
Being a landlord, even if you hire a property manager, is not fun if you are in poor health or in your late retirement. As well as the hassles of dealing with tenants and maintenance, there is also the need to keep records of all income and expenses and to prepare an annual tax return.
But perhaps the most compelling disadvantage of investing in property in retirement is that although it produces an income, it is difficult to access your retirement capital. Managing your money in retirement is all about making sure you have money available when you need it. That means using up your capital as well as the income from that capital.
Unless you have a desire to leave a large inheritance for the beneficiaries of your estate, at some point you will need to sell your investment property and invest in liquid assets that can be gradually spent for your enjoyment over the course of your retirement.
Liz Koh is one of New Zealand's most well-known financial commentators and is a certified financial planner and chartered accountant. She has run many successful seminars on wealth creation and has worked in strategic planning and research for major corporations, including Databank and Ernst & Young.
Disclosure Statements for Britannia's Financial Advisers are available on request and free of charge. Product Disclosure Statements for the Britannia Retirement Scheme and the Integral Master Trust are available from the schemes’ issuer, Britannia Financial Services Limited, phone 0800 500 811.
The information contained in this article is of a general nature only and does not take into account individual circumstances. It is not intended to provide comprehensive or specific financial advice. Before making an investment decision you should talk to your Britannia Financial Adviser.
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