A. Brace yourself for one of the longest answers ever in Money Matters! There's lots to say.
Many people would be content in your situation. And, as it has turned out, being overly invested in Auckland housing has worked well for you in the last few years. But that might not continue. Let's look at the performance of your rental properties.
In considering expenses, we won't include the principal paid off your mortgage. That's a saving rather than an expense. It adds to your wealth. Your properties, then, are bringing in about $2030 a month after expenses, or $24,360 a year.
They are worth about $540,000, minus the $50,000 mortgage, which comes to $490,000. So the ongoing return on your investment is about 5 per cent or, after tax, 4 per cent.
You could do better in the bank. But, of course, you wouldn't get the capital gains, which have been super lately. Will that continue? Certainly not at the current pace.
Over recent decades, house prices have risen about 2 per cent more than inflation each year and that's as good a guess as any for future average increases, over the long term. These days, that amounts to about 4.5 per cent. Added to the rental income, our best forecast for your total return comes to an average of 8.5 per cent after tax. That's pretty healthy.
What would happen, though, if you didn't have tenants for a few months?
There was a tenant shortage not long ago. And it could happen again, now that a bigger proportion of houses are rentals. With two rental properties, you're better off than most. It's unlikely that both houses would be untenanted at once. Still, one empty house would slash your income.
Then, perhaps, right after you finally fill that house, the other tenants move out. You've already said you don't want to be a landlord forever. You might get to the point where you want to bail out. The trouble is that other landlords, also lacking tenants, are likely to make the same move at the same time. And we know what happens to prices when there are more sellers than buyers.
I'm not saying house prices will fall. But I don't share your confidence that the value of your houses will keep increasing. We don't have to look back far to see house price dips. If you had bought a typical Auckland house in the first quarter of 1991 and then decided to sell, you wouldn't have got your money back - even before commissions, legal fees and so on - until the last quarter of 1993. And if you had bought it in the last quarter of 1997, you would have waited until the first quarter of 2002 to get your money back, according to Quotable Value NZ's data on median prices. That's more than four years.
The upshot of all this? While your rental properties sound like pretty good investments, like anything that offers a high return they come with risk. That would be true even if you also owned $1 million of other investments. But, as you acknowledge, you are badly undiversified and that adds to the risk.
Importantly, too, you're not really enjoying being a landlord. Why bother when - as you will see in a minute - you don't have to? I suggest you sell. It might be an idea to put both houses on the market, at fairly high prices and sell whichever goes first. Then, perhaps, sell the other a year from now. That way you won't miss out if house prices keep rising at a silly rate. But you also won't get fully caught if they fall, or rise at a slower pace than alternative investments.
Your sale proceeds might be around $540,000 minus the $50,000 mortgage and $30,000 in commissions and other selling costs. That's $460,000. What should you do with that?
If you like, you could be really conservative and still get your $2030 a month. We'll use the useful
internet calculator
described in last week's column. Scroll down and click on
Retirement Payout Calculator
. With that, we find that if you invested $272,000 in the bank at 5 per cent before tax for 13 years, you could take out $2033 a month in the first year - and your monthly income would rise by 3 per cent a year to allow for inflation. At the end of 13 years, that money would be gone. But you would then be 65 and eligible for NZ Super. Currently, that's $1285 a month before tax for single people living alone and it can be expected to rise with inflation.
In today's dollars, then, you would want $745 more a month after age 65 to get to your current $2030. In the meantime, you've invested your remaining $188,000 in Government stock, maturing in April 2015. Its current yield, after brokerage, is about 6.2 per cent. Allowing for inflation of 3 per cent, your money would grow to nearly $270,000 in today's dollars. (I used the lump sum calculator on the
Retirement Commission website
.)
If, in 2015, you invested all of that at 5 per cent before tax, you could take out $745 a month, rising 3 per cent a year for inflation, for 48 more years. In other words, you could live until 113 before you ran out of money. And then you would still have NZ Super. You might prefer, though, to have more to spend over the years and/or the likelihood of leaving some money to family or friends.
To do that, I suggest you keep the money you want to spend over the next three years in term deposits or Government stock.
The money you want to spend over the following seven years should go into high-grade corporate bonds. And the rest, which you will spend in 10 years or more, could go into diversified New Zealand and international share funds, where it is likely to grow faster.
The value of the share fund money will fall sometimes, though. If that makes you too nervous, keep a portion in corporate bonds to reduce the total volatility.
Every year or so, move some money out of the share funds into bonds, and some from bonds to term deposits, so you maintain the three-year and 10-year horizons.
A good sharebroker or financial adviser can help you set this up.
* * *
Q. I read your first reply last week with interest.
My wife and I would love to retire, feel we could on $40,000 net per year and, although we have about the same amount of capital to invest as you came up with, are only in our late 50s.
I went to the website you suggested and tried to do some calculations based on our circumstances, but could get answers that included only the eventual disappearance of our capital outlay.
Is there another such site where calculations can be done with the proviso that the initial capital outlay is retained?
A. I don't know of a website that does exactly that, but you can do the calculations yourself.
I think that you will find the answer depressing.
Retaining your capital rather than using it up over the years makes a huge difference to how much you must start with.
Let's say you can earn 5 per cent after tax - which, incidentally, means going into risky investments.
When you are looking over a period of several decades, you should allow for inflation. And I like to use 3 per cent, even though that's a bit high these days, because we don't know what the future holds.
That brings your real (inflation-adjusted) return down to 2 per cent.
You want $40,000 a year. Divide that by 0.02 (2 per cent) and you'll find that savings of $2 million will give you a return of $40,000 a year. Yikes!
Perhaps, though, I'm being too conservative about inflation.
Including it in the above calculations means that your initial $40,000 will rise each year by 3 per cent and your retained capital will also grow by 3 per cent.
Maybe you would be content to see your retirement income fall each year - in terms of what it can buy - by whatever the inflation rate is.
After all, people tend to spend less as they progress through retirement.
And maybe you don't mind if your retained capital also loses buying power over the years.
If so, we can work with 5 per cent. Divide $40,000 by 0.05, and you find you'll need $800,000.
It's still a lot more than in last week's example, though. You might want to think again about retaining that capital.
By the way, there are several other good calculators on www.sorted.org.nz, which can help you with saving and retirement planning.
In response to another reader, when you are using the calculator this correspondent mentioned - which is the one I refer to in today's first answer - it doesn't matter what your age is.
All that matters is the number of years over which you want to get payments.
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