Every now and then I see people recommending a rental property as a great retirement investment.
If you have plenty of assets, a rental property might be a good investment as part of a broader investment portfolio.
But I think it’s a bad idea to tie up the majority of your retirement nest egg into a rental property.
I wouldn’t do it. And I wouldn’t recommend it to close friends and family members.
A rental property doesn’t let you spend (or rather, enjoy!) your capital through retirement
Last year I wrote an article where I explained why you may not need to save as much for retirement as you think.
I explained that if you only spend the income generated by your retirement assets, you’ll enjoy a lower quality of life than if you spent some of the capital.
Living off the income of your assets is great for your kids, because they’ll stand to inherit more from you.
But if you spend some of your capital, and do this in a measured, carefully managed way, you can enjoy a much higher quality of life. This is called “decumulation”. Retirement calculators like the calculator on Sorted.org.nz assume that you spend your capital in retirement.
The reality is, most people need to do this. Not everyone can live off just the income of their retirement assets.
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It’s even legitimate for wealthier people, who want to enjoy more of the wealth that they’ve worked so hard to build while they’re still alive.
The trouble with locking most of your investment assets into a rental property is that you’re effectively locking yourself into a situation where you can only live off the income.
Maybe the income yield from a mortgage-free rental provides a decent income that supplements your NZ Super income. But without arranging a reverse mortgage or something similar, you won’t easily be able to spend more – whether that’s because you want to spend more or whether you need to spend more (for example, for medical reasons or a family emergency).
Relying on a rental is risky
I’ve written about this before so I won’t go into this in detail. But if your money is tied up in a single property, your investment is:
- Undiversified. All of your eggs are in one basket. You’re subject to risks associated with the property market in general, as well as your specific property. What happens if the property is untenanted for an extended period of time? If there is a major issue with the property that requires funds they can’t easily access? What about if there is an earthquake and they weren’t appropriately insured – and even if they are, they have to go through a long period of negotiating with insurers, not receiving income etc? As Martin Hawes said in a recent presentation: his three rules of investing for retirement are “diversification, diversification, diversification”. I couldn’t agree more.
- Illiquid. If you want – or need – funds at short notice, things can get tricky. Unlike most shares or interests in most reputable managed funds, where you can access some or all of your investment fairly quickly, with property there is a great deal of uncertainty about when you’ll be able to sell and how much you’ll sell the property for. On top of that, there are significant transaction costs involved with buying and selling property.
I’m open to the idea of property being a good retirement asset.
Especially if it is a part of a diversified investment portfolio, and/or there are unique characteristics relating to the client’s situation that make it suitable. I’ve got clients who have accumulated a lot of wealth and have a number of rental properties, and it makes some sense for them to keep investing in this way – especially since they understand the investments (including the risks) and can usually add value.
But I always recommend expanding and diversifying their investment portfolio to include financial assets which provide them with some liquidity and allow them to spend some of their capital and enjoy their hard-earned wealth.
Personally, buying a rental property as a retirement investment is not for me.
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