Don’t make this major property mistake when you retire

Many Australians are sold on the idea of using an investment property to fund their retirement. Often the sums don’t add up.

it’s difficult to overstate the national obsession with property. Australia has the second-highest median wealth per head of population in the world, but 53 per cent of that is tied up in real estate.

While property speculation might be a wise wealth-building strategy for younger people, there is one group for whom it can be downright detrimental – retirees.

Financial advisers say they are witnessing a generation of asset-rich, cash-poor retirees living needlessly frugal lives to protect investments that frequently return less than a high-interest savings account.

“Australians are fanatical about investment properties as a retirement asset,” says Ryan Scherini, an executive adviser at Viridian Advisory. “The rental income has been sold as passive income, but in my experience as a financial adviser, there are better ways to retire.”

Scherini says retirees often find that rental income from their investment property – once relatively high costs are considered – isn’t enough to live on, forcing them to draw down their superannuation faster.

“Everyone gets caught up in the idea of the properties providing a monthly or weekly rent, which will replace their salary when they retire. But what a lot of people miss is that it’s an illiquid asset – you can’t sell a bedroom, you can’t sell a garage.”

To demonstrate the drawback of investment properties in retirement, he steps through the maths using the example of a typical couple – we’ll call them Brad, 62, and Jackie, 60 – who have a family home and modest investment property.

The couple owns both their home and the investment property outright. They receive $800 per week in rent, so a year’s rental income is $41,600.

Once $12,000 in rates, agent fees, maintenance and insurance are taken into account, that income shrinks to $29,600. There may be other costs too, such as state-based land tax, which can extend into the thousands.

That means the yield, or the net income as a percentage of the total value of this property, is 2.96 per cent.

While this is actually pretty healthy, it’s still less than you’d get by putting that money in a high-interest savings account, Scherini says.

Let’s say Brad and Jackie want to draw an income of $80,000 a year in retirement, which is just over the Association of Superannuation Funds of Australia’s comfortable standard of about $76,505.

Remember, they make $29,600 from the property annually. That leaves a shortfall of $50,400 that will need to come from their super.

In this scenario, Brad has $430,000 in super and Jackie has $250,000 – they’re a “normal middle-income family”, says Scherini.

If they’re funding that $50,400 equally, for Jackie, that’s a drawdown requirement of 10.08 per cent. For Brad, it’s 5.8 per cent.

Jackie’s going to run out of super by the time she’s 75, based on the Moneysmart account-based pension calculator – and the assumption that her super’s returning 8.62 per cent a year – like AustralianSuper’s average balanced fund return for the past 10 years in pension phase. After that, they’re going to be relying on Brad’s super and the income from the property alone.

To make matters worse, says Scherini, that $1 million property will likely soon exceed the age pension asset threshold of $1.074 million, and by the time they’re 67, they won’t be eligible for the age pension.

But it’s more likely they’ll seriously cut their spending.

This is especially the case if the kids live in the investment property, or it has some other sentimental value, Scherini says.

“It’s not my job to say, ‘Don’t do it.’ My job is about pointing out the risk to them, and saying, ‘OK, well, in 12 years time, for example, I anticipate that your liquid capital is going to be exhausted. So what are we going to do at that point in time? Are we going to downsize the family home?’”

There’s another option for Brad and Jackie, which is to sell the investment property in the year after they retire so that they have a low or non-existent taxable income. Then, using a combination of concessional, carry-forward and non-concessional contributions, they can put that money into super.

If they do this, Jackie’s super balance will grow to $708,000, and Brad’s to $888,000. They can now meet that $80,000 income by drawing down 4.5 per cent a year from Brad’s super, and 5.6 per cent from Jackie’s.

“If we’re looking at a balanced fund which is returning 8.62 per cent, and you’re only drawing down 4.5 per cent a year to cover your living costs, then if anything, your fund balance will continue growing,” Scherini says.

“That means that later in life, if you’ve got aged care expenses, you’re going to still have a nice capital base to draw on in the future.”

While the above example shows that income from investment properties often isn’t as great as people think, Scherini says his real concern with the strategy for retirees is how illiquid it is.

“Best-case scenario, if you need to sell that property, you’re looking at six to eight weeks to get access to that capital,” he says. “What if something blows up in your life? The kids get sick? Or you want to give them $100,000, and you can’t access that money?”

Property within super

Many Australians also hold property within their super via a self-managed super fund. This brings with it its own set of challenges in retirement, says Sangram Rana, a financial adviser and director of Build My Wealth.

“Property-heavy SMSFs can appear perfectly healthy on paper yet remain fragile in practice,” he says.

“A fund can hold an asset and still have very little cash when obligations fall due. That is when trustees get forced into rushed decisions, disputes between members, and in the worst cases, a forced sale or a strategy reversal that costs more than the original plan ever saved.”

Rana says the question isn’t whether SMSFs should buy property, but whether their SMSF can fund the ongoing maintenance costs that come with property ownership.

He believes there are five liquidity stress tests that trustees should run before deciding to buy or continue to hold property through their super. They’re particularly applicable to retirees, but important for SMSF trustees at all stages.

1. The pension payment test

“If any member is in the pension phase, the minimum pension must be paid each year,” says Rana.

While trustees often think rent will cover it, this isn’t a given, especially if the tenant leaves, expenses spike or rent is late.

“Ask yourself this: if rent stopped for three months, could the fund still meet pension payments on time without selling assets or scrambling?”

2. The vacancy and repair test

A key consideration is whether your SMSF has a cash buffer of at least six months’ worth of expenses, including pension payments and loan repayments.

“Vacancies happen. Repairs happen. Commercial property can be particularly unforgiving because downtime and make-good costs can create sudden cash calls,” Rana says.

3. The member exit test

Sometimes couples separate and business partners split. If one member needs to exit the fund within 90 days, can the SMSF fund that without having to sell the property?

4. The valuation and contribution capacity test

What happens if valuations move unexpectedly and contributions are constrained? Can the fund still fund obligations, or is it relying on contributions that may not materialise?

“This is where policy debate can become relevant for larger balances, including Division 296,” Rana says. “Regardless of where it lands, property-heavy funds share a practical vulnerability: liquidity and valuation timing can turn a long-term plan into a short-term scramble.”

5. The governance and paperwork test

You need to consider whether your trust deed and investment strategy (along with the minutes, member instructions and lease documentations) are aligned with how the fund is operating.

“When governance is messy, everything takes longer. Trustees spend weeks chasing documents and approvals. That is exactly when liquidity pressure becomes outcome risk.”

More than money

Approximately 2.26 million Australians owned an investment property in the 2023 financial year, according to the most recent ATO data.

Of those, 609,507 are 60 or older, or 27 per cent of the total property investor pool.

Based on population data, this means one in 10 people over 60 owned an investment property in 2023.

The government is mulling reductions to the capital gains tax discount for property investments in the hope that less generous tax treatment could ease investor interest and clear some hurdles for first home buyers.

But advisers say property investors are motivated by more than money.

“It’s that bricks and mortar approach,” says Scherini. “I see that a lot. [Retirees like it] because it’s a real asset and not stocks that seem to go up and down all the time.

“But there’s another side to it, which is learned behaviour and biases. If you’ve been invested in property for 10 years already, and you’ve done well out of it, you naturally revert to what you know.”

This is compounded by the shift that comes with exiting the workforce and leaving a regular salary behind. For many, switching from earning income from a rental property, to earning it from investment markets, feels like too much, Scherini says.

Consider this: according to Vanguard analysis, $10,000 invested in Australian listed property 10 years ago in June 1995 would be worth $99,911 by July 2025. The same amount invested in Australian shares would be $143,786, or $214,332 invested in the S&P500.

Of course, the real appeal of property is the ability to use leverage to buy extra exposure to market gains. But by the time you enter retirement, and need income, this – say advisers – is largely beside the point.