Are you happy to retire by "living out of capital"?

[Steve Navra]

Question for everyone:

Hi Bill.L (And everyone interested in this thread)

I have been considering the implications of Rents NOT keeping pace with Capital Growth . . . hence my previous post. (Adjusting the Spreadsheet to link rental growth to inflation.)

My question is:
Is this a valid assumption??

I have looked at my own property portfolio and have noticed as follows:

1) Current Rental Income / Current Total Value = Yield of 4.25%

2) Five years ago my yield was 5.45%. So yes the yield has decreased by 1.2% approx during a time that capital growth has averaged in excess of 12% p.a. (Which is quite consistent with the price growth we have seen these past 5 years.) Admittedly the exact figure is difficult to quantify as I have been acquiring a couple of properties each year, so there are different start/end dates to contend with.

3) My portfolio kicked off with low yields . . . back in 1988/9; when prices were very high. My yield% grew to nearly 6% by 1993/4 and has been subsiding ever since the last growth cycle started.

4) If I apply an inflationary link of 3% for spreadsheet purposes to the rents as they existed at that time, then the result would come out reflecting a Yield of approx 3.5%. (Obviously too low; when compared to reality.)

5) In pondering a solution, my thoughts are as follows:
a) Given that the 'Long Term Yield expectation' in Australia (Good times and bad times) is about 5.2% . . . should we then allow for the current yields we are now experiencing, but simultaneously cap the rental income for future spreadsheet purposes to a maximum of 5.2%; irrespective of the projected future growth of the properties.
(This seems to work with my current figures.)

Your thoughts will be appreciated . . . and I will adjust the spreadsheet to reflect this consensus.

Regards,

Steve

 

[always_learning]

A few random thoughts

• Could the massive growth in prices that we have experience in "our" generation be a one off "one shot" change? The excessive growth in property prices as Australian economy moved from Menzie's era "riding on the the sheep's back" produce/mining economy to a first world knowledge worker based society dominated by the middleclass living in the big cities? ie in the last 40 years we have seen tremendous big city growth. Could this growth slow, stop or even reverse as communications standard improves (better communication => less need to travel) and big cities loose appeal due to the natural limits on price/affordablity, generating interest in secondary satelite cities? Acey I read has moved from Sydney to near CBR for lifestyle and cost advantages.
  
• Ongoing rise of skilled teritiary educated professional workers linked to a massive decline in manual workers. Knowledge workers (whitecollar) types benefit the economy more than traditional "unionized" blue collar worker. This resulted in a massive growth of the middleclass society, who as a whole is paid more, expects and life at a higher standard of living, and can seemingly can afford more for a house/rent. In my parents generation just a few % went to uni, when I went 35% attended, I understand now close to 70% will attend some form of teritairy education.
  
• Unavoidable long term linking "rental" return and "property value", we cannot pretend they are not! The link is elastic but the link exists and cannot be ignored. This means long term rental returns cannot keep falling unless interest rates also keep falling, it would be worth noting that interest rates can only fall so low or the economy stops. As Japan found out...negative interest is not good.
  
• Huge increase in available capital (money) => "credit" for the masses, 50 years ago getting a home loan was hard work. Today credit has never been easier to get! The world is awash with money/capital. A who works in development in Japan says there is too many "super fund" investors chasing too few deals! They may allocate $1B of investment from their $50B pool for Japan property and then get stressed out finding something to spend the $1B on! Normal guys like me can get access to millions of dollars of finance if I have enough assets.
  
• The value purpose of the land generally overtime will be improved. The returns of the same land will be periodically improved by changing the purpose it is used for ( extentions, dual occupancies, full redevelopment). For example as a baby I lived Mentone Melbourne, our delapidated house/shack with the dunny at the back was sold and then bulldozed and a new house was built, this house in turn was bulldozed 20 years latter and a nursing home was built. Same land put to higher value purposes. The %rental return on nett value may be the same as 35 years. ago. But if the old house was still standing on that 1200m2 block the rental return would be very very low, how much would you pay for delapidated 2BR house with outdoor dunny..

So rental reality is OK, but for me it would be rental reality plus. The plus being that I wouldn't and shouldn't plan to keep all IP's "as is". I believe this probably wont work in the long term (10+ years), I would periodically need to improve the value purpose of my real estate holdings. ie. rebuilding older houses, redevelopment to units, even nursing homes etc. etc. This would have a benefit of increasing my asset base and keeping yeilds consistant with the asset value.

 

[simonjulie]

Always learning

in the last 40 years we have seen tremendous big city growth. This will stop as communications standards increases and natural limits on price/affordablity generates interest in secondary cities.

I'm not so sure about this. Having lived in Canberra for 12 years I am now buying back into Sydney because it has so much more to offer. I can't imagine growth in our big cities slowing down too much - especially on the eastern sea board.

Regards
Julie

 

[oceangirl]

This article in today's Sydney Morning Herald re baby boomer landlords, made interesting reading. I wonder what the statistical impact on "rental reality" will be, if the market is flooded with generational ip ownership?

Anyone want to have a go?

http://www.smh.com.au/articles/2004/03/16/1079199227684.html

Cheers

Oceangirl

 

[Bill.L]

Hi Steve,
You made me go and do some homework, as I had taken for granted the rent grows at the rate of inflation. I first read it in Jan Somers book, and have since seen it referred in various places. The higher growth properties have a lower yield, the lower growth properties have the higher yield, the average property a bit of both.

On the numbers for the property in Mulgrave (vic) we owned from '81-'90, the rent grew from $65pw to $120 pw, about the rate of inflation. The yield ranged between 5.5% and around 8%, with the 5.5% being in '90.
Since then the pattern is very similar to your experience, yield rising to about '96, and being on the skids since. (current yield 4.33%) Taken as a whole, the period between '90-'04, the rent has risen at about .5% pa above inflation(ie about 3.5% compared to inflation of about 3%). One or two years of no rent growth will see the figure come back to the rate of inflation.(Given the number of vacancies in the area, this is highly likely)

I know it's only a sample of one, but it was 25 years old when we bought it, had one kitchen reno('79) and one bathroom reno('81) only. so it maybe more representative of what happen over time to yields as there are now new fancy looking homes in the same area asking much higher rents.
As AL says the fibro shack in Mentone just won't draw the same yield as it once did.

The "long term yield expectation" figure of 5.2% is probably not much help, because if it is for median priced housing, then we already know that the median priced house of today is a much different animal to that of even 10 years ago.

Taken from a slightly different perspective, a house that has had rental growth equal to inflation, is likely to have the same socio-economic group of people able to rent it in the future. Whereas if we assumed rent to rise above inflation for a given property, then we are expecting a more wealthy group of renters to be attracted in the future. This despite the fact that there will probably be newer properties for them to choose from.

From my perspective, using the inflation rate in the spreadsheet is the safe conservative option, but how do we predict what that will be in 10 years time???

bye

 

[Steve Navra]

BUMP

Hi Everyone,

Only AL & Bill.L have given any feedback concerning RENTAL GROWTH in relationship to CAPITAL GROWTH.

I will be devoting some time over the weekend to making adjustments to the spreadsheet, based on forum consensus.

If you have any thoughts in regard to this question they will be appreciated:

Given that the 'Long Term Yield expectation' in Australia (Good times and bad times) is about 5.2% . . . should we then allow for the current yields we are now experiencing, but simultaneously cap the rental income for future spreadsheet purposes to a maximum of 5.2%; irrespective of the projected future growth of the properties??”

Regards,

Steve

 

[MJK]

Hi Steve,

We are using 5% capital growth because it is " conservative" so why dont we use 3% inflation on rents because it is also "conservative". Then we may stand a chance of doing better than the model and have done due dilligence by looking at a worst case scenario ( so to speak ).

MJK

 

[Steve Navra]

We are using 5% capital growth because it is " conservative" so why dont we use 3% inflation on rents because it is also "conservative". Then we may stand a chance of doing better than the model and have done due dilligence by looking at a worst case scenario ( so to speak ).

Hi MJK,

Yes this is also my line of thinking

HOWEVER:

On the assumption that property averages 5% pa capital growth and we index the rent at 3% . . . this works fine.

The scenario gets out of kilter when you wish to look at property averaging 7% or more capital growth. The problem is if the rents only grow at a projected 3%, then the cost of using the "lazy dollars" goes up considerably.
This serves to cause an increasing serviceability problem; which is okay because the cashbond can fund the difference . . . BUT:

The true picture becomes distorted by the unrealistic amount of serviceability required.

My thoughts are that up to the 5% it is reasonable to link rents to 3% inflation. (Especially as I see a need to be conservative and not have 'Pie in the sky" dreams.)

My current thoughts in solving the projection dilemma are that above the 5% capital growth figure; the inflation % should be linked to the % growth in price.

Comments please. (Bill.L?)

Regards,

Steve

 

[NigelW]

Hi MJK,

Yes this is also my line of thinking

HOWEVER:

On the assumption that property averages 5% pa capital growth and we index the rent at 3% . . . this works fine.

The scenario gets out of kilter when you wish to look at property averaging 7% or more capital growth. The problem is if the rents only grow at a projected 3%, then the cost of using the "lazy dollars" goes up considerably.
This serves to cause an increasing serviceability problem; which is okay because the cashbond can fund the difference . . . BUT:

The true picture becomes distorted by the unrealistic amount of serviceability required.

My thoughts are that up to the 5% it is reasonable to link rents to 3% inflation. (Especially as I see a need to be conservative and not have 'Pie in the sky" dreams.)

My current thoughts in solving the projection dilemma are that above the 5% capital growth figure; the inflation % should be linked to the % growth in price.

Comments please. (Bill.L?)

Regards,

Steve

A study into the correlation between inflation, interest rates, capital growth rates and rental yields would be a very worthwhile one methinks...surely one of the research houses would have this data???

Linking inflation to CG above the 5% figure wouldn't have worked in the last couple of years would it? We've had inflation of within the RBA's target of between 2-3% but huge capital growth. So there doesn't seem to be a strong correlation in recent years between inflation and cg.

In the model, I think you should assume inflation remains within the RBA's target. If you want to link it to something, a better link would be to the cash rate, ie inflation about 2-3% below the cash rate and hence interest rates.

My 2.2c worth.
N.

 

[MJK]

Steve,

You said the amount of servicability required becomes unrealistic, but ,this is what some are saying.... that servicing the costs is an issue that could thwart the plan.
3% would be a stress test would it not ?
The issue is, the better the capital growth the worse the yeild. So with the growth and lowering yeild LVRs need to come down ?
Now 3% rental growth may be too conservative, we do need a conservative fiigure.I would say no higher than 5% growth. Now 5% rental growth is just growth, not 5% yeild so over time your yeild % will fall ?

What do you think?

 

[ToGetProperty]

Steve:

I think that rental growth should be 3% or at the same rate as inflation rate. The reason is my wife's shop rental growth is inline with CPI which should be the same as inflation rate.

Regards

TGP

 

[bawley]

Hi, I'm a newbie and trying to get my head around all of these concepts. I very much like Steve Navra's - debt is just an expense to hold an asset. My mood lifts perceptibly when I read this. D E B B B B B T is just so heavy, brother.

How difficult is it to put in place a "cash bond" after retirement when one doesn't have an income?...........assuming one has a few IP's (getting the hang of it)and a modest-ish allocated pension from super.

Can someone please enlighten me as to what "top 100" "top 5" etc means under a forumites name???

Enough questions for now!!

Bawley

 

[Aceyducey]

Hi, I'm a newbie and trying to get my head around all of these concepts. I very much like Steve Navra's - debt is just an expense to hold an asset. My mood lifts perceptibly when I read this. D E B B B B B T is just so heavy, brother.

How difficult is it to put in place a "cash bond" after retirement when one doesn't have an income?...........assuming one has a few IP's (getting the hang of it)and a modest-ish allocated pension from super.

Can someone please enlighten me as to what "top 100" "top 5" etc means under a forumites name???

Bawley,

Talk to Steve Navra about how difficult it is to get a cashbond. I know he has helped a number of people in similar situations to the one you described.

Top X refers to the 'level' of the poster based on the number of posts they have made to the forum. It doesn't specifically signify a level of knowledge or experience, it's simply a measure of activity.

Cheers,

Aceyducey

 

[geoffw]

Steve: I think that rental growth should be 3% or at the same rate as inflation rate. The reason is my wife's shop rental growth is inline with CPI which should be the same as inflation rate. Regards TGP

Commercial property is a different market to domestic, driven by different forces.

Domestic rental growth might have more to do with vacancy rates, demand, supply, and a lot of other factors.

Also a shop has a lease term (apparently) over a number of years. This is unusual for a residential lease.

 

[ToGetProperty]

Commercial property is a different market to domestic, driven by different forces.

Domestic rental growth might have more to do with vacancy rates, demand, supply, and a lot of other factors.

Also a shop has a lease term (apparently) over a number of years. This is unusual for a residential lease.

Hi, Geoffw:

Not against your comment. However, it is my view that those financial models in the real world have some co-relative. The figures of rent/return in Commercial market are different with Residencial market. However, their growth/decrease is highly co-relative with inflation rate, and actually almost the same as inflation rate in the case of commercial market. I can't find any evidence to support this argument in residencial market. However, I can find it in Commercial market.

By the way, can we count commercial property investment into this spreadsheet? If yes, then my argument should be considered.

Cheers

TGP

 

[Steve Navra]

. . . and I will adjust the spreadsheet to reflect this consensus.

Here then is the same example; the spreadsheet has been adjusted so that the rents increase at inflation, rather than being calculated as a fixed yield on property value.

This serves to present a more conservative view of the future outcomes:

At a 5% Capital Growth for the property, with rents increasing at 3% inflation, the end of 10 year income result reduces to $102,112 (Less $8,182 p.a.)

The difference obviously get larger as the difference between Property Growth and Inflation increases:
At a 7% Capital Growth for the property, with rents increasing at 3% inflation, the end of 10 year income result reduces to $307,403 (Less $51,193p.a.)

Please peruse the example carefully . . . your feedback will be most welcome.

Having taken this conservative approach, the income achievable is still of a fairly decent standard for financial indepence . . . which leads us back to the original topic: "LIVING OUT OF CAPITAL"

I say a definite YES!!

Regards,

Steve

 

[Macca]

Hi all,

As the amount of rent that we collect is effected by what the market is prepared to pay, it follows that the rent is effected by what our tenants can AFFORD to pay.

Could rental increases be linked to percentage increase in the average normal time pay packet or the average income per household, these figures could be available from ABS.

Also Steve, once you have decided on these figures, will you be doing a working example of living off capital, as you have done for accumulating capital ?

Very good thread.....definitely 5 stars

 

[Steve Navra]

Could rental increases be linked to percentage increase in the average normal time pay packet or the average income per household, these figures could be available from ABS.

Also Steve, once you have decided on these figures, will you be doing a working example of living off capital, as you have done for accumulating capital ?

Hi Macca,

Average Weekly Ordinary Time Earnings is about 3.25% p.a.
And yes, perhaps this is slightly more accurate. (Currently reflecting inflation at 3%)
I suppose that it is easier to link the rent growth to the inflation figure, as this can be easily adjusted when using the spreadsheet.

The main point though is that these are "PROJECTED" figures; so who is to know what inflation / A.W.O.T.E will be in future years.

Perhaps the consensus of forum members is right: " To use a CONSERVATIVE approach".

Yes I will give a working example . . . will post this after the next Sydney Course.

Regards,

Steve

 

[jahn]

Hi
Have been reading and learning on the sidelines. Love the thread. Love the workings. I must admit I also like the idea of the 'conservative' approach to the workings. One of our IP's had a voluntary rental increase when tennants changed last month, and it came in at a 4% increase with a 5.2% yield.
The CG has been better than 16%, but predictions for the area for the next 3 years are a figure of 8% (according to residex) .
Lots of talk about falling prices, (can't see it here) but I like conservative approach, so 5% sounds good.
BTW. Steve, see you at the next Sydney course.
jahn

 

[Mark Leo]

Rents increasing at the rate of inflation - I like it!

Here then is the same example; the spreadsheet has been adjusted so that the rents increase at inflation, rather than being calculated as a fixed yield on property value.

This serves to present a more conservative view of the future outcomes:

At a 5% Capital Growth for the property, with rents increasing at 3% inflation, the end of 10 year income result reduces to $102,112 (Less $8,182 p.a.)

The difference obviously get larger as the difference between Property Growth and Inflation increases:
At a 7% Capital Growth for the property, with rents increasing at 3% inflation, the end of 10 year income result reduces to $307,403 (Less $51,193p.a.)

Please peruse the example carefully . . . your feedback will be most welcome.

Having taken this conservative approach, the income achievable is still of a fairly decent standard for financial indepence . . . which leads us back to the original topic: "LIVING OUT OF CAPITAL"

I say a definite YES!!

Regards,

Steve

The rate of inflation is used as a baseline for negotiations on wage cases in the Australian labour market. If an industry's employers can demonstrate real productivity improvements their wages will generally increase by inflation + x. The reality is that x is either zero (no productivity increase) or a positive number. Therefore wages increase by at least the rate of inflation over time.

Rents are proportional to wage levels in the long run. Therefore rents will grow by at least the rate of inflation over time.


I've learnt so much from this thread. Thank you.

Regards,
Mark.