Drawing down equity on IP's for shares

[Kasper]

Hi,
I have a printout from the forums that caught my eye in 2007. This is how long it takes me to make a move on things... It was a thread from keithj.
We have 4 IP's with a fair bit of equity in them. I would like to invest some money off the back of this equity.
The thread speaks of 'drawing down' equity from the IP's and taking out a margin loan off this. My question is how does this physically happen? How do you 'draw down' on the equity. I can't quite work it out and though I would run it by you all before going to a bank.
I guess I will need to get some valuations done (which would be good anyway after all these years).
Also could you tell me what an LOE is?
Cheers,
©

 

[Propertunity]

The thread speaks of 'drawing down' equity from the IP's and taking out a margin loan off this. My question is how does this physically happen? How do you 'draw down' on the equity.

You take out a second mortgage on them or refinance them with a different lender - releasing the equity as cash.

Also could you tell me what an LOE is?

Living Off Equity (i.e. the cash mentioned above)

 

[Kasper]

OK. I see how it works. Thanks for both of those answers. Something to think about. Great.
©

 

[wobbycarly]

*snip*
The thread speaks of 'drawing down' equity from the IP's and taking out a margin loan off this.
*snip*

Word of warning. This is borrowing money to borrow money. Drawing down equity to buy shares is one thing. Margin lending with those shares bought with borrowed money is another.

You may already be aware of the risks involved - in which case good on you, knock yourself out. Bigger cojones than I!

Don't mean to condescend if you knew all this...

 

[Propertunity]

Word of warning. This is borrowing money to borrow money.

Don't be a wuss

This is exactly the same strategy PIs use to buy more than 1 house. You borrow money from the equity on 1 house to use as the deposit on another house, that you borrow the balance of the money for. Excluding transaction costs this is 100% gearing.

 

[wobbycarly]

Don't be a wuss

This is exactly the same strategy PIs use to buy more than 1 house. You borrow money from the equity on 1 house to use as the deposit on another house, that you borrow the balance of the money for. Excluding transaction costs this is 100% gearing.

100% gearing is one thing. 100%+ gearing is another!!

(I know you know this, but I'm going to explain it here as much for myself.)

IP valued @ $400k. Mortgage remaining: $200k.
Available equity = 80% x $400k = $320k - $200k = $120k

Put this $120k in a LOC.

Drawdown the LOC and buy 3000 BHP shares @ ~ $38 = $114k.

Using the $114k of BHP shares @ 75% margin will give me a further $85k with which I buy 2250 BHP shares.

So now I have 5250 BHP shares, worth nearly $200k! That's looking to me like 166% gearing against our original $120k.

Now tell me that's not risky!! I could lose on the BHP shares and lose [some of] the $120k of equity. Yeah, I'm a wuss!!

(Ignore the specific security risk of only purchasing BHP - that was for example only and compounds the risk again.)

 

[Propertunity]

So now I have 5250 BHP shares, worth nearly $200k! That's looking to me like 166% gearing against our original $120k.

wobbly, I think your maths is a bit dodgy. Reminds me of Paul Keating's throw away line about John Hewson being a 'feral abacus'

If you have 120K loan LOC against $200K of BHP, then that it only 60% gearing (against the original LOC).

But in reality, in your example you have a $120K LOC + $85K margin loan = $205K worth of loans against the same amount of BHP shares = approx. 100% gearing on the shares.

 

[wobbycarly]

*backs away looking at calculator*

That's the 2nd time in 2 days I've posted dodgy maths

Anyway, I still think that margin gearing with borrowed funds is too risky for my taste!

 

[Propertunity]

That's the 2nd time in 2 days I've posted dodgy maths

Just as long as you are not in the accounting profession I think you can be forgiven

Anyway, I still think that margin gearing with borrowed funds is too risky for my taste!

Oh yes, it is a highly geared strategy, no doubt.

As with all high risk ventures, (and especially so in the hands of a novice), you have to be prepared to suffer some losses or not play that game Also there are some risk mitigation strategies to undertake as well to reduce risk.

 

[wobbycarly]

Just as long as you are not in the accounting profession I think you can be forgiven

Oh yes, it is a highly geared strategy, no doubt.

As with all high risk ventures, (and especially so in the hands of a novice), you have to be prepared to suffer some losses or not play that game Also there are some risk mitigation strategies to undertake as well to reduce risk.

Such as? Buying puts? What else?

And no, I'm not an accountant.

 

[Propertunity]

Such as? Buying puts? What else?

Yes, buying puts. Selling out of the money calls. All that lovely hedging stuff .

Don't just buy all of ONE share like BHP - spread the love around a little. Don't just buy mining stocks. Diversify.......etc.

 

[wobbycarly]

Of course, diversification should go without saying... Or the margin loan could be a capital-protected product.

 

[Kasper]

Wow. I have been working away on something else and all these threads have happened! look what I've started. I am going to take a serious look at all these over the weekend and digest them. So glad I asked. ps i am terrible at maths.
©

 

[Rolf Latham]

Wow. I have been working away on something else and all these threads have happened! look what I've started. I am going to take a serious look at all these over the weekend and digest them. So glad I asked. ps i am terrible at maths.
©

No probs, coz this looks like arithmetic rather than calculus

ta
rolf

 

[oracle]

100% gearing is one thing. 100%+ gearing is another!!

(I know you know this, but I'm going to explain it here as much for myself.)

IP valued @ $400k. Mortgage remaining: $200k.
Available equity = 80% x $400k = $320k - $200k = $120k

Put this $120k in a LOC.

Drawdown the LOC and buy 3000 BHP shares @ ~ $38 = $114k.

Using the $114k of BHP shares @ 75% margin will give me a further $85k with which I buy 2250 BHP shares.

So now I have 5250 BHP shares, worth nearly $200k! That's looking to me like 166% gearing against our original $120k.

Now tell me that's not risky!! I could lose on the BHP shares and lose [some of] the $120k of equity. Yeah, I'm a wuss!!

(Ignore the specific security risk of only purchasing BHP - that was for example only and compounds the risk again.)

Wobbycarly, your example is no different to me using $120K in LOC and using it as 20% deposit against another IP worth $600K and borrow $480K. What's the gearing ratio now on the $120K???

For every liability (Loan) you have you have an asset (Shares or Property) against it.

If you believe the asset (property/share) you are buying with borrowed funds is going to be worth more in future and will rise above the cost of borrowing money (interest rate) and the loan servicing costs (cashflow) is managed there is nothing wrong with the strategy. You just need to know what you are doing and be prepared for the worst case scenario.

Cheers,
Oracle.

 

[bene313]

Hi,
I have a printout from the forums that caught my eye in 2007. This is how long it takes me to make a move on things... It was a thread from keithj.

http://www.somersoft.com/forums/showthread.php?t=34046

That one. Works very well in a rising market.

The question is, when will we have another rising market?

 

[Sunfish]

Yes, buying puts. Selling out of the money calls. All that lovely hedging stuff .

Selling calls is not not hedging, is merely getting some rent.

Of course, diversification should go without saying... Or the margin loan could be a capital-protected product.

Buying BHP is diversifying from property and if you don't have a fair bit of cash don't cut it too often or your brokerage will kill you and all you'll have done is guarantee "average" returns. Don't put it all in banks because they are highly correlated to property and you will have gained nothing of note.

I had over $200k equity in my margin account before the GFC and I was fairly conservatively margined. I was proactive in selling down before I got margin calls but even then I only came out with $10k. So my advice is to stage your entry. Bed down one cash parcel before looking to invest the next. It could take a couple of years to do this but if you toss in the lot at once and get shaken out of your holdings you may never go back and that would be a pity.

 

[wobbycarly]

Wobbycarly, your example is no different to me using $120K in LOC and using it as 20% deposit against another IP worth $600K and borrow $480K. What's the gearing ratio now on the $120K???

For every liability (Loan) you have you have an asset (Shares or Property) against it.

If you believe the asset (property/share) you are buying with borrowed funds is going to be worth more in future and will rise above the cost of borrowing money (interest rate) and the loan servicing costs (cashflow) is managed there is nothing wrong with the strategy. You just need to know what you are doing and be prepared for the worst case scenario.

Cheers,
Oracle.

Yep, I realise my mistake. I guess I was just thinking about margin calls; that when you only have your shares leveraged against other shares, it's a lot easier to get out without too much hassle, and not "lose more than you put in", so to speak, because of the (typically) lower LVR with equities.

Thanks for those who took the time to correct me - opened up my thinking a bit more, which is why I hang around here.

Apologies to Kasper for hijacking and hopefully didn't end up confusing him/her.

 

[long88]

Hi,

how about if you buy put options on the bhp shares, for say 6 month ? your break even is higher, but if market go above your break even, then you earn even more money, and if market drop a lot, then you still get all of those losses back ? anyone does this ?

100% gearing is one thing. 100%+ gearing is another!!

(I know you know this, but I'm going to explain it here as much for myself.)

IP valued @ $400k. Mortgage remaining: $200k.
Available equity = 80% x $400k = $320k - $200k = $120k

Put this $120k in a LOC.

Drawdown the LOC and buy 3000 BHP shares @ ~ $38 = $114k.

Using the $114k of BHP shares @ 75% margin will give me a further $85k with which I buy 2250 BHP shares.

So now I have 5250 BHP shares, worth nearly $200k! That's looking to me like 166% gearing against our original $120k.

Now tell me that's not risky!! I could lose on the BHP shares and lose [some of] the $120k of equity. Yeah, I'm a wuss!!

(Ignore the specific security risk of only purchasing BHP - that was for example only and compounds the risk again.)

 

[Propertunity]

Selling calls is not hedging, is merely getting some rent.

If you accept a "Definition Of Hedging" as being defined as entering transactions that will protect against loss through a compensatory price movement, then selling call options has to be considered hedging, in my opinion. The premium received would go to offsetting any loss in the event of a fall in the price of the underlying share. (I supposed I should have mentioned selling covered calls not naked ones).

Buying BHP is diversifying from property

Yes it is, but the point I was making, was that in wobby's example, he used his LOC and a margin loan to only purchase BHP. That is not diversifying across different industries in the share market.