Property Planning to Unlock Financial Security: Hold or Sell Decisions Through Rising Holding Costs & Modelling for Retirement Success (Ep. 226)

The Trio enjoy fielding this second question from a loyal, long time listener, Alison. Only last year, Alison reached out to ask the Trio to weigh in on a stay/move question. Alison and her daughter were living in a recent purchase on the inner-side of Melbourne’s Nepean Hwy, but missed their days by the beach in their former home. Alison had purchased a four bedroom townhouse on ‘the other side’, but aside from missing her beach life, she also found the home was too big for their needs.

The Trio encouraged her to make the move back to their old stomping ground, and Cate recalled some of her happy days in her old ‘hood in beachside Mentone too.

Alison, now 47, took the plunge this year. She rented out the four bedroom townhouse and purchased a three bedroom unit back on the beach side of Mentone.

This time, she writes to the Trio to ask about their thoughts on whether she should retain the four bedroom townhouse, or whether she should sell. With all of the changes to land tax and possible changes to planning laws, ongoing rental reforms and heftier interest rates, Alison is feeling a little bit nervous and wondering what the Trio think. She notes that her large townhouse is projected to be cashflow neutral in six years, but she is also mindful of the pressure she faces as a sole bread-winner. She is also managing a property in the Bass Coast and while her long term intention is to retain this property into retirement, Alison throws out the question to the team about her entire portfolio.

Alison’s Question

Hi team, I had a question last year about whether I should buy back on beach side of Nepean hwy. My daughter and I lived in Beaumaris, sold and bought on non beach side in Mentone but found that our life was mostly on beach side- and the back and forth was adding a lot of time to our day. Plus I had bought a 4 bedroom house, which was a bit much for the two of us. So, I took the plunge this year, rented out our 4 bedder and bought a 3 bedder back on the beach side of Mentone. 
 
Our current status: 
-I’m single parent who is self employed-run a consultancy- business last year turned over around $535k but unsure if that kind of turnover will carry over to this year.  
-Mentone 4 bedder- rented out (approx. Value $1.25m) 
-House in Bass coast 600m from the beach – rented out to a long term renter (approx value $550k) 
-Townhouse in Mentone- PPR (approx value $1.12m) 

My question is this: given all the land tax changes and possible changes to planning laws/rents etc do I hang on to the 4 bedder and wait until it has enough value to clear my ppr mortgage or hang on to it for the longer term- past 6 years until it is earning me money-it won’t be for a long time.

I’m almost 47 years old. I know previously the advice has been to do this, but circumstances are looking like they are changing in a big way for investors.

It’s a lot of pressure on me as the sole bread winner, and I will admit I’m a little a spooked by all the changes. 
Obviously with interest rate rises I’m contributing a fair bit to the mortgages even with the rent… 

Landord woes

Firstly, I have to commend you for being a single parent, managing to own 3 properties and also running your own contracting business. Well done, an amazing effort!

I completely understand why you might be feeling a bit unsettled with all the changes and conversations surrounding landlords. It’s a bit disconcerting, isn’t it?

According to the Australian Landlords Association, landlords own more than 80% of rental properties. Despite this significant contribution, it often feels like landlords are somewhat overlooked (and in some cases, trampled on) in discussions focusing on the challenges facing renters.

Much like yourself, the majority of landlords are hard-working individuals—many of them ‘mum and dad investors’ —aiming to set up a prosperous future. They’re taking risks today, stretching themselves to invest, limiting their spending, all to ensure they’re financially stable later in life, able to provide some extra support to their kids, and not dependent on government support during retirement.

So well done to all those landlords out there!

In terms of Alison’s property planning, what are your initial thoughts on her situation and how she might be able to see beyond the short-term challenges and perceived external risks?

Property value

Alison currently owns $2.92 million worth of property at age 47.

If she is able to hold onto these assets and they grow at a 5% annual rate of capital growth (let’s assume), here’s how the total value would grow:

By age:

• 60 – $5.36m
• 65 – $7m
• 70 – $8.8m
• 80 – $12.94m

This gives you a rough idea of what her portfolio value and net asset position could look like down the road if she holds.

The purpose of projecting these calculations is that it provides a picture of your potential financial future.

Often projecting forward like this can help us stay the course when we are feeling the short-term pressures that come and go over our lifetimes.

Debt

Now if we take a look now at your debt position.

We understand that your debt is approximately $2M with around –

• $850,000 – PPR
• $1,150,000 – Investments x 2

This means you have an LVR of around 68% and net equity of around $920k.  ($2M debt / $2.92)

Assuming your debt doesn’t increase over the coming years, and ideally it is paid down, your net asset position across all three properties should keep climbing, along these lines:

From $920 today to

• $3.36m at age 60.
• $5m at 65
• $6.8m at 70
• And a whopping $10.94m at age 80.

Once again, this illustrates the longer you can hold onto your properties (without increasing your debt), the greater your nest egg becomes, thanks to the power of compounding capital growth and inflation.

This means the longer you can wait to sell, the more cash you will have once you do sell.

This number crunching really highlights the benefit of holding for as long as you can, assuming –

1. Your cash flow is positive
2. holding property isn’t severely hampering your lifestyle
3. Property values continue to increase

You can always sell one of the properties at any time, when and if required, to pay down debt and access cash to invest and live off.

That is the first set of numbers for us to consider as part of your Property Plan.

There are two parts of any investment equation, one is value growth, the other is income received. How about we turn our attention to understanding the rental returns?

Rental Cash flow

Yep, let’s take a closer look at the potential rental income for the properties.

If we’re assuming a 3% yield for Alisons property in Mentone and a 5% yield for the one in Bass, the figures would work out as follows:

• Rental Income for Mentone would yield approximately $37,500 per year.
• Rental Income for Bass at a 5% yield would generate an annual income of about $27,500.

When you combine these, the total gross rental income comes to around $65,000 whci is a nice addition to your retirement income should you be able to hold the properties.

However, there will be holding costs, so let’s look at some of the ongoing holding costs that will eat into your rental income starting with

Land tax

The total value of Mentone and Bass combined is $1.8M

Let’s assume the land value will be around $1.4M out of that $1.8M given the high land value of Mentone and assuming the Bass property is a simpler style house.

This is a 78% land to asset ratio, which means

• Your land tax in Victoria next year will be $8,250

This is a reasonably large sum to pay each year, which chews up around 12% of your rental income since Victoria raised its land tax levies.

This has been a jump of around $2k extra per annum for you to pay.

Holding costs

Let’s now factor in holding costs excluding interest, and assume slightly above 1% per annum for repairs and improvements, rates, insurances, property managers and the like.

On the total property value ($1.8M), then you’d be looking at about $20,000 per annum or around 30% of your total rent chewed up.

So overall we are looking at –

• Rental Yield of – $65,000pa
• Land tax – $8,250
• Holding costs – $20,000

This means you are left with net rental income of only $35,000 in round numbers.

This means that around 43% could be lost via land tax and holding costs before factoring in the interest you pay on your mortgages.

This is quite a substantial cost to your cash flow and further highlights the pain investors feel when governments like the Victorian government add extra disincentives for investing in residential property.

It also highlights why getting a return on capital growth that you can turn into cash or invest and live off down the track is so important when investing in residential property, especially in low yield locations like Sydney and Melbourne.

So if we now factor in the interest costs, what can this tell us about Alison’s situation and planning?

Interest repayments

Alison has $1,150m in lending on the investments, so if we assume she is paying an interest rate of 7% on average across the portfolio which would be a signficant jump from where her interest bill was 18 months ago, she is looking at $80,500 in interest paid per annum. This is greater than all the rent received, even before factoring in holding costs. This emans she would be signficantly negative geared meaning that the cash flow losses can be claimed as a tax deduction against her personal income.

In this scenario

• Yield pa – $65,000
• Land tax – $8,250
• Holding costs – $20,000
• Interest – $80,500

So overall, Alison is negatively geared, that is her expenses on the property are about $43,000 p/a less than her rent which she needs to fund out of her personal savings.

This is about $3,500 pm she needs to find although she will get close to half of that back when she does her tax return.

Given like many people she is probably finding the rate increases difficult, she can complete a tax variation that allows her to have less tax taken out of her salary so that she gets the cash flow benefits of the tax savings during the year rather than having to wait until she completes her tax returns.

Projected growth in rent is an important consideration, just as it is for capital growth, can you outline for us what does rental growth look like over time and when could that property become positively geared?

The good news for Alison, and all investors is that just like how the value of her properties will increase over time, so will her rental income, whereas her debt and interest is likely to stay at the same level or reduce over time.

And at some point, the property will become positively geared, if she can withstand the impact to her cash flow now and over the coming years and hold onto them.

Assuming that the investment loans are not paid down and Alison doesn’t take out any further lending, the figure of $80,000 interest paid per annum should remain the same or reduce (of course, that may vary depending on any rate increases or decreases which also highlights the benefits of fixing part of your debt for certainty of repayments when you are reasonable stretched which is usually the case for first time buyers, and sometimes for upgraders and those who have stretched themselves investing).

The upside is that while the debt and the interest remains the same, Alison’s rental income will continue to increase over time.

For example, if Alison’s gross rental income, is at $65,000 p/a today, and assuming it grows at the same rate as the property value growth, her gross rent will be:

• 60 – $119k (which is $39,000 greater than the interest, although holding costs and land tax will still take up most of the remaining rent. But she could expect the property to cover its own costs by then)
• 65 – $156k (this is now $91,000 more than the interest costs assuming a rate of 7%)

Therefore, Alison is likely to become positively geared sometime around 60 to 65 years of age on the properties.

• 70 – $196k )rent V’s interest costs of $80,000 and you would suspect that some of the debt may have been paid down by now.
• 80 – $305k

Once again, highlighting the benefit of being able to hold the property long term and struggle through the difficult times.

That is quite a long time to wait for the properties to become positively geared. Do you think this has any ramifications in the broader picture for housing?

Yes, I think this highlights a couple things –

1. The significant risks to the supply of rental properties for renters if governments keep eating into the cash flow of landlords with taxes, rental restrictions and other disincentives. Remember around 80% of all rental properties are provided by investors.
2. Number 2, it highlights why it is so difficult for governments to incentivise corporate investment to invest in “Build to rent schemes” in Australia, given the difficulty to get a return on investment from a cash flow perspective, especially in Sydney and Melbourne where the yields are so low. When coupled with all the entry, development, and holding costs, it becomes complex for the government to incentivise such programs, without offering sizable tax breaks to major corporations.

The flow on impact is that if investors of any kind don’t want to purchase property, there is less incentives and greater risk for developers to build new property further deepening the problem.

So now we’ve thoroughly picked apart the financial aspects of Alison’s position, what are some considerations regarding selling?

As we can see, because of inflation, property values and rent grow over time, and so does our income. BUT our debt shouldn’t, if we manage our money.

Therefore, it becomes easier to hold assets the longer we own them. For many, it will be a big financial stretch in the beginning, but the pressure will ease over time.

If Alison does decide to sell a property, from a long-term investment perspective, it might make more sense to part ways with the Bass Coast property rather than the ex-home in Mentone first because:

• Selling Bass Coast would leave Alison with the more valuable asset base appreciating over time as well as the property that receives greater gross rent and we have covered the power of compounding capital growth.

If and when Alison decides to sell, she can stagger the selling process. Some key considerations include –

• If you hold until you have retired, the capital gains tax payable will be a lot lower because your taxable income is a lot lower, so the tax rate is significantly less.
• Selling propertys in a different tax year will reduce the tax payable because you are not paying tax on the accumulated capital gains in the one financial year.

Again, the longer you hold, the cash you will have available from the sale after paying off any debt, so that you can invest the cash and live off its return and drawdown on the cash until you feel like you need to sell the final investment property Or you can bequeath the property or properties to loved ones.

Do you have any final thoughts or other lessons for our listeners?

One certainly is the age old adage of try before you buy.

If Alison had of rented before purchasing the property on the other side of the Highway, she could have discovered that was not her preference, and would not have outlaid the significant expenditure on the wrong property.  

This is why we always recommend renting before committing to buying, especially when relocating to an unfamiliar area for work or lifestyle changes.

Renting first provides you with the freedom to test out the area, its amenities, and overall vibe before making a long-term investment. This approach can help you avoid buyer’s remorse and ensure you’re fully comfortable in your new environment.

The opportunity costs associated with buying and selling properties are significant as we know, largely due to hefty stamp duty taxes.

It’s a rather punitive and inefficient tax, as opposed to a universal land tax for example.

So, if you’re considering a lifestyle or location change, renting first is always a sound strategy.

It allows you to dip your toes in the water—sometimes quite literally if you’re looking at beachside properties—without diving in headfirst. It’s a smart approach that can save you both time and money in the long run.

Our listener was in the fortunate position that she hasn’t needed to sell, she was able to convert the home into an investment and purchase a home that truly suited herself and her daughter. But this won’t be achievable for everyone in that boat.

The other is if she had of done this, she then could have purchased the home and considered an investment in a different state.

This could reduce the land tax premium significantly and could potentially save you $5,000 to $8,000 pa. Not to be sneezed at.

The problem with land tax in one state is that it aggregates the total land value of all investments.

By purchasing interstate you also would have greater diversification, which would reduce risk when it comes to market cycles moving at different times for different locations, 

This could also allow for investment in different types of properties providing further diversification.