To live off equity or not to?

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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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

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.

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.

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.

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?

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.

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

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

http://www.themortgageadviser.com.au

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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

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’?

http://www.themortgageadviser.com.au

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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.”

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….

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.

http://www.themortgageadviser.com.au

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