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

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  • Profile photo of IbuycashflowIbuycashflow
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    Originally posted by foundation:

    1. When $2.0m of capital compounds at 10% and an annual drawdown of $100k compounds at 7%, at what year is the “turning point”? (ie when your capital starts reducing)

    Jeff, surely you don’t think this is a normal situation (ie sustainable) do you?
    I just checked my stats for median Melbourne house price (REIV) versus standard variable rate home loan (RBA) over the 34 years from 1971 to 2004 and found that the home loan interest rate was higher than nominal house price inflation in 15/34 years. IRs were higher than inflation adjusted HPI in 24/34 years with an average of -7% (HPI-IR).
    Yeehaa. Where is the turning point in that scenario?When you drawdown no more than 50% of the capital growth there is still no turning point Yeehaa
    Cheerio, F.[cowboy2]

    No, not at all F.

    I was merely defending the example as it was given in Michael Whyte’s post from Steve Navra’s course. This was the same example used in the property developing thread. The variables were already given.

    Before you can discount the method you must first understand the methodology. What I am seeing in this discussion is a lot of miscalculations which is all I am trying to clarify. Perhaps you might actually like to answer my 3 questions.

    BTW, by persisiting to use averages and medians I suspect you will only ever get averages and medians. As an investor you attempt to beat the averages.

    Cheers
    Jeff

    Profile photo of Robbie BRobbie B
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    Jeff, how do you draw down 50% of negative growth?

    What do you live on in the negative growth years?

    Just trying to beat averages does not mean it will happen year in and year out for you!

    The Mortgage Adviser


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    Profile photo of IbuycashflowIbuycashflow
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    Originally posted by The Mortgage Adviser:

    Jeff, how do you draw down 50% of negative growth?
    Rob, the example we are discussing specified 10% growth and that is all I am explaining. In reality you would not draw down anything on negative growth, by the same token, when you have those peak years with say 50% growth you should only draw down what you need to live – the balance being rainy day stuff. Remember Rob, I did not say I approve of this stategy but it does have some merits
    What do you live on in the negative growth years?
    What you have accumulated from your early years of growth. If you haven’t had those years then you are not ready to use this strategy for any length of time
    Just trying to beat averages does not mean it will happen year in and year out for you!
    Then perhaps if one doesn’t understand how to spot value in a property and how to add value to a property then this game is not for them and they should persue another course towards retirement
    The Mortgage Adviser


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    Foundation, I have to concede on the turning point for a 7% difference between HPI and Floating interest rates. I applied a 3% growth rate to 10% interest rates and the turning point is around Year 7. At this stage the portfolio was worth $2.388m and debt was approx $310k. (This of course assumes absolutely NO rental growth and whether or not more competitive fixed rates were available.) At this stage you would have to sell part of your portfolio ($310k) to eliminate the debt and interest bill. This would then leave you with the original $2.0m to start again.

    On that I’ll have to take back my Yeehaa but must stress that given different interest rates and growth rates then different amounts of capital and different configurations of the strategy maybe required.

    I’ll have to leave you on that note. The skies have darkened and the lights are flickering and I’m sensing the storm might send a few power lines down in this neck of the woods.

    Cheers
    Jeff

    Profile photo of markpatrickmarkpatrick
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    I agree that the number 1 point is that we can`t ever take for granted that values of properties will rise at a certain rate and the time frames in which they will, even given the historical cycles, this is plain and simple gambling imo, it would not take much to throw this out of whack, and the one thing which makes me cautious is that there is such a herd mentality out there with regard to how easy it is to become financially free.

    Profile photo of Robbie BRobbie B
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    Originally posted by Ibuycashflow:

    Rob, the example we are discussing specified 10% growth and that is all I am explaining.

    The question put to you had changed to tougher times and I found your “I am good and pick investments that will continue to grow at sustainable levels” response as inadequate.

    In reality you would not draw down anything on negative growth, by the same token, when you have those peak years with say 50% growth you should only draw down what you need to live – the balance being rainy day stuff.

    And how are you supposed to know what to save for a rainy day? What if it was negative straight away because you made a mistake or got ripped off (eg: bought through The Investors Club)?

    What you have accumulated from your early years of growth. If you haven’t had those years then you are not ready to use this strategy for any length of time.

    But this ‘strategy’ is your plan. You have nothing else to live on and no equity to draw down. What do you do?

    Then perhaps if one doesn’t understand how to spot value in a property and how to add value to a property then this game is not for them and they should persue another course towards retirement

    There is that response again. Some people make mistakes. This ‘strategy’ does not allow for any error whatsoever. You need to invest with the equity, not live off it!

    At this stage you would have to sell part of your portfolio ($310k) to eliminate the debt and interest bill. This would then leave you with the original $2.0m to start again.

    How do you think you can sell only the growth you obtained? You have to sell the property or properties that that growth is linked to. If you are lucky to still be left with 2M worth of property, you would still have your initial debt and less property to utilise. Your options are getting tighter.

    given different interest rates and growth rates then different amounts of capital and different configurations of the strategy maybe required.

    You can’t say this ‘strategy’ works if you use this rate and that rate. Things move and you have no control over them. To remedy an unexpected problem using this ‘strategy’ can result in disaster. There are many more ‘cons’ than ‘pros’.

    Why is everyone assuming you can just keep borrowing 50% of capital growth when you have a negative rental income position and no job while you still have substantial debts on your properties???

    The Mortgage Adviser


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    Profile photo of TerrywTerryw
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    Has anyone tried to plot some figures into excel? Either those for or against?

    I have been trying, but am not no excel expert – there are too many variables for me to work it out.

    If anyone has, could you please email me.

    Terryw
    Discover Home Loans
    North Sydney
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    Terryw | Structuring Lawyers Pty Ltd / Loan Structuring Pty Ltd
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    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of Robbie BRobbie B
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    I have done various calculated scenarios. It only works with large equity positions and low LVRs unless the funds are for investment. You won’t live long if you ‘live off equity’.

    The Mortgage Adviser


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    Profile photo of AUSPROPAUSPROP
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    Kevin Young is not happy!



    http://www.megainvestments.com.au

    John Carroll

    Profile photo of Robbie BRobbie B
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    Do you know something that you would like to share???

    The Mortgage Adviser


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    Profile photo of AUSPROPAUSPROP
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    no breaking news or anything, just commenting that in a 2 line summary you have completely shot down the philosophy of his company (i.e. buy 10 of their properties, watch them double every 7 years, redraw equity and live happily ever after)



    http://www.megainvestments.com.au

    John Carroll

    Profile photo of Robbie BRobbie B
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    Yeah, it is an old ‘strategy’ that has no place for mum and dad investors. I do not see professionals using The Investors Club any time soon due to the off-the-plan crap they are selling right now.

    The Mortgage Adviser


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    Profile photo of IbuycashflowIbuycashflow
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    Originally posted by The Mortgage Adviser:

    I have done various calculated scenarios. It only works with large equity positions and low LVRs unless the funds are for investment. You won’t live long if you ‘live off equity’.

    It works in times of high capital growth and rental growth as well. You still need a large portfolio but this can be leveraged. The strategy is also used by developers, home renovators and even share traders (as I doubt they rely on dividends)

    Your scenario of Mum and Dad with an over valued, negatively geared portfolio, with no job, don’t know how to use a paintbrush, and no other sources of income, during times of negative growth, is a worst case scenario.

    How do they live? I agree Rob, in such a scenario they couldn’t. So being unable to use the strategy of “living off equity” could you please tell us, how would they live?

    The question put to you had changed to tougher times and I found your “I am good and pick investments that will continue to grow at sustainable levels” response as inadequate.

    Regarding this comment. Good to see you don’t get personal Rob but you know what they say about people in glass houses. Your arguments against living off equity have been backed up by inaccurate calculations and by placing unrealistic constraints on an example to prove a point. Not very convincing.

    There’s plenty of info here for everyone to read and make their own minds up. I know you will want the last say, so I’m timing out of this thread and will let you have it.

    Cheers all
    Jeff

    Profile photo of Robbie BRobbie B
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    Originally posted by Ibuycashflow:

    It works in times of high capital growth and rental growth as well. You still need a large portfolio but this can be leveraged.

    Does this comment not support exactly what I have been saying about a strong equity position?

    The strategy is also used by developers, home renovators and even share traders (as I doubt they rely on dividends)

    This is where I would support such a ‘strategy’ as funds are being used for investment purposes.

    Your scenario of Mum and Dad with an over valued, negatively geared portfolio, with no job, don’t know how to use a paintbrush, and no other sources of income, during times of negative growth, is a worst case scenario.

    How do they live? I agree Rob, in such a scenario they couldn’t. So being unable to use the strategy of “living off equity” could you please tell us, how would they live?

    It seems you think that they should use this ‘strategy’ to live. As a mortgage adviser, I can assure you that the above individual will not be able to get a loan unless they use no doc or lie. To be negatively geared, that would mean that they are either out of or borderline for the no doc loans. That leaves lying.

    How would they live??? They can lie to get a loan and ‘live off equity’ and risk all their assets or SELL a property, reduce their levels of debt and access the cash. They would certainly need to invest in income producing assets if they only had the one property.

    The question put to you had changed to tougher times and I found your “I am good and pick investments that will continue to grow at sustainable levels” response as inadequate.

    Regarding this comment. Good to see you don’t get personal Rob but you know what they say about people in glass houses. Your arguments against living off equity have been backed up by inaccurate calculations and by placing unrealistic constraints on an example to prove a point. Not very convincing.

    I just can’t see how saying a comment is ‘inadequate’ in my own opinion is some sort of personal attack. You are way too sensitive!

    My calculations are very accurate as they were simplified for ease of reading. Regarding the constraints, the question put was about ‘living off equity’ for the 100th time. It is not ‘investing off equity’ which you keep speaking about. There is a huge difference.

    There’s plenty of info here for everyone to read and make their own minds up. I know you will want the last say, so I’m timing out of this thread and will let you have it.

    As for this comment about me having the last say, it is a very common tactic for poor debaters to use to try and prove a point or win some browny points. Of course I will respond when you provide inaccurate information as I am certain you will respond yet again which I would welcome.

    That is the nature of discussing or debating a topic. Just because you don’t like what the other person is saying does not mean you should spit the dummy and run.

    I look forward to your further responses Jeff.

    The Mortgage Adviser


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    Profile photo of Michael WhyteMichael Whyte
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    Rob and others,

    The main point being overlooked in the discussion to date is the point that the structure is neutrally geared. So, you don’t need to cover the borrowing costs (7%) with your capital growth (5%) to be able to stay ahead. You’re neutral on holding so all of your growth is gain.

    I’ll try and illustrate this with a simple example. This is by no means exhaustive in its components but is meant to illustrate the concept with a simple model.

    Structure:
    You hold $2M in property with $400K in and $1.6M in borrowings (80% leveraged).
    You hold $2M in shares with $1M in and $1M in borrowings (50% leveraged).

    Income:
    $100K (5% dividend yield on shares)
    $100K (5% capital growth on share). The shares are liquid so you can use the growth as an income.
    Rental income on IPs covers the other expenses not listed below.

    Expenses:
    $112K (7% interest on $1.6M property loan)
    $70K (7% interest on $1M shares loan)

    Net Income:
    $18K ($200K – $182K)
    So, your income assets fund the holding costs of your growth assets.

    Growth:
    $100K (5% capital growth on $2M property assets employed)

    So, if I “spend my growth” I can now draw down the $100K in growth on my property via an LOC. This costs me 7% or $7K for the year. This is still covered by my net income from my income assets. At the end of the year my growth assets have gone up by another $100K at 5% and I can pull it out again and spend it again. And once more this is at a “tax” rate of only 7% which is my LOC interest.

    My tax on this structure is pretty much zero since my income is offset by my expenses, all the gain is growth which I spend and am taxed at only 7%.

    This is by no means an exhaustive example, but I just wanted to help paint the picture on how it might all hold together. I’m effectively earning a gross passive income of $100K per annum taxed at only 7% and I’m doing this on a net asset worth of only $1.4M.

    I’m not a guru, and I put this forward in the spirit of shared knowledge and mutual education. I apologise for not posting a reply earlier, but I’ve been busy at my real salaried job for the last little while. Please don’t consider my absence as any indication of unwillingness to post a reply to your questions.

    Regards,

    Michael.

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    I am still out on an opinion on this interesting discussion, but some of my thoughts would be:

    “$100K (5% capital growth on share). The shares are liquid so you can use the growth as an income.”

    if you use the growth that means your real value of the shares is declining. I also wouldn’t want to rely on shares to consistently grow 5% per annum. maybe I have just had some bad picks in my time, but DJ’s for example went from $2.20 to $1.60 and have only recently climbed back to $1.90. I paid about $1.20 for annaconda and sold for 38c before they became worthless. telstra have been under water for years. ERG collpased on me as well, despite having some promising projects on the go. i had a few wins on the way as well but to average it at 5% is a very big assumption IMO.

    Just some poitns off the top of my head:

    – I note you have no allowance for property costs, which at 80% gearing there would typically be negatively geared.

    – I see you are also banking on a steady 5% cap growth on your properties, which according to many on this forum, there is unlikley to be growth for a decade or so.

    – how will you draw the LOC out of the growth (if any) without any job or income to support it? the income is already committed to supporting the loans (I couldn’t see the bank accepting projected grwoth to cover your ongoing loan commitments).

    If I had more time it would be interesting to model all this on a spreadsheet with tax rates and cPI adjustments etc to see if it were possible.. .there must be a definitive answer



    http://www.megainvestments.com.au

    John Carroll

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    How about Peter Spanns ideas of purchasing Investment Property and using Listed Property Trusts to pay off the loan from the dividends?

    Any opinions on this strategy..

    REDWING

    “Money is a currency, like electricity and it requires momentum to make it Effective”
    Count The Currency With This Online Positive Cashflow Calculator

    Profile photo of AUSPROPAUSPROP
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    I am skeptical of that approach. the exposure to the cyclical nature of the economy is huge. it works great at the moment as the housing boom is funding the consumer spending that is boosting business activity and resulting in great LPT returns, but if/when the boom eases you will have a double edged sword of easing cap growth and lower LPT returns. not being an expert in commercial property it may be that I just don’t understnad how LPT returns fare in a cooling economy.



    http://www.megainvestments.com.au

    John Carroll

    Profile photo of TJamesXTJamesX
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    This link may be of some assistance…

    http://www.aireview.com/index.php?act=view&catid=8&id=2082

    Macquarie thinks LPT’s are due for a correction

    it works great at the moment as the housing boom is funding the consumer spending that is boosting business activity

    There are not too may retail shares that have not already announced profit downgrades in the past 6 months

    Profile photo of TerrywTerryw
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    The other day I was pondering living off equity and had a thought. What would happen if one was to continue to increase the loan on an investment property year after year and then died. The person’s estate would have to pay CGT on the property, but with the loan up high, there could be a shortfall after paying CGT and the loan back. ie you could possibly leave a mess for your children.

    This could possibly be avoided if you had a large enough portfolio and were only looking at low LVRs, but still must be considered nevertheless.

    Terryw
    Discover Home Loans
    North Sydney
    [email protected]

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

    Lawyer, Mortgage Broker and Tax Advisor (Aust wide) http://propertytaxbook.com.au/

    Profile photo of MichaelYardneyMichaelYardney
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    Originally posted by Terryw:

    ….. What would happen if one was to continue to increase the loan on an investment property year after year and then died. The person’s estate would have to pay CGT on the property, but with the loan up high, there could be a shortfall after paying CGT and the loan back. ie you could possibly leave a mess for your children……
    Terryw
    Discover Home Loans
    North Sydney
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    Terry, there is a simple way around that. Most high nett worth individuals would not own properties in their own names, but in trusts (with companies as trustees).

    This entity survives the death of one its beneficiaries so the assets would be passed on with no tax payable as the beneficial ownership does not change.

    It avoids CGT, vendors tax, stamp duty and something we had years ago called death tax.

    Michael Yardney
    METROPOLE PROPERTIES
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    FREE subscription http://www.metropole.com.au

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