Across the world, property has been a great investment story. And this has never been more true than right here in Australia. Many investors have ridden the property wave during the past few decades and enjoyed tremendous capital growth, rivalling the returns of Australian and global share markets.
In this country, investors have also been fortunate to be able to take advantage of the phenomenon of negative gearing. Introduced in the early 1980s, the aim of negative gearing was to increase housing supply for renters by providing tax benefits for the investor. This tax benefit has seen investors flock to residential property investments during the past 30 years, with demand pushing prices to the lofty levels we see today.
We are also currently seeing an increasing number of baby boomers retiring, with the first baby boomer having reached age 65 in 2011.
Many of these baby boomers have grown their wealth by holding property during the past three decades, in addition to their superannuation funds. As people move into the new phase of life, retirement, it is critical their investments match their needs.
They no longer have a steady income from employment; rather they will need to rely on the income delivered from the assets they have accumulated over their lives.
So where does property fit into these plans?
One of the great things about property is that it has delivered excellent capital growth for investors. Not all have experienced this, but most have. In fact, according to the Australian Bureau of Statistics, since 1880 house prices have increased four-fold after accounting for inflation. The interesting thing is that from 1880 to the mid-1950s, house prices remained stagnant after adjusting for inflation. The four-fold increase occurred from the mid-1950s through to today.
This growth has put retiring investors in a sound financial position. Property has performed as well as shares, particularly in the last 30 years. The latest Russell Investments Long-term Investing Report shows that although shares outperformed property over the 20-year period to December 2012, property outperformed shares over the 20-year period to December 2013.
For those investors who have been able to repay the debt on their investment properties, they will retire with a source of income from rent. An investor who can have different kinds of investments and therefore, multiple sources of income, will put themselves in a much stronger position in retirement with far less risk.
So what are the things that retirees need to look out for when investing in property through retirement? The first fundamental issue is that the primary requirement for a retired person is cash flow. Unfortunately, after the costs of maintaining an investment property the income that is actually received from the investment averages around 2 per cent; lower than interest earned from a bank account. This clearly does not meet the needs of most retirees. Without cash flow, it doesn’t matter how much capital growth one has; and I have seen too many people under financial pressure as they are asset rich and cash-flow poor.
Another important factor to consider is that once retired, it is important to be able to access money for one-off expenses or unforseen events. A difficulty with property is that we cannot sell a bathroom or a chimney to access some cash. This lack of flexibility can often limit the freedom we have in retirement as we are bound by the fact that a property is an illiquid asset.
The above “bad” factors need to be considered, but as long as we are aware of them they can be somewhat managed. However, there are some risks we need to be aware of that can have a long-term detrimental impact on our financial position and more importantly, the rest of our lives.
The biggest risk a retiree can face with holding too much wealth in investment properties is having all your eggs in one basket. We so often hear people say that property in Australia can never fall in price, but I have seen many people holding properties that have fallen in price, which seemed like great investments at the time.
Now, I’m not saying that property prices will fall, but we should not be naive in thinking that they can never fall. The thousands of property owners in places such as the US, Germany, Japan and the UK also never expected their property prices to fall; yet fall they did.
In conclusion, property investments have an important role in a sound investment portfolio. We simply need to ensure the investments as a whole deliver on our requirements throughout retirement.
No matter what your situation, the key to retiring comfortably is not entrenched in finding that perfect investment that hopefully has amazing performance. The key is managing risk and protecting the money for which you have worked so hard.