Bread & Butter Properties

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Monday, July 19, 2010

Retire Well by Investing in Rental Properties

Retire rich, retire young? Well, that is the dream for a lot of people but hey, if you can’t, you should at least retire well. What does that entail? To me, it is having a passive income stream which you don’t have to worry about in your twilight years. A bit like my mum having a pension from the government that comes in on time every time. She was a school teacher.

If you don’t work for the government and thus have no pension, how else can you do this? I will show you how you can do this by: 1) investing in little green houses (rental properties) and utilizing some of your EPF money (Employees Provident Fund).

Let’s start with your EPF fund
Most people work hard all their lives, building up their nest egg for retirement, but seldom spend time planning for what to do with the money when they eventually retire. I mean, they know they will have a lump sum of money in their bank account when they turn 55 years old, but how many know what to do with it? Most likely two things will happen: firstly, they will put the money in fixed deposit which earns a paltry return that is not enough to pay for their upkeep, or 2) they (or someone else) will spend the money for them. Fact: those who withdraw EPF at age 55 will have exhausted 70% of their savings after 10 yrs . These are scary thoughts: at retirement you will either live poorly or be broke, before you kick the bucket.

So what can you do this solve this dilemma? It was also reported that Malaysian’s will need to have at least RM1.4mil to 2.8mil in the bank to live comfortably in their retirement . How they figured this out was that with RM1.4mil, earning a fixed deposit rate of say 3% p.a. will give you at least RM3, 500 per month in income, to live on. Well, how easy is it to save up RM1.4mil in your life time?

Investing in little green houses to retire well
Rental properties may not look like an exciting vehicle but it can work quite well. It can help secure your retirement income, with some help from your EPF funds.

Here is how it works: let’s say you invest in a medium cost flat which cost you RM100, 000. And you get bank to finance it up to 80% (i.e. RM80, 000 loan), for 25 year tenor, at 4.3% p.a. (current base lending minus 2.2%).

Your monthly installment is RM422.0 or roughly RM5k per year. This amount goes towards paying off the bank’s interest, and also reducing your principal outstanding. Initially, a large portion goes towards servicing interests, and this gradually reduces as we go along. If you are 35 years old now, you should finish paying off your loan when you are 60 (when you own the unit outright).

Next, let’s assume that you can rent this unit out at RM600 per month. And maintenance charges, quit rent, Indah water, etc sets you back RM80 per month. That leaves you RM520 per month; after paying installment to the bank, you are left with RM100 per month. Hmm, that’s not a lot of money left over in this day and age, is it? But, something is better than nothing, right?

But, what if you had 10 of such units? that would mean an extra RM1, 000 in your pocket at end of the month (yes, I know, assuming we can rent them all out, and it’s not empty, burnt down, etc right?). But, that’s not what we are talking about here, though. Assuming worst case scenario, your rent only covers the installment; you would still be building up massive equity in the units. In any case, you won’t need the extra income until you retire.

EPF + Little green houses = retire well
This is where your EPF money comes in. By investing in your rental properties now, you are effectively leveraging on your EPF, and in a sense, have determined how you will be investing the lump sum that you’ll receive at retirement.

Here’s what I mean. Let’s assume that you are:
- Now 35 years old.
- Have RM100,000 in your EPF account now, and earn RM5,000 per month (from salary),
- EPF pays 5%p.a. dividends (which is the long term average over 10 years),
- Your salary increases 3% p.a. and you make normal contributions (12% employers, 11% employees).

At age 55, when you retire, you should have RM950, 000 in your EPF (assuming no withdrawals along the way for unit trusts, medical etc). And of course, you are gainfully employed till you retire.

From the loan amortization schedule, your original RM100k owing should be around RM22, 000 (at end of yr 21) which coincides with age 55 when you retire. At this stage what you can do, is to use your EPF lump sum to pay off your loans as you don’t really want to service your loans after you stop working. So, if you had 10 units you would need to fork out RM220, 000 (and you’ll still have RM730k left).

But, more importantly from the cash flow perspective: you will now have RM520 per month /unit as you no longer are paying for the loan. That would mean RM5, 200 per month of passive income from your 10 units which are now fully paid up. That would certainly a better return on your EPF money, right? RM220, 000 to generate RM5, 200 per month!

Of course in this example, we are assuming that
- there’s no increase in property value,
- you do not refinance the property,
- interest rates and rental rates remain unchanged,
- and the “excess” (diff between rental and installment) is not used to reduce the amount outstanding.

What I have shown here is a simple plan to retire well: by investing in rental properties, and setting aside some EPF money when you retire to secure your retirement income. All you have to do is to find 10 rental properties, with rental income that can at least cover their installment, and watch your equity build up. And, at retirement pay off those properties with your lump sum money from EPF and take over the rental income stream of RM5, 200 per month. What if this is not enough for you to retire on? Your retirement income is only limited by the number of little green houses that you have, so go out and find a few more!

*Read the rest of this Blog to find out how.


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