Are you happy to retire by "living out of capital"?

[JumJones]

Yeah, the dollar used 6x... ive seen this before, but I can only ever see it working that many times on a small portion of a portfolio .. you only save so much in rent, your PR only has so much equity etc.

it would be nice if you could use every dollar 6x though.

 

[Bill.L]

Hi all,

Thanks Steve for your thoughts spelled out. I will agree that what you have provided is a good conservative approach to a long term investment plan.

The cash reserve above the LVR we were discussing is where there has been confusion. I was trying to answer your question about $4M debt on $5M assets, not with extra assets up the sleeve.
You also tried to apease my question by using lower LVR and overall numbers than we were originally discussing.(mind you after just going back and rereading the last 30 or so posts,there are any number of numbers being bandied about.)

But we digress, what about "living out of capital"

bye

 

[Steve Navra]

Now for my next trick!

But we digress, what about "living out of capital"

Hi Bill,

Okay so we are getting somewhere . . .

The size of the numbers matters not . . . the percentages are the same / the mathematics is transitive.

Did I pull some extra equity (Cash buffer) out of my sleeve??

No, it was always there in the structure as presented in full at my course.

I have always referred to an holistic and diversified approach utilising Property, Cash and Shares. The cash element, whether as a LOC, Offset acc, Cashbond or other has always been part of the equation. Has always been part of the LVR.

However you are right, we digress "What about living off capital"??

I strongly suggest that everyone reads Simon's posts . . . he is doing just that . . . is an excellent example of financial independence.

Beyond that I will give a further example of the situation where an investor has procured sufficient assets so as to actually live off the capital in perpetuity!


Aaaaah . . . the suspense

Bye,

Steve

 

[ToGetProperty]

Steve:

This structure seems very conservative to me. Can I ask you that how to achieve the goal of 5M equity in the portion of property/Share investment with this structure?

Regards

TGP

As promised here is a more in depth example of the workings of Optimised Investment Structure:

Before we kick off, perhaps I should spell out some investment philosophy to basically set the scene:

1) Investments should by necessity be diversified:

I recommend the most standard investment split . . . 1/3 Property: 1/3 Cash: 1/3 Shares

a) Property for Maximum leverage:
Property remains the favoured asset class for leverage. (Well certainly in the Banks eyes) One can obtain loans against the property asset in excess of 90%. I generally advise the more conservative approach of Property LVR = 80%
So for every dollar invested in property you can hold assets of 4X (80% LVR)

b) Cash for liquidity and serviceability:
The cash fund is a low returning medium; however the purpose of holding amounts in cash is as a risk management exercise so as to cater for difficult circumstances. (Examples: Increasing interest rates, lack of tenants, maintenance et al.)
The second use of cash is to create a cash flow . . . which takes its literal meaning: to create a flowing income stream which is very useful for serviceability to acquire more assets. (Cashbond) Also, once one has acquired sufficient assets to generate enough capital to live off, then the cash flow is very useful, rather than continually having to revalue and draw down equity.
There is obviously no leverage with cash.

c) Shares for best Percentage increase:
Shares offer the best percentage return in the long run, are highly liquid and can be leveraged, but to a lesser degree than property and also with the higher risk of margin calls.
Currently on a conservative share portfolio you can get 67% leverage against your shares. I recommend up to 60% maximum, with the balance as a buffer over and above of your cash buffer.
So for every dollar invested in shares you can hold assets of 3X. (60% LVR)


EXAMPLE:
An investor has a $500,000 unencumbered home, no other investments and wishes to create an ‘efficient’ portfolio.

1) Approach a lending institution and borrow 80% of the value of the asset.
On the assumption that the investor has income sufficient for this loan a cashbond is not required. The result of the banking exercise is a LOC of $400,000.

Proceeds are to be invested as follows:

Property: $133,000
Purchase a $450,000 property with a 20% deposit. [80% loan <$360,000>]
The balance of the cash is used for costs.

Total property assets = $500,000 (home) + $450,000 (IP) = $950,000
Total Loans = $400,000 (LOC) + $360,000 (IP) = $760,000
LVR = 80%

Now just to point out that many resist this LVR as being too high. (No sleep factor.)
What they are failing to realize is that there is still $267,667 to be held in cash in the LOC and in shares as a buffer.

Shares: $133,000
Purchase shares to the value $332,500 with a 40% deposit, [60% loan <$199,500>]


Cash buffer of $133,000.
There are some choices as to the form of the cash buffer:
a) LOC . . . the dollars are readily available, no cost until drawn upon.
b) Further shares (No Leverage) . . . liquidity readily available, cost of dollars is offset by dividends / income plus potential capital gain / loss.
c) Cashbond . . . utilized only if extra serviceability required, cash available as a monthly income stream, resulting income can be re-invested into shares, or paid down to reduce a loan or placed into the LOC or the offset account.
d) Offset Account


Consequences: (Assumed capital growth on all asset classes = 5%)

If the investor did nothing:
$500,000 home growing at 5% p.a. = $25,000 p.a.
(But hey . . . NO RISK . . . you should be able to sleep easy and look forward to your pension)

Structured Investment:
Property Portfolio of $950,000 at 5% p.a. = $47,500 (Capital Growth)
Rental income say 4.5% on $450,000 = $20,250 p.a.
Share Portfolio of $332,500 at 5% p.a. = $16,625 p.a. (Capital Growth)
Dividend income say 4% = $13,300
Income from cash say 4.5% = $5,895
Total Return: $47,500 + $20,250 + $16,625 + $13,300 + $5,895 = $103,660 p.a.

Cost of the loan: $760,000 property + $199,500 shares at 6.5% = $62,367 p.a.

Net effect: $103,660 - $62,367 = $41,219
Add back depreciation benefits and tax savings and you will see that this is more than 2X better than doing nothing.

NOTE: The portfolio is negatively cash flowed:
Costs = $62,367
Income (Not including the capital growth) = $39,445
Therefore the cash flow cost p.a. = -$22,922 p.a.

What about the RISK??

Well if you are thinking what risk? REMEMBER the dreaded 80% LVR against your properties.

Okay so the LVR against property is 80%.
However the overall LVR is 67.78%
Total Debt = $959,500 / Total Assets: ($500,000 home) + ($450,000 IP) + ($332,500 shares) + ($133,000 cash) = $1,415,500.

If the portfolio averages 3% pa for the next 5 years = $1,667,498 (Gain of $251,998)
If the portfolio averages 5% pa for the next 5 years = $1,834,204 (Gain of $418,704)
If the portfolio averages 7% pa for the next 5 years = $2,014,065 (Gain of $598,565)

This compares very favorably with the gain over 5 years on just the home
at 3% p.a. = $106,182
at 5% p.a. = $165,768
at 7% p.a. = $230,029

Aaaah yes . . . I nearly forgot: WHAT HAPPENS IF INTEREST RATES GO UP TO 10% AND THE LVR ON YOUR PROPERTIES IS 80%

So total loans = $959,500 x 6.5% = $62,367 p.a.

If interest rates are 10% then the cost increases = $95,950 p.a.
An extra cost of $33,583 p.a. which will be VERY DIFFICULT to sustain, if say your Gross Income is $60,000 a year. (Ahem Bill.L’s question )

Total Cash Buffer = $133,000 / $33,583 = 3.96 years. (4 years of cover)

So at the end of the 4th year assuming interest rates have remained at 10%, you might need to draw down some of your equity gain to survive.

Assume it was a VERY bad 4 years and you achieved less than the cash rate, say 3% pa.
Portfolio value end of 4th year = $1,614,075 (Equity gain of $198,575)
80% of the gain is available = $158,860 at a cost of $15,886 pa (Also at 10%)
$158,860 / 33,583 + 15,886 = 3.21 years.
So you are covered for a further 3 years. (Even if your portfolio is only averaging 3% p.a.)

I believe this to be of a very low risk profile.

NOTES:

1) In the building phase, (Acquiring the assets for financial independence) the only income spent is used to cover the holding costs of maintaining the asset base.
2) A buffer is maintained upfront to allow for extra (unforeseen) costs that might occur before you have accrued an equity gain.
3) Although the Property LVR = 80%; the overall LVR = < 70%
4) The scenario at the end of 5 years based on a 5% p.a. portfolio growth = Net equity of $874,704 at an LVR = 52.31% (Loans = $959,500 and Equity = $1,834,204)
5) Cashbonds are only used if and when extra serviceability is required.
6) One “ONLY LIVES OFF CAPITAL FOR RETIREMENT” when you have accrued sufficient assets to provide Capital Growth in excess of your needs less the costs of maintaining the asset base.
7) Circumstances change continuously; so does your budgeting.
8) Value adding by re-investing your equity gain each year into further assets (Duplicating) will double your asset base every 5 years. (Dollar working 6X)

I hope this clarifies some of the many questions,

Regards,

Steve

 

[see_change]

Please note I have edited my previous reply.

I had the quote "tabs" incorrectly positioned , so what may have appeared to have been Quoting Simon , actually contained part of my reply.

I havn't changed any of the text, just the location of the Quote tabs

See change

 

[Steve Navra]

Example of achieving $5M of Assets

This structure seems very conservative to me. Can I ask you that how to achieve the goal of 5M equity in the portion of property/Share investment with this structure?

Hi Tang,

Too conservative?? (Others might strongly disagree )

As per the example in this thread, one can achieve the $5M quite easily as shown in the attached file. (At 5% Capital Growth for the properties)

I have shown the growth and property acquisition regime over a 10 year time period. This structure uses the 'Value Add' method. (Re-investing all the LAZY $$$$$ each year, until Financial Independence is reached.)
NOTE: Without a cashbond.

I have also included the same example showing what can be achieved if property achieves 7% Capital Growth.

I shown the 7% return, NOT to get everyone's hopes skyhigh; but rather to emphasize the point that a 2% differential makes such a huge difference!

So PLEASE BE VERY SELECTIVE with your DUE DILIGENCE when acquiring the assets.

Regards,

Steve

PS: I am more than sure that a quintillion questions will eminate from this spreadsheet . . . TOO MANY to explain here on the forum. (Come to a course! )

 

[Steve Navra]

PS: I am more than sure that a quintillion questions will eminate from this spreadsheet . . . TOO MANY to explain here on the forum. (Come to a course! )

This was not meant to stop further discussion on how to 'live out of capital"!!
(I just would like to prevent a huge debate on the workings of the actual spreadsheet )


Regards,

Steve

 

[ToGetProperty]

This was not meant to stop further discussion on how to 'live out of capital"!!
(I just would like to prevent a huge debate on the workings of the actual spreadsheet )

Steve

Ok, Steve:

Thank you very much for your effort to make excellent contribution. You don't need to reply to me as I am quite comfortable with this spreadsheet.
However,
1. this spreadsheet is not consistant with your last message of splitting 1/3 of capital into cash/LOC; No this 1/3 cash reserve is used in this spreadsheet as long as I see.
2. Investments should be based on economic environments. For example, if the stock market is bad, what is the point to allocate the 1/3 capital in the shares?

Why I said that your previous approach is very "conservative"?
As said in my point 2, only 30% of capital money is functioning very well in every moment if splitting the capital money into 1/3 cash, 1/3 share and 1/3 IPs. We all understand that the financial market is going in cycles: if property market is good, the stock market may be bad.

Wish more discussions to come for those tops.


Cheers

TGP

 

[see_change]

EXAMPLE:
An investor has a $500,000 unencumbered home, no other investments and wishes to create an ‘efficient’ portfolio.

1) Approach a lending institution and borrow 80% of the value of the asset.
On the assumption that the investor has income sufficient for this loan a cashbond is not required. The result of the banking exercise is a LOC of $400,000.

Proceeds are to be invested as follows:

Property: $133,000
Purchase a $450,000 property with a 20% deposit. [80% loan <$360,000>]
The balance of the cash is used for costs.

Total property assets = $500,000 (home) + $450,000 (IP) = $950,000
Total Loans = $400,000 (LOC) + $360,000 (IP) = $760,000
LVR = 80%

Now just to point out that many resist this LVR as being too high. (No sleep factor.)
What they are failing to realize is that there is still $267,667 to be held in cash in the LOC and in shares as a buffer.

Shares: $133,000
Purchase shares to the value $332,500 with a 40% deposit, [60% loan <$199,500>]


Cash buffer of $133,000.
There are some choices as to the form of the cash buffer:
a) LOC . . . the dollars are readily available, no cost until drawn upon.
b) Further shares (No Leverage) . . . liquidity readily available, cost of dollars is offset by dividends / income plus potential capital gain / loss.
c) Cashbond . . . utilized only if extra serviceability required, cash available as a monthly income stream, resulting income can be re-invested into shares, or paid down to reduce a loan or placed into the LOC or the offset account.
d) Offset Account


Consequences: (Assumed capital growth on all asset classes = 5%)

If the investor did nothing:
$500,000 home growing at 5% p.a. = $25,000 p.a.
(But hey . . . NO RISK . . . you should be able to sleep easy and look forward to your pension)

Structured Investment:
Property Portfolio of $950,000 at 5% p.a. = $47,500 (Capital Growth)
Rental income say 4.5% on $450,000 = $20,250 p.a.
Share Portfolio of $332,500 at 5% p.a. = $16,625 p.a. (Capital Growth)
Dividend income say 4% = $13,300
Income from cash say 4.5% = $5,895
Total Return: $47,500 + $20,250 + $16,625 + $13,300 + $5,895 = $103,660 p.a.

Cost of the loan: $760,000 property + $199,500 shares at 6.5% = $62,367 p.a.

Net effect: $103,660 - $62,367 = $41,219
Add back depreciation benefits and tax savings and you will see that this is more than 2X better than doing nothing.

NOTE: The portfolio is negatively cash flowed:
Costs = $62,367
Income (Not including the capital growth) = $39,445
Therefore the cash flow cost p.a. = -$22,922 p.a.

What about the RISK??

Well if you are thinking what risk? REMEMBER the dreaded 80% LVR against your properties.

Okay so the LVR against property is 80%.
However the overall LVR is 67.78%
Total Debt = $959,500 / Total Assets: ($500,000 home) + ($450,000 IP) + ($332,500 shares) + ($133,000 cash) = $1,415,500.

If the portfolio averages 3% pa for the next 5 years = $1,667,498 (Gain of $251,998)
If the portfolio averages 5% pa for the next 5 years = $1,834,204 (Gain of $418,704)
If the portfolio averages 7% pa for the next 5 years = $2,014,065 (Gain of $598,565)

This compares very favorably with the gain over 5 years on just the home
at 3% p.a. = $106,182
at 5% p.a. = $165,768
at 7% p.a. = $230,029

Aaaah yes . . . I nearly forgot: WHAT HAPPENS IF INTEREST RATES GO UP TO 10% AND THE LVR ON YOUR PROPERTIES IS 80%

So total loans = $959,500 x 6.5% = $62,367 p.a.

If interest rates are 10% then the cost increases = $95,950 p.a.
An extra cost of $33,583 p.a. which will be VERY DIFFICULT to sustain, if say your Gross Income is $60,000 a year. (Ahem Bill.L’s question )

Total Cash Buffer = $133,000 / $33,583 = 3.96 years. (4 years of cover)

So at the end of the 4th year assuming interest rates have remained at 10%, you might need to draw down some of your equity gain to survive.

Assume it was a VERY bad 4 years and you achieved less than the cash rate, say 3% pa.
Portfolio value end of 4th year = $1,614,075 (Equity gain of $198,575)
80% of the gain is available = $158,860 at a cost of $15,886 pa (Also at 10%)
$158,860 / 33,583 + 15,886 = 3.21 years.
So you are covered for a further 3 years. (Even if your portfolio is only averaging 3% p.a.)

I believe this to be of a very low risk profile.

NOTES:

1) In the building phase, (Acquiring the assets for financial independence) the only income spent is used to cover the holding costs of maintaining the asset base.
2) A buffer is maintained upfront to allow for extra (unforeseen) costs that might occur before you have accrued an equity gain.
3) Although the Property LVR = 80%; the overall LVR = < 70%
4) The scenario at the end of 5 years based on a 5% p.a. portfolio growth = Net equity of $874,704 at an LVR = 52.31% (Loans = $959,500 and Equity = $1,834,204)
5) Cashbonds are only used if and when extra serviceability is required.
6) One “ONLY LIVES OFF CAPITAL FOR RETIREMENT” when you have accrued sufficient assets to provide Capital Growth in excess of your needs less the costs of maintaining the asset base.
7) Circumstances change continuously; so does your budgeting.
8) Value adding by re-investing your equity gain each year into further assets (Duplicating) will double your asset base every 5 years. (Dollar working 6X)

I hope this clarifies some of the many questions,
Regards,
Steve

First comment re this example is that I agree with you that the LVR is < 70 , mainly because you havn't drawn down all you equity. Even if you consider the property in isolation , even though you have the capacity to draw more down , you havn't ,so from a purely practical point of view you LVR is comfortably below the 80 % mark.

Re your spread sheet , this is similar ( if not the one ) that I was referring to earlier. It clearly shows the sorts of debts that are necessary to reach financial independence using your approach . It is up to individuals to look at the details and see if that is a structure that they feel happy with.

As has been said before , in isolation the LVR of 80 % isn't a worry

My concern is the combination of high LVR , high debt on a background assumption that the field of play isn't going to change , and then the concept of drawing down on your equity to fund retirement.

See Change

 

[Steve Navra]

To see_ or not to see_

My concern is the combination of high LVR , high debt on a background assumption that the field of play isn't going to change , and then the concept of drawing down on your equity to fund retirement.

Hi see_change,

You are seeing a high LVR; I am not.
You are seeing high debt; I am seeing high net equity.

We all see things according to our individual level of comfort; and fortunately this is what makes the world all the more interesting.

So each to their own; who is right and who is wrong is not the question.
The answer is that ultimately reality will prove to be correct and some will get wealthy, some even wealthier and some not at all.

"It's better to be guided by your dreams than your fears."

Do we dream of success; only to be guided by our fear of debt?
Ahem: it is rhetorical . . . after all, one man's dream of success might well be another man's poison.

Regards,

Steve

 

[ToGetProperty]

Different views on the same animal

Hi, all:

I never view this spreadsheet as a must schedule that I must follow in order to achieve financial freedom. If the market is down, why I have to invest into it?

I view it as my guild: Acquiring 7 IPs in Sydney within 10 years. If I can achieve it, I will achieve my goal of fanancial independent at certain stage of my life. If I achieve it earlier, my whole portforlio LVR will be much less than 80% and much lower level of debts.

I also see that the share in this spreadsheet can be used as a reserve.

And, I actually have achieved it within last 4 years with much lower LVR and debt levels.

Finally, from the spreadsheet, it seems IPs is the very important way to financial freedom.

I don't know what other people's thought. Please comment.

Cheers

TGP

 

[Steve Navra]

And, I actually have achieved it within last 4 years with much lower LVR and debt levels.

Please comment.

Hi Tang,

Fantastic . . . seems you have achieved well and that always takes courage, commitment and a little bit of knowlege.

4 years is an excellent result and with low LVR is to be admired.

However I suggest that the result is similar to as projected in the spreadsheet!

The spreadsheet projects at 5% (To be conservative.)
Whereas your actual result is based on at least a 14% average.

But fortune favours the brave and thus you are to be highly congratulated.

Steve

 

[see_change]

"It's better to be guided by your dreams than your fears."

Do we dream of success; only to be guided by our fear of debt?

Regards,

Steve

Steve , if your way was the only way to succeed financially , I'd be with you all the way.

The reality is there are different ways. I am taking a more proactive approach to the property market . That suits some and not others .

You like buying good negative geared properties when you can afford them .

Personally I'll buy what ever I think is the best value at the particular time of the market. If that property is a positively geared cheapie in logan for 65 K in sept 2002 which I could sell tomorrow for 165 K 18 months later that is what I will buy.

If I think that Rockhampton offers the best opportunities I will buy there.

If the best opportunity I see is a house in wahroonga on 3000m2 which I can dual occ I will buy that.

Debt ? Well I've given my opinion about debt before on this post , so we don't want to go repeating ourselves , do we ?

If I can't find any thing , then I'll happily stand aside , knowing that at some time in the future there will be good buys.

I believe that your approach to how you structure your share investment is something I will be looking at closely.

See Change

 

[Alan H]

Steve,

Just going back to the current poll results for a minute........even though 78 votes wouldn't be considered a huge sample..............

At present 7.7% of Forum voters state they are currently living off capital.

Out of interest, if you had to make an estimate, what percentage do you think of your current Client base would be living off capital?

 

[Steve Navra]

Hi see_change,

My apologies . . . most of my comments to you were 'tongue in cheek' hence the many 's.

Actually we seem to be 99% in accord :

The reality is there are different ways.

Absolutely, hence me previously saying this is what makes the world interesting.

I see all your mentioned options as sound.
My choices match my circumstances . . . as should all our individual choices.
I too step aside if there are no 'good buys' around.

Debt? I don't believe the term 'debt' applies to property! So we can only agree to disagree . . .

Lastly, thank you so much for your contribution to this thread . . . in addressing your line of questioning, many answers were made clearer for other members.

Sincerely,

Steve

 

[Steve Navra]

Out of interest, if you had to make an estimate, what percentage do you think of your current Client base would be living off capital?

Hi Alan,

Interesting question:

About 40% are living off capital to some degree, but only about 2% are Fully Financially Independent.

Only a handful are actually retired, the rest of the financially independent clients continue to work at what they love best. (I'm one of these )

The vast majority are structured to become financially independent within 5 to 10 years max, so I guess most are on the path to "'living off capital".

My goal is for 80% of my current clients to have achieved Full Financial Independence within the next 5 years.

Then maybe I can slow down and retire 15 years too early!

Regards,

Steve

 

[Bill.L]

Hi all,

I have had a look at the spreadsheet presented by Steve, and yes the numbers do look impressive.
However there is one weakness with all these types of spreadsheets (not just Steve's), and that is in some of the assumptions. On Steves 5% growth projection, there is an assumption that the net rent return will grow at 5% p.a. in a 3% inflation environment (to keep the net yield constant at 4.5%).
What has been happening in the real world over the long term is that rental yields have fallen while cap growth continues at above inflation.
I don't know what this discrepancy would have on the overall figures, but my guess is that serviceability will become an issue much earlier than would be expected. Perhaps Steve could elaborate.

See-ch, I couldn't agree with you more. Sounds very much like Jan's philosophy of buying to me.

 

[Steve Navra]

. . . there is an assumption that the net rent return will grow at 5% p.a. in a 3% inflation environment (to keep the net yield constant at 4.5%)

Hi Bill,

This is great feedback . . . and I agree with you completely. I will adjust the spreedsheet to index the rental at the inflation figure, rather than linking it to the property value.

I see this as a sound improvement; and will certainly when completed,
present the results on the forum.

Regards,

Steve

 

[Theo]

New here. Enjoying these posts.

Steve N

Looking at your spreadsheet. Aren't there going to be practical problems with arranging ever increasing levels of debt - 4.7M at yr10, 5.2M at yr 12, etc?

I know you look somewhere else and see 'net equity' but that doesn't mean the bank sees it that way.

Theo

 

[Steve Navra]

Looking at your spreadsheet. Aren't there going to be practical problems with arranging ever increasing levels of debt - 4.7M at yr10, 5.2M at yr 12, etc?

Hi Theo,

'Ve haf vays und means' of making it happen! (Search Cashbonds)

Regards,

Steve