a retirement investment strategy

If you can wait 5-10 years before retiring in your dream home, here's an investment strategy for you!

Steve White and his wife, Katrina, were facing a dilemma, common to many couples approaching retirement. They had worked hard, saved a few dollars and were looking forward to enjoying retirement in a nice riverside or beachfront apartment close to facilities. Herein lay the problem.

Although they had a pleasant family home in the suburbs, it has not appreciated its value as much as they'd hoped. On the other hand, the price of the apartment they had been eyeing over the years had skyrocketed.

This left the Whites with two choices. Either they dip into the retirement kitty to cover the cost difference, or compromise and settle for a cheaper home. For the Whites, neither option was what they had really hoped for.

A LITTLE PLANNING FOR A HUGE BENEFIT

While it's too little, too late for the Whites, if they had implemented a plan I'm about to share with you 10 years ago, they could easily have afforded their dream retirement home - and most probably have had a little cash to spare.

LOOK TO THE PAST TO SEE THE FUTURE

But before we explain the 'nuts and bolts' of this property retirement strategy, we must first briefly delve into the historical performance of property - and the changing needs of homeowners. You'll see why in a moment.

In the past, young couples got married and headed off to the suburbs to raise a family. But as we all know, 'the times they are changing'. The population is ageing and family formations are smaller than they were in the past. As a result we now have fewer people living in each household and with the busy lifestyles we all lead these days most people want low-maintenance homes to live in. At the same time that this is happening and as a result of inadequate infrastructure on the fringes of our cities there is an increased demand for properties close to our city centres and to quality lifestyle beachfront locations.

The impact of this demand on inner city and 'water or beachfront property means that this type of property is now appreciating in value much faster than other properties in less desirable areas.

Let's presume your suburban family home is worth $650,000 and its average capital growth over the next 10 years is going to be 6 percent (this is the median capital growth of houses in Australia over the last 20 years). You have been eyeing an apartment right on the beach for future retirement which costs about $750,000. $100,000 more than the value of your current home. Quite a gap, but you think you’ll be able to manage an extra $100,000 in the future so that you can achieve the lifestyle you desire in your retirement.  

LET’S SEE WHAT HAPPENS IF YOU WAIT UNTIL RETIREMENT TO PURCHASE 

We’ll wind the clock forward 10 years. Your current home which was worth $650,000 ten years ago is now worth about $1,165,000 based on a compounding capital growth rate of 6 percent – a lot of people are going to have $1,000,000 plus properties in ten years. But those apartments that you had been looking at longingly for years imagining a wonderful retirement have now increased in value at the much faster capital growth rate of 7.5 percent because of demand for those types of properties. That means that the $750,000 that you are currently looking at, as your preferred lifestyle retirement property, now would cost you about $1,550,000 ten years from now. Now that’s a problem. What was a manageable gap of $100,000 is now a much more challenging gap of $385,000.

Starting to get the picture? And that's the problem the Whites faced. It was impossible for the capital growth of their home to keep up with the capital growth of their dream retirement home. But all is not lost - you can use this disparity to your advantage. 

WHAT THE WHITES SHOULD HAVE DONE

Had the Whites been forewarned, here's what they would have done 10 years earlier. For the purpose of this analysis, Steve earns $100,000 p.a. and they own their own home worth $650,000 (the same general principles apply regardless of income or value of home.)

• First, they would have found their dream retirement home. In this case, an apartment on the beach worth about $750,000.
• Second, they would have borrowed 100% of the purchase cost of the new apartment using interest-only loan.
• Third, they would have structured the apartment so that the taxman and the tenant contributed to the lion's share of the repayments.
• And last, they would have sat back, relaxed and waited.

IT'S NOW TEN YEARS LATER AND HERE'S THE WASH UP

Thanks to the capital growth, the White's family home is now worth $1,165,000 (6% pa growth), while their beachfront apartment is worth $1,550,000 (7.5% pa growth).

Eager to move into their luxury beachfront apartment (after all Steve's retired!), they sell their family home and pay off the principal component of their interest-only loan ($750,000). This leaves them with more than $400,000 (value of their home less the $750,000 borrowed for the apartment) for any refurbishment of their apartment (it’s 10 years old now) and still have money left over for retirement, perhaps even an overseas holiday.

The Whites now move into their new home debt free - and with an extra $800,000 in equity that they otherwise wouldn't have had!

What makes this strategy so exciting is that the cost of implementing it, compared to the results generated, is minimal.

Continuing the White's example. If we assume an interest rate of 7.5%, an inflation rate of 4%, and an overall tenant vacancy rate of 3%, the White's total cost of holding the apartment for 10 years was $145,600. An average cost of $280 a week. Now we’re not saying that this is not a lot of money, of course it is, but for a ten year cost of $145,600 your capital gain could be $800,000 based on our example.

The even better news is that these figures are relatively conservative. History shows that the actual vacancy rates of properties in desirable areas are, in fact, much lower than the figures we have used. Interest rates are generally lower over the cycle and as a result of growing shortages of property rents will also rise, reducing your holding costs.

With modern medical science, most people are going to live much longer in retirement. Properties in premium locations are rising in value, much faster than average suburban homes. Retirement should be carefree and financially secure. As you can see, this is a strategy that anyone can use to turn that dream of an ideal retirement home into reality.