Over the last few weeks we have been talking a lot about the “why” in our lives and what it is that we really want. We have also spoken about property as being the simplest and most effective vehicle to produce regular income – but really, you could choose any investment asset that suited you. Property just happens to be the favoured asset of most Australians. And we have talked a lot about having assets that will produce the income we need for the lifestyle we want.
But how do we achieve that? How do we know what we need to do? How much property do we need to have that freedom & choice?
The answer is simple – we must start with the end in mind.
That might sound a bit counterintuitive, but we can’t start on the journey unless we know which way we are headed or where we are going to end up. Otherwise we are just going to go around in circles and not end up anywhere in particular.
So your first decision is – how much income do you want to have for your lifestyle? This is income that you don’t need to exchange your time (work) for.
That number could be wildly different for each of you. For the sake of the exercise, I will assume that an income of $100,000 would provide a reasonable standard of living – your own personal number may be much higher or much less than that – only you can decide how you want your life to be. The first part of the exercise is some mathematics. No groans please – you need to be able to do some basic math to understand the what’s and why’s and wherefore’s – and if you can’t – pay someone to explain it to you!
If you decided that you wanted a $100,000 income flowing from your assets, you would need to be able to calculate what net return your assets could, would or are flowing to you. For example, most capital city residential real estate will produce around 4-5% return. For easy math, let’s just say 5%. To work out the value of the assets needed to produce a $100,000 income with a 5% return, you divide $100,000 by 5%. Your calculator will tell you that you need $2,000,000 worth of capital city residential real estate, to have a freedom & choice $100,000 lifestyle.
Easy right? That’s only about 4 houses. Everyone should be able to do that? Not so easy I know, but over time with a good plan, it can be done. The key is, this simple math also assumes that you completely own these houses – no mortgages. So, either you get very good at paying off your mortgages, or you find a way to buy, say eight properties. Then when you are ready to do so, sell down four, pay the tax and pay off the four you have left, leaving you with free and clear property earning you $100k per year. Again, easy right?
But we have to also deduct costs in running our houses – that could be 20-25% of our gross rent. That means you probably need about $2.5M free & clear property owned to get your $100,000 net income. Or if you are expanding your portfolio to later sell off and pay down debt, you would probably need to own 10 houses. The mountain becomes steeper.
The way to lower the amount of property you need to own to get that $100k income is to have property with a higher return – positive cashflow property – something north of 8% rent return. If you could own property that provided you a 10% income return, you would only need to have $1M worth of property owned free and clear to achieve your $100,000 income – the mountain is now not so steep. Or perhaps you could have a mixture of positive cashflow property at 10% and some capital city growth real estate at 5%, blend your return so your portfolio makes 7.5%? Then you need to own $1.5M worth of property to achieve your $100,000 income target – all of this of course is not including the home you live in.
Over the next few weeks, we will spend a bit more time on planning and designing your investment portfolio, so you can do what you want to do rather than what you have to do.