LOE: Starting with $560k.

[D Money]

Hi all,

Thinking seriously about LOE (Living off Equity) starting early next year. Here are the numbers:

• Current Assets: $2.31M (incl PPOR)
• Current Liabilities: $1.298M
• LVR: 56%
• Income required to cover annual expenses: $40k
  • Note 1: The low amount of $40k pa is due to Frugal living (see http://www.mrmoneymustache.com/2012/10/08/how-to-go-from-middle-class-to-kickass/ for further info)
  • Note 2: the $40k includes current property cashflow shortfall of $10k pa
  • Note 3: I have allowed for this $40k living costs to increase by 3% inflation every year
• The plan is to have $700k PPOR fully paid off by early next year with an 80% LVR $560k line of credit available to start LOE.

I have done a rough Spreadsheet modelling my properties growing at 5% pa at an average interest rate of 8% pa. The added bonus of any rental increases (which would decrease the $10k property income shortfall) have not been factored in.

The attached spreadsheet shows it will take approximately 9 years for that initial $560k to run out, due to the interest on the increased borrowings being continually capitalised. However at that point I should have approximately $938k in available equity at 80% to draw on. This obviously assumes property portfolio is growing at 5% annually.

Once the $560k runs dry, I will need to work out a strategy that will convince the bank to continue to lend me money without any income (Cashbond, Low Doc, capitalising interest?)

Its kinda like a race between the increase in property equity vs the snowballing effect of the capitalising of interest. If you change the annual growth of the portfolio of to 3% then the LVR accelerates upwards much faster and the strategy is less sustainable.

Even at 5% pa property growth, the LVR eventually starts increasing upwards, however our contingency plan is that the missus and I would most likely at some stage do some part time work / consulting or start a business. I am sure that over the next 27 years we will earn some sort of income before accessing any sort of Superannuation.

I am really over work at the moment and would love nothing better than take a year off in 2014 (as a minimum), do some travelling, and then reassess what I want to do with my time .

Anyways, would appreciate any thoughts on whether this stategy seems feasible and if there are any alternative strategies that would allow me to not have to work ASAP.

Cheers

 

[jingo]

Have you considered working part time to fund your living costs instead of capitalising interest like this?

How about building an income stream by investing in shares? You could sell a property or two to get you started.

I just think Loe is fraught with too many unknowns and relies on capital growth and the ability to borrow money to keep the strategy going.

 

[D Money]

Have you considered working part time to fund your living costs instead of capitalising interest like this?

How about building an income stream by investing in shares? You could sell a property or two to get you started.

I just think Loe is fraught with too many unknowns and relies on capital growth and the ability to borrow money to keep the strategy going.

Hi Jingo.

Yes I have considered working part time to fund my living costs and as mentioned will most likely earn some sort of income to fully or partly fund my living costs at some stage, however would as a minimum love to have a year off

I have also considered investing in shares, however most of my equity is in my PPOR so didnt want to sell that.

$560k of borrowed funds say at 6% against PPOR invested in shares doesnt generate enough income (ie $560k x 7% share returns less 6% interest cost = $5.6k income per year)

I completely understand the concerns about LOE, however what other strategy would allow me to not work ASAP?

thanks

 

[Peter_Tersteeg]

Once the $560k runs dry, I will need to work out a strategy that will convince the bank to continue to lend me money without any income (Cashbond, Low Doc, capitalising interest?)

This is the point where LOE strategy starts to fall to pieces for many. Cashbond can work under the right circumstances. Lo doc & capitalizing interest won't.

My suggestion would be to look at implementing this strategy with a substantially higher capital base. $560k simply isn't enough.

 

[ok180]

My suggestion would be to look at implementing this strategy with a substantially higher capital base. $560k simply isn't enough.

Exactly, triple it and add 10. If it was possilbe to retire on half a million odd dollars everyone would be doing it.

 

[Peter_Tersteeg]

Exactly, triple it and add 10. If it was possilbe to retire on half a million odd dollars everyone would be doing it.

And with that kind of equity behind you there's a lot of easier ways to get access to $40k a year, after tax and with cashflow and capital base increasing over and above inflation.

 

[Corey Batt]

What's more stressful/straining in the long run:

a, Work part time for 10 years while your move forward with a CF strategy
b, Go to bed each night wondering whether you will have any more equity to dig you out of the debt hole when your cash runs out.

Property is a great wealth creation device, however the retirement funding does become unhinged when you are reliant on continued strong market conditions for sustain living costs.

Consider if you took up this strategy and entered the current market with falling prices and or price stagnation.

IB margin 4.46%, buy well into Index Funds and or LICs. Keep your yields above interest. Post tax, highly liquid, comes twice a year (that's more frequent than Santa!). SANF by the wheelbarrow load in comparison to the aforementioned LOE scenario....

 

[Terry_w]

D Money,

I am a fan of MMM too.

If you want to travel you may be able to rent out your PPOR and that rent could greatly assist in your cashflow.

You could also possibly buy some high yielding shares which pay fully franked dividends. Possibly from a LOC to speed things up.

With the rent, dividends and tax back from franking credits this may get you there.

You may also be able to capitalise some interest on investment loans and legitimately claim the interest while you are living on rents - ie living on rents instead of equity. Meaning increasing loan interest deductible - possibly.

 

[twodogs]

Please don't take this as criticism, but my numbers are better than yours and there is now way I would go down that path right now. And I really, really would love to quit the day job

Thought about it few years back, GFC sorted out those fantasies.

You are either brave or dumb, in time maybe neither good luck!

Ps with shares, investing may get you 6%, but you can do much better than buy and hold.

 

[joanmc]

Is there any way you can take an extended break from work but still be able to go back?
We packed everything in a few years ago to LOE and trade shares. It was AWESOME for the first year and then quite a few things went to custard. We had walked away from a very profitable business and were then stuck. Our portfolio of properties had dropped by about 20% so we had no servicability and and no equity for a refi/LOC. We are actually living the disaster that can happen when you jump too early
We are only now (3 years in) starting to make a comeback but our properties are still way below their last bank vals when things were good.
I am not trying to scare you and you may not make the mistakes we made BUT the reason we jumped when we did was sheer exhaustion from the business clouded our judgement. If there had been a way to take 6 months off maybe we would have done things differently.
Good luck with whatever you decide.

 

[virgo]

Loe

Hiya

How about:

1) downsize from your 700K PPOR...to a 300 one (plenty of those in Western Sydney ...ok i will not suggest Wilmot but hey there's always Penrith?; if you say u are intending to finish paying it off next year, this would leave you with 400K which you can stuff it into high interest rate deposits...

or

2) create a granny flat behind your PPOR or one of your IPs; if you are in Sydney the cash flow would be good; check out also what Travelbug did recently with her PPOR /grannyflat...plus you can live in that granny flat and then rent out your PPOR

or if you are up to it

3) retire to Thailand or Cambodia or Vietnam where the rents are 300 a month and you can eat for less than 10 a day and there are jobs teaching English on a part time basis...

It all depends how determined you are; follow your dreams

 

[virgo]

Kids

Oh I forget...these are assuming kids do not come into the pic...i have 3 and i reckon they set my retirement back 10 years but on the other hand, i may live longer by 10 years

 

[virgo]

How?

D Money,

You may also be able to capitalise some interest on investment loans and legitimately claim the interest while you are living on rents - ie living on rents instead of equity. Meaning increasing loan interest deductible - possibly.

Please explain using some simple numbers....thanks

 

[scha9799]

I feel so over my job for a long time already, but after many guidance from more experience investor.

I found below.

If you are so over the JOB.

I think the priority is to take a year off first. then think about how to fund your lifestyle for long term later.

While you are traveling. you may relaxing and thinking more clearly, you might even see something, meet someone and find out some more interesting and exciting thing along the way which can help your generating income.

A lot of time stress from day job/business is clouded our mind, which lead up to UN-pleasant outcome.

an extension for the existing IP you are holding is a way to increase rental and equity.

second dwelling/granny flat on your existing IP is also another way to bring in income.

also high yield share, like big for bank share.

vendor finance your IP is another option

pay time less stress job.

So many ways to to move forward.

however, don't let the "over-the-job-feeling" destroy your life.
Go on take a year off, "investing in your feeling" : )


I hope it helps.

Taylor

 

[Terry_w]

Please explain using some simple numbers....thanks

ok, but don't try this at home.

based on the ops situation, roughly
Current Assets: $2.31M (incl PPOR)
Current Liabilities: $1.298M
LVR: 56%
Income required to cover annual expenses: $40k
I assume living expenses really $30k because of the $10k negative cashflow with property

Apply for a LOC for as large as possible while you still qualify. Lets assume it is $300,000.

Based on 4% yield these properties should be bringing in around $92,000 pa.

Based on 6% interest rate the interest would be $78,000 so I assume the op's figures don't include renting out his PPOR which he could do if travelling long term.

But there would also be costs such as rates, insurances etc. These may be around 25% of rents all up. So about $24,000. So there would still be a negative cashflow in the first year. About $8k or so.

So how he could proceed is to get the rents paid into a 100% offset account and live on this. He would pay for all expenses with the LOC, ie borrow. The interest would be deductible as it is an investment expense. He could also borrow from the LOC to pay some of the interest on the other loans.

This way instead of living off the LOC and not being able to claim the interest he is living off the rent and borrowing to pay the expenses. Since he is not doing this to pay off his home loan sooner he would have a strong argument if that it is not a scheme and the ATO, if they came looking, would probably not deny the deduction (depending on many things).

One problem is that if travelling then he won't have an income so no tax will actually be saved. But he may be able to carry forward any losses which could be used in future years and the LOC would be increasing so future deductions would be larger.

He may only need to draw a relatively small amount anyway and a small increase in rents will greatly assist. eg. 5% increase would be about $5k per year.

 

[virgo]

ok, but don't try this at home.

Apply for a LOC for as large as possible while you still qualify. Lets assume it is $300,000.

Based on 4% yield these properties should be bringing in around $92,000 pa.

Based on 6% interest rate the interest would be $78,000 so I assume the op's figures don't include renting out his PPOR which he could do if travelling long term.

But there would also be costs such as rates, insurances etc. These may be around 25% of rents all up. So about $24,000. So there would still be a negative cashflow in the first year. About $8k or so.

So how he could proceed is to get the rents paid into a 100% offset account and live on this. He would pay for all expenses with the LOC, ie borrow. The interest would be deductible as it is an investment expense. He could also borrow from the LOC to pay some of the interest on the other loans.

So your LOC is 300K; going by your example; the interest on the IPs is 78K plus other rates etc 24K altogether 102K ..correct me if i am wrong here....doesn't it mean your LOC will get eaten up in about 3 years seeing you are saying he gets his rents paid into a 100% offset and live off this

 

[Terry_w]

So your LOC is 300K; going by your example; the interest on the IPs is 78K plus other rates etc 24K altogether 102K ..correct me if i am wrong here....doesn't it mean your LOC will get eaten up in about 3 years seeing you are saying he gets his rents paid into a 100% offset and live off this

Yes it would be hard to work out, especially with our made up figures.

But if his properties are cashflow neutral and he is spending $30k pa then he would likely be drawing $30k pa off the LOC (to pay expenses). Interest on this would be about $1800 pa so not too much. Assuming no rent increases a $300,000 LOC may last about 7 years or so.

But rents would possibly increase faster than his expenses so things may get better each year.

And, the main thing is to to able to get away from his job. Using MMM principals he wouldn't be laying on the lounge but would probably develop some sort of hobby which may end up making more money than he did at his last job.

The op would also have super available at some time in the future which could help pay down the loans so he has more rent to live on or which would give him more income to live on.

 

[scha9799]

Hi Terry,

What's MMM ?

do you mind to explain what it is ?


Thank you
Regards,
Taylor

 

[Terry_w]

Hi Terry,

What's MMM ?

do you mind to explain what it is ?


Thank you
Regards,
Taylor

Mr Money Moustache (sp?) a blog the op mentioned in first post. It is very interesting - be frugal and you can save more of your income and retire much much faster type philosophy. Another is Early Retirement Extreme. Worth a look.

 

[china]

I think the generally accepted amount, depending on age, you need to retire/achieve financial independence is PPOR plus 1 mil of income producing assets. I think this is regardless of how you choose to structure this, LOE, dividends, LICS, ETFs, etc. This allows a frugal lifestyle so I think that the OP is still at least 500k away. Personally, I don't think 40k per year would suffice in Sydney, with a personal preference for living on the north shore.