If share markets make you nervous with their volatility, then investing in property is a valid alternative for building a retirement income.
And let’s face it, money in the bank experiences very little growth after you take into account inflation and income taxes.
But what are we aiming for when building a property portfolio?
It is important to set goals when investing in property and then choose a proven strategy that will help us achieve those goals.
Work Out Your Required Income
Let’s say you are 40 years old and want to retire at 55 years old. You are currently paying off your own home and in total you are living off an income of $65,000 per year which is enough to cover your mortgage and expenses and a little bit left over for savings.
When we adjust for inflation of 3% per year, to maintain the present day income, you will require 1.55 times this current amount or approximately $100,000 per year.
Where did I get the 1.55 number from? I plugged in the 3% inflation rate into a compound interest formula, so it looks like this:
(1 + 0.03) ^ 15
That formula might look fancy, but all I’ve done is add 1 to the inflation rate of 0.03 to get 1.03 and then use the “to the power of” function on my calculator with the 15 year period. That gives us the factor we need to multiply by our starting amount ($65,000).
Ok, so we think we will need $100,000 to live comfortably in 15 years time, based on the average inflation rate compounding over that time.
Now that we know how much income we need, we can work out how much assets we require to generate that income.
Work Backwards to Get the Total Property Value
Now let’s say that the properties in our portfolio will average 6% yield which means every year, our income will be 6% of the total property assets we own (ignoring any debt).
So $100,000 is 6% of our total property value. Therefore if we divide the required income amount by 6 and multiply by 100, we get our answer.
100,000 / 6 * 100 = $1,666,666
We need over $1.6 million of unencumbered property by age 55 to replicate the present day salary of $65,000.
This might sound like a lot of money, but this could translate into having just 2 properties worth $800,000 each or 4 properties worth $400,000 each and that is in tomorrow’s money.
Identify Your Strategy
Now that you know how much property you need to retire with, you can choose your property investment strategy.
Keep in mind, if you are using debt to fund your property acquisitions, all of this debt will need to be paid off by the end of the 15 years. Otherwise, you can apply the calculations to a mixture of debt and equity in your portfolio.
This means the $1.6 million in value may be the net equity you have in your portfolio but your overall property holdings may be twice that amount (with 50% debt).
The expected yield will play a big part in the final value of property that you require. If you can get 10% or higher yields, then you will need less property but if you can only get 4 or 5% yields then you will need more property to generate that same income.
Of course, if you are buying lower yielding properties then you will probably be also aiming for higher capital growth and therefore your end amount may be higher such as around $2 million in net equity.
So this is how you can work out your goals when it comes to property investing. This is a rough guide and does not take into account the expenses required to hold a property which will vary wildly depending on the type of property and location.
Everyone’s situation will be unique. If you are younger, you may be earning less, but you’ll have longer to achieve your goals. If you are older, you might have a shorter time frame but more money to invest.
So use these calculations to determine your requirements in retirement and start accelerating that property portfolio!
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