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Is Property a good investment in retirement?

Is Property a good investment in retirement?

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Australians’ love affair with property continues, and it is not cooling off any time soon. And the incredible thing is that all the migrants follow this trend as well, so no wonder the property prices around Australia keep going up. Our property prices got to the point that based on the data from the International Housing Affordability Survey from 2020, Sydney was placed as the 3rd most unaffordable city in the world and Melbourne at No 4, only after Hong Kong at No 1 and Vancouver at No 2.

This survey is not ranking cities based on the actual price but based on our affordability of an average property price and median household income per each city.

Does it mean that the rest of Australia is affordable?
Absolutely not, many other cities and districts are very close behind, so if buying an investment property is your plan, please do your due diligence, lots of research and speak with professionals.

So let’s look at investment property from the perspective of the retirement asset, so asset that is supposed to assist you in your retirement and provide an ongoing stable and reliable income.

Real property that has been rented out provides two forms of financial benefit:

  • rental income
  • capital appreciation
Rental Income:

You retain ownership of the physical assets while generating an income by renting out the property. The properties can be rented out for residential or commercial purposes, or as a holiday house. There could be tax benefits that come with owning a rental property, but that depends on your financial situation and your level of taxable income.

If we are looking at tax benefits in your retirement phase, I wouldn’t be surprised if all those tax benefits were unutilised by you, as most likely your retirement income is either below the taxable level, or you are on a very low Marginal Tax Rate. If in retirement you are paying a high tax bill, please review your retirement planning and tax-planning, as this should not be the case.

Capital Appreciation or Capital Growth:

Owning the property for some time or making significant home improvements, will help your property to appreciate in value. If that’s the case, you could decide to sell the property, to access the equity for other investment ideas. You may decide to live off the total sum, reinvest in shares, downsize into a smaller property, or boost your superannuation. Just make sure you fully understand Capital Gains Tax on the sale of your real estate.

Negatives of buying rental property:
  1. very high entry costs – very often prohibitive to buy outright, hence necessity for a loan. However please do not do it in retirement, as any interest costs will only deplete rental income received, this is not a good retirement planning.
  2. lack of diversification – how many properties can you buy? And please do not invest all your savings into one investment property for retirement, even if this is what you dream of all your life, you need asset and income diversity in retirement. Do not put yourself in a situation on relying on one source of income, especially with the property where you are relying on this one physicals person called tenant – covid is a perfect time to show what happens when things go wrong, and they are totally outside of your control.
  3. illiquidity – you either sell the whole asset or nothing, you cannot sell one window, just because you have an urgent bill to pay,
  4. there could be problems with underlying property, that could end up being a very costly exercise
  5. lack of tenant or a bad tenant could be a real nightmare
  6. high ongoing costs that will reduce your level of retirement income – discussed in a minute
  7. reliability of rental income – rental income can become a reliable supplement to your other forms of income, as long as you have a reliable tenant that is. And that will depend on the economic situation in Australia, interest rates, location of your property, price of rent requested, affordability of possible tenants and many other factors.
High ongoing expenses on your investment
  • annual insurance,
  • annual council rates, maybe you have to pay body corporate fees
  • ongoing property management fees,
  • income tax and accountant fees – even if you are retired and income earned is below the taxable level, you need to do your annual tax return for rental income earned, unlike income from pension funds
  • maintenance expenses and renovations if needed
  • water rates
  • cost of interest if you still have a loan.

This list is most certainly not an exhaustive one, but it gives you an indication that real property is not an easy, buy and forget type of asset, which generally we could say about superannuation, managed funds or even shares if you are a buy and hold investor.

Investment Property and Age Pension

So now let’s review holding an investment property while you want to be receiving Age Pension.

As you have seen me repeating in many videos, that Centrelink office runs two tests: Income Test and Assets Test. Whichever one give the lower Age Pension payment outcome, this is the payment you are going to receive.

Therefore, the same treatment is applied to your investment property.

Income Test

Let’s look at the rental income first – based on Social Security rules, Centrelink office will allow to deduct 1/3 of the income to cover your ongoing expenses, therefore as an example if your receive $500pw in rental income, Centrelink will deduct $166pw for your expenses and calculate the difference, therefore $334pw as your earned income under Income Test.

If in addition you have a loan of say $200,000 at 3.5% that means you still have to meet repayments and Centrelink will allow to deduct the interest payable on money borrowed.

If we calculate, your annual interest on $200,000 loan is $6,000, which is $115pw. Therefore the previously calculated income of $334pw, will be further reduced by $115pw, leaving $219pw as the final income calculated under Income Test.

I think this is pretty reasonable treatment of income, but I repeat, from the perspective of reliability and security of your retirement income, I do not recommend buying an investment property if you have to borrow funds. Even if you bought a property earlier, now you are ready to retire, but you still have a huge outstanding loan, this is a risky retirement plan, as it is very easy for things to go wrong and if you don’t have back up assets you are toast – I think I used that expression before – maybe I am hungry

Asset Test

When it comes to the Assets Test – It depends. So let’s see those options:

  1. If you own the property outright – the Centrelink office will calculate the actual property value under Assets Test. This happens when you are first applying for Age Pension, Centrelink usually send out their contracted valuers, who will advise of the value of your property with updates happening when Centrelink requests it.
  2. If you have a loan of say $200,000 against your investment property valued at $500,000, then Centrelink will only calculate the net value of your property of $300,000, that is fair.
  3. If however you have the same loan of $200,000 to buy the same property of $500,000 but that loan is secured by your family home, you have it all wrong, as the Centrelink office will actually assess the investment property at its full value of $500,000. As you know from my previous videos, family home is in most cases an exempt asset, therefore the loan of $200,000 is not even considered by the Centrelink office in your Age Pension assessment under Assets Test. This is an example of terrible planning and not understanding the system.

The difference of this $200,000 can mean a solid level of Age Pension as opposed to not having any payment at all. So my suggestion is for you to talk to an expert either how to fix it and even better, speak to a financial planner long before you start the process of buying a property.

So to finish off, I think that if you are a self-funded retiree with lots of savings in super, shares and other income deriving investments, then an investment property or two or three are a great way to diversify and continue growing your estate. If this is you, what I would stress immediately is the fact that you need a solid Estate Planning tool, so if you missed that essential part of planning, please contact me for a chat to find out what should be done to improve and secure passing your assets to your chosen beneficiaries.

If however you are either just above the cut off point for the Age Pension or you are receiving part Age Pension, I think that rental property ownership might be of too high risk, form the perspective of income that may not be as reliable as you would like it to be, high ongoing expenses, lack of liquidity.

If Age Pension is your goal, be very careful as if the property grows up in value, it can prohibit your access to Age Pension altogether, as Assets Test is not as generous as it used to be few years back.

“Retirement is a journey NOT a destination, so be well prepared for the ride” 

By: Katherine Isbrandt CFP®
Money Strategist & Retirement Planner
Principal of About Retirement

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