(Because this topic is so big, I had originally intended to break it up into two parts. Turns out it needs three…!).
For those who missed last week’s blog, here it is.
In Bulletproof Investing I provide a template for turning between $80,000 and $120,000 into a net wealth of between $4,140,000 and $4,560,000 over a 20-year period (the amounts differ based on whether you choose to put down a 10 per cent or 20 per cent deposit).
This is what it looks like in year 20 on a theoretical example of someone who buys four properties over an eight-year period and holds them for twenty years from the date of buying the first one:
But what then?
At some point we will want to enjoy the fruits of our labour.
Let’s say you were wanting $80,000 per annum for living. You would need an exit strategy to transition from having growing assets to having income.
Before we get to the exit strategy itself, it’s important to remember that rents go up over time. They typically increase at a rate of 2 per cent above inflation.
We worked out the same property portfolio in the above example would pay you $57,121 per annum in cash flow or income:
If you’re wanting to get $80,000 per annum, you’d need to find another $22,879 per annum.
How do we bridge the gap?
The two ways to get more income from a property portfolio are:
- Consolidation (I’ll cover this in part two); and
- Growth to income conversion (I’ll cover this in part three).
Consolidation
Consolidation is the traditional method used by property investors and involves selling some assets (property) and using the proceeds to pay down debt.
This enables us to increase our income, and potentially also pocket some cash.
For example, let’s say you were to sell ‘Property 4’ in the above example (which makes sense, given it would have the least amount of capital gains tax and lowest rental income).
By selling ‘Property 4’ for its value at year 20 ($1,300,000) you would pocket approximately $1,108,800 after paying sale costs and capital gains tax. If you then used the full $1,108,800 to pay down debt across the property portfolio, you would reduce your debt from $1,960,000 to $852,200.
You have less rental income, but you also have a lot less debt. As a result, your cash flow would increase from $57,121 per annum to $71,710 per annum:
Your net assets drop from $4.14 million to $3.95 million (the difference being due to sale costs and tax), but the income generated from the properties increases by $14,589 per annum.
You could then go a step further and sell two of the four properties.
Let’s say you were to sell ‘Property 3’ (which again makes sense, given it would have the least amount of capital gains tax and lowest rental income).
Because in this example ‘Property 3’ and ‘Property 4’ were bought at the same time, by selling ‘Property 3’ for its value in year 20 (also $1,300,000) you would pocket another $1,108,800 after paying sale costs and capital gains tax.
After selling ‘Property 4’ you are only left with $851,200 in debt, so you would pay off all the outstanding debt (new debt amount $0) and be left with $257,600 in leftover cash.
You have less rental income, but you now have no debt, and your cash flow would increase from $71,710 per annum to $75,996 per annum.
Plus, you would be sitting on $257,600 in leftover cash that you could either use for living expenses (bills, travel, children or grandchildren) or invest in a term deposit to make up the difference between the $80,000 per annum you are seeking and the $75,996 per annum you are receiving. I’ve also seen people tip the $257,600 into renovating their remaining two properties, to then increase the rents they’re able to get.
There’s another strategy you could use called growth to income conversion. It can be used as an alternative to consolidation, or in conjunction with it. We’ll talk about this strategy next week.
