LOE in these times

[kum yin lau]

Hi Rixter, thanks for your input.

The fallacy lies in the 'increase in equity' assumption.

For instance, I have property that's been really very stable, the council has increased the valuation quite a bit & the rental income has not changed very much. It's unlikely to change very much in future either.

Assume LOC $250000

In 5 years, the equity has to increase by $320000 at least. Not impossible but there's also the possibility that it may stagnate or go backwards.

Fortunately, I'll have excess eke out some sort of growth. I still lean towards stocks at this point in time.

Have a good weekend,
KY

 

[boomtown]

KY

The problem is that your numbers are too small.

To really go effectively LOE you need a massive portfolio on lowish LVR. In my mind a 5 million dollar portfolio which is cashflow neutral on say a 50 percent LVR is the entry point. If can live on 50k per annum your portfolio only has to go up on average by 1 percent pa. If your portfolio doesn't grow on average by 1 percent per year then you haven't picked a good portfolio.

The low LVR allows you to draw down on equity even if there is a crisis and your portfolio goes backwards for a couple of years.

If you keep your spending at the 50k level then after one property cycle you should have 3 million debt and 10 million in property.

By this time the portfolio should have swung heavily CF+ and rents will be supplementing your equity draw down.

The key is building a portfolio so big that your living expenses just become irrelevant - they are a rounding error.

 

[Rixter]

-Now do you have 5 seperate LOCs
-Do you combine the lot to give you One big LOC
-Do you have to create seperate LOC for living vs the interest deductible portion.
-Do you have to create seperate LOC for living vs the interest deductible portion.

You could also use investment income purely for lifestyle expenses and then capitalise investment expenses.

Which finance structure to use?? Well there is no right or wrong ways - just different ways. Really comes down to the comfort zone of each investors individual risk profile.

Hope this helps.

 

[Rixter]

The problem is that your numbers are too small.

To really go effectively LOE you need a massive portfolio on lowish LVR. In my mind a 5 million dollar portfolio which is cashflow neutral on say a 50 percent LVR is the entry point. If can live on 50k per annum your portfolio only has to go up on average by 1 percent pa. If your portfolio doesn't grow on average by 1 percent per year then you haven't picked a good portfolio.

The low LVR allows you to draw down on equity even if there is a crisis and your portfolio goes backwards for a couple of years.

If you keep your spending at the 50k level then after one property cycle you should have 3 million debt and 10 million in property.

By this time the portfolio should have swung heavily CF+ and rents will be supplementing your equity draw down.

The key is building a portfolio so big that your living expenses just become irrelevant - they are a rounding error.

KY, Boomtown has hit the nail on the head. The bigger the portfolio & the lower the LVR, the lower the risk!

Hope this helps

 

[landlubber]

Very good description Boomtown . Kudos !! With "pure" LOE you have two main "expenses" in your equation (1) your annual negative gearing costs and (2) your personal cost of living. If you're portfolio is cash flow neutral then you can eliminate (1). In our case we've chosen to keep buying IPs when we see good opportunity so we're still neg.geared. We ONLY buy growth IPs in capital cities. ( This is what Rixter was talking about with your structure.) Your "income" (I use that term reluctantly as it's not quite correct accounting wise for LOE) is (a) rents and the growth in rents and (b) the capital growth in your portfolio. If you do some numbers you'll soon see which one is "king". If you accumulate a $10m portfolio it only needs to increase by 1 or 2% to pretty well cover the expenses above...and when we get a 10-20% year it's party time! PLUS you need to have enough LOC in reserve at all times to cope with the four to five year periods in the property cycle where we KNOW that the market will be "flat". We're in the middle of one of those periods now.
LL

 

[Rixter]

Very good description Boomtown . Kudos !! With "pure" LOE you have two main "expenses" in your equation (1) your annual negative gearing costs and (2) your personal cost of living. If you're portfolio is cash flow neutral then you can eliminate (1). In our case we've chosen to keep buying IPs when we see good opportunity so we're still neg.geared. We ONLY buy growth IPs in capital cities. ( This is what Rixter was talking about with your structure.) Your "income" (I use that term reluctantly as it's not quite correct accounting wise for LOE) is (a) rents and the growth in rents and (b) the capital growth in your portfolio. If you do some numbers you'll soon see which one is "king". If you accumulate a $10m portfolio it only needs to increase by 1 or 2% to pretty well cover the expenses above...and when we get a 10-20% year it's party time! PLUS you need to have enough LOC in reserve at all times to cope with the four to five year periods in the property cycle where we KNOW that the market will be "flat". We're in the middle of one of those periods now.
LL

Great call LL - kudos!

 

[kum yin lau]

Hi Boomtown/Rixter, thanks for opening up my eyes.

The numbers are good guidance. $3M debt & $10M portfolio means $7M net worth.

Most ordinary folks will find it hard to think up to $1M so you're right. My thinking is too small.

I find though that $1M paid up property generates more than the $50K p.a. so there's little necessity to LOE, just rental income will do.

Will think about it further.

Thanks all,
KY

 

[landlubber]

Ditto Rixter !! Here's to LOE !!
LL

 

[landlubber]

I find though that $1M paid up property generates more than the $50K p.a. so there's little necessity to LOE, just rental income will do.

KY, Can merely suggest that you do yourself some numbers before deciding on the "live from rents" strategy. Firstly,to arrive at "$1M paid up property" you will firstly have to accumulate a large enough portfolio to then sell-down and pay all the capital gains tax, the REA fees, the legals etc. and THEN pay off your bank loans ! Secondly, then you've got a pretty good return at 5% gross... but that's not anywhere near enough. You still have to pay all your rates, insurances etc. on the IPs...and THEN you have to pay your income tax on the income. If you think you can live on $50K net after tax income, you gotta start with (maybe) $100K gross rents. Suggest you perhaps look more closely at the numbers.
LL

 

[kum yin lau]

Hi, with newly purchased property, the yield is generally lower but by the time they're paid off, rents would have increased to > 6% so living off rental income is not such a bad idea. I know quite a few older people who do that.

Obviously, the younger we are, the higher lvr we should aim for.

Even my 'dud' investments [student accommodation units in NZ] are looking to return some decent yields.

And don't need to tell me how stupid I was to buy them in the 1st place!

Overall, I'd assess my rental yield to be 9-10% so you're right, I'm looking at $100000 pre tax to achieve after tax $50000.

Sigh! You're all so right to look at $10M portfolio in order not to be 'average'.

KY

 

[landlubber]

Don't beat yourself up KY ...We've all got "less that perfect" IPs in our flock. He who never made a mistake... never made anything !! It's all experience.
LL

 

[bernly]

Sigh! You're all so right to look at $10M portfolio in order not to be 'average'.

KY

Hi KY

I'm sure you're already on the right track. The commercial property you mentioned you have in an earlier post I pass everyday and includes not only the KFC and Cheescake shops you mentioned but also a Hungry Jack's outlet and a TipTop dry cleaner. I'm sure there is nothing "average" about your investing. Good for you.

Cheers