MAKE MONEY FROM PROPERTY

Table of Contents

9 – PROPERTY INVESTOR (PENSION)

I. Vital Statistics

Earning potential before tax	£10,000 to £200,000 per house
Capital Required	£10,000 to £75,000
Skills Required	None
Qualifications preferable	None
Competitiveness Low/Med/Hi	Low
Risk Low/Mid/High	Low
The Business Model in a nutshell	To buy a property or properties to provide for you in retirement
Potential gaps in the market and suggested USPs	Executive Let

Introduction

Let me tell you the key findings of a major investment bank’s survey:

Only 1 in 4 workers are set to retire on a pension greater than half their salary
This means that 3 out of 4 workers will retire on half their salary or less and,
1 in 2 workers will retire on less than 40% of their final salary

Can you afford to live on half your salary in today’s terms? Or even 40% in today’s terms?

The reason for this is that the stock market has not performed as expected. Annuity rates have declined due to people living longer and the situation is only going to get worse with the increasing quality of health care.

I initially invested in property to provide me with a pension 13 years ago at the age of 24. The main reasons why I did were because:

I didn’t trust anyone handling my hard earned cash apart from myself
I thought it was morally wrong for a pension company to take my money and not allow me to have access to it until I was of retirement age

The funny thing is that even though I invested in property initially to provide me with a retirement income, I found that my property income was in excess of my salary so I retired at age 27! Now I own a portfolio of 200 properties that will earn me an income now, in to retirement and beyond.

When you contribute to a pension fund you are investing in to a business (by way of shares) that you have no control of. If the managing director decides to go on a mad shopping spree and bleed the company dry you have no recourse. Okay, the director may go to jail but you won’t get your money back. Just have a look at some of the high profile cases – WorldCom, Enron etc. These are the ones that hit the press. There are companies that you probably won’t of heard of that a pension fund company invest in that may have suffered the same problems but on a smaller scale.

Property is something you do have control of. It yours! You don’t own a piece of paper called a share certificate. You own something you can see, touch and do with whatever pleases you. But simply owning property is not your route to retirement bliss. You need to know how to exploit the opportunities that ownership brings.

The difference between property and any other investment is the ability to borrow. You can borrow to purchase the property and let the tenant pay your interest payments by way of rent, hence it’s a self-funding investment. Now you can borrow to buy shares but the dividends receivable are rarely sufficient to cover the loan repayments. Also the maximum any bank will lend to you will be up to 50% of the value of the shares and the interest rate is much higher than a typical mortgage because shares are riskier than property. This begs the question - if shares are riskier than property why do people invest in shares rather than property?

Well there are some answers to this. Apart from the tax breaks you get which make investing in pension funds seemingly tax efficient we invest in shares because:

We are lazy! Its easier to simply pay over some money and let someone else do the hard work.
Other people do! We act like sheep sometimes and follow the crowd. If others are doing it we’ll do it too.
We are too trusting of these big pension companies. We fall for their mock caring TV adverts, glossy spreads in the national newspapers and magazines and impressive head offices and branches.

So its time to take up the profession of becoming a landlord and start enjoying the rewards that have been enjoyed by the middle class for centuries - its time to build that property pension!

I wish you the best of luck with your future property purchases.

Traditional Pension v Property Pension

Pensions are a numbers game.

But its not about how much you put away for retirement. You can heavily contribute to an pension investment fund and it can return you very little in the long term – no matter how many tax breaks, frills or top-ups you receive. There is no come-back or guarantee – it’s your loss! There are tax breaks, frills and top-ups there to entice you in to investing in companies which prop up our economy but have no real strategy in providing you with a real long term income that is related to your lifestyle or even your contributions.

I can already hear you say – what a cynic! But if you understand the principles involved you may change your opinion. I am going to show you in words, pictures and numbers how property is a better way to invest for your retirement than any other method suggested by below. Its important to understand why:

The Government, Pension Companies & The Banks cannot deliver you a guaranteed long term income sufficient enough to live a comfortable life and,
Property can deliver an income for you, your family and your subsequent family members that is far in excess of what any of the above can do.

You may think this is a tall order. But if you take the time to really understand how long term income is created you will realise that what I first say, that pensions is a numbers game, is a true statement and you will laugh at what is currently offered to you as a ‘pension’ from a traditional pension provider.

Traditional Pension Providers

There are three broad categories of traditional pension providers:

The Government
Pension Companies

3.The Banks

Okay, so what is so bad about the traditional providers? Well lets look at what they offer:

Providers	What they offer
The Government	They offer you a state pension. You will get this whether you like it or not. You contribute, via your National Insurance contributions which is deducted at source or, if you are self-employed, deducted from your profits twice a year. The contribution is capped and when you come to retirement they pay a pension currently of around £300 per month. This equates to 9% to 20% of the average UK annual salary depending on where you live in the country.

	Even though the government offer a debatable value on your contributions, being only £300 per month from full service, a state pension is something we cannot avoid so it’s not worth applauding it or rubbishing it as there is nothing we can do about it!

	Another incentive they offer is a contribution to a pension fund if you contribute to a pension fund. The contribution is paid by way of not having to pay tax. So if you earn £2,000 per month and pay £200 to a pension company then your taxable income is £1,800 being your income less your pension contribution. If you are a basic rate tax payer, then you will save 21% x £200 = £42 on tax. This is then expressed as an additional contribution by the government as if you didn’t contribute you would have only got £158 out of the £200. So it’s a contribution of £158 from you and £42 from the government.

	If you’re a 40% tax rate payer the government contribution is even bigger! In the above example it would be a £120 contribution from you and £80 from the government – quite an incentive on the face of it.

	But what are they allowing you to contribute to? They are not giving you this money to put away or to invest for your future. They are saying you can contribute to something that only the government agrees with – their economy!

	This has a double effect. Firstly, it means there is investment in the UK economy which helps our UK based economies grow and increase the tax collected from these UK companies.

	Secondly, it forces the man on the street to take a risk on their retirement income rather than have the government take the risk. If the pension fund doesn’t grow to the desired level then that’s just your misfortune. The government has given you a big incentive to invest in a pension fund but they carry no responsibility if your pension fund is worth zero! To be fair to the government it’s not a bad trade off. They lose anywhere between 21% - 40% of your salary, being tax, to mitigate their risk of having to provide for you in the future.
Pension Companies	So the government have given you a tax break of up to 40% - what do the pension companies offer you? Well they offer you no guarantees that’s for sure. What they will do however is, take your money, charge you a fee for doing so, invest it in companies that they have no control over and hope to return you an amount greater than a building society would. The reality is that in the last 5 years you’ll be lucky to get any profit at all! The stock market is very risky even if it is managed by a pension company. You’d have been better off investing in a building society or bank. See next section.

	Please disregard past growth rates of the stock market. Quite impressively the stock market has outperformed every investment out there in the past 50 years apart from the last 10. This is why people have assumed that it is so safe but you must never assume that the past = the future. The stock market has changed dramatically in the way people invest, the type of companies listed, the fluidity in which the market moves and the legislation governing these companies. Dramatic gains are likely to be a thing of the past as most of the gains occurred during the last 50 years.
The Banks	If I were to recommend a pension fund other than property then I would recommend a good old deposit account with an established bank or building society. If you want to retire with peace of mind knowing that you will have at least something to live on then this is the safest way. The problem is you have to contribute so much to even come close to an income that will match your current salary that it seems an impossible task. There are no tax advantages of following this route and the rates the bank pay are incredibly low that it doesn’t even seem worth bothering.

	Also if you look at any pension fund they have cash reserves. The trend has been off lately to keep most of these funds in cash – and they charge you an annual management fee to do so! This results in the poor performance of the pension fund due to their charges and the lower returns to be had from cash. You have to ask yourself - why pay a pension company to put your money in to a cash reserve when you can do it yourself and for free! You’ll probably get a better rate than them as well.

How A Traditional Pension And A Property Pension Work

The only real competitor to a property pension is a pension offered by a pension company. So it makes sense to look into how both these pensions work and how they compare. Can I warn you that the numbers get quite complex if you’re not that numerate. I’ve tried to keep it as simple as possible so bear with me. I guess the reason why so many people have been duped by the pension companies is because of this very fact! It is easy to get blinded by the science.

Lets look at a traditional pension.

Traditional Pension

Joe is 41. He works in an office earning £30,000 per year and is a basic rate tax payer. He decides to take out a private pension. He comes across a reputable firm offering:

Management Fee 1%

Estimated Growth 5%

A management fee is the charge a pension company charge to you for managing your money. This seems reasonable from their side as no one would do this for nothing. They invest your money in so called ‘safe’ investments such as cash deposits, bonds and shares. Some pension fund managers are very good at what they do (even though they are an exception) and are well worth their charge as they can out perform the general market.

Estimated growth is how much the fund manager thinks he can make your money grow. If current rates offered by building societies are 2.5% then a 5% growth is very attractive as it is double what is being offered from a bank or building society. If you took in to account the tax breaks then it seems even more attractive.

Lets assume that the pension company actually achieve their estimated growth target of 5% year on year. If Joe invested £100 per month, increasing his contribution by 4.25% year on year his personal contribution, government contribution and fund value would be:

Age	Personal Contribution	Government Contribution (tax)	Value of year’s contribution at age 65
41	1200	252	4868
42	1251	263	4833
43	1304	274	4799
44	1360	286	4764
45	1417	298	4730
46	1478	310	4696
47	1540	323	4663
48	1606	337	4630
49	1674	352	4597
50	1745	367	4564
51	1819	382	4531
52	1897	398	4499
53	1977	415	4467
54	2061	433	4435
55	2149	451	4403
56	2240	470	4372
57	2336	490	4340
58	2435	511	4309
59	2538	533	4279
60	2646	556	4248
61	2759	579	4218
62	2876	604	4188
63	2998	630	4158
64	3126	656	4128
65	3258	684	4098
Total	51692	10855	111814

So Joe’s pension fund at his chosen age of retirement, 65, is £111,814. Then Joe has to purchase an annuity, which is a guaranteed annual income till his death, with his pension fund. AXA Sunlife offer £45.78 annual income for every £1,000. So Joe’s annual income in retirement is:

£45.78 x £111,814/1000 = £5,118.84 p.a. (say £5,119)

Now let me draw your attention to 2 key figures – what you put in and what you get out:

What you put in	Total pension contributions for the 25 years	£51,692
What you get out	Annual income from the annuity till death	£5,119 p.a. till death

These should really be the only 2 figures you should be interested in. These 2 key figures can only ever be the most important figures in the whole pension equation. In fact, these 2 figures are always the key indicators whenever a business person appraises the likely success of a potential investment. A pension fund is an investment so there should be no other way to look at the performance of it.

What you put in is totally within your control. Therefore this number is known. It is for you to decide how much you should put away for your retirement. You can be advised on how much you should put away but no one can guarantee what you’ll get out of it. However, you can be assured that most sane people want to put the least away for the most gain.

What you get out is totally out of your control. Unless you have taken out a guaranteed benefit pension (which guarantees a fraction of your final salary, usually two thirds) which is hugely expensive and normally only available to executive directors, you will have no idea what your pension fund and thus your annual income will be. You can only ever estimate what you’ll get out with the accuracy of your estimation increasing as you get closer to the maturity date.

So in the above traditional pension Joe put in £51,692 and he’s got out £5,119 p.a. He may get £1,000 p.a. or he may get £10,000 p.a. depending on the performance of his pension fund. But at 5% growth rates he has got roughly 10% of his contributions as an annual income, being £51,692 contributions and £5,119 annual income. Now we can’t say that’s good or bad unless we have an alternative to compare to.

Now lets look at a property pension. More importantly – what you put in and what you get out.

Property Pension

So what’s a property pension? Well the name suggests it all! It’s a fund invested in property that delivers an income from the rent derived from these properties. In other words retirement income from rent. But why is a property pension better than a traditional pension? It has nothing to do with the past. Its to do with the present and the future. If we were to get in to a game of how pension funds have out performed property or the other way round then we would go nowhere. The reason for this is because its historic. Look at this table:

Return	Pensions1	Property2
Over 5 years	11%	92%
Over 10 years	61%	142%
Over 15 years	191%	156%
Over 20 years	441%	358%
1Average individual pension: income reinvested. Figures do not include tax relief. Source: Standard & Poor's 2Average UK house price. Source: Nationwide

Both have done well but it depends on which time frame you look at. Over 15 & 20 years pension funds win but over 5 & 10 years property win! So it depends on what time frame you look at. The only common thing between these figures are that they all happened in the past. The only people that benefited form these are the people that made these investments. The key to understanding how you can always win with property is to understand the concept of gearing. Or in other words having the ability to borrow.

The mortgage market has changed dramatically. It is now possible to buy a property with the lender’s money based on the rental income only. So you are not expected to earn a certain salary to obtain a buy-to-let mortgage of up to £500,000. The only problem is you need a larger deposit compared to the traditional 5% deposit for a residential mortgage. The least you need is 15% deposit but in some cases you need 30%. Due to the introduction of the buy-to-let mortgage house prices have risen way above wage inflation rates. This is because property prices are now determined by the rental value of the home rather than its desirability.

So lets look at the cashflows. Jill is 41. She works in an office earning £30,000 per year and is a basic rate tax payer. She decides to build a property pension. She can afford to save £100 per month to build a deposit and buy a property costing £30,000. She can rent it out for £2,400 per year which equates to 8% of the purchase price i.e. 8% yield. She decides to buy a property every time she saves up enough for a deposit.

Now I’m going to have to hold your hand through these figures! Jill buys 4 properties over the 25 years with property values rising 5% every year (the same growth rate as the pension fund). She rents them out and allows a 20% loss of rent due to agent’s fees, void periods and repairs. Allowing for this she gets an annual profit rising every time she buys a property and allowing for rent inflation (applied every 5 years). So the annual profits after tax (basic rate 21% - average used) are calculated from the following table:

Property		1	2	3	4
	yrs 0-5	Yrs6-10	yrs11-15	yrs16-20	Yrs21-25	Yrs 26 onwards
Purchase price	30,000
Deposit (15% of purchase price)		4,500
Debt		25,500

Rent (8% yield)		2,400	3,063	3,909	4,989	6,368
Interest (5% APR)		1,275	1,275	1,275	1,275	1,275
Other costs (20% of rent)	480	613	782	998

					1,274
Net Inflow Before Tax	645	1,175	1,852	2,717	3,819
After tax (21% Basic rate)		510	929	1,463	2,146	3,017

Fees		1,500
Total Deposit & Fees		6,000

Purchase price			38,288
Deposit (15% of purchase price)		5,743
Debt			32,545

Rent (8% yield)			3,063	3,909	4,989	6,368
Interest (5% APR)			1,627	1,627	1,627	1,627
Other costs (20% of rent)			613	782	998	1,274
Net Inflow Before Tax			823	1,500	2,364	3,467
After tax (21% Basic rate)			650	1,185	1,868	2,739

Fees			2,000
Total Deposit & Fees			7,743

Purchase price				48,867
Deposit (15% of purchase price)				7,330
Debt				41,537

Rent (8% yield)				3,909	4,989	6,368
Interest (5% APR)				2,077	2,077	2,078
Other costs (20% of rent)				782	998	1,274
Net Inflow Before Tax				1,051	1,915	3,016
After tax (21% Basic rate)				830	1,512	2,383

Fees				2500
Total Deposit & Fees				9830

Purchase price					62,368
Deposit (15% of purchase price)					9,355
Debt					53,013

Rent (8% yield)					4,989	6,368
Interest (5% APR)					2,651	2,651
Other costs (20% of rent)					998	1,274
Net Inflow Before Tax					1,341	2,443
After tax (21% Basic rate)					1,059	1,930

Fees					3,000
Total Deposit & Fees					12,355

Annual Profit Inflow		510	1,579	3,479	6,586	10,070

Now having calculated the figures above we can derive the key figures in building a comparison with a traditional pension. The key figures being:

Deposit & Fees put down to acquire the properties
The profits from these properties
The purchase price of these properties
The value of these properties at retirement
The debt outstanding on these properties at retirement

Property	Age	Deposit & Fees (outflow)	Profit (inflow)	Net Outflow	Purchase Price (5% growth pa)	Property Value at age 65	Debt (mortgage)	Net Value
	41
	42
	43
	44
1	45	6000			30000	83579	25500	58079
	46	0	510
	47	0	510
	48	0	510
	49	0	510
2	50	7743	510		38288	83579	32545	51034
	51	0	1579
	52	0	1579
	53	0	1579
	54	0	1579
3	55	9830	1579		48867	83579	41537	42042
	56	0	3479
	57	0	3479
	58	0	3479
	59	0	3479
4	60	12355	3479		62368	83579	53013	30566
	61	0	6586
	62	0	6586
	63	0	6586
	64	0	6586
	65	0	6586
		35928	60764	-24836	179523	334316	152595	181

So Jill’s property pension fund is £181,721 being the value of the properties less the mortgage debt. But just like the traditional pension fund we have assumed a 5% growth in property prices. Now, I am not a fortune teller, so I have no idea what the growth rate will be averaged out over the next 25 years. Even though a property pension fund is greater than a traditional pension after tax at the same growth rates (£181,721 v £111,814) - the great thing is that IT DOESN’T MATTER!

So why doesn’t it matter? The 5% growth is nice and probably realistic but it doesn’t provide us with an income. What we’re interested in is the rental income. The key figures you should be looking at are the 2 key figures I talked about earlier. Let me remind you – what you put in and what you get out! So here’s what we’ve put in and what we’ve got out:

What you put in	Deposit & Fees less profits from the properties over the 25 years	(£24,836)
What you get out	Profits for years 26 onwards	£10,070 p.a. forever

So with a property pension you actually get money back! What you put in is a negative amount. Your investment in property by way of deposits and fees are replenished by the profits made in property and more. Being prudent, lets assume that the profit just covers the deposit and fees only. This means that over the 25 years what you have put in is still only NIL!

So what have you got out of it? Well a nice income of over £10,000 p.a. which is twice as much as what a traditional pension can offer. And this income is not just for your life but for your descendents after your death as the properties pass to your beneficiaries in your will.

If you do want a risk free pension and want to purchase an annuity then the net value of the properties does matter because you have to sell the properties. The beauty of property is that you can sell when you want to. So you can sell when the market is high or hold when the market is low. The market could be high enough to sell within 15 years of you making the first property purchase or you may have to wait 30 years. Assuming the property portfolio does perform at 5% growth p.a. then the net fund after tax will be:

Proceeds of Property Sales £334,316

Purchase Prices £179,523

Profit £154,793

Tax Relief (£61,917)

Chargeable Gain £92,876

@40% £37,150

So net proceeds will be:

Proceeds of Property Sales £334,316

Tax Bill (£37,150)

Net Proceeds before Mortgage Debt £297,166

Mortgage Debt (£152,595)

Net Proceeds £144,571

Using the same annuity rates as above of £45.78 per £1,000 the risk free pension till death is:

£144,571 x £45.78 / 1000 = £6,618.44 p.a.

Comparison Tables

So lets look at a proper comparison table of the figures:

	Traditional Pension	Property Pension	Property Pension

		(Buy&Hold)	(Buy&Sell)
What you put in	£51,692	Nil	Nil
What you get out	£5,119 p.a.	£10,070 p.a.	£6,618.44 p.a.

	till death	forever	till death

I hope that you can clearly see that property pensions out perform traditional pensions quite astronomically even with all the tax breaks. This is because you essentially put no money in and get more out! Even if the traditional fund did return you a higher income the property pension would win as you haven’t put anything in!

This is why traditional pensions are a joke.

But it doesn’t stop there! Its not only the numbers that make a good case for a property pension. There are other factors that make a property pension superior to a traditional pension which are in part drawn out from the figures above. Look at this table:

	Traditional Pension	Property Pension
Flexibility	Pensions are inflexible by their very nature, as you can't get hold of your cash until you are 50. And even then its only 25% of the fund.	You can sell your property or properties when you want. So if the market is high or you need the cash then the money can be unlocked relatively quickly whenever you want.
Longevity Of Income	The income from a pension stops when you die. Now this may not be a problem for you (because your dead!) but this could be a problem for your dependents. You can get a pension that pays out to your spouse but you have to pay for it! The annuity rates are much lower.	The income streams carry on regardless of your death. Just because you die it doesn’t mean your tenant has to stop paying rent. The rent will simply be paid to whoever you leave the property or properties to when you die. This is how some families have become very rich due to the inheritance of property from their ancestors.
Income Now	There is no income stream until you purchase the annuity. This may be 40 years after you made the first payment in to the pension fund.	When you invest in property you will get income straight away. If you’ve bought the right property then you will get an income even after paying out for the expenses such as the mortgage and repairs.
Instinctive	How do you choose a good pension fund? Its very hard to choose a good fund. You can use historic data but historic data tells you nothing about future performance. You have to take on the risk that your fund manager will do well with your money. How well he or she will do is impossible to tell. You do not even get the chance to meet them!	Its easier to pick a good house rather than a good stock or pension company. You will have an instinctive knowledge about property as we have all lived in one! Its something you can touch and feel rather than a paper statement sent to you once a year!
Income rises with inflation	If you purchase an annuity with a fixed income payout then you will receive a fixed amount till death. You real income will diminish over time due to price inflation. The only way to counteract this is to take out an annuity that pays an income that rises with inflation. But you’ve guessed it – it costs! So the annuity rates are lower.	Rent rises with wage inflation at the very least. However current demographics show that property is in short supply and the situation is set to get worse. Fragmenting families, increasing population, first time buyers being priced out and building quotas not being met will cause rents to probably rise above inflation.
Gearing	You are unable to borrow to contribute to a pension fund as there will be no way you could service the loan repayments.	You are able to borrow because the lender takes first charge on the property and knows you can service the debt from the rent paid by the tenant. The potential growth of your property fund is magnified due to the growth being on the whole property price rather than the actual amount invested.
Known retirement income	You will have no idea what your retirement income will be. You can only make an estimation but will depend heavily on the size of your fund and the annuity rates being offered at the time of retirement.	Its easier to predict your retirement income if you choose properties that give you an income you desire now. So for example if you require an income equivalent to your salary of £2,000 per month then choose 4 properties that have a rental figure of £500 each. Then you can be assured that when you retire the rental figures would have risen roughly with inflation to provide you with a real income of £2,000 per month.
No cap on contributions	You are capped on the contributions to a pension fund to qualify for full tax relief. You can contribute further but you do lose out on all the tax benefits.	Because you have already factored in the lack of tax benefits in the whole equation then the amount you want to contribute is completely up to you.
Not relying on growth	The fund has to grow to a desired level for you to draw an income sufficient for your retirement. This is very difficult to predict which has been shown by all the pension companies offering these type of pensions.	Growth is nice but you are relying on rental income. Rent does not go down – it rises with inflation so you can be assured that the income derived from your properties will be sufficient and growth will be irrelevant. (This is only applicable for a buy & hold strategy).
Annuity rates are always inferior to property yields	Annuity rates are very poor but will never exceed 8% for someone aged 65. This is because we live longer. In this example if they gave you 8% then they will expect you to die in 12.5 years. This is just under the average life expentancy of 79 being 77.5 years. They will give you an income based on you living till 90 and hope you die at 79! This equates to a 5% rate.	8%+ yields are easily achievable – even though property prices are said to be at an all time high. A list of over 350 areas are listed in the reference chapter that offer an 8% yield or greater. Thus property will always be a better investment than an annuity.
Risk & Control	You place all the control with a fund manager. He is in full control of your money and exposes you fully to the risks that only he takes on.	You take the risks that you want. You are in full control of the decisions you wish to take. You are exposed exclusively to the risks only you wish to take.

Assumptions

Now there have been a number of assumptions made in deriving these calculations. These are necessary otherwise we could not build a picture of your future income. Here are a list of the assumptions I have taken for each type of pension, how reasonable they are and how relevant they are to the overall performance of each.

Traditional Pension

Assumption	Reasonable?	Relevant to performance?
Basic Rate Tax Payer	I have chosen basic rate as I have assumed most people are basic rate tax rate payers which is the case.	Yes. A higher rate tax payer gets a higher retirement income than a basic rate tax payer in a traditional pension example but they still receive less than a property pension. So a property pension is still superior.
1% Management Fee	There are few if any that charge less than 1% and there are some that charge in excess of 1%. 1% is the industry norm for pension funds.	Because this is the industry standard it is a safe assumption as not to distort the figures.
5% Growth of Fund	This is a very difficult question as we are crystal ball gazing. We cannot base it on past performance as that is stupid. The key fact is that it is the same growth rate as the property calculations so neither has an advantage.	No. As both growth rates were set equal.
4.25% growth in contributions	Would seem reasonable due to taking into account inflation and promotional pay increases.	No. As we have looked at the contributions in total over the 25 years the individual contributions over the years are broadly irrelevant as in both examples the contributions were spread out.
Start age of 41	The start age is not really relevant due to the fact that both pensions were being compared.	No. Both start ages were the same.
Retirement age of 65	The retirement age is not really relevant due to the fact that both pensions were being compared.	No. Both retirement ages were the same.

Property Pension

Assumption	Reasonable?	Relevant to performance?
Basic Rate Tax Payer	I have chosen basic rate as I have assumed most people are basic rate tax rate payers which is the case.	Yes. A higher rate tax payer gets a lower retirement income than a basic rate tax payer based on the same contribution level under a property pension but its still in excess of the traditional pension.


8% yield	There are many properties and areas that offer an 8%+ yield. Join my newsletter at www.ahuja.co.uk to get a full list of them	Yes. The higher the yield the higher the profit per year thus reducing your overall contribution. If the yield is 6.75% then the profit over the 25 years matches your contribution to property so that your overall contribution is nil. Below 6.75% yield and you will then have to contribute out of your own pocket. Above 6.75% yield requires no overall contribution.

		Over 75% of properties on the market offer a 6.75%+ yield so there is no shortage of suitable properties. 8%+ just gives you that comfort margin.
Fixed Interest rate of 5% APR	A fixed rate had to be used to keep the examples simple. Again we are crystal ball gazing here. 5% APR is reasonable because we can fix interest rates to around this level for a period greater than 10 years. Also, fixed rates are determined by the fixed bond market which is less volatile than the variable rate market.	Yes. The cost of borrowing affects profits quite dramatically if we don’t buy at a good yield. If you buy a property in excess of 8% then you can weather interest rate fluctuations.

		You need to consider what you think the average interest rate will be over the next 25 years - and if you know the answer to that then let me know!
Interest only mortgage taken out	Interest only monthly payments are less than repayment monthly payments thus monthly cash inflows are higher due to the balance never being reduced. It’s a reasonable assumption as all the mortgage companies offer it but it depends on whether you want the property paid in full by the time you hit retirement.	Yes. If the example used a repayment mortgage instead of an interest only mortgage then the profit would be the same but the cashflows would have been different. The monetary difference between repayment and interest only could be considered as a contribution. The beauty is that this contribution can be structured as a voluntary contribution if you took out an interest only mortgage and paid the capital off as and when you wished to.
Other costs being 20% of rent	20% of rent is quite a generous allowance. This equates to 1 month void period, management fees of 10% of rent and 2% of rent spent on repairs.	Yes. The amounts of voids, management charges and repairs affect profit which affect your overall contribution.

		You need to consider if 20% is enough.
Professional Fees	I have assumed £1,500 for year 5 increasing by £500 every 5 years. This is a standard charge for valuations, solicitor costs and arrangement fees. Its unlikely that you will face a charge greater than £1,500 and the £500 increase every 5 years is above the rate of inflation so is a prudent estimate.	Yes. The size of your contribution is dependent on the amount of professional fees required. The less required means that you can acquire properties sooner as the requirement to purchase a property is lowered.
Deposit Level of 15%	At the time of print there was only one 15% deposit level lender. However the credit freeze is melting and I expect many more 15% deposit products to come on to the market and in the long run be the average level of deposits in the future.	Yes. If you have to find more deposit money then this will affect performance. You could use more complicated no money down strategies to match if not better the performance outlined above. If you want to find out more visit www.ahuja.co.uk and join my newsletter.
Property purchase price of £30,000 rising by 5% every year.	I have chosen £30,000 just as a notional figure to compare like with like based on a rough £100 per month contribution. If a property can only be bought for £90,000 then a contribution of £300 per month is required.	No. As the contributions in both examples were the same. So if £90,000 had to be the purchase price then we would have to alter the contributions in the traditional pension example to £300 per month so we could compare like with like.
5% Growth of Property Prices	This is a very difficult question as we are crystal ball gazing. We cannot base it on past performance as that is stupid. The key fact is that it is the same growth rate as the traditional pension calculations so neither has an advantage.	No. As both growth rates were set equal.
Start age of 41	The start age is not really relevant due to the fact that both pensions were being compared.	No. Both start ages were the same.
Retirement age of 65	The retirement age is not really relevant due to the fact that both pensions were being compared.	No. Both retirement ages were the same.

ts up to you to think are these assumptions reasonable and/or relevant? Try flexing the numbers to see what other results you get. Do whatever it takes for you to come to a decision on whether what I’m saying has some basis or is fundamentally flawed due to very relevant omissions. Until you do this you will always be waivering between traditional pension funds or property pension funds or even something else! - and always kicking yourself for not making the right decision when one of them booms.

Risks v Returns

So we have established the returns to be had from a traditional pension and a property pension but what are the risks and are they worth it? Lets look at the risks for each one.

The Risks Involved In Investing In Property

They’re a number of fears that people have which are fully justified. They are not dissimilar to what business people face when appraising a potential investment. These are called risks. The difference between the ordinary person and a business person is that a business person:

Identifies all the risks involved
Mitigates each risk as best he or she can
Considers the overall risk based on how well he or she can mitigate each individual risk
Makes a decision based on the overall risk

So to build a property pension you need to:

Identify all your fears involved in building a property pension
Think how you can overcome each fear involved in building a property pension
Consider the overall fear factor based on how well you can overcome each individual fear
Decide whether you want to build a property pension or not based on the overall fear factor

Fortunately for you I’m not going to ask you to think up all the fears involved, how to overcome these fears and calculate the overall fear factor. I am going to tell you this!

Unfortunately for you I am not going to decide for you whether to build a property pension or not because I am not you! However, I will present a very strong case to you and I will recommend that you build one - but the ultimate decision rests with you.

The Fears and How To Overcome Them

With every fear you can take what I call Countermeasures which overcome each fear. A countermeasure is an action you take to counteract each fear. No countermeasure is fool-proof otherwise the fear would not be a fear purely by its definition as it could be fully overcome.

There will still always be an overhang of fear albeit a lot less than the starting fear. This is what I call Residual Fear. The residual fear is therefore still present even after the countermeasure and thus is a real fear. You can take further countermeasures to reduce this residual fear but it depends on how far you want to go.

There will always be residual fear however. An example of residual fear that cannot be eliminated is the destruction of your property if there was a war. No insurance company will take on this risk. The only way you could mitigate this risk would be to build a bomb proof shell around your property – but this would be impractical and probably cost more than your property itself!

The fears, countermeasures and residual fears in buying a property are:

	Fear	Countermeasure	Residual Fear	Further Countermeasure
1	Cant find a tenant.	Buy a property that can be easily let out, like near a major train station or in a desirable area.	Still cant find tenant.	Reduce the rent.
2	Interest rate rises beyond affordability	Fix the interest rate for a fixed period of time.	The interest rate rises beyond affordability after the fixed period of time.	Fix the interest rate for the whole term of the mortgage.
3	Get caught in negative equity trap.	Don’t sell the property and realise your loss. Continue to rent it out. Wait for the recovery and then sell.	It never recovers and you have to sell.	Buy the property without a mortgage so that negative equity is not a possibility.
4	The tenant does not pay the rent.	Take out landlord insurance that covers your for loss of rent due to tenant default.	None	N/A
5	Major repair becomes due and can’t afford to carry out works	Take out a thorough and comprehensive buildings and contents insurance.	The policy doesn’t capture every eventuality.	Take out specific policies for specific items i.e. British Gas offer full insurance on your boiler from £8 per month.
6	Buying a property you can’t sell	Avoid difficult to sell properties such as studio flats, ex local authority flats, flats above shops, non-standard construction properties or any property that is difficult to get a mortgage on.	Still cant sell it!	Buy a property near a train station city or major road junction.

Overall Fear

To calculate your overall fear is to gather all the residual fears that remain. To do this you:

Decide which fears listed above 1 to 6 are fears that you actually have
Decide what countermeasures you are willing to take for each fear
Calculate the residual fear for each fear applicable.

So for example if you had the following fears and were willing to take the following countermeasures then your overall fear is all the contents of the residual fear column:

	Fear	Countermeasures willing to take	Residual Fear
1	Cant find a tenant.	Buy a property that can be easily let out, like near a major train station or in a desirable area and be willing to reduce the rent.	Not being able to find a tenant for a property near a major train station or desirable are even though you are flexible on the rental price.
3	Interest rate rises beyond affordability	Fix the interest rate for the whole term of the mortgage.	Nil.
4	Get caught in negative equity trap.	Don’t sell the property and realise your loss. Continue to rent it out. Wait for the recovery and then sell.	It never recovers and you have to sell.
6	The tenant does not pay the rent.	Take out landlord insurance that covers your for loss of rent due to tenant default.	None
8	Major repair becomes due and can’t afford to carry out works	Take out a thorough and comprehensive buildings and contents insurance as well as specific policies for specific items.	The policies don’t capture something you hadn’t thought of.

So the overall fear is the total of the residual fear column being:

Not finding a tenant even though you have bought a desirable property and you can reduce the rental price asked
You buy a property that goes falls into negative equity and you have to sell
You get stung for a repair that you never thought you’d get

You have to make an estimation of how likely these fears will materialise and are the rewards in investing in a property pension are compensatory enough. If you are happy with this overall fear then you will invest in property. If you are not then you won’t. If you are not happy with the overall fear then I suggest you take more countermeasures so that your overall fear is reduced. Reduced to a level that you are happy with so you are comfortable in investing in property.

The Risks Associated With A Traditional Pension Fund

Because you transfer a lot of your control over to the pension fund manager there are only two real risks:

	Fear	Countermeasure	Residual Fear	Further Countermeasure
1	The fund is not big enough to pay your desired retirement income	Contribute more to the fund	Still isn’t big enough	Wait for annuity rates to rise
2	At the time of retirement the annuity rates are poor	Wait for the rates to improve	Rates do not improve	Contribute more to the fund

So in summary you can either add to your fund or wait. These are the only two strategies you have!

So Are You Convinced?

Well I’ve laid out both arguments for you but its for you to come to a decision. Do you think property is better than traditional pension funds? I really want you to study this chapter as this is key to your motivation to build a property pension. Once you are convinced the motivation to build a property pension will be there. This is because you understand the uniqueness of property and how property is a superior investment to virtually any of the other investments out there.

The illustration above is only one strategy to achieve a property pension. There are many strategies you can adopt to achieve a retirement income but this all depends on YOU. It depends on how much you are willing to contribute, how much you want and when, your attitude to risk and your level of involvement. Lets look at this in more detail in the next chapter.

YOUR PROFILE

Objective

If you want to build a property pension you need a strategy. A strategy is a method to achieve an objective. So in this scenario the objective is to:

‘have an income sufficient enough to meet all your needs in retirement’

This is what a pension aims to do but often fails. This is why there are so many charities to help pensioners such as Age Concern and Help The Aged. So to achieve this objective you need a strategy! The first stage in constructing a strategy is to really think about the objective. The objective throws up some obvious questions you need to ask yourself. The obvious questions that need answering, why and how to answer them are:

Question	Why	How To Answer
How much do you need?	You have to know how much you need! If you don’t spend the time to think about it then you face the possibility of not having enough. Setting a target income means that you have something to aim for.	On the face of it it seems a difficult question to answer. Your retirement age may be 25 years away and you will have no idea what £1 is worth in 25 years time. The fact is you don’t need to! What you can do is ask yourself what will you need in today’s value of money. Because rental income rises with inflation then all we have to do is express our desired retirement income as rental income at today’s value. So if you earn £25,000 per anumn now and would like to keep the lifestyle you have then you require £25,000 rental income at today’s rental market value.

		So how much will you need? Think about your likely monthly expenses of living and what you would like to do in your retirement. So don’t forget the obvious expenses such as food, bills and clothing and don’t forget to omit your mortgage expense if you plan to pay off your home by the time you hit retirement. If you wish to travel in retirement then allow for that expense. So you should be able to come up with a monthly figure.
When do you want it?	You need to know when you wish to retire so you can put a timescale to the objective. You can then set mini-targets within the timescale so you can monitor how well you are doing. If mini-targets are not being met you can adjust your strategy to bring you back on track.	So when do you want to retire? Answering ‘tomorrow!’ is neither helpful nor practical. Consider your age now, how long you would like to work and what you want to do in your retirement. Remember, retirement can be boring for some people, as many early retirees have admitted. Set a realistic timescale which takes in to account your target retirement income.

So an example of someone’s objective would be:

Target Retirement Income at today’s value	£25,000
Timescale	18 years

What’s Needed From You To Achieve Your Objective

Your objective is not going to land in your lap! It requires the following from you:

Time
Money
Acceptance Of Risk

All these factors are correlated. That is to say if you don’t have much money to put in then be prepared to put in more time and accept a higher degree of risk. If you increase the time you put in then you won’t have to put so much money in or accept so much risk. Lets look at exactly whats expected from you.

1.Time

Your time is needed in the following ways with ways to reduce them:

	Needs From You	Ways To Reduce Your Time Input
Acquisition	You need to find the properties that will deliver you an income! This involves researching suitable areas, looking through the local press, speaking and dealing with agents, visiting prospective properties, arranging finance and whatever else is needed from you to acquire a property.	You can approach a property buying company that will do all this for you based on your criteria. This costs! These companies can charge up to 5% of the purchase price so they can work out expensive.

		I offer this service. If you don’t have the time and require this service then contact me. My details are in the front of the book.
Find a tenant	You have to advertise, do viewings, credit check and take up references of prospective tenants.	Use a letting agent. They charge a fee of around 10%+VAT on the rent collected.
Legal documents	You need to prepare the legal documents to bound all parties or to evict tenants.	Use a letting agent. They charge a fee of around 10%+VAT on the rent collected. Or use my documents detailed in the Appendix.
Rent Collection	You need to arrange for the rent to be collected. This may be face to face collection from the tenant’s doorstep, collection from the benefits office or through your bank.	Use a letting agent. They charge a fee of around 10%+VAT on the rent collected. Or you can use my standing order set up form detailed in the Appendix.
Repairs	You need to either repair the problem or instruct someone to do the repair.	Use a letting agent. They charge a fee of around 10%+VAT on the rent collected.
Tax Return	You need to declare what you’ve earned during the financial year in order to pay tax. This requires accounting for all receipts and expenditure associated with the property.	Use an accountant. Or you can subscribe to www.propertyhotspots.net to manage your finances.

2.Money

You need money to buy a property! Here is why you need money and ways to minimize the amount needed:

	Needs From You	Ways To Reduce The Cost
Initial investment	You need a deposit to buy a property. At a minimum it will be 15% of the purchase price. You will also need the associated fees that come with buying a property. These are valuation fees, solicitor costs, arrangement fees, finder fees, initial void period and essential repairs required before letting the property.	You can borrow the deposit and fund the repayments to the loan from the rent achievable once the property has been bought. This increases your risk due the increased borrowing.

		You can find a property yourself thus eliminating a finders fee to a property agent.

	You need to save for a deposit if you want to buy a property.	You can buy a property in a good state of repair thus avoiding any essential repair costs.
Monthly contribution	You may have to contribute over and above what is received in rent if you get hit for a large repair bill, interest rates rise, the tenant defaults or you wish to pay off the mortgage early.	Take out insurance on tenant default or any large repairs. This means the insurance company pick up the bill. The cost of this is the insurance premium.

		Fix your interest rate so fluctuations are not a concern. Thus if you have chosen a property that returns a rental income in excess of the fixed mortgage payment then you are assured that you do not have to contribute.

		Take out an interest only mortgage. This keeps the mortgage payment at its lowest possible point so the margin between rent and mortgage cost is at its highest.

		Go for a higher yielding property. The higher the yield the higher the profit margin. Please note – the higher the yield the higher the risk!

3.Acceptance Of Risk

In chapter 1 we dealt with the risks in property. There are always risks of owning an asset but there are also benefits! You can mitigate against these risks and they cost but there will always be a residual risk remaining. So you will always have to accept a degree of risk.

You need to decide what risks you are willing to take as this will determine the strategies open to you.

The Relation Between What’s Needed From You & Your Objective

Now these three factors, time, money and acceptance of risk have to bear some relation to your objective.

If your objective is to have a retirement income of £100,000 p.a. at today’s value in 5 years and you earn £20,000 p.a., have no savings, no time and willing to accept a very low level of risk then it won’t happen!
If your objective is to have a retirement income of £100,000 p.a. at today’s value in 5 years and you earn £20,000 p.a., have no savings, willing to contribute, little time and willing to accept a high level of risk then it might happen!
If you wish to earn a retirement income of £20,000 p.a. at today’s value in 15 years and you earn £20,000 p.a., have no savings but the discipline to save, have a bit of time, and willing to accept a medium level of risk then it probably will happen.

So how do know what won’t, might or will happen? This is best explained by looking at two extreme cases and what’s in between.

Target Retirement Income At Today’s Value	Timescale	Time	Money	Risk	Outcome
Double income being earned today	Less than 5 years	None	No savings and not willing to contribute	Acceptance of low level risk	Won’t happen
Equal or more than income being earned today	Greater than 5 years	Have some time	Have some savings and ongoing contribution	Acceptance of medium risk	Might happen
Same as income being earned today	Greater than 15 years	Willing to put time in over all aspects	Has savings and willing to contribute ongoing	Acceptance of medium level of risk	Will happen

So, in my professional opinion, as long as you are willing to earn a retirement income that is what you are earning now, that is 15 years away, have the time, can save and have savings, accept a medium level of risk then it WILL happen.

Deriving Your Profile

Based on the above you should be able to build a profile of yourself and your aims. Your profile should follow the answers to the above prompts. A profile would be made up of the following:

Profile	Range Of Answer	Considerations
Target Retirement Income at today’s value	0.5 – 5 times your actual income now	How much do you want based on today’s value. Do you think you will have expensive tastes in retirement? Do you want a simple life in retirement? Or do you just want what you have now?


Timescale	5 – 30 years	How soon do you want to retire? Is it soon, next decade or next millennium!


TIME	Low/ Medium/ High	Are you willing to be involved in the buying process, rent collection and repairs? Or do you work full-time (and overtime!) and want zero involvement?
MONEY	Low/ Medium/ High	Do you have a deposit? Are you good at saving? Are you willing to contribute month to month? Or do you have no savings and require a monthly profit from the properties?
ACCEPTANCE OF RISK	Low/ Medium/ High	Are you willing to borrow significantly, accept fluctuations in interest rates, take interest only mortgages and go for less desirable properties that yield highly? Or do you want minimal borrowings, fixed rate borrowings, repayment mortgages and nicer properties near your home town?

So a typical profile may be:

Profile	Answer
Target Retirement Income at today’s value	£30,000
Timescale	24 years
TIME	Low
MONEY	Medium
ACCEPTANCE OF RISK	Medium

Based on this profile we can match it to the strategies available. What’s your profile? Take your time to really think about what you want. Is it realistic? Will it be enough? Do you earn enough to save and/or contribute? Can you take a higher level of risk?

Based on your profile we can match a strategy or even a number of strategies based on your profile. Chapter 3 has all the answers.

3.THE STRATEGIES

The Three Core Strategies

There are 3 core strategies to a property pension:

Buy & Then Hold
Buy & Then Sell
Buy, Then Part Hold & Part Sell

There are variations within these strategies but every strategy will fall within these core three. Remember from the last chapter the definition of a pension, being the objective of a property pension:

‘have an income sufficient enough to meet all your needs in retirement’

Well the 3 strategies above can meet this objective.

In more detail:

Strategy	What it entails	Features
Buy & Then Hold	This involves buying a property (or properties), repay for it in full by retirement and live off the rental income through retirement.	You rely on the property to be an easily rentable property so as to provide a safe income for retirement.
Buy & Then Sell	This involves buying a property (or properties), making the repayments during the period of ownership and then sell the property and clear the debt (if any). The balance of the monies are then used to purchase an annuity to provide an income till death.	You rely on the growth of the property to be sufficient enough to purchase an annuity to meet your target income in retirement.
Buy, Then Part Hold & Part Sell	This involves doing a mixture of both strategies above.	Combination of both above.

Choosing The Right Strategy

You need to choose the strategy that’s right for you based on your level of time, money and acceptance of risk. Here’s how these strategies could work with the level of time, money and risk a potential investor has:

Strategy	Level	Refined Strategy
Buy & Then Hold	TIME	Low	Buy a desirable property with less than a 9% yield on a repayment mortgage and place with a letting agent to manage the property. The investor understands that he might have to contribute on top of the rent to cover the mortgage payment but has the assurance that the property will be paid in full. It will then provide an income for life.
	MONEY	Med
	RISK	Low

Buy & Then Sell	TIME	Med	Buy a property in a less desirable area but yielding in excess of 10% on an interest only mortgage. The investor will manage the property himself but knows that it is unlikely that he will have to contribute on top of the rent as the property yields high and the mortgage is interest only. He hopes that the property value grows sufficiently in value in order to purchase an annuity to provide him with an income till death.
	MONEY	Low
	RISK	Med

Buy, Then Part Hold & Part Sell	TIME	High	He does a bit of both above. He is happy to buy more than one property and manage them himself. He uses the profits from some to fund the others but his risk is reduced due to the investor not relying on one single strategy. Overall risk is medium due to the greater exposure he has to the property market but he can capitalize in each market when the market is high.
	MONEY	Med
	RISK	Med

So think about whether you want to own and run a property or properties pre and post retirement. Think about how much money you want to put away for saving up for a deposit and ongoing pre-retirement. Think of the level of risk you want to expose yourself to – Do you want only one property or a few? Do you want repayment or interest only mortgages? Do you require a risk free income in retirement?

Based on your own profile and personal preferences you should come up with a strategy you want to go for. To help you decide lets look at some examples. I have decided to ignore tax consequences in these examples to keep the figures simple.

Buy & Then Hold

Richard has the following profile:

Profile	Answer
Target Retirement Income at today’s value	£24,000
Timescale	25 years
TIME	Low
MONEY	Medium
ACCEPTANCE OF RISK	Low

He has decided that he wants to Buy & Then Hold so he can pass the properties down to his children. But he also doesn’t want to pass any debt on so he intends to own the property outright. He works full-time so he doesn’t want to manage the properties and he wants desirable properties that are easily let out. He has the ability to save and a willingness to contribute on an ongoing basis if need be.

The strategy would to be buy one or more properties that give a rental income of £24,000. As he is a low risk investor he would buy a low yielding property, such as 8%, on a repayment mortgage. This could be 3 properties costing £100,000 producing an £8,000 per year income. He will also have the property managed by a letting agent.

Using Your Own Home To Provide A Retirement Income

Some people do use there personal home to provide for themselves in to retirement. The theory is that you downsize to a smaller property due to the kids leaving and purchasing a bungalow in a quieter area and rent out your own property.

The key things you need to consider are:

Is the rental value of your home equivalent to your desired income in today’s standards?
Will the property be paid in full when its time to retire?
Will you have saved enough to buy a property for yourself to live in?

You can always sell your own home and buy two cheaper properties and live in one and rent out the other. This falls in to the strategy of Buy & Then Sell. But the key things you need to consider above still apply.

Buy & Then Sell

Susan has the following profile:

Profile	Answer
Target Retirement Income at today’s value	£30,000
Timescale	20 years
TIME	Medium
MONEY	Low
ACCEPTANCE OF RISK	Medium

NEXT CHAPTER

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