The Three Core Strategies
There are 3 core strategies to a property pension:
- Buy & Then Hold
- Buy & Then Sell
- Buy, Then Part Hold & Part Sell
There are variations within these strategies but every strategy will fall within these core three. Remember from the last chapter the definition of a pension, being the objective of a property pension:
‘have an income sufficient enough to meet all your needs in retirement’
Well the 3 strategies above can meet this objective.
In more detail:
|Strategy||What it entails||Features|
|Buy & Then Hold||This involves buying a property (or properties), repay for it in full by retirement and live off the rental income through retirement.||You rely on the property to be an easily rentable property so as to provide a safe income for retirement.|
|Buy & Then Sell||This involves buying a property (or properties), making the repayments during the period of ownership and then sell the property and clear the debt (if any). The balance of the monies are then used to purchase an annuity to provide an income till death.||You rely on the growth of the property to be sufficient enough to purchase an annuity to meet your target income in retirement.|
|Buy, Then Part Hold & Part Sell||This involves doing a mixture of both strategies above.||Combination of both above.|
Choosing The Right Strategy
You need to choose the strategy that’s right for you based on your level of time, money and acceptance of risk. Here’s how these strategies could work with the level of time, money and risk a potential investor has:
Buy & Then Hold
|Buy a desirable property with less than a 9% yield on a repayment mortgage and place with a letting agent to manage the property. The investor understands that he might have to contribute on top of the rent to cover the mortgage payment but has the assurance that the property will be paid in full. It will then provide an income for life.|
Buy & Then Sell
|Buy a property in a less desirable area but yielding in excess of 10% on an interest only mortgage. The investor will manage the property himself but knows that it is unlikely that he will have to contribute on top of the rent as the property yields high and the mortgage is interest only. He hopes that the property value grows sufficiently in value in order to purchase an annuity to provide him with an income till death.|
|Buy, Then Part Hold & Part Sell|| |
|He does a bit of both above. He is happy to buy more than one property and manage them himself. He uses the profits from some to fund the others but his risk is reduced due to the investor not relying on one single strategy. Overall risk is medium due to the greater exposure he has to the property market but he can capitalize in each market when the market is high.|
So think about whether you want to own and run a property or properties pre and post retirement. Think about how much money you want to put away for saving up for a deposit and ongoing pre-retirement. Think of the level of risk you want to expose yourself to – Do you want only one property or a few? Do you want repayment or interest only mortgages? Do you require a risk free income in retirement?
Based on your own profile and personal preferences you should come up with a strategy you want to go for. To help you decide lets look at some examples. I have decided to ignore tax consequences in these examples to keep the figures simple.
Buy & Then Hold
Richard has the following profile:
|Target Retirement Income at today’s value|| |
|ACCEPTANCE OF RISK||Low|
He has decided that he wants to Buy & Then Hold so he can pass the properties down to his children. But he also doesn’t want to pass any debt on so he intends to own the property outright. He works full-time so he doesn’t want to manage the properties and he wants desirable properties that are easily let out. He has the ability to save and a willingness to contribute on an ongoing basis if need be.
The strategy would to be buy one or more properties that give a rental income of £24,000. As he is a low risk investor he would buy a low yielding property, such as 8%, on a repayment mortgage. This could be 3 properties costing £100,000 producing an £8,000 per year income. He will also have the property managed by a letting agent.
I have created a Yield Profit Table. This is in the Appendix. It calculates the profit every month based on a £100,000 purchase price for each yield on an 85% LTV repayment mortgage. The interest rate is set a 5% APR and the term of the mortgage is set as the number of years to retirement. It also allows for 20% of rent to be lost in expenditure and voids.
If we look at the Yield Profit Table in the Appendix for this example we can see that an 8% yield £100,000 value property has a monthly profit figure of £30.75 if he is 25 years off retirement. This is how much you will get back every month if you invested from day 1. So he knows that if he buys today he will not have to contribute on an ongoing basis and the property will be his in 25 years.
He knows that he has to buy more than one property if he is to achieve an income of £24,000. 5 years later he sees the property next door for sale at £110,000. Because he has been saving he can afford the 15% deposit of £16,500 (being 15% of £110,000). The property is yielding 8% and looking at the table for 8% with 20 years off retirement for £100,000 purchase price the profit is:
-£35.05 i.e. £35.05 loss. Because the purchase price is £110,000 then the loss has to be increased by 1.1 so the overall monthly loss is £38.56.
Another 5 years later the house on the other side is for sale at £120,000 and yielding 8%. He decides to buy again with a 15% deposit of £18,000. So again from the tables with 15 years to retirement at 8% yield for £100,000 is £149.09 loss. Multiplying it by 1.2 equals a monthly loss of £178.09
So in summary:
So Richard gets 3 properties paid in full providing him with a real income of £24,000 per year in 25 years with an overall contribution of £84,795. The likely scenario is that he will contribute nil as the rent will increase with inflation over time to reduce his overall contribution.
If he required an income from of £24,000 in real terms from an annuity then his pension fund would have to be £524,246. Based on a pension fund growing by 5% year on year this would mean personal contributions of over £1,000 per month!
Again, play around with the figures to see for yourself that however you tweak the figures a property pension is far superior than a traditional pension. If Richard went for a 9% yield on property 2 and 11% yield for property 3 then his contribution would have been zero. But because he had a low acceptance of risk he went for the 8% yielding properties all the way.
Please note in this example even though Richard owns 3 properties it doesn’t matter what they’re worth. Richard owns 3 properties that we know return £8000 per year in rental income NOW in 25 years. So it is safe to say that the will provide a real income of £24,000 in 25 years time. His only risk is if he can’t let them or there has been a deflation in rental values.
Using Your Own Home To Provide A Retirement Income
Some people do use there personal home to provide for themselves in to retirement. The theory is that you downsize to a smaller property due to the kids leaving and purchasing a bungalow in a quieter area and rent out your own property.
The key things you need to consider are:
- Is the rental value of your home equivalent to your desired income in today’s standards?
- Will the property be paid in full when its time to retire?
- Will you have saved enough to buy a property for yourself to live in?
You can always sell your own home and buy two cheaper properties and live in one and rent out the other. This falls in to the strategy of Buy & Then Sell. But the key things you need to consider above still apply.
Buy & Then Sell
Susan has the following profile:
|Target Retirement Income at today’s value||£30,000|
|ACCEPTANCE OF RISK||Medium|
Susan doesn’t earn that much money. She earns £15,000 and cannot afford to contribute anything on a monthly basis. But she does have savings of £15,000 left to her by her late grandmother. Susan want’s twice her annual income in real terms in her retirement within 20 years! Funnily enough this is possible due to her attitude to risk.
She buy’s a £100,000 property yielding 12% on an interest only mortgage. Looking at the table it provides her with a monthly profit of £445.83. Susan is willing to manage the property herself so we can add at least another £50 per month so lets say her monthly profit is £500 per month.
In 4 years, 48 months, she saves all the profit, being £500 per month, to give her a deposit of £500 x 48 months of £24,000 to buy a property of £160,000 yielding 12%. This gives her another monthly contribution of 1.6 x £500 per month of £800 per month.
In 2 years, 24 months, she saves all the profit, being £1300 per month, to give her a deposit of £1300 x 24 months of £31,200 to buy a property of £200,000 yielding 12%. This gives her another monthly contribution of 2 x £500 per month of £1000 per month.
In 2 years, 24 months, she saves all the profit, being £2300 per month, to give her a deposit of £2300 x 24 months of £55,200 to buy a property of £300,000 yielding 12%. This gives her another monthly contribution of 3 x £500 per month of £1500 per month.
So in summary:
So overall there is a net profit of £531,200. This goes forward to purchase an annuity. But we still own the properties and their associated debt. The scenario may look like something like this after 20 years from the first purchase:
So if we add up the total value of the fund it gives £531,200 + £849,400 = £1,380,600. At the £45.78 annual income rate per £1000 this would equate to
£1,380,600 x £45.78 / £1000 = £63,203
This could be the same as £30,000 per year in today’s terms or it may not. The fact is that a fund has been amassed with a nil contribution as all the properties (apart from the first purchase) have been funded by the profits from the rent. The beauty is that if the market peaks at any point after you have purchased you are free to sell to maximize your gain. If not then live off the rental income until its time to sell.
Now the property purchase prices don’t have to be the actual price. So in the above example Susan bought a property worth £300,000. This could be 6 properties at £50,000 each (totaling £300,000) being rent out at £6,000 per year. So in fact Susan could end up owning around 20 properties of an average value of £50,000 or so.
Buy, Then Part Hold & Part Sell
An example of this strategy is to do what both Richard and Susan have done. That is to buy a selection of low, medium and high yielding properties on both interest only and repayment mortgages and allow some properties to fund others.
I would suggest that you choose repayment mortgages for properties that you decide to hold and interest only mortgages for properties you decide to sell.