Five questions you need to ask before you buy another investment property

Most property investors have their eye on long-term financial freedom, particularly when it comes to retirement.

But how many investment properties do you need in your portfolio to achieve this?

You need to answer a few questions first.

1. Where are you starting from?

What are your current levels of income, tax, assets and liabilities?

2. What level of income are you targeting in retirement?

It's fairly easy to calculate what your level of income is right now, harder to determine how much you're spending to fund your current lifestyle, and harder again to calculate how much income you'll need to fund your lifestyle in retirement.

So you need to define what a comfortable retirement means to you. Some investors want a bigger nest egg and higher levels of cash flow to fund their ideal lifestyle in retirement. Equally, some investors prefer a more modest income but want to fast-track their results to be ready for retirement much earlier.

At the end of the day, the number of investment properties you need to own is actually less important than the total value of the asset base you need in order to generate the income you desire.

3. How many years before you plan to retire?

Do you want to retire at the age of 30, 65, or somewhere in between? Knowing this allows you to work out how many years you have left in the workforce and how many years of retirement you will need to fund. If you retire at 60 and live until you're 90, that's three decades.

Typically, most investors wait too long to begin their retirement planning. As a result, they panic and end up chasing higher (and riskier) returns, or they need to defer retirement. Both mistakes can be avoided through better, and earlier, planning.

4. What level of debt are you comfortable carrying into retirement?

Many people see debt as a burden, and most Australians have been taught by their parents that property debt is something to be paid down as fast as possible. Homebuyers will often take out a 30-year mortgage and then wait until that has been paid out before they even begin to think about investing for retirement.

In addition, most Australians also have the ambition to be debt-free in retirement, but the reality is that many will be carrying some level of debt. And that is not necessarily a bad thing as long as it has been carefully planned and appropriately managed.

Again, this will impact the number of properties you need to retire and the degree of financial stress you'll be exposed to.

5. What structure do you plan to own property assets in?

What many investors overlook is that the structure they acquire their assets in can make a considerable difference to how much tax they will ultimately need to pay.

Major property taxes include stamp (or transfer) duty, land tax, council rates, capital gains tax and income tax.

Structures include your name, a trust or self-managed superannuation fund (SMSF).

For example, under current tax law a property purchased within a SMSF may have considerable taxation benefits as compared with property acquired in your own name.

Ultimately, how much tax you pay comes down to how well you plan, so carefully consider what structures your assets will be held in and ensure you understand the taxation implications.

You also need to consider:

• How much do you want to leave behind for your loved ones or favourite charity?
• Will you eat into your portfolio during your retirement or live purely off the income?
• How much will the properties in your portfolio increase in value over the period of your retirement?

If your goal is to live off your property-based assets and derive an income of $100,000 a year before tax then, using a total return of 3% net a year, your asset base would need to be at least $3.33 million (excluding your own home). If we use an arbitrary average property price of $650,000 your portfolio would need to hold between five and six unencumbered average properties.

Alternatively, you might inherit a commercial property tomorrow valued at $2 million with a net rental yield of 5% to provide a total annual passive income of $100,000 before tax.

In either case, if you are serious about using property to create a stress-free retirement you need to create a plan that is right for you, surround yourself with the right team, measure performance regularly and start your investing journey as early as possible.

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