Refinancing to continually get equity out - is it worth it?

[younginvestors]

I'm not sure how to explain my question....I'll try this way...

If you purchase investment property after investment property, each time refinancing your portfolio to 80% to pull the equity out aren't you continually increasing the debt on each property, reducing the equity?

So for example, say a $300K IP now would be worth $550K in 10 years, then in year 10, you refinance to pull out 80%, you've increased the debt from $300K to $440K, leaving only $110K equity rather than the original $250K equity.

Do we do this to enable us to continue to purchase assets and eventually you stop refianancing, leaving the equity to accumulate as much as possible?

Or have I missed the concept?

 

[marg4000]

That's the general idea.

Just make sure that any withdrawn equity is used for income-producing purposes or it will not be tax deductible.
Marg

 

[Rolf Latham]

Spreading the growth in equity to hold further investments is one way to explain that.

ta
rolf

 

[younginvestors]

Thanks guys....I think I see the spreading the growth - say after 4 properties, I refianance to pull a little equity out of each for the deposit on the 5th - this means I'm keeping down the LVRs whilst maintaining the accumulation.

 

[Perp]

So for example, say a $300K IP now would be worth $550K in 10 years, then in year 10, you refinance to pull out 80%, you've increased the debt from $300K to $440K, leaving only $110K equity rather than the original $250K equity.

Yes, you've decreased your equity in that particular property to $110K, but you now have $140K in the bank, too - your overall balance sheet is unchanged.

The idea during the accumulation phase would be use that $140K for deposit and purchase costs to buy another, say, $550K property, and now you get the capital growth on 2 x $550K properties rather than 1.

Obviously this strategy is only workable if, over the longer term, (capital growth + rental income) > (interest payments plus holding costs).

If you assume that rental income is 4%, interest payments are 7% (80%LVR, av interest rate just under 9%, so paying about 7% of your total portfolio value out in interest payments during accumulation phase), and holding costs are 2%, this means that the long-term capital growth has to average at least 5% (7% int + 2% holding costs less 4% rent = 5%). Less than that and you're losing money each year.

FWIW, I do think there are many locations in Australia where residential property won't achieve 5% average growth over the next decade.

 

[The Y-man]

Remember that the money you draw down can be used for other purposes as long as it is an income producing instrument in the eyes of the ATO. eg you can buy shares which pay dividends, managed funds etc. As long as the underlying assets return a higher rate than the interest costs on the redraw, it's worth it.

i.e. you draw down at 8% and invest in something making 8.5% it's worth it.

Cheers,

The Y-man

 

[handyandy]

i.e. you draw down at 8% and invest in something making 8.5% it's worth it.

Cheers,

The Y-man

Obviously taking into account the risk factors associated with the investment!!!

Investing in something for a .5% arbitrage is a bit slim

Cheers

 

[Ausprop]

and of course keep detailed records where every dollar has gone. if say $500 is deemed private for example and then that gets repaid you will need to allocate back %'s of your claimed interest forever.

 

[asdf]

i.e. you draw down at 8% and invest in something making 8.5% it's worth it.

Cheers,

The Y-man

Great idea in concept but these days you'd be lucky to get 9% for low-doc, closer to 10% no docs, which you would require to keep tapping the equity strategy. Now getting an asset to perform 10% + relatively risk free in our current environment would be challenging, not impossible. But if you stuck it back into resi IPs, no matter where its located in Oz, be prepared to have your equity nicely trickled away while you wait to be compensated with that elusive capital growth.

 

[SupaRex]

Thanks guys....I think I see the spreading the growth - say after 4 properties, I refianance to pull a little equity out of each for the deposit on the 5th - this means I'm keeping down the LVRs whilst maintaining the accumulation.

Personally, I wouldn't worry about the LVR - I'd borrow as much as I possibly could (assuming you can afford the repayments) and use that. Sure, you're going to have to pay LMI, but (and I'm just making up the figures here) if it cost's you $10k LMI to borrow another $30k which allows you to buy a $400k IP rather than a $370k IP and the both double value in 10 years time, then it's *really* been worth it - hasn't it.