After a few years the house was worth $250,000, a $50,000 gain on a deposit of $25,000.
If he had sold early on, real estate agents fees would have gobbled up a good portion of the early gain.
At some point or other, he would have had a vacant house and no rent for a few months. Along the way, he would also have had to renovate the property, or add a new roof, or incur other expenses.
And he would not have done so well if he had bought at the top of the market, such as 2007.
The keys to successful property investment are not buying at price peaks, good income, long time frame, patience, good management, and the courage to venture forth and buy a rental in the first place.
Now after some 20+ years, Bill ends up with a with a debt free rental property that is worth a lot more than he paid for it.
Now Bill retires
Now the house is worth $400,000 and the rent is $400 per week, or $20,000 pa.
Expenses are rates and insurance of about $3,000 pa. Maintenance will vary but is probably on average be at least $3,000 pa.
Net rental after expenses is $12,000 pa before tax.
That is only a 3% pa. return (before tax) on an investment of $400,000.
Of course there should be capital gain too, but that is not always there, and anyway it cannot be spent or used as income till he sells the property.
A game changer
The situation has changed. For 20 to 30 years Bill had been an accumulator whilst he had an income from his job. Now he is retired and needs income from investments.
Cash flow is King
We have written previously that “cash flow is king”. Bill used to have income from his job but that has now stopped.
Bill and his wife receive about $26,000 pa government super but they want an income of $50,000 to $60,000 pa.
They do not take long to realise that net rent is only about $12,000 pa. before tax which seems pretty paltry, considering property is worth $400,000.
Furthermore they would quite like to upgrade the car and buy a caravan, but they cannot take a lump sum of $40,000 to $50,000 from the property without selling it.
Their game has changed.
What are their options?
We are not saying they should, or should not, sell the property.
That will depend on their situation, their other assets, and a number of other variables.
The right mix
Since cash flow from their investments has suddenly become their number one priority, and now access to some cash is a priority too, just having rental property alone in retirement is not ideal for them.
The right combination will nearly always include a substantial portion of investments in bonds and shares, as they can fulfil two purposes;
- Provide income
- Provide access to ready cash
The return on their rental property is 3% rental income and say 3% to 5% pa capital gain, a total of 6% to 8% pa.
A balanced portfolio of bonds and shares will probably provide a similar return over time, but with the added advantages of liquidity (access to cash) and of course diversification.
Over the past 20 years we have had a number of people come to us who were around age 65 and were tired of managing rental property.
Some of these people sold a rental or two, and invested in a diversified portfolio which freed them up from looking after tenants, maintenance, and all those other concerns that property comes with.
Property investment can be pretty rewarding, but it takes time.
Once you move into retirement and require investment income, it may not be quite so good.
As always use common sense, and if you are unsure, do half and half.