I often hear financial advisers tell their clients that their primary residence is already a sufficient asset in bricks and mortar to hold in terms of an overall post-retirement investment strategy.
They argue strongly against a client wishing to acquire additional residential property in retirement, and living off the rental.
Their arguments are usually well-founded and persuasive:
- The costs of dealing with a fixed property are high;
- Imagine the nightmare of a bad tenant;
- You cannot liquidate a property in a hurry or if you need cash;
- You cannot diversify a single property; its much better to own a Property Trust;
- the investment is not tax efficient because the rental is fully taxable.
The cynic in me suspects this advice is also good for the adviser. Once capital is invested in a second property, it falls outside all remuneration and commission systems for the adviser and fund manager. It is therefore usually not considered at all, and is certainly rare to be even mentioned in an investment proposal.
But, to be intellectual honest, there are very strong reasons for a client to invest in a second rental property as part of their overall retirement portfolio.
Going back to basics, the needs of a client in retirement are quite simple:
- You need an income (in Rands) to pay your living expenses;
- Payable monthly at the end of every month;
- Which goes up every year in line with inflation;
- And there is something left over at the end of your life to leave to your children.
If these are the needs, I cannot think of a better investment than rental property which so perfectly matches the stated needs. A carefully chosen rental property does all the above things. This dynamic is backed up by the theory of asset/liability or cash flow matching.
In fact, the aim of portfolio construction out of various asset classes is to create a total portfolio which behaves exactly according to the above stated needs.
It would therefore make sense in portfolio construction to include one fairly dominant asset in a portfolio which behaves so perfectly in line with the objective. It therefore provides an anchor or even a benchmark for the rest of the asset classes, and possibly provides them more leeway in terms of the risk/return profile. Expressed in another way, if a rental property in a portfolio is delivering 33% of the client’s income needs, the rest of the portfolio can be more focused on capital growth.
A share portfolio may be the next closest single asset class to lead the way, but dividends at best can be fickle and then disappoint just when the need is the most. Also, the fund manager fees will typically take up a fair percentage of the dividends, leaving the client with an insufficient yield.
An inflation-linked Life Annuity is another option which also comes close. However, in times of extreme inflation, the small-print in the contract will usually explain why full inflation is not possible. Also, the annuity will die with you, leaving nothing to your children.
Almost paradoxically, the dominant asset class in most pension funds, namely Government Bonds, provides a very poor match to the client needs. The capital value of the bond pays out in nominal terms while the coupon is often too large in the initial years and because it is also fixed, gets depreciated every year by inflation. It also only pays 6 monthly.
In all my 25 years of managing client portfolios, I have always found that, where a client owns an additional property, it provides a positive and calming effect especially when markets are in turmoil.
There are certainly issues and problems which must be taken into account. To be clear, such advice to own an additional property is not for every client.
But an additional property will often fit neatly into a client’s overall LifePlan. To illustrate, I will give a few examples:
Invest in a Retirement Village
Purchase a property in a retirement village
or similar complex for the elderly long before retirement. There are some retirement complexes which allow for properties to be rented out to tenants. These tenants are often people who have just sold their own residential property, and require capital from the sale of their family home to live out the rest of their lives. A rental option for them usually provides a good solution. These tenants are usually extremely reliable. In addition, the property is maintained by the management of the complex.
At some stage in your future, you can then sell your own residential property (or rent it), and move into the retirement complex yourself.
Build a 2nd Dwelling on your own Property
Purchase a property with 2 dwellings, or build a 2nd dwelling on the same property as your primary residence (if you are allowed!). At first, this can be used to house your refugee children when they inevitably come back home after some setback in life. Such dwellings are often also used to care for elderly parents.
However, at some stage in your life when this makes sense, find a reliable tenant to rent the 2nd dwelling. This can be a wonderful solution when wanting to travel, and
there is a person living on your property to care for your pets or just for security and having a presence on your property when you are away.
Then even later, when you wish to scale down yourself, you can move into the 2nd dwelling yourself and rent out the main house. In this way, the family home will be retained in the family, and potentially left to children in your will.
Purchase a second property in your Security Complex
Purchase another property in the same security complex as where you live. In this way, you don’t need a managing agent because there is no better method of ensuring a tenant does not neglect the property. In addition, the complex usually takes responsibility for the gardens and outside maintenance, which is included in the levy.
So, there is no question, if the matter is carefully considered and structured properly, a 2nd property can enhance the overall retirement portfolio of the client, and work in conjunction with a client’s LifePlan. In fact, a good LifePlanning discussion often starts with the client’s primary residence, because that discussion starts to tease out what the client really wants to do with their life after work.
As a LifePlanner, I charge a fixed Rand annual fee for managing a client portfolio. My fee is not based on the value of a client’s portfolio as is the norm in the industry, but rather on the complexity and time taken to fully analyse a client’s overall situation.
I treat a 2nd Property as a standard question in LifePlanning advice. Such advice can include the following:
- Recommending specifics such as the optimal capital amount to be spent, what type of property and what rental is required. Also, whether to apply for a bond and how much.
- Tax considerations.
- Whose name the property should be held.
- Sourcing an attorney or expert in the drafting of a lease and other legal matters.
- Assist with the risk assessment of potential tenants
- Appointment of a managing agent if required
- Annually reviewing the lease, and processing of the increase in the rental.
Because my advice is strictly fee-based and payable by the client, I am uninhibited in the range of my advice. This is fundamentally different to the norm in the industry where ongoing fees and commissions are based only on a percentage of assets under management, and therefore biased towards products and funds which pay such fees on an ongoing basis.
My advice is unbiased and professional. It is incentivized to pursue only the best interests of the client.
Based on my experience and the benefits explained above, a second rental property should always at least be considered when providing retirement advice to a client.
Richard Bryant