Alan H said:
I'm pretty sure a large part of what Steve is alluding to will be about CASHFLOW. ie. having financial structure in place that will see you through the 'financially difficult' times
And the first prize goes to AlanH
Please refer to the attached file for my background thoughts regarding Forum members responses
Nearly every response has alluded to the need of CASHFLOW
Now the only question that remains is
HOW to create the CASHFLOW that will solve all problems?
RE-ASSESSING STRUCTURE:
Desired outcomes:
- Making sure all elements of your investment structure is efficient. (No Lazy Dollars)
- Financing structure. (Optimising Serviceability)
- Creating the correct balance between CG producing assets and Income producing assets. (From a cash flow point of view as well as from a tax efficiency point of view)
- Maintaining Affordability (Self funding portfolios; stress tested buffers; creating passive income streams)
- Building the passive income stream for the purpose of initially funding lifestyle requirements and eventual Financial Independence.
Making sure all elements of your investment structure is efficient. (No Lazy Dollars)
The three key elements to structure efficiency dictate that all assets must by definition produce:
a) Income:
Assess the various assets in your portfolio and list which of them do / do not produce an income.
Some examples of income producing assets:
Shares: Dividends; distributions
IP: Rental income; cash flow positive income
Annuities: Regular cash payments
Yourself!: Income from working; running a business / various
Cash: Interest
Superannuation: (Only upon retirement)
Businesses
Some examples of assets that do not produce an income:
PPOR
Vacant Land
Motor vehicles
Luxury items: (Plasma TV’s; Jewelery; Boat; etc.)
b) Capital Growth:
Assess which assets do / do not produce CG.
Some examples of CG producing assets:
PPOR
IP’s
Shares
Vacant Land
Superannuation: (Only realized at retirement)
Businesses
Some examples of assets that do not produce CG:
Annuities
Yourself (We are all mainly depreciating!)
Cash
Motor vehicles
Luxury items
c) Collateral Value:
Assess which assets can / cannot be used as collateral:
Collateral Assets:
PPOR
IP’s
Shares
Cash
Vacant land
Businesses
Non Collateral Assets:
Annuities
Yourself (or your children; spouse; mother-in-law for that matter)
Superannuation
Motor vehicles
Luxury items
PLAN of ACTION 1:
Minimise as far as possible the use of assets that do not fulfill all three categories!!
PLAN of ACTION 2:
Convert where possible non income producing assets into income producing assets.
Examples:
PPOR
Set up LOC and use these lazy dollars to produce an income stream.
Shares:
Optimise the share portfolio to produce maximum income via the use of income funds.
Cash:
Optimise the use of cash so as to produce income over an above the interest (Capital return) so as to enhance serviceability. (Cashbond when necessary)
PLAN of ACTION 3:
Balance your portfolio between CG producing assets (Including allowable deductions for tax efficiency) and Income producing assets, which in the first instance allow sufficient cash flow to cover all the holding costs, stress test buffers and passive income for lifestyle and eventual financial independence.
Working Example:
Current situation:
PPOR: valued $620,000
Debt: <<$73,900>>
Deductible debt used for an IP deposit <$55,900> and Shares <$18,000>
IP 1: valued $320,000
Debt: <<$210,000>>
Deductible debt used for IP property loan and Shares <$10,000>
Rent: $12,480
IP 2: valued $580,000
Debt: <<$324,000>>
Deductible debt used for IP property loan.
Rent: $20,280
Personal Income:
Husband $94,000 pa
Wife: Nil
Commentary:
Here we have a couple in a pretty good situation.
LVR = $607,900 / $1,520,000 = 40% (Very comfortable but hopelessly inefficient because of unemployed Lazy Dollars)
Net equity at $912,100
I haven’t included the share portfolio as an asset as ION shares were purchased
and are all but worthless.
So how to move forward from here??
Well, one could take the view that:
1) Property CG in the short to medium term might not be very much?
2) Share Market is at a record high and might crash?
3) Interest rates might well increase?
4) Perhaps safer to sit on ones hands and do nothing?
Position in 5 years time assuming property, shares and cash average 5% pa each.
Property value PV $1,520,000; FV $1,939,942
Debt remains the same:
Future
net equity value $1,332,042 (1.46 times original equity . . . rated a poor result)
Structured Approach:
Given that times are somewhat uncertain it is imperative that cashflow stress testing is incorporated into the following planning:
Step 1:
Set up maximum (80%) LOC’s against the property assets:
PPOR LOC = $422,100 ($620,000 x 80% - $73,100)
IP 1 LOC = $46,000 ($320,000 x 80% - $219,000)
IP 2 LOC = $140,000 ($580,000 x 80% - $324,000)
Total available LOC =
$608,100 (Currently Lazy Dollars)
This couple wish to upgrade PPOR (Sell) and buy a new PPOR at $850,000 some time in the foreseeable future.
Serviceability:
On an income of $94,000 plus rental income of [$12,480 + $20,280] x 80%
Then Westpac would offer approx $700,000
Total loan facility.
However there are already loans of $607,900
Meaning that all that is available is a further $92,100
Solution: In order to enhance the borrowing capacity to allow for the maximum LOC plus further potential loans,
FURTHER income is required. (From a cashbond and /or from a share income fund)
On this basis it is proposed:
Of the $608,100 (potentially available from the LOC:
$250,000 should be allocated for the New PPOR (held in an Offset until necessary)
$100,000 should be allocated for another IP
$150,000 should be allocated for a cashbond
$100,000 should be allocated for a share income fund
And all the dollars will be actively employed.
New Situation post Structure:
PPOR: valued $620,000
Debt: <<$496,000 >>
IP 1: valued $320,000
Debt: <<$256,000>>
Rent: $12,480
IP 2: valued $580,000
Debt: <<$464,000>>.
Rent: $20,280
New IP: valued $400,000
Debt: <<$320,000>>
Rent: 18,720
Total Property LVR 80%
Share Fund: $200,000 (50% margin)
Cashbond: $150,000
CASHFLOW Requirements:
Outgoings:
New Loan Costs: <$25,174>> LOC (The $250,000 allocated for a future PPOR is as yet not drawn down)
Margin Loan: <$7,750> Shares
Total outgoings: <$32,924> pa
Income:
Cashbond : $30,000 pa
Share distributions $20,000 pa
Total Income: $50,000 pa
Excess Income per year: $17,076 (A pretty handsome buffer)
Asset situation in 5 years (5% growth assumed Cash, Property, Shares)
PPOR: valued $785,770
Debt: <<$496,000 >>
IP 1: valued $408,404
Debt: <<$256,000>>
Rent: $12,480
IP 2: valued $740,238
Debt: <<$464,000>>.
Rent: $20,280
New IP: valued $510,507
Debt: <<$320,000>>
Rent: 18,720
Total LVR 80%
Share Fund: $343,528 (includes reinvested yearly excess)
Cashbond: $Nil
Property value PV $1,920,000; FV
$2,544,396
Debt: $1,536,000 property (Including LOC) + $100,000 shares =
$1,636,000
Future equity value Property $2,544,396 + Shares $343,528 =
$2,887,924
(3.17 times original equity . . . rated as better!)
Net Equity has grown from $912,100 to $1,251,924
a gain of $339,824.
Note at a 7% return the net equity gain would be a staggering
$1,631,132
(Never underestimate the power of compounding at just 2% extra.)
Conclusions:
- Even in an unsure and difficult market, it is still worth keeping your portfolio working. (An extra equity value of $339,825 @ 5% and $1,631,132 @ 7%)
- Utilising lazy dollars can obtain extra serviceability
- Extra income from the structure can cater for all the holding costs of the portfolio, as well as serve as a buffer for extra costs. (Increasing interest rates.)
- Passive income is available if one chooses to use it for lifestyle.
- Over time the build up of net equity will create Financial Independence.
Cashflow is your portfolios “Oxygen”, without it difficult circumstances can suffocate the process.
I hope this has been of some help and interest.
Regards,
Steve
