All Topics / General Property / To live off equity or not to?

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  • Profile photo of Robbie BRobbie B
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    Terry, the $200,000 for the couple was not my example. It was the $100,000 per annum for a single individual.

    Regarding you brainwave about using the money to pay for expenses and then living off rent, that is NOT ‘living off equity’. It is common practice to borrow to pay expenses and then deduct the interest on this expenditure and it is the sensible thing to do.


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    Profile photo of redwingredwing
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    http://www.somersoft.com/forums/showthread.php?t=16897&highlight=peter+spann

    More Information for you to ponder Rob[happy3]

    REDWING

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    Profile photo of Michael WhyteMichael Whyte
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    All,

    Apologies for the double post but I didn’t know this topic had moved threads out of the development thread. For me living off equity is certainly the main game and is absolutely what I aspire to do. Let me work a sample scenario through using some simple numbers:

    Year1 opening: Net asset worth $2M, total assets employed $4M (50% borrowings neutral gearing)
    LOC: $100K to live on plus costs of $7K interest = $107K reduction in net worth.
    Year1 conservative asset growth at 5% = $200K CG(0.05 x $4M) increase in net worth.
    Year1 closing: Net asset worth $2.093M

    Year2 opening: Net asset worth $2.093M etc.

    In this example, your asset base (which is neutral) has accumulated growth of $200K of which you spent $107K for the year. You’re still ahead by $93K net! This is about a 5% return on capital employed and exceeds inflation.

    So, in summary, your closing net asset worth has increased greater than the inflation rate so you are AHEAD. At the same time, you’ve lived off your equity on a comfortable NET income of $100K for the year. You pay no tax as your structure is neutral, and the “cost” of your $100K income is only the 7% interest charge from the financial institution.

    Remember, I’ve already said that you spend that growth in ARREARS so there is little risk of you over spending in a bad growth year. Of course, the portfolio is spread across asset classes to mitigate exposure to any one class and reduce downside risk.

    Hope this helps spell it out.

    Cheers,
    Michael.

    PS At the same time as outstripping inflation with growth, your rents are going up so your gearing is improving. So you’re actually going even further ahead and will soon be better than neutral too.

    PPS Just read Dazzling’s post at the beginning of this thread and noted the similarities. [biggrin] The main point I’ve added is the neutral gearing to get around Rob’s point suggesting living off rent instead. You’ve got “quality growth” assets neutrally geared to maximise your CG opportunity via leverage. There is no “income” per se from this structure except growth.

    Profile photo of IbuycashflowIbuycashflow
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    Pretty simple really,

    Don’t start living off equity until you have enough equity to live off. And if you don’t spend the equity in your lifetime, someone else will.

    Michael Yardney has pointed out the tax advantages of living off equity

    My reason for living off equity was to become full time in property investing until I established enough residual cashflow. It freed up my time from full time employment.

    Everyone has different long term goals and comfort zones. Some may wish to be the richest in the cemetery, others do not wish to leave a cent when they die. Some require very little to live while others wish to have all the toys and holidays.

    By setting you longterm goals you can determine where you would like to be when you die, how much you’ll need by when and which is the best strategy to achieve those goals.

    The amounts required can be calculated out on a simple spreadsheet
    eg $1.0m invested at 5% gives you a $50k income for the first year, less $100k drawing would leave you with $950k to invest at 5% for the next year, less another $100k. It would take you about 14 years to run out of money.

    Cheers
    Jeff

    Profile photo of SeeChangeSeeChange
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    Steve Navra is certainly the most articulate proponent of living of equity around, though personally it’s not something I plan to use.

    However Steve Navra covers more than just this, he’s a very genuine person ( must be something about the name Steve :) ) , and his course is well worth doing for anyone who is serious about investing ( not just in property )

    See Change

    Profile photo of Michael WhyteMichael Whyte
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    SeeChange,

    Agree completely, just did his course last Saturday and the best $150 I ever spent. Looking forward to the full blown plan now…

    But I think you know this. [biggrin]

    Cheers,
    Michael.

    Profile photo of TerrywTerryw
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    Hi Michael

    Good to see you did the course. Could you please give us a brief run down if you have time??

    Terryw
    Discover Home Loans
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    Profile photo of Michael WhyteMichael Whyte
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    Terry,

    No problem. Below is “my take” on some of the key messages Steve delivered. This is by no means his complete teachings, and in all honesty is probably a misrepresentation of his material. It is just my personal key messages from the day:

    Steve Navra Course Summary

    The core message from Steve’s course is one of “making your money work for you 6 ways”. That’s why its called “Optimising your Investment Structure”. The structure is, unsurprisingly, composed of three asset classes: property, shares and cash. Steve argues that 1 dollar invested in your PPOR can in fact work for you 6 ways as follows:

    PPOR:

    1. Offset rent (5%)
    2. Capital growth (5%)

    He then says you can re-use this dollar by taking an LOC against your equity to leverage at 10% down in to Investment Properties.

    IPs:

    3. Rental income (5%)
    4. Capital growth (5%)

    You can further re-use this dollar by taking an LOC against your equity in your IPs to leverage at 50% down in to shares.

    Shares:

    5. Dividend yield (5%)
    6. Capital growth (5%)

    So, structured properly your one dollar in your IP can earn you 30% returns pa. Of course, this is a very simplistic representation, but the fundamental message here is maximum leverage.

    The biggest issue people face when trying to maximise leverage is cash flow, so Steve spends quite a bit of time describing approaches to provide cash flow out of the structure. His particular share fund uses Dollar Cost Trading (DCT) instead of Dollar Cost Averaging (DCA) to maximise returns. It is an income oriented fund which pays high franked dividends for cash flow and re-invests the capital gain for growth. He also talks about securing a cash bond with your equity LOC. This then serves as income and increases your borrowing power (leverage) even further. So long as the leveraged borrowing performance exceeds your costs for this income stream then you’re well ahead.

    e.g. I use an LOC to buy a $100K cash bond. This cash bond shows as income in my next loan application so I am now able to borrow up to $1M whereas before I had insufficient serviceability but was equity rich. I invest the $1M in IPs making me 10% pa, and due to leverage that $100K return far exceeds my $7K interest charges on my cash bond. He advocates avoiding this if possible if your normal income streams are sufficient to satisfy servicing requirements at your maximum leverage.

    Finally, he describes the compounding effect of having all your money work for you as hard as it can. With this structure in place it is possible to have phenomenal returns over a relatively short time period.

    He also spends time talking about risk mitigation. His trading fund significantly limits the actual stock he trades in. He only trades the ASX100, and further limits these stocks down to his Top 25 based on a series of tests. He then actively trades these stocks buying when they fall and selling when they rise. He has a mathematical model which does the trading for him, he and his team spend most of their time selecting the low risk stock that they want to trade.

    For IP risk mitigation he introduces his concept of “Rental Reality”. This basically advocates taking the mean rental yield over the last 5 years. Then use this as the basis for determining maximum purchase prices in your selected postcode. Start by taking the achievable rent then divide by the rental yield % to get the maximum buy price.

    e.g. Yields over the last 5 years in postcode 2067 might have been 4.0, 3.5, 3.0, 2.8, 2.5. This gives a mean yield over the period of 3.16% pa. So, if you are interested in a property and know that it will deliver rent of $550 pw ($28,600pa), then the maximum you should be willing to pay for this property is $28,600 / 3.16% = $905,000. With yields currently at 2.5% they’re probably asking $28,600 / 2.5% = $1,330,000. So, buying within rental reality ensures you buy below fair value over the long term.

    This is only a brief introduction to what Steve discusses but might help give some insight in to the broad areas of his expertise. I should say that I in no way work for Navra Financial Services and can not guarantee that this is an accurate representation of Steve’s information. It is just my personal take on his material based on a very brief exposure to it.

    Regards,
    Michael.

    Profile photo of Robbie BRobbie B
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    Originally posted by Michael Whyte:

    In this example, your asset base (which is neutral) has accumulated growth of $200K of which you spent $107K for the year. You’re still ahead by $93K net! This is about a 5% return on capital employed and exceeds inflation.

    Firstly, not many people can accumulate a $2,000,000 net position in their lifetime so at least we agree that you need a lot of equity to do this. Do you not see how you would run out of equity with capital growth running at 5% on average and the cost of funds running at 7% annually?

    Remember, I’ve already said that you spend that growth in ARREARS so there is little risk of you over spending in a bad growth year.

    In a bad growth year, do you not need to eat or fund lifestyle? Where does the money come from then?

    Of course, the portfolio is spread across asset classes to mitigate exposure to any one class and reduce downside risk.

    Previous discussions have only focused on property to this point. Can you please explain how you gear at higher and higher levels against shares with no income?

    PS At the same time as outstripping inflation with growth, your rents are going up so your gearing is improving. So you’re actually going even further ahead and will soon be better than neutral too.

    This is a huge assumption and cannot be counted on. Any rental increase from inflation would be offset by the higher interest rate and you could possibly go backwards in some years on rental income – look at the current market.

    The main point I’ve added is the neutral gearing to get around Rob’s point suggesting living off rent instead. You’ve got “quality growth” assets neutrally geared to maximise your CG opportunity via leverage. There is no “income” per se from this structure except growth.

    It certainly provides the requirement to ‘need’ this ‘structure’, but please also explain how someone with a neutrally geared portfolio can borrow money without income from another source?

    Are you suggesting another condition of being able to use this ‘structure’ is not only a huge positive net asset position, but a very low gearing level against those assets and then having to lie on applications to access funds?


    The Mortgage Adviser

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    Profile photo of Robbie BRobbie B
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    Originally posted by Michael Whyte:

    PPOR:

    1. Offset rent (5%)
    2. Capital growth (5%)

    He then says you can re-use this dollar by taking an LOC against your equity to leverage at 10% down in to Investment Properties.

    Don’t forget the effect of inflation on capital growth.

    Can you please explain how you “offset rent” and its effect to generate useable equity or cash flow?

    Also, add to the 10% the cost of stamp duty and other closing costs (between 4 and 5% for residential property), the cost of mortgage insurance (between 1 and 2% at 90% LVR) and loan application fees and charges for new loan.

    IPs:

    3. Rental income (5%)
    4. Capital growth (5%)

    You can further re-use this dollar by taking an LOC against your equity in your IPs to leverage at 50% down in to shares.

    You only put 10% into the IP so how do you get a LOC here in the short-term especially when you have debt on your PPOR and this loan would be interest only growing at only 5% per annum (if that) less the effect of inflation.

    What about the gap between your highly hopeful 5% rental income and the interest on the loan? What about the strata costs, insurance, maintenance, land tax….???

    What happens if you achieve this level and the stock market has a negative correction and a margin call occurs?

    Shares:

    5. Dividend yield (5%)
    6. Capital growth (5%)

    So, structured properly your one dollar in your IP can earn you 30% returns pa. Of course, this is a very simplistic representation, but the fundamental message here is maximum leverage.

    I would suggest a person who expects figures anywhere near those above year in and year out across all asset classes should regularly attend church.

    He also talks about securing a cash bond with your equity LOC. This then serves as income and increases your borrowing power (leverage) even further. So long as the leveraged borrowing performance exceeds your costs for this income stream then you’re well ahead.

    What do you expect your return on a cash bond to be?

    e.g. I use an LOC to buy a $100K cash bond. This cash bond shows as income in my next loan application so I am now able to borrow up to $1M whereas before I had insufficient serviceability but was equity rich. I invest the $1M in IPs making me 10% pa, and due to leverage that $100K return far exceeds my $7K interest charges on my cash bond. He advocates avoiding this if possible if your normal income streams are sufficient to satisfy servicing requirements at your maximum leverage.

    Are you suggesting that a lender will view a 100K cash bond as an income of 100k per annum?


    The Mortgage Adviser

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    Profile photo of GrantH_1974GrantH_1974
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    Mortgage Adviser, thanks for introducing facts & common sense (the mortal enemies of seminar advice).

    I reckon we will have to add another thread titled, “Seminar said…Reality is…”

    Cheers,
    Jason.

    Profile photo of SeeChangeSeeChange
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    I’m not going to get into an indepth discussion of something I don’t intend to follow ( Living off equity ) , but I do know of a couple of people who have used cash bonds to good effect in the last property cycle. These were people who had lots of equity but were told by their finance providors that they had reached their servicability limits.

    They got LOC’s and then bought a cash bond which involves the capital and interest of the bond being paid back to the investor , and the Capital repayment and the interest were treated by the banks as income. As a result , with the increase in servicability they were able to buy further properties and made significantly more money.

    Both these people did this several years ago at a time when the market was in the earlier stages of the property cycle and good capital growth wasa reasonable expectation, unlike the current situation.

    I can imagine myself using a cash bond in a similar situation in the next cycle , if I have a problem with servicability.

    My concern with Living off Equity is what happens if the planned on amount of capital growth doesn’t occure further down the line.

    See Change

    Profile photo of TerrywTerryw
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    Thanks for the detailed summary Michael.

    Terryw
    Discover Home Loans
    North Sydney
    [email protected]

    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
    http://www.Structuring.com.au
    Email Me

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    Profile photo of Robbie BRobbie B
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    Are none of the ‘living off equity’ advocates willing to respond to the questions I put forth above?

    Have I scared everyone off or can no-one answer sufficiently to support this very restricted use ‘strategy’?


    The Mortgage Adviser

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    Profile photo of GrantH_1974GrantH_1974
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    I’d say it’s the latter.

    Profile photo of DazzlingDazzling
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    Rob,

    Perhaps the people who are successfully using this strategy, and by default whose comments should carry the most weight, are so loaded and so casual and so happy with life they have no desire to explain it.

    I’d also suspect that with enough equity to make this strategy really zing, most of the folks would be fairly senior in years. This in turn might preclude them from jumping on this medium – through fear / unfamiliarity / or plain don’t want to talk about it…different eras – and telling you exactly how it works…

    Who knows – maybe Pickworth could add his opinion to the matter ??

    Cheers,

    Dazzling

    “No point having a cake if you can’t eat it.”

    Profile photo of SeeChangeSeeChange
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    All the people who I know who plan to do it “live ” over at somersoft where there have been some heated posts in the past.

    See Change

    Profile photo of vicgirlvicgirl
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    OK, so I have found the relevant thread, now Robert, my point was that if living off the equity means I have to sell after 10-15 years, I’ll still have some cash in the bank, let’s say a million or two so whether the interest will be enough for me or I have to use up the capital, I can’t see much problem unless I live to a 100 or more….

    Profile photo of MichaelYardneyMichaelYardney
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    I’ve been in Sydney this weekend presenting at the Reno Kings seminar ( as was Steve McKnight and a host of others)

    Lots of things were discussed from +ve geared properties to property development.

    But 2 smart presenters (advanced investors themselves) explained the concept of living off equity. It was similar to my explanantion in this post.

    Geoff Doidge (one of the Reno Kings) does it and has for years. He even showed his spreadsheets and how he calculates it.

    I repeat my previous cooments. Its not for everybody – you need substantial equity (>$1million) and a strong portfolio of growth properties.

    You also need the right mindset.

    I will give a summary of the seminar in my July Newsletter

    Michael Yardney
    METROPOLE PROPERTIES
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    Profile photo of Robbie BRobbie B
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    Originally posted by vicgirl:

    …if living off the equity means I have to sell after 10-15 years, I’ll still have some cash in the bank,

    If you need to live off equity, you would not have any cash in the bank and if you are forced to sell because you run out of equity, you would have very little cash left after the sale.


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