uhhh ... yeah ... I don't follow you at all..... a LOC that generates interest ???? I think I need one of those
. There's plenty of theads on LOE , maybe do some searching & reading. LL
LOE Model
- Thread starter Perth Investor
- Start date
. There's plenty of theads on LOE , maybe do some searching & reading. LL
Thanks for the reply!
AFAIK I don't think you can get a LOC with a fixed rate, but I just said fixed for the simplicity of the calculation for the interest payable.
"The idea is that your properties' values go up more each year than you spend from the LOC, so when you get to the end of the IO period and have to refinance to go again, the properties are worth more than the debt."
This is where I get a bit confused....
For simpicity sake I'm forgetting about LVR's and whatever else. Say I have a house valued at $200,000 and a $100,000 IO mortgage against it. I draw out the $100,000 in equity in LOC. So I still have a mortgage of $100,000 and keep making my IO repayments as I always have. But now I have a $100,000 5 year LOC loan which is secured again my house which I am now making my IO repayments towards.
Now, fast forward 5 years and I've spent the $100,000 LOC loan and I now need to repay the principal back. I don't want to sell anything to cover the LOC so I refinance my mortgage making it now $200,000 to cover the LOC loan and now (as I see it) I'm paying interest on that $100,000 LOC all over again???
Is that right?
So I guess if rents go up an average of 5% a year that will help compensate for the extra interest repayments over the period?
uhhh ... yeah ... I don't follow you at all..... a LOC that generates interest ???? I think I need one of those
LL
Ha, it'd be awesome if it earnt interest at 7.41%. But what I meant was the interest payable.
I tried to search "loe" but apparently that's too short and if I try using more than one word my computer can't handle it and freezes up.
Hi Kesse
I think you need some bigger numbers to get the idea. Let's say you have a portfolio worth $10m with $5m of debt (50% LVR) that is roughly cashflow neutral (ie you can't LOR as you bought "prime" resi real estate a long time ago and the yields are still too low). Let's say a Bank is willing to let you go up to 60%LVR ($6m debt) without worrying about serviceability tests etc (which ain't necessarily so but this is a hypothetical). So you can get an extra facility for $1m on top of your $5m debt.
Let's say it takes you 10 years to use up that $1m facility for living expenses as you draw it down and pay more and more interest on it. Let's say in those ten years your rents have grown to be able to service this new ($1m principal) interest bill on top of your previous ($5m principal) interest bill (due to the miniscule rental yields on your "prime" resi portfolio). Let's also assume your properties have doubled in value over 10 years, as per recent history.
With the higher value of your portfolio, the Bank may only lend you 50% LVR now without worrying about serviceability. Due to your higher borrowing you are still cashflow neutral but you are now able to borrow $4m this time before going over 50% LVR (Portfolio value = $20m and Loan value = $10m). Rinse and repeat.
All sounds fine and dandy but we have made a lot of assumptions there. Some will see those assumptions as grossly unrealistic and conservative. Others will see such a strategy as incredibly risky. But the theory is that your borrowings increase at a slower rate than your property values so Banks will let you keep borrowing more, as your LVR will still be dropping. This strategy depends as much on the behaviour of Banks as the behaviour of property values, on top of how LOR depends on the value of rents and interest rates.
I think you need some bigger numbers to get the idea. Let's say you have a portfolio worth $10m with $5m of debt (50% LVR) that is roughly cashflow neutral (ie you can't LOR as you bought "prime" resi real estate a long time ago and the yields are still too low). Let's say a Bank is willing to let you go up to 60%LVR ($6m debt) without worrying about serviceability tests etc (which ain't necessarily so but this is a hypothetical). So you can get an extra facility for $1m on top of your $5m debt.
Let's say it takes you 10 years to use up that $1m facility for living expenses as you draw it down and pay more and more interest on it. Let's say in those ten years your rents have grown to be able to service this new ($1m principal) interest bill on top of your previous ($5m principal) interest bill (due to the miniscule rental yields on your "prime" resi portfolio). Let's also assume your properties have doubled in value over 10 years, as per recent history.
With the higher value of your portfolio, the Bank may only lend you 50% LVR now without worrying about serviceability. Due to your higher borrowing you are still cashflow neutral but you are now able to borrow $4m this time before going over 50% LVR (Portfolio value = $20m and Loan value = $10m). Rinse and repeat.
All sounds fine and dandy but we have made a lot of assumptions there. Some will see those assumptions as grossly unrealistic and conservative. Others will see such a strategy as incredibly risky. But the theory is that your borrowings increase at a slower rate than your property values so Banks will let you keep borrowing more, as your LVR will still be dropping. This strategy depends as much on the behaviour of Banks as the behaviour of property values, on top of how LOR depends on the value of rents and interest rates.
Remember, there is a very good case for the banks to let property continue to double every 10-12years atleast. As they are in the business of lending and if there is no property growth they have to rely solely on new entrants borrowing. Currently, they have a big chunk of money being lend on re-finance due to the increase in property values.
Housing loans will probably be very high % of total money the banks lend, so not only is it in their best interest to do everything possible to avoid crash in property as that can mean they would be wiped out as well, but to let property prices continue to rise so they can keep increasing their lending and thus keep making bumper record profits.
Cheers,
Oracle.
and not just the banks ....
LL
Oracle, I agree. And it's not just the banks. Seeing the mess that USA is in, I think it's kind of pivotal to the "whole ball of wax". It's very politically sensitive. 70% of property is owner occupied. As Costello said "The only people I know who don't want property to increase in value are those that don't own it ...BUT only until they own it. Then they change their tune."
LL
Where to start on LOE.
Good post HiEquity, you pretty much nailed it. The LOE "game" starts with two numbers. (1) What you need $$$ annual for your desired way of life/cost of living COL and (2) how many years of "comfort" do you want? This number is really the number of years you "estimate" that propertry may take to stagnate & then recover so your equity increases. Typical numbers might be $70K per year and 10 years. So you then need a SPARE LOC of $700K. And you need a portfolio that has proven with past performance that it pretty much doubles every 10 years. So it will keep "doing it's thing". This model is for a cash flow neutral portfolio. If you still have a negative cash flow portfolio, that number needs to be added to your annual COL. Hope that helps.
LL
Good post HiEquity, you pretty much nailed it. The LOE "game" starts with two numbers. (1) What you need $$$ annual for your desired way of life/cost of living COL and (2) how many years of "comfort" do you want? This number is really the number of years you "estimate" that propertry may take to stagnate & then recover so your equity increases. Typical numbers might be $70K per year and 10 years. So you then need a SPARE LOC of $700K. And you need a portfolio that has proven with past performance that it pretty much doubles every 10 years. So it will keep "doing it's thing". This model is for a cash flow neutral portfolio. If you still have a negative cash flow portfolio, that number needs to be added to your annual COL. Hope that helps.
LL
Thanks for the reply HiEquity, makes more sense now with the bigger numbers.
Why not just invest the $700k
Why not just invest the $700k LOC into shares etc and try to live of the earnings / capital growth? This way you are not continually increasing your borrowings and you are not 'relying" on the property portfolio doubling to fund the next 10 years.
ie assuming a 10% capital growth on shares + 5% dividend yield less the 7% on the borrowed money = 8% x $700k = $56k. Returns and LOE cashflow may be improved by the use of a margin loan.
This scenario should also be easier to secure new loans in the future because your bank can see that you have income and thereore servicability.
Why not just invest the $700k LOC into shares etc and try to live of the earnings / capital growth? This way you are not continually increasing your borrowings and you are not 'relying" on the property portfolio doubling to fund the next 10 years.
ie assuming a 10% capital growth on shares + 5% dividend yield less the 7% on the borrowed money = 8% x $700k = $56k. Returns and LOE cashflow may be improved by the use of a margin loan.
This scenario should also be easier to secure new loans in the future because your bank can see that you have income and thereore servicability.
I could give you SO many reasons I'd bore you. But first and foremost, is because you can "wake up" tomorrow and your shares are worthless... or near to worthless. This just cannot happen with property. Even if the building "evaporates" and is un-insured, you still have the dirt. That's reason #1.
LL
PS Are you following what's happening to Mr. Samuels, head of the ACCC. right now he's looking at $100m personal wealth evaporating as DFO "goes bad".
Diworsified...
LL
Our bank was concerned at on stage that we "were not diversified" and brought a financial planner along to a meeting. He was saying just that, use some equity and put into managed funds. Get some Oz and some International exposure etc. That meeting was a couple of years ago, just before the GFC hit. Not only did the markets crash, the AUD strengthened. It would have been a blood-bath. Instead I went and bought another 6 IPs. The bank don't mention it anymore.
LL
Hi Bill,
http://www.fusioninvesting.com/2009/07/australian-share-market-performance-and-returns/
According to the above source, the average long term (109 year) return of the australian stock market is 7.48% excluding dividends and 12.42% including them.
I dont think it is unreasonable to expect a slightly more sophisticated investor to often exceed the average by at least a couple of percent
The assumption that property wil continue to double every 10 years as it has been doing, is also not guaranteed.
Remember SONRAY ???
Sophisticated investors ?? .. like the ones who invested with SONRAY ???
LL
Sophisticated investors ?? .. like the ones who invested with SONRAY ???
LL
HI LL,
Yes you can wake up and shares can be worthless if you dont manage the risk (stop losses, diversification, share selection and research etc etc)
I have modelled both scenarios to try and decide what is the best for my situation.
Scenario 1 is pure LOE as you describe (and you are obviously succesfully implementing). Scenario 2 is using Equity to generate returns (eg Shares) and Scenario 3 is a mixture of both.
The modelling shows that after 15 years, Scenario 2 (Shares) generated the most equity, resulted in the lowest LVR, was more diversified across asset classes and seemed to contain the lowest risks.
I had originally thought that Pure LOE was the "easiest" (ie no headache of trying to decide what to invest in and manage that investment) but now I think it is the "riskiest". Thats not to say that if you have heaps of equity that you cant make it work and manage the risk.
Yes there are certainly some horror stories out there but equally I am sure there are horror stories with some property stagnating / or even negative growth (ie off the plan, buying in regional areas where the mining company shuts up etc).
In both cases prudent risk management / Due dilligence and research can minimise or elimanate these risks.
Maybe ....
!!
( High of around 1550 in 2000 , currently around 1100)
LL
PS and if you think that's bad, check the Nikkei ( Japan)
...unless you invested in the S&P500 (diversified US industrial index) in which case you're about 30% below where you were 10 years ago. Bummer
!! ( High of around 1550 in 2000 , currently around 1100)
LL
PS and if you think that's bad, check the Nikkei ( Japan)
Cheers Tess, that works amazingly well and what's even better is when I try to search with more than one word my computer doesn't poo itself
