Pass it on: building intergenerational wealth through property

I have never viewed investing in real estate as a get rich quick proposition. It’s a slow burn and takes time and effort to locate the right properties to suit your own individual circumstances and objectives.

If you’re willing to learn the fundamentals, do the research and take the plunge, investing in residential property carries relatively low risk and can offer enormous rewards down the line.

But as property values continue to head skywards, it’s becoming increasingly difficult for younger Australians to save the required deposit and get their foot on the first rung of the property ladder.

Affordability is clearly an issue in today’s market but teaming up with your kids could offer a potential solution.

There have traditionally been three phases to property investment: acquisition, hold and transition.

The first two phases haven’t changed. You build a property portfolio by acquiring one, using the capital growth in that property to cover the deposit and costs for the next, and repeat. Then hold those properties for a cycle or two and reap the benefits of compound growth.

The final phase, transitioning from working years to retirement, has typically involved cashing in - selling down assets and paying down debt.

However, this is 2021 and not all of the same rules still apply. 

We live in interesting times and there’s been a change in recent years due to record low interest rates and affordability pressures.

Where paying down debt used to save an investor six to seven per cent per annum, it’s only saving two or three per cent today.

As a result, many investors are preferring, instead, to bring the next generation into their property portfolio.

The rationale is that young adults have income but little in assets, while older people have assets but little income.

The costs of entering and exiting real estate are high. Investors can expect to outlay at least three per cent of the purchase price on the way in and five per cent of the sale price on the way out - and that’s before paying capital gains tax! 

More importantly, the median house price has increased at a compound growth rate of four per cent per annum after inflation. This means the longer you hold the property, the higher the annual growth increase due to the magic of compounding.

Most real estate investors hold their property for five to six years before selling. Less than 10 per cent of property investors hold their properties for two cycles and less than one per cent for three.

This presents an incredible opportunity for parents and kids. It allows parents to squeeze every last drop of juice from the fruits of their labour and for kids to see significantly higher returns than they would if they had to start from scratch themselves.

What we are increasingly seeing is the combining of kids’ income with parents’ equity, creating benefits for everyone involved. 

This can occur through kids paying their parents an income each year in exchange for the gifting of equity in a property or property portfolio, or kids taking on additional borrowings to improve the property, in exchange for equity in that property. 

An example might be the kids borrowing $100,000 to build a granny flat that ultimately provides their parents with an extra $15,000 per annum in income, in exchange for a percentage of equity in the home or portfolio. It’s a win-win, the asset remains intact and continues to grow in value.

It’s worth noting that we are also seeing more of the ‘traditional’ joint ventures between parents and their kids, commonly referred to as ‘The Bank of Mum and Dad’.

A growing number of parents are opting to use their ‘lazy equity’ to lend a house deposit to their kids and charge an interest rate or a percentage of the property’s increase in value in return.

Parents usually require an income to be able to access that equity, but in instances where an income is still available, it’s become an increasingly popular and relatively simple way for families to build intergenerational portfolios.