Retirement Plan through Investment Property?



From: Dave :)

Hello everyone,

I've been trying to get answers to a particular issue for quite some time, but have only managed to get mixed and conflicting responses from the people I've spoken to. I'm hoping any experienced property investors and/or finance brokers may be able to help me out on this. You'd be doing me a fantastic favour.

Many IP seminars I've attended explain that it's possible to retire after 7 years by purchasing at least 1 IP each year. I'll provide a simplified summary of how they say this is possible, for the sake of simplicity and for those who don't know what I'm talking about.

Lets say that I buy 1 IP each year, in a good capital growth location, for $200,000.

At the end of the 7th year, provided the rent from my first couple of IP's covers the costs, I should be able to retire from my normal job (according to the 'guru's' at these seminars). If I have bought the right IP in the right location, property 1 should now be worth approximately $400,000. I get it revalued and refinance it to 80%...leaving me with $120,000 to do as I chose. Because I have increased the loan, I would have to pay interest on the $120,000, which would be $8340 per year. This would be paid a year in advance, leaving me with $111,660 to live off - tax free, because I haven't sold the property. This is the equivalent of a $220,000 salary. I would live off this 'equity' for possibly two or three years and then 'harvest the equity in the second property, which should have also doubled in value since purchasing it, and repeat this. Once I've 'harvested' the equity in all seven properties, I would go back to property one, which should have again doubled in value, and keep doing it all over again. True, there is the issue of spiralling debt, but because the IP's are refinanced to 80%, the debt is always less than the actual value of the IP's. This is typical of the NEVER SELL philosophy. However, it the proverbial hits the fan and I'd need to offload a couple of IP's, I'd still be making money on them.

Being new to this 'retirement plan' idea, I ran it past my finance broker. He said that for this to work, I would need to get ALL 7 IP's valued and refinance the lot, JUST prior to retiring in year 7, in an equity/line of credit type of loan. This is because, once leaving my normal job, the lenders would not be willing to refinance subsequent IP's, every second year or so, without an income source.

What If I sold two at the 7th year, paying a couple off, leaving the rental income from two or three IP's as my prime source of income? Would this enable me to adopt the strategy mentioned above? ie, harvest the equity in each IP to live off?

This is a fascinating concept, and I'm still unsure how, if at all, it's possible. I'd love to hear from anyone who can see how this would work and, even better, from any of you who are planning to do this or have already done so.

I hope to hear some feedback...and I think many of us in this forum would benefit.


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Reply: 1
From: Kevin Forster

Using the rule of 72 for a property to double in price every 7 years means that a 10% capital gain needs to be achieved every year. Is this achievable consistently?

The only other question is that will banks allow to take equity from a property for a personal purpose i.e. living expenses.

The only other question is what do you leave your children, dog, etc in the event of your death is 7 properties mortgaged to the hilt?

Personally I think properties free of a mortgage is a better bet also for security reasons - economy turning bad, area becomes no longer desirable for capital growth, etc. It would be really hard to be retired for 10 years then have to head back into the rat race.

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Reply: 1.1
From: Dave :)

Hi Kevin,

Thanks for your comments. Just have some points to make regarding yours, if I may.

1. 10% gains over an extended period of time is quite achievable if the IP's are bought at below market price and in the right area. I have recently purchased 2 IP's, and had them valued two weeks later, for up to 13% more than what I paid. If the suburb and type of property is right, 10% should be no problem. ( I live 20km outside of Melbourne CBD, for lifestyle reasons at this stage of my family life. However, I would never buy an IP more than 8 or 9 km outside of the CBD)

2. What do I leave my family in the event of my death? Obviously a portfolio mortgaged to the hilt. However, I would much prefer to leave them with a $2.5Million debt and a portfolio of properties worth $4 Million, than a couple of hundred thousand dollars to do with as they chose. If they HAD to sell, the mortgages would be paid with money to spare...thats the reason they'd be refinanced to 80%. The banks approval for such refinancing virtually guarantees that, I feel.

3. I agree with you - when I'm out of the rat race, I'm staying out!

Thanks for your input Kevin.


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Reply: 1.1.1
From: J D

Dont forget to add the Capital Gains Tax
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Reply: 2
From: Michael Yardney

Firstly the good news….you can retire rich by investing by investing in real estate.
The bad news is you will NOT be able to do so in 7 years without taking some enormous risks, and probably not even then. I know some “gurus” say it’s possible, but I don’t think so for a number of reasons.
1. 7 years is not long enough to let the powers of compounding and time work their effect. Remember property prices only double every 7 to 10 years.
2. It is difficult for someone on an average salary to finance the purchase of one property each year for this period because, depending on your income, your ability to service the debt will often run out after your 3rd or 4th property.
David, you were at my recent seminar and you know I advocate something similar to what you are suggesting, but growing your portfolio much more conservatively and with patience. While you can easily become a property multimillionaire in 10 years, you won’t have built up sufficient equity to retire with any decent lifestyle.
As you know, one way of speeding up the whole process of capital appreciation is adding value to the properties by renovating them or buying your properties wholesale as some of our clients are doing by developing their own properties. This boosts capital growth and makes it easier to neutrally or positively gear the property.
So if you borrow on your IP’s using an interest only loan, what happens over the years, how do you start living off the fruits of your investments?
You can start developing positive cash flow in a number of ways:-
1. As you reach retirement age, grow your property portfolio more slowly – let your equity build up, but don’t buy more properties and you will eventually get into positive cashflow OR
2. As you reach retirement age, start paying off debt by borrowing using a principal & interest loan. Over time this will get you to the point of positive cashflow.
3. Use some of your savings or super to retire debt.
4. Develop some of your properties. You may have a house that is now getting old on a block of land that could take 2 or more units. This would boost your cashflow.
So David, even if you can’t retire in 5 years, start building your property portfolio because what is the alternative. If you don’t you may not be able to retire in 25 years either!

Michael Yardney Metropole Properties
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Reply: 2.1
From: Anonymous

A good question and some very informative replies. I'm sceptical of being able to buy an IP within 8 to 9 km of melbourne CBD at below market - details please.

Capital gains tax was mentioned but no-one picked up on that - how do you avoid that ? or do we conveniently ignore it.

In summary the consensus seems to be that it is difficult to purchase an IP each year, unless the equity in the first IP is used to purchase the second IP in year 2, then the equity in both is used in year 3 to purchase the third IP, etc - which is what I'm doing - so far I'm up to 5. Then sell 2/3 before retirement.
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Reply: 2.1.1
From: Anonymous

One point to note. The funds taken out as a result of the refinancing of the IP's will not be tax deductible. Remember it is the purpose or use of the funds, not the source, that determines its tax deductibility.
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From: Dave :)

Hi JD and Anonymous

Capital Gains Tax is only an issue if you sell your IP's. This strategy assumes you never sell. You can live off and make use of the equity without selling. Why go to all the trouble of buying well, incurring all those buying costs, and then selling. After selling expenses, you always end up with less $$ than if you borrowed against the equity and held the IP.

I don't know why there is sceptisism about buying at below market prices within 9 km of the CBD. For me, the same rules apply as per any property purchase. I never buy at auction (agents are very skilled at exciting bidders to bid way past what the property is worth.) If a property is passed in at auction, the conditions for negotiating a good price are more favourable. My last two purchases were actually done by bypassing the agent and dealing with the vendor directly (there are ways of finding out who this is). You quickly find out how motivated they are...which puts you in a great position to negotiate.

True, funds used from refinancing an IP are not tax deductable. However, these funds are tax free. So, this is twice as good as re-financing to free up $50K, and claiming tax's the equivalent of almost $100,000 salary.

Why sell 2/3 just prior to retirement?...just curious, because I don't see why you'd have to do that.


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