10 Oct 2018

Where Will I Get My Income In Retirement (Part 2)

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In the second part of this article, we analyse how property can be used to provide an income in retirement. 

The shock the Irish property market took between 2008 and 2013 left investors with a very sour taste and in many cases burnt fingers. Never in the history of the state had we seen such a fall in asset prices and in the overall wealth of the economy. A property slump which began with the financial crisis in the autumn of 2008 developed into a property disaster when the IMF arrived to provide national economic salvation.   During that period the outlook for property of all shapes and types was bleak to say the least.   In most cases it is very hard to believe now as we look back that both commercial and residential property have made the kind of recovery that they have.    There are certainly enough ghost housing estates and commercial ‘skeletons’ around to remind us just how wrong it can go with property just like it can every other asset.   In fact they serve as a good reminder that buyer must beware when it comes to what you invest in with property.   No one wants to be left holding an asset in which they have invested significant cash only to see that initial investment turn to dust and be left with little or nothing.

Investing in Property Directly

If you decide you wish to invest directly in property using your pension funds, you have a number of options available to you.  Your first decision will be whether you choose to invest in commercial or residential property.   There are merits and demerits for both.   Commercial buildings generally having longer leases but carry the risk of the lessee going into liquidation leaving the landlord with no rent or tenant.    Residential leases tend to be shorter and carry a risk of good tenancy, not to mention having to look after repairs and maintenance which you don’t have to do with a commercial building. In both instances if your tenant lets you down you are left without the yield that you wished for in the first place.  Choosing your tenants wisely is very key to your success here.

In an ideal world if you are using a property to provide income within your pension structure it is most efficient if you have done so during your career. If you have 10 or so years to go you may be able to borrow up to 50% of the purchase price on residential (not commercial).  That level of gearing can work well for pension investors if they give themselves enough time for the gearing to be cleared without any potential stress on the rental income.   What I mean by that is not to borrow too much or over too short a timeframe potentially resulting in a strain on you and the investment.

Property Funds

The most convenient way for an individual to partake in the property market in their pension is through property funds which are run by pension and investment companies.    The majority of these funds invest in large commercial properties with long leases in place.  The method by which these funds operate is through the purchase of units in the fund. As the property within the fund increases or reduces in value the units price chances in line.   While the majority of these funds don’t have a distribution paid to the investor you can take an income from them on a monthly or quarterly basis if you wish. This is done by the encashment of units within your fund as you take the income. Property funds that do pay a distribution do so by keeping some of the rent aside and paying it to their investors on a quarterly or half yearly basis.

The downside for the investor with these property funds is that if the property market falls the manager has the right to close the fund to either new investment or more importantly withdrawals.  This would mean that if you were concerned that the market is falling they may insist that you give six months’ notice (or longer) before your investment is returned to you, and you will get the value in six months’ time, not todays value. They do this to prevent a run on the fund and allow them meet dis-investment requests. Commercial property markets aren’t that liquid during recessions thus it is difficult to retrieve your investment if you are concerned about future valuations.

In Summary..

As with most things in life, moderation and diversification are very much key factors that people must remember when they are investing for income in retirement.   There is no such thing as a silver bullet to retirement income.   All of the assets I have discussed over the last two articles will fall in value at some stage, we just don’t know when.  The income percentages and yields available from them will also fall and rise at some point in the future that we know to be inevitable, the timing of those fluctuations we don’t know.  So, be aware of what your investing in and the potential downsides, be diversified and be comfortable with the risk level you are taking with your funds.