Living off Equity - is this still an option?

Was actually thinking about this on my stroll home from work today. Jamie, you've pretty much hit it right on the head as far as I'm concerned. For my personal choice of 'living off equity' would be to draw down the equity from IP's and invest it in the sharemarket, which gives me an income to live off. Now, I would have a substantial asset base providing said income before doing it - which is my personal preference.

Now, some people may not see this as LOE but do I care? Not really. To me it is - because the way I see it, I'm using the equity acquired from property purchases to invest in another asset class class which provides me an income. As I've said in other posts - horses for courses and all that.

Mark.
 
Just to add my opinion, I'd like to define living on equity, in such a way that it is separated from living on debt.

I think there are basically two views of living on equity floating around in this thread.

The first, A, is where an investor who has received, say, $100K in capital gain over the last 12 months. This person then uses this gain to buy something, let's say, a luxury car, for $75K. The investor has utilised $75K from their portfolio, and is now paying interest on this $75K.

The second method, B, is where an investor reinvests this $75K into something else, (shares, options, managed funds?), and receives distributions and dividends from this reinvested $75K. The investor can now use the dividends from this reinvestment to buy the $75K car.

To me, the difference between methods A and B is that A actually uses the equity gained prior, where B simply uses the equity gained prior, to produce an income on which can be used for living expenses and luxury. In the B scenario, the investor still has the full $100K, ($75K reinvested + $25K left untouched).

A = Living on debt, ($75K spent).
B = Living on equity, ($75K reinvested).

Just my $0.02.

Please correct me if you think my views are flawed — they may very well be. :)
 
Hi all,

Merovingian,

You have just pointed out one of the weaknesses of LOE by reinvesting into another asset class.

If you take the $75k and reinvest it somewhere else, even if it paid a 10% dividend, you would only have a net 3% (after interest) to spend on the luxury car. Now according to my calculations 3% of $75k is only $2250. This will not get you the luxury car.

Using Les's $100k pa to live off, this method would require $3.33m of borrowings from an equity of $4.16m (assuming 80% leverage) if your portfolio was neutrally geared (before the borrowings for investment). You would also have to assume the alternative (sharemarket fund???) could pay the 10% very consistently, in all market conditions.

bye

p.s. Duncan, I agree that is the only reason for using it. However if you are thinking along those lines, why not just sell and live of the profits without the hassle of tenants etc?? Sell one property per year and if this is the only income CGT would be greatly reduced.
 
simonjulie said:
Hi Glebe
Yes. Does it matter?
All our loans are for investment purposes. Yes, even the loans on our PPOR. This is also possible and legal. Financial structuring is an important facit to investing.
Simon

Are you referring to paying off the PPOR in total and then re-borrowing against it to buy investments?
 
Bill.L said:
why not just sell and live of the profits without the hassle of tenants etc?? Sell one property per year and if this is the only income CGT would be greatly reduced.

I love my Tenants! Aside from the occasional bad apple.. I love doing maintenance and I love owning houses..

Selling a property per year is a really, really bad thing to do :) You end up paying Agents fees, CGT, Conveyancing fees, mortgage discharge fees etc..

Simply drawing down the equity means that in 7-10yrs the market (with a leap of faith required) re-establishes another dollop of equity for me to draw down.
 
Hmmm.......I actually don't think Bill is being conservative enough here......also I think the equity required would be more and the interest rate higher for the Les situation....... :eek:

BUT

I still think it could work!

We can all sit around and pick out the deficiencies of a number of quite workable investment structures, but let's not forget what many other people are doing out there. :rolleyes:

They're sitting on perfectly good assets and wondering if their pensions, perhaps a bit of Super......... and for the really clever ones, a bit of rent will give them much more than the pension to live on in their retirement years.

Anyone here know of people living in their own home who maybe have another property and are living a very ordinary retirement on the pension? I certainly know a few.......


Let's use an example a Sydney couple aged about 50 who've showed some foresight by paying off their Sydney home(now valued at $920K) a few years ago and they've also accumulated three other IP's valued at $450K each....... For simplicity, let's also assume no pensions or Super as this will really vary......let's simply assume 'Living on Equity' (whatever that means? :D

As the wife's health is now not that good, and they'd like to spend more time with the grandkids, they'd LOVE to retire now on an average of $120K indexed for life but that doesn't look possible. The house they live in is also more than a house.......it's 'home' and they don't want to sell it.

They've looked at living on the IP Rentals:
Assumptions:
- Each valued at $450K and no debt on them.
- 5% Rental Yield achieved or rent of about $22.5K per year each.
- Costs of about $4K per year for Management, Rates, Insurances, Repairs etc.

Therefore income per IP each year would be about $18.5K ($22.5K - $4K) or about $55.5K per year combined.

Not bad..... but it doesn't give them anywhere near that $120K they wanted.


Next they looked at selling the IP's and living off the invested money.

They sell each property at $450K each or $1.35mil in total and pay say $80K each for Capital Gains, Agents Fees etc. They now have $1.11mil to invest......

They firstly look at putting it all into a nice safe Term Deposit paying around 5% pa.

5% of $1.11 will give them $55.5K pa. BUT they're are getting NO Capital Growth on their 'Assets' anymore. Damn it! Still no $120K pa. :mad:


They then look at a higher risk profile situation and possibly put the $1.11mil in a Managed Income Fund that averages 10%pa.

10% of $1.11mil will give them $111K pa. :D but being an Income Fund the Growth isn't likely to be anywher near the growth from their previously held Assets. Things certainly look better under this scenario but will probably get progressively worse over time due to the inhibited Capital Growth and inflation.

They sit down, have a coffee and look at each other glumly... It would have obviously been nice to a) keep their home, b) keep their IP's c) have $120K pa income d) retire early and e) spend more time with the grandkids but this doesn't really look possible.......

Or is it?

Let's say they draw down 80% of their equity.......

$736K from home valued at $920K
$1.08mil from IP's valued at $1.35mil
Total of $2.27 mil available.

They get a Margin Loan at 50% giving them $4.54mil in Managed Income Fund.
Fund Returns on average 10% or $454,000pa.

Interest on Loans:
6.7%(LOC's) of $2.27mil = $152,090
8.0% (Margin Loan Rate) of $2.27mil = $181,600
Total Interest Bill = $333,690pa

Income($454K) - Interest$333.69K) = $120.3K pa.

This is $64.8k pa better than the 'Rent Only' solution and $9k pa better than the sell and invest directly in a Fund solution BUT most importantly, they haven't sold any assets!

Ok......pick it to pieces.......I've simply splashed down some 'unchecked' figures quicky before going to work.........hope it adds to the debate though......


Oops....I just noticed....it was $100K pa we were after.....not $120K wasn't it? Ok......reduce required assets accordingly......
 
Hi all,

Alan,
So this couple have the choice of having an income fund produce a variable $110k per annum with no debt.

or

have an income fund produce a variable $120k per annum with a debt of $4.54m hanging over their heads.

This is a no brainer for most people near 50 years of age!!!!

Now I know you will raise the argument about having all those assets that keep growing at 5% or 7% or whatever pa.....


but


I know whose position I want to be in if the markets (property and share) take a tumble for a few years.(it is not the one with the huge debt)

In retirement, people are looking for a bit more safety as they may not have the ability( read job prospects) to recover from a financial disaster, so will look to the options that reduce the debt and potential problems, even if the chance of "disaster" is extremely small.

bye
 
Bill.L said:
Hi all,

Alan,

Now I know you will raise the argument about having all those assets that keep growing at 5% or 7% or whatever pa.....

bye

Of course you're quite right Bill.........keeping those assets probably isn't worth while...........at 7% the couple would be lucky to get an extra $161,700 pa in growth..........



:)
 
Alan,

That is good, if it continues to happen.

Now could you post how well off the couple will be if there is a fall in sharemarket values of 30% over a couple of years as well as say a 15% decline in property prices over the same 2-3 years?? Both have happened in the past and could easily happen again. We are not talking gloom and doom here , just normal market reactions to rapid rises. Of course there could be a few flat years after this as well.

Of course you would be able to compare with the couple who just lived off the rent, or sold and bought income funds, but had no debt.

bye
 
Bill.L said:
Alan,

That is good, if it continues to happen.

Now could you post how well off the couple will be if there is a fall in sharemarket values of 30% over a couple of years as well as say a 15% decline in property prices over the same 2-3 years?? Both have happened in the past and could easily happen again. We are not talking gloom and doom here , just normal market reactions to rapid rises. Of course there could be a few flat years after this as well.

Of course you would be able to compare with the couple who just lived off the rent, or sold and bought income funds, but had no debt.

bye

Bill........I know whatever I say, you can always come back and say......."But what if the sharemarket falls by 60%, 70%, 80%?" "What if house prices don't move for the next 10 years, 20 years or more?" etc etc. Whatever my response, you can always simply 'notch it up' another 10% next round and nobody can ever absolutely say that it's not a possibility. So be it.

Yes.........yes.......life and investments are calculated risks. Your choices (presumably?) work for you and others risk profiles are different. Not necessarily better or worse.....but different.

Risk often depends on where you're standing.......

The wife in our example may be dead in 3 years from her health issues. The couple may get to spend more quality time with each other in the next 5 years than they have in the last twenty. They may really get to know their grandchildren in a way that may not have been possible if they worked and worked. The couple may live for another 35 years! That loss of capital growth could be a real stinger in that scenario........but then not if property prices don't go up for the next 35 years.......and yes.......I guess that's theoretically possible too.

If the sharemarket falls by 30%? This is nowhere near a Margin Call at 50%, therefore keep your shares and the Income Fund should still generate about 10% in income. Not necessarily a big problem.

Property falls by 15% over 2-3 years? So what? We've locked in our LOC's for funding Income. If property prices fluctuate a bit after that I don't have a great concern.

This is another option for those who have a particular risk profile Bill. Obviously not you........but then it doesn't mean it couldn't work nicely for others........
 
Bill.L said:
Now could you post how well off the couple will be if there is a fall in sharemarket values of 30% over a couple of years as well as say a 15% decline in property prices over the same 2-3 years??
Hi Bill,

Has there been a 2 year period in Australia where both a 30% fall in the sharemarket and a 15% fall in property prices have happened in the same 2 years?

Only having been in both markets for a few years, Im not sure whether this has happened before. Appreciate your input.

Jamie.
 
Alan H said:
Property falls by 15% over 2-3 years? So what? We've locked in our LOC's for funding Income. If property prices fluctuate a bit after that I don't have a great concern.
There is usually a clause in the T&C's for LOC's that allows the bank to disallow access to your LOC if there is a "significant change in your financial circumstances".
One could consider insufficient equity as a significant change.
The T&C's in my case also state the bank can demand immediate repayment of the outstanding funds on the LOC, which is worrying when they are holding a mortgage over the property that can be enforced.

I haven't done any digging but I haven't heard of this happening to anybody before. I would think if a bank were to do such a thing during a downturn it would have to do it to a lot of customers at once, thus possibly risking collapse of the Australian financial system.

The other reason they could cancel your LOC's it is if you open a load of LOC's while working just before retiring, once they find out you are retired and have a lack of income to meet serviceability (even if increasing equity can cover the interest) they can consider this a change in financial circumstances.

Is there a safer alternative to LOC's? What about Re-financing to 80% of the property value with an offset? If the money in the offset is considered "your money" then surely they can't use that to pay down the loan if the security reduces in value?
 
All Ords 1900-2003

An interesting graph off the all-ords from 1900 up to the beginning of the present bull run. Note there has been a nice spike since this graph finishes, but % wise it's somewhat less sharper than the run up to the 87 market tank.

Perhaps someone can correlate this with property declines to find any killer Living off equity years!?

All Ords performance 1900-2003

Edit:

Having a tough time finding the historical data for house prices going back further than 20 years, certainly it would make sense to look at the whole of the last century I think. Then you might compare shares and property together, I suspect you would find some mighty lean 1-5 year periods in there somewhere.
 
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Hi Guys
Don't you think you are all missing a basic truth here?
Whether or not the market falls or rises,property booms and crashes and plain boring sidways tracks, there is one thing that an active investor will NEVER lose and that is the knowledge gain through experience. So you can sit around all day long pondering formulas and arguments so that mistakes can be avoided but the bottom line is that, for me and other active investors nothing beats doing it. Only then does this whole brave new world become real.

Bill L.
What if we are invaded and our currency is not recognized by the invaders and what if some one drops a bomb on us and we all blow up?
Kind regards
Simon
 
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Action

Well said Simon.

And living well now is difficult to put in a mathematical formula. So don't let fear put you off making mistakes, just try and make the most educated mistakes possible.

I'm very interested personally to see how long if any were the disaster periods for a highly geared LOE strategy during the 20th century. If you want to test the strength of a structure then try and find out how tough it is to knock down.
 
simonjulie said:
What if we are invaded and our currency is not recognized by the invaders and what if some one drops a bomb on us and we all blow up?

Oh thanks very much Simon!

Now I'll worry all weekend about how I'll have to cater for these possible occurences too..... :D

Let me see.......if I keep all my money under the bed........and put mines in the front lawn........damn it.......how do I cater for that direct bomb hit through the roof?

That's it........my long weekend is ruined!

Hmmmm.....maybe I could dig a reinforced cellar under the house........sorry.....sorry......just thinking aloud........ :(

Now you guys have a nice weekend won't you?




:D :D
 
equity

hi all
This is an interesting post a couple of things
First a bank even if there is afall of 50% in the market will not forclose on a lender if he or she is keeping up with there repayments on the loan nor will they revalue a property unless you ask them
so my property at 263 wardell rd is valued to day at $1mil if my rent increases at 6% and I am paying my loan every month with no defaults why would the bank do any thing if the markets fell 50%
they wouldn't if the market goes up then the increase in rent value I draw out of my increase equity.
Second if you mix resi with comm
comm value is govern buy rental return and if the floor fell out of the market then my rentals will cover the short fall of equaty access.
three I like the post that says that investor must keep investing just like developers must keep developing
This is true and this system is not for every body but les I would rather have the 4.9mil debt and would increase that to 20mil debt if possible as long as I had amix of rentals that covered that debt repayments and were linked to my rent increases.
yes a bomb may come down and strike my investments ( and in some of them I do wish it did as the insurance cover will replace and I would have a better building) but unless they invent abomb that can be programmed to only hit my low paying and under insurance covered building I do go to bed and sleep very well.
fourth fornulas are great and I like to use them but so are cars and boats and to some extent power tool but I am not driven by them I use them as a tool to position myself in a particular market.
and everybody should take information, evaluate it and then structure to there needs some might like crown casino black against red and there are alot of high rollers but I don't gamble never, have never will but thats my choice.
I take calculated risks the higher the risk usually not always the higher the return.
This is my .002% and for bill I know your post followed mine previous and I wasn't having a go I was just explaining my position.
 
Hi all,

Amazing how the talk of normal market corrections stir up people to believe you are talking gloom and doom.

Let's just reflect on a little history....

Between '89-'91 the stockmarket retreated about 30%, depending on where you owned property there were also falls during this time.

Between '81-'83 the stockmarket also lost about 30%, and again was a bust period for property. (We bought a property in '81 at the top of the boom :eek: )

Between '74-'75 the stockmarket lot over 50%, and again was a bust period for property.

All 3 of these busts were masked by inflation.

If we look abroard, there are many examples of long declines in markets, often with property and sharemarkets declining in tandem. You have to look no further than what has happend in Japan over the last 15 years to see what is possible, though that type of meltdown is way beyond what I suggest is likely.

So let's look at the logistics of Alan's couple at 50 years of age who wish to live off equity.
They have a life expectancy of another 35-40 years......
They have knowledge that large corrections happen about every 10-15 years..
They know we have just had a record boom in property prices......
They know we have just had a 100% gain in stockmarket indices....
They know that the last bust was 15 years ago.......

They know that their savy FP wants them to go from NO debt to $4.54m DEBT.

They also know that should they lose it all the chances of recovery at their age by gaining new employment is limited. (remember that they would have been out of employment for a while by the time disaster strikes)

Alan/Grossreal, your faith in trusting the banks not to change rules/policy are admirable, but I am sure there are many grain farmers from the late '80's that lost their farms, even though they had kept up repayments, because of negative equity, would not share your faith.

A common perception is that 90% of people lose money in various forms of investments. They buy at the peak of a boom and sell at the bottom of the bust. The reasons for this is the psychological effects of buying when everyone is making money ( The, I don't want to miss out factor). The same effect happens towards market bottoms. People just want to stop the pain of losing (and all the news is bad). If you add this effect to the retired couple who are living off a declining equity, and have a huge debt, the chances are that they will bail out at exactly the wrong time to save what little equity they have left.

Simon, if you really think that a 25%-30% decline in the stockmarket and a 15% fall in property prices is equivalent to the end of the world scenario, then may I suggest you do a little bit of study to bring you back to reality.

bye
 
That`s a good overview Bill.
It`s interesting how people seem comfortable in predicting outcomes after they have a win or two.
This market cycle was unusual in that it moved up fast, seemed to stop, and there was a point where I thought to be wise and sell, but I held on (as most do), then the market really took off!. :eek:
These days I like to think where would I be if interest rates went to 18% and homes could not be sold/values dropped drastically, I remember those days.
But I swear by property, it`s the best way for an insignificant someone with nil to get a chunk of the world, some self respect and a feeling your getting somewhere, but you don`t need to be rich, you don`t need much to get to that secure outlook that you are on your way.
Greed is dangerous in R/E and there is way more to life imo.
At some point this scramble for riches has to stop, it takes too much time and effort.
 
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