How many properties do you think you need to own to generate enough wealth to fund a comfortable retirement? Most people think they need more than 3 properties to become independently wealth.
Of course, the answer will be different for everyone because it depends on your income, existing assets, time until you retire, goals and other factors. However, having been involved in developing hundreds of investment strategies (possibly more than a thousand), I can tell you that 90 per cent of people need to hold somewhere between one or two investment-grade properties. It is unusual for an average person to need to invest in three or more properties.
Quality is the key
Indeed, the number of properties is not really the most relevant measure. In fact, its meaningless. More important is the quality of the assets that you own and the amount of equity you have in them. I would prefer to own only one sensational investment property compared to three average ones.
Maybe it’s a sales pitch
Some books and property promoters suggest that investors should aim for acquiring a portfolio of more than three investment properties. However, I fail to see how this could work and think this is a high-risk approach.
You either have to acquire several low-value properties and are therefore you are likely to compromise the asset quality, meaning they aren’t investment-grade. Or, if you are buying investment-grade property, you must borrow a significant amount of money. I have seen profiles of investors (in property magazines) who have $2 million to $3 million in loans when their family income is between $100,000 and $150,000 p.a. in total. This is a very high-risk approach and a recipe for disaster in my opinion. Given the immense amount of credit tightening over the past 1 to 2 years, it would be difficult to access this level of financing anymore (which is a good thing).
Think about debt
Debt is a great servant but a very bad master. You must control it, not the other way around. Therefore, when borrowing to invest in property you must conservatively assess your capacity to be able to service the debt and sleep at night regardless of the variability in interest rates and repayments.
Also, you need to have a debt exit strategy. That is, how will you repay the debt when you retire? I typically like my clients to have little to no debt when they enter retirement because, at this stage of life, they will be very sensitive to interest rate changes (because their only income source is investment income).
Therefore, if an investment strategy involves borrowing a lot of money to invest, you must also develop a plan for how you will reduce debt before retirement. This might be achieved through gradual debt repayment funded from your surplus cash flow, the sale of investments on or after retirement (property or shares) or drawing a lump sum from super – or a combination of these things. The point is, you must have a clear debt repayment strategy.
Constructing your investment property portfolio
You need to consider a few factors when constructing or planning out what types of properties you will include in your property portfolio. These factors relate to diversification of your portfolio and include:
1) Diversifying geographically
Spread your properties among different suburbs and market segments, and even consider investing in different capital cities. The idea behind this is that markets do not grow uniformly so, by diversifying geographically, you will hopefully smooth your return (growth). Growing your asset value will allow you to access further equity to assist you in building wealth.
I realise that it is tempting to invest in one location you know well. However, the benefits of diversification should not be discounted.
2) Diversifying across various price points
Different sectors of the market (in terms of price points) will perform differently at different times – mainly because different buyers drive this performance. For example, if you have an investment apartment already, then you could look at buying a house for your next investment – and vice versa. Stick closely to the median value within a suburb too – because that is the price point likely to attract the larger volume of buyers.
3) Diversifying your tenant profile
This involves owning properties at different rental income amounts so that you appeal to a wide sector of the market. For example, if you have a house as an investment and are charging, say, $800 per week in rent, then you might be better off investing in an apartment next at a rental level of $400 per week (to reduce the risk and financial impact of vacancy).
Also, different types of properties will appeal to different markets – some will appeal more to couples and singles, for example, whereas others will be more suitable for professionals or for families. It is advantageous if all your properties do not appeal to any one market.
4) Investing in a different market to where your home is located:
While your home is purchased for different reasons than building wealth, investing in a different geographic location from your home is advisable. I’m not necessarily suggesting a different state, but a different suburb is advisable for the purposes of geographical diversification.
Your home can be an investment too
When coaching my clients, I try and encourage them to approach a home purchase similar to an investment purchase. I realise this is not always possible and there are maybe lifestyle considerations. However, I know the significant compounding benefit to my clients of buying a home that generates a strong amount of (tax-free) capital growth. Sometimes its possible to have your cake and eat it too i.e. a nice home that also makes a good investment.
Leave some room for other investments
Another very good reason not to try and buy too many investment properties is to leave some room to invest in other assets such as shares or making additional super contributions. If you over-invest in property, you might find that all your eggs are in one basket and that might be something you end up regretting.
You probably only need one or two investment properties
Most people will only need to acquire one or two investment-grade properties to fund a comfortable retirement. A few people might be able to comfortably invest in three. However, it is very unlikely that you will need more than that.
If you feel strongly that you need more than 3 properties, or someone is suggesting the same to you, please get a second opinion from an independent advisor as it could help you avoid making a very costly mistake.