Relying on property to fund retirement may be a necessity, but it is not without risk.
By choice or necessity, some retirees are relying on property to generate income in retirement.
According to the Guardian newspaper, one in three people are relying on property to help provide an income in retirement from one or more buy-to-let properties, and more than half said they would sell their own home and use the proceeds to pay for retirement.
But is property a good asset in terms of generating income in retirement?
“With any investment that you may have, whether a retirement fund, unit trust, share portfolio or property, there are benefits and risks, says Mark Lapedus, head of product development at Liberty Investments.
“An important goal for retirement is that you should not only have one source of savings. You should have diversification so that you have different options.” If, for example, you have 100% of your savings in equity markets, you could lose a large chunk of your money if share prices collapse. “Similarly with property, it is important to have diversification and to have other income-generating assets if possible,” says Lapedus.
With investments largely in property, however, diversification is more difficult to achieve because of the high cost of property. “If I have R5 million to invest, and only invest in the equity market, I can afford to buy a large number of companies – from financial to retail, or mining,” says Lapedus. “But if I am choosing to go into the property market, and if a property costs R1 million, I can only have five properties and I have less ability to diversify unless I have lots of money.”
Another issue is liquidity. Using the same example, shares can be sold quickly, should you need to do so. Property may be difficult to sell, even over an extended time, if property markets are weak or interest rates unfavourable.
However, property is generally a good asset in terms of one’s ability to derive recurring income and many people rely on property to supplement their income in retirement.
If retirees bought their home when they were younger and have paid it off and then rent it out, they have the ability to generate an income and benefit from capital growth. “But there is a diversification risk and illiquidity, and a lot to do in order to manage the property, which may be increasingly difficult as one gets older.
“While a managing agent could be appointed, there is definitely more hands-on involvement required than if you invested in unit trusts or shares, where you can sit back and earn dividends and capital growth,” says Lapedus.
If a retiree still has a bond on a property, and is able to get decent rental income to cover the bond, or if they decide to take out a bond to acquire the property to rent out and the rental is more than the bond repayment, the property investment can be financially lucrative. A few years down the line, income will exceed the bond repayments. Property investors must, however, ensure they can meet cashflow requirements on the property.
Property investment may create inheritance issues, as heirs will need to take over management of the property or have to sell it in order to distribute the proceeds. If they keep holding the asset, there may be liquidity issues as all of your capital may be tied up in the asset, with no funds available to pay estate duties.
“You should also be aware of the tax implications, as you will not get tax deductions as you would for a retirement annuity, pension or provident fund, and it could be a significant disadvantage to lose out on a retirement fund tax benefit.
“The big disadvantage of property, while it may generate income, is limited access to funds and illiquidity,” says Lapedus.
There are, however, many people who have property as one of a few income options in retirement and have done well out of their investment.
“There is nothing wrong with it,” says Lapedus, “but it should not, if possible, be the only savings option. Retirees with a good spread of traditional and non-traditional savings are more able to maximise their impacts than those with all their eggs in one basket.”