The Interview #11

rambada said:

Thanks for the quick reply.
Good use of structure. So when the trust receives income via dividends, you would use this to pay down margin loan/buy more margined shares, & draw down to 'pay' yourself for living?

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Hiya,

The DT passes the divs (& franking credits) through to me & partner & kids. ML interest is capitalised, so deductions keep increasing (ie interest on interest). I've never paid down ML (except from borrowed IP equity), so all borrowings remain deductible. And as I said in prev post, I sometimes LOAN (after tax) funds (divs/rent) to DT & expect them to be paid back at some point.

One of the problems with explaining the structure, is that what happens in practice isn't what my accountant does behind the scenes. EG I just transfer cash (for living expenses) from ML account to my account, but the accountant considers it as partial repayment of DTs debt to me, and the DT has to borrow extra funds from margin lender.

Cheers Keith

And ..... (the cogs are turning) could you also include high growth shares in the portfolio & just draw down as the available margin loans allows? Or does this raise a tax issue again? ie you couldn't ask the trust to pay back more than you 'lent' it in the first place? The amount you receive back from the trusts margin loan has to be < capital input & be sourced from a dividend payment?

Can really see how this works with property & accessing equity via another investment field - again, I love the use of structure!!

rambada said:

And ..... (the cogs are turning) could you also include high growth shares in the portfolio & just draw down as the available margin loans allows? Or does this raise a tax issue again? ie you couldn't ask the trust to pay back more than you 'lent' it in the first place? The amount you receive back from the trusts margin loan has to be < capital input & be sourced from a dividend payment?

Can really see how this works with property & accessing equity via another investment field - again, I love the use of structure!!

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I doubt if the trust will ever repay me what it owes me. If it does then I suppose I'll have to accept that some of the ML interest is non-deductible. Obviously I'll make sure that its from of different ML to keep it clean.

EG If the DT has $1M of high yield shares (eg banks,TLS,WES,etc) they will pay it $75K (after grossing up for franking). That $75K gets passed though to me for living expenses. If I need more living expenses, then the DT will repay me a bit of what it owes me.

If the DT has a further $1M of high growth shares then the margin loan LVR is likely to stay at an acceptable level. It also gets (say) $25K divs, which get passed on to me. This initial $2M can be either borrowed from IP drawdowns and/or from personal after tax profits.

Since the trust has a $1M margin loan (@8.5%) it pays $85K interest pa. So the DT actually makes a loss of $10K pa ($75K divs less $85K interest). Somehow (ask an accountant) that loss gets transferred to me, so I pay v. little tax.

In practice, as IP values increase I draw down IP equity (@7.5%), pay off a bit of ML, maybe buy some more shares to get ML LVR back up. The new shares I buy can be either high yielding or high growth depending on whether I feel I want more div income or more equity/growth. The IP drawn down equity is deductible too.

There's a lot of flexibility in the structure, it's self perpetuating, it's fairly efficient, reasonably low volatility and fairly low risk. Ultimately it's a way of capitalising interest using ML.

NB all these figures are hypothetical, do your own spreadsheet.

Thanks for your patience - information like this is invaluable, and I'll apply it to my strategy.

Originally Posted by yadreamin
Thanks for sharing your experiances keithj. I enjoyed the diversity of your growth in such a very short period of time.
Quess you were just lucky hey?
In todays climate of Ips and shares and interest rates, could you see someone doing this in the next 6years with a similar outcome to yours?


You make your own luck.

Another question for Keith.

Hi Keithj,

I've been re-reading your interview to help my thinking process on a few things, and I have a question.

You mention that when you started your journey that your IPs increased in value so that you had $1M in equity, you were then able to draw on that equity. My question is: How did you manage to solve the serviceability issue? I know you weren't highly -ively geared and maybe you still had a wage, but it's not a done deal to just go to the bank and refinance. Did you use a low-doc loan?

This is a concept I'm still struggling with (which surprises me), I have built a lot of equity in my portfolio but cannot access it due to reaching the serviceability limit (highly negatively geared). I imagine that going low-doc is the best direction for me but I would like to know how you did it.

I refuse limit myself because of something that I see as an 'artificial' barrier to my continued wealth creation.

Cheers
Nick.

Hi Nick,

If I may reply on Keith's behalf - yes he did use low doc loans.

If he hasn't said it in this post, he has said it in other posts.

Some of the low/no doc loans are becoming a little less flexible now, but generally there is still a pretty good range if you have had an abn for 2 plus years. You might also consider registering for GST.

I have an abn in my own name and am registered for GST, even though I am not a sole trader. I started as a sole trader, but have a trust structure now. I kept my abn and gst registration active, and lodge an annual gst return, a nil one. I haven't used a low doc loan to date - but at least I will have the option if I ever need to down the track.

If you don't have an abn now, maybe consider registering for one now, it may give you more choices down the track. You can have an abn and not register for GST, or you can register for GST, upto you. The only downside is having to lodge an annual nil GST return, the ATO send out the form for you to fill in at the end of July each year.

Thanks Willy,

Ok, so he did use low-docs. This looks like the only way forward for me, the downside being higher interest rates which would erode cashflow further. (I was planning to re-finance to lock-in gains, but it's not worth it until I want to buy something as I'd be paying more interest).

So having an abn would give me more choice of low-doc loans? How would having an abn affect my tax? Would Ibe charged a flat-rate 30%? (too much!)

Cheers
Nick.

McBrain said:

I was planning to re-finance to lock-in gains, but it's not worth it until I want to buy something as I'd be paying more interest.

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G'day Nick,

You wouldn't be paying more interest UNTIL you buy something because your new borrowings would be sitting in a redraw or an offset account until you need to use them.

Assuming your properties have increased in value, the best time to refinance is BEFORE you need the money - less stressful that way.

Regards - Ben

McBrain said:

How would having an abn affect my tax?

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G'day Nick,

I have an ABN from a business that I tried to get off the ground a few years ago. Business is no longer trading but I'm still registered for GST. Each quarter the ATO sends me a BAS statement - I fill it out in ten seconds (no activity to calculate) and post it back.

So, the ABN has absolutely no effect on my tax. I keep it so that the lo doc / no doc door is open for my next property purchase.

The first piece of advice to all new property investors should be "GET AN ABN". It may not be needed now but it might be very useful in two years. Nobody told me but I was lucky to have one anyway.

Regards - Ben

Hi Ben,

You wouldn't be paying more interest UNTIL you buy something because your new borrowings would be sitting in a redraw or an offset account until you need to use them.

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I'm not sure what you mean here. If your outstanding loan is for $500k, say, even if you refinance for more and don't use it you still have to pay interest on the outstanding amount. e.g you were paying 7% on 500k on original loan, now paying 8% on 500k on low-doc loan.

Unless of course you only take out the low-doc on the increased portion of the equity, which I don't think is possible?

The first piece of advice to all new property investors should be "GET AN ABN". It may not be needed now but it might be very useful in two years. Nobody told me but I was lucky to have one anyway.

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So you're saying that having an abn does not affect your tax position as you're not trading as a company? Does it matter if you're registered for GST or not? i.e can you get an abn and not worry about registering for GST and still get the benefits of low-docs? The only extra cost then would be registering the abn?

What are the benefits of the abn for getting low-docs? Easier to get, lower rates?

Cheers

McBrain said:

I'm not sure what you mean here. If your outstanding loan is for $500k, say, even if you refinance for more and don't use it you still have to pay interest on the outstanding amount. e.g you were paying 7% on 500k on original loan, now paying 8% on 500k on low-doc loan.

Unless of course you only take out the low-doc on the increased portion of the equity, which I don't think is possible?

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Either put it into an offset account (if the offset it's against your IP, it's still deductible) or leave it as an undrawn LOC.

McBrain said:

What are the benefits of the abn for getting low-docs? Easier to get, lower rates?

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Easier to get, but with higher rates especially in this environment, I would imagine.
Alex

McBrain said:

Hi Ben,



I'm not sure what you mean here. If your outstanding loan is for $500k, say, even if you refinance for more and don't use it you still have to pay interest on the outstanding amount. e.g you were paying 7% on 500k on original loan, now paying 8% on 500k on low-doc loan.

Unless of course you only take out the low-doc on the increased portion of the equity, which I don't think is possible?

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it is possible

So you're saying that having an abn does not affect your tax position as you're not trading as a company?

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yep

Does it matter if you're registered for GST or not? i.e can you get an abn and not worry about registering for GST and still get the benefits of low-docs?

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gst registration does matter now for getting low docs

The only extra cost then would be registering the abn?

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it's free

What are the benefits of the abn for getting low-docs? Easier to get, lower rates?

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To get the higher LVR low docs you need a 2 year old ABN that is GST registered (although it doesn't matter if you only registered for GST yesterday)

Brain's a bit slow today

alexlee said:

Either put it into an offset account (if the offset it's against your IP, it's still deductible) or leave it as an undrawn LOC.



Easier to get, but with higher rates especially in this environment, I would imagine.
Alex

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I still don't get it:

Say I have an IP worth 750k with a full-doc loan of 500k at 7%. I'm paying 35k pa interest.

If I want to access the 250k equity I need to refinance, using a low-doc loan as servicability is maxed out.

So IP is refinanced to 80% of 750k which is 600k at 8% (higher interest rate as it is low-doc).

I don't draw on the extra 100k equity yet as I don't use it, but the outstanding 500k is still owing against the IP. So I am paying interest of 8% on this 500k which is 40k pa interest.

So by refinancing I have an extra 100k to use but I'm paying an extra 5k pa in interest (on 500k) even if I don't use the extra 100k.

This is correct? So it's going to cost me 5k in cash flow per year to lock in this gain? Am I missing something?

Cheers
Nick.

I really enjoyed this interview, the value investing method seems to have really paid off, and I agree with a number of keiths ovservations..... the structure seems a bit complex but definitely food for thought.

McBrain said:

You mention that when you started your journey that your IPs increased in value so that you had $1M in equity, you were then able to draw on that equity. My question is: How did you manage to solve the serviceability issue?

Cheers
Nick.

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Without re-reading Keiths brilliant story, I think he geared into shares in a big way in about 2003. Shares were much better value then, compared to today. The banks were all paying 6% fully franked, property trusts were paying 7% to 9%, lots of other stuff like tabcorp, BHP steel etc paying 7%. At those levels of dividends, plus franking credits, and with interest rates a little lower than today, the shares payed for them selves anyway.

Then, profits increased, as did dividends, and Keith probably found that in a short time there was an excess of cash. As an example, anyone buying Commonwealth bank shares in 2003 for $25, got $2.50 in fully franked dividends this year for a 10% yield, or 13/14% or so counting franking.

I geared into shares then too. Shares in 2003 were like property in 97/98. Once in a lifetime stuff I reckon.

See ya's.

McBrain said:

Hi Keithj,

I've been re-reading your interview to help my thinking process on a few things, and I have a question.

You mention that when you started your journey that your IPs increased in value so that you had $1M in equity, you were then able to draw on that equity. My question is: How did you manage to solve the serviceability issue? I know you weren't highly -ively geared and maybe you still had a wage, but it's not a done deal to just go to the bank and refinance. Did you use a low-doc loan?

This is a concept I'm still struggling with (which surprises me), I have built a lot of equity in my portfolio but cannot access it due to reaching the serviceability limit (highly negatively geared). I imagine that going low-doc is the best direction for me but I would like to know how you did it.

I refuse limit myself because of something that I see as an 'artificial' barrier to my continued wealth creation.

Click to expand...

Hi Nick,

Sorry for the slow response - I've been overseas for all of October walking in the Himalayas.

As mentioned, I used lo-docs. I also bought 'good value' assets, that mostly paid for themselves. One example was bank shares, they yielded 7%+, while their IRs were 6%. And IPs yielding 5-6% gross are a lot easier to service than most of the stock available today. Those IPs were in middle/inner ring capital cities and have shown the same growth as 'growth' IPs.

Some lo-docs rates are the same at full doc AFAIK, but the LVR is lower - this may be ideal for you. That suited me as I didn't especially want the highest possible LVR, but I did want the best rate. Or you could always pay the <1% LMI to get a higher LVR.

Other things I remember were -

• some lenders didn't take margin loans into account, but did take dividends into account for servicability purposes - this was because interest was capitalised.
• one existing lender appeared to overlook the fact that I had retired and had no personal income - they looked at a previous years income. I think they were on a mission to improve their figures.

There's always a way of achieving the result you want - those artificial barriers are put there to stop those that aren't as determined as you - good luck....

Cheers Keith

WASP said:

With the Sharemarket of late has your plan been affected in any way other than the values now being lower and Margin Loan higher?

Are dividends dropping?

Have any of your shares taken a really bad hit in price of late as there's been some big moves?

I like the idea but the volatility of the sharemarket would see us greying earlier than planned

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Hi WASP,

Not really much practical effect. Values are lower, therefore margin loan LVR is higher, mine was 42% as of Friday. The max allowable LVR is 72% (or 77% including the buffer), so it would take another 40%+ fall to hit a margin call. Apparantly this is the worst financial year for the ASX for over 25 yrs, so I'm pleased the structure has survived (so far). My view is that provided a share continues to provide a rising income stream then the price is of secondary importance.

Some dividends are dropping eg AFG is now $0. Some LPTs & Infrastructure Funds will drop significantly (eg Transurban has recently cut its' div by 60%). Fortunately I didn't have any of them. The banks are increasing their divs by around 6%+ & they look likely to contine to rise (albeit more slowly).

Some shares have taken a big hit (AFG is the worst 95% loss), most have taken around 15-20% hit, some are stable (eg TLS, BHP, WES). Diversification works for me.

The volatility can cause sleepless nights, but a low margin LVR, well managed cpys with quality managers & good diversification helps. History tells us that dividends fell by 30% in the depression....I consider that to be a worst case scenario. My mindset is that if Woolies, 4banks, BHP etc all go broke then 99% of the world will be in a far worse position than me. IMO capital growth isn't nearly as important as reliable income in the final phase... although it's v. nice to have for LOE .

Cheers Keith

keithj said:

In practice, as IP values increase I draw down IP equity (@7.5%), pay off a bit of ML, maybe buy some more shares to get ML LVR back up.

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Fantastic thread Keithj. Just so I can clarify it in my mind...

The IP's are all owned by you directly.
The Margin Loan (and shares) is owned by the DT

So in effect, your statement above means you draw down the equity from the IP's .... you then loan this money to the DT ..... the DT then pays down the margin loan..... in that process you have actually lent the money to the DT...

So the DT technically owes you money which you can call on to be repaid at any time. In addition to that the DT can distribute losses (and gains) to you and all of this is deductible ....???

If this is right then its bloody awesome .....

meatgroup said:

The IP's are all owned by you directly.
The Margin Loan (and shares) is owned by the DT

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Mixture - IPs are in DT & personal names. Shares & margin loan are in DT.

meatgroup said:

So in effect, your statement above means you draw down the equity from the IP's .... you then loan this money to the DT ..... the DT then pays down the margin loan..... in that process you have actually lent the money to the DT...

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Exactly.

meatgroup said:

So the DT technically owes you money which you can call on to be repaid at any time. In addition to that the DT can distribute losses (and gains) to you and all of this is deductible ....???

If this is right then its bloody awesome .....

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Yes. DT owes me both after-tax cash (from IP sales & PPOR sale) and also $$$ I've drawn down from IP growth.

So in effect, I use the margin loan like a LOC. However, everything I draw down (inc personal expenses) is deductible because it was my after-tax money originally.

Another way of looking at it is that my after-tax $$$ are offsetting a (relatively) expensive margin loan.

And.. yes it is awesome