This week, we have a listener question from Linda. Linda and her husband live on the Sunshine Coast and are 5 years away from retirement. They have $200,000 in cash and her question is whether they should invest the money into superannuation, or use it to build a 2-bedroom cottage on their existing acreage, allowing for dual occupancy. The detached cottage would provide an income stream for Linda and her husband over the next 5 years and continue into their retirement. Linda and her husband might move into the cottage later on in life and rent out the main property instead, for about $600 a week.
Linda estimates the gross rent from the cottage would be $350 a week (or $18,200 a year). Linda’s building costs were estimated at approximately $150,000 but we’ve included all of the $200,000 as building and renovations often go over budget.
So we’ve crunched the numbers, bearing in mind the costs of maintaining the additional home as well as the value it adds to the existing property. We’ve compared it to putting that same $200,000 into super with an assumed 8% rate of return ($16,000 per annum).
The figures are based on the estimated $350 rental return over 49 weeks a year, to allow for a changeover of tenants, which does happen frequently. The return on rent would then be $17,150 a year.
That’s the rental return – but what expenses would the cottage incur? We have worked out an average of Linda’s potential expenses per annum. Bear in mind, there are many different factors that would affect these costs, so they are an estimate.
Short-term expenses
- Rates and water – $500
- Insurance – $500 (and this would probably be more, in reality. Then there’s also landlord’s insurance).
- Advertising to get tenants and other miscellaneous costs – $500 (and if this is too much, it would probably even out the insurance costs)
- General maintenance – $500 (electrical work, plumbing – this might be less in the earlier years when the property is brand new).
Long-term expenses
- Long-term maintenance – $4,300 a year. Of course, people will think this is very high. But the break down looks like this: internal and external repainting of the house every 15 years (approx. $30,000 or $2,000 a year); replacement of split system air-conditioning every 15 years ($12,000 or $800 a year); replacement of bathrooms, kitchen and floor covering every 20 years ($30,000 or $1,500 a year)
It’s easy to forget about these long-term costs because they don’t come up every year, but they’re certainly there when you think about expenses over a longer period of time. We might be a little bit over or under in our estimation, but the fact is that these costs exist. (For more information on the long-term costs of owning a property, check out
Podcast 98: Why Depreciation is a Real Expense, Not Just a Tax Deduction). However, in Linda’s case, even though the long-term costs we’ve mentioned come to $4,300 per annum, they wouldn’t be starting from Day 1 given that it’s a new property. So what we have done is start the costs from the 10-year mark, and thus we’ve halved the costs over an average of 20 years. With that in mind, the long-term maintenance would be $2,150 per year over those 20 years.
We have also assumed that Linda and her husband would have no real estate management fees due to the fact the new property is on their land and they would be overseeing it.
Total short-term and long-term costs: $4,150 per year
If we take the total expenses from the rental return of $17,150 then we have $13,000 left, which is $250 a week. This is important to note because when people think of income, they often think about the gross rent rather than the net rent.
We’ve also assumed an average of 2.5% per annum in capital growth, because that’s what the Reserve Bank of Australia’s targeted inflation rate is. Generally speaking, properties grow at the same rate as inflation. With capital growth and the return from rent, Linda is looking at $18,000 per year.
We’ve compared these figures to her alternative: putting the money into super, in which the money is spread across a diversified group of companies with an 8% rate of return. For the same $200,000, this would amount to $16,000 per annum.
In Linda’s example, you can see that the property option is marginally better (by $2,000) a year. Of course, this amount will diminish as the property gets older. And as we said, we’ve halved the overall costs given that the property is new – but in 20 years’ time, the costs will be vastly different.
One positive is that Linda already owns the land. Someone who didn’t would be looking to add at least another $200,000 for purchasing the land (location-dependent).
One negative is that having money in property is not liquid. Money can’t be withdrawn from it like it can from super. To withdraw from property, you’d need to sell the whole thing, whereas with super, it’s possible to make small withdrawals.
Another risk for Linda is that she would have two properties in the same location. Generally, it’s better to diversify when it comes to location, if possible.
Another potential barrier could be trying to sell a property which is so unique. We would class it as a niche asset – the pool of buyers for such a property would be much smaller than for a regular house. With a niche asset, you might need to accept a lower price than you’d ideally like if you are selling in a hurry.
Another positive of putting the $200,000 into super is that it could be claimed as a tax deduction if it’s contributed in a certain way. With all of the factors associated with that, the financial gains would again be better than if invested in property.
Linda is actually in a very good situation to make this a success. For many people, this is not the case. Also, the figures we’ve calculated are based on the assumption that nothing goes wrong; that everything runs perfectly with tenants, maintenance, selling the property and so on. And from experience we know that’s not always the case. With Linda’s property, she would be about $2,000 better off a year assuming everything goes to plan.
So the decision rests on whether that $2,000 a year is worth all the work that would go into building and maintaining that property.
For a lot of people, dealing with tenants, chasing up rent and acquiring council permits just isn’t worth the money.
And if Linda and her husband decide not to go ahead with the building now, it doesn’t mean they can’t go ahead with it in 20 years’ time, if the cottage still suits their needs (and the needs of their family) at the time.
Often, we recommend that our clients ‘stress-test’ something like this. Get a caravan, rent it out on AirBnB or something similar – see how you feel about sharing the land with strangers. If you like it, and it’s not a burden, then go ahead with the original plans.
A big thank you to Linda for sending us her question! If any of our readers or listeners would like us to send them a copy of these figures on a spreadsheet, please send us an email at
podcast@mo50.com.au
Listen to the relevant podcast here!
