To answer this question, here is an article from a previously published WAGMAGazine, written by Xavier Quenon...

One of the most common questions that I hear investors asking me is ‘What do we do when it is time to retire?’

Part of the beauty of property investing is the range of choices it opens up to investors. There are a range of retirement strategies that are open to suit different types of property investors.
First there are many types of properties an investor can choose as their preferred vehicle. These can be residential, industrial, retail, office or some people choose to simply invest in land.
As there are different types of assets in property, there are a variety of investment strategies. Here are just a few.

1.  Buy and hold.
2. Renovate and hold or renovate and sell.
3.  Developing land or apartment projects.
4.  Offering ‘Rent to Own’ arrangements to your tenants also called ‘Wraps’.
5.  An investor can also mix and match between these different strategies if they wish.

Few people realise, however, that there are also many choices available to property investors in terms of how they retire on property.  In the same way that there are multiple means of investing in property, there are also multiple ways to use property to retire wealthy – or early. Let’s have a look at three ways to do that and the ins and outs of each option.

Method 1: Retire on Rental Income

This is the ‘plain vanilla’ approach to retiring on property, the one most investors automatically think of. The investor accumulates a leveraged portfolio of properties over time and then sells some properties to pay down any outstanding debt. The remaining properties in their portfolio are either unencumbered (that is, there’s no debt associated with the properties) or have only a small amount of debt associated with them that the interest on the loan is minimal. The passive income supporting the investor in retirement is the rental income generated by the unencumbered properties. This is the method advocated by well known property writer Jan Somers. Let’s take an example of this particular strategy.

An investor calculates that he needs six unencumbered properties to retire. He acquires ten properties over a period of years, lets them appreciate to a value of $9 million financed by $4million in borrowings. He then sells four properties (paying sale costs and capital gains tax), leaving six unencumbered properties. The rent from these six properties provides the funds to pay the investors an income sufficient to cover living expenses in retirement.

Method 2: Critical Mass Strategy

In this method a property portfolio is accumulated, as in the ‘retire on rental income’ approach, but instead of selling properties to pay down debt, the entire portfolio is refinanced in retirement so that the Loan to Value Ratio (LVR) is topped up periodically to provide funds.

Both Metropole property investment strategist’s director Michael Yardney and Wealth Acceleration Group’s chairman Jacque Mamet both advocate this approach. With this method the passive income is the additional borrowings to pay for the groceries. The interest is capitalised, that is, it is added to the principal and the interest is payable on the new, larger borrowing amount. Rents and tax deductions are used to reduce the overall cost of the portfolio. The Investor may need to rely on low doc or no doc loans. Yardney maintains that a bank will likely be happy to lend to a borrower with an LVR of 60 percent or less without the borrower having to show a real income. On the plus side, the funds generated by the refinancing aren’t classed as income so tax isn’t payable. It is important to note that the investor’s portfolio needs to have reached critical mass to enable this strategy to function – this means that the difference between the value of the portfolio needs to be in tune with the required income needed from the portfolio. Here’s an example of how the Critical Mass strategy can work.

An investor has accumulated a property portfolio worth $8 million with $4 million in borrowings associated with it. The investor’s LVR is therefore 50 per cent (4 divided by 8 equals 0.5 which is 50 percent). The investor requires $100,000 to meet her living needs.  So she refinances to 60 percent LVR and frees up $800,000 of equity in a Line of Credit. This enables her to pull out $100,000 in tax-free funds to live off for this year and further $100,000 lump sums most probably for the next 6-7 years to come.

The $100,000.00 is added to the $4 million debt, taking total borrowings to $4.1 million. At a later time, the property can be revalued and the Line of Credit readjusted accordingly.

Method 3: Sell up and Park

The sell up method treats property investing as a means of accumulating wealth to retire but not of generating income in retirement.
The capital growth of the portfolio is what creates the wealth with this approach, and the wealth is then transferred to a different vehicle that has no borrowing commitment, nor any tenant or property management concerns. An investor using this approach would build their property portfolio focusing on high capital growth properties rather than cash flow positive properties. The trade-off for these benefits is that in retirement the income is subject to other forces like the stock market or interest rates, depending on where you decide to park your money.

There seems to be one main flaw in this strategy. The question to ask oneself is that if property has brought the benefit of building your portfolio for retirement why would you not trust it in retirement.  Or I could put it a different way and ask why one would trust an asset class that they did not rely on or trust to take them to the point where they could retire.

An investor builds a high capital growth portfolio of four properties worth $3.5 million financed by loans of $2 million. He sells all four properties and after extinguishing the loans and paying capital gains tax on the sale plus sale expenses, is left with net proceeds of $1.1 million. This amount is invested in a managed fund which pays an average 6 percent (or $66,000) distribution per year, providing the passive income that pays the investors living costs in retirement.

Mix and Match

One thing to bear in mind is that many investors will likely have some funds coming to them in retirement from compulsory superannuation. These funds could be used to pay down debt in the ‘retire on rental income’ or ‘critical mass’ methods. Or they could be used to supplement income in retirement, while keeping the tax advantages associated with borrowing, provided that there’s sufficient income to meet the investor’s desired standard of living.

Each of these three methods uses property wealth in a different way to support retirement and each generates passive income in a different form. It is useful to note though that these three methods are not completely mutually exclusive: you can mix and match elements of each according to your preferred trade- off risk and return. This brings us full circle as to the range of choices that property investing affords. Not only the type of property you accumulate and the investment strategy which guides your accumulation efforts, but also in how you use property to fund your early – or wealthier- retirement.

If you would like to explore options to create a wealth building property portfolio, contact us on 07 3489 2555.