The keithj Interview

Welcome to the Interview #11

In an effort to keep keith’s popular “How I got” thread as a valuable future resource I’ve included the first post and a link to the original thread in this interview.

How keithj got from just a PPOR to multi millionaire retiree in 5 years using only OPM

The first half of my story is all standard stuff that many here have done, buy IPs, watch then grow, draw down the equity, repeat. The 2nd half (LOE & shares) is what I've posted here about over the years. All the figures mentioned below are vaguely ballpark.

It all started with a Geoff Doidge seminar & breakfast in 2001 - $250 well spent. I had $250K of equity in my PPOR in 2001. Drew it down & bought $1M or so of slightly c/f -ve IP in Bris & Blue Mtns. I borrowed 105%. Nothing was particularly cheap, or a great bargain. It doubled in value, so there was the 1st $1M of equity. PPOR value increased too. I sold a couple of duds & kept the quality ones. Many people here will have done similarly well. I also hung around the SS chatroom & was inspired by many there - particularly TW.

I also did a couple of renos. However, I decided the effort I was putting into them was eclipsed by the growth I was getting from doing nothing, so I stopped. I kept depreciating the power tools though.

Some time around then I went to a Navra seminar - another $100 well spent. I liked the idea of LOE, but definitely NOT his version of LOE with his income fund and/or cash bonds. Also bout this time I realised that IP wasn't going to give me a passive income – it was great for creating wealth with low risk. But something else was needed to replace my income. I've always had an interest in the share market, particularly remember Telstra T1 – I bought for $2 and sold at $2.79 – a huge 40% gain :D , and then watched them go to $9 :eek: . I also set up a discretionary trust around this time.

By 2003, IP was expensive & low yielding & I considered poor value, I had stopped buying more. And at that time I didn't believe that Bris IP could possibly get more expensive. Rents had gone up, so the IP was paying for itself after 2 years.

Shares were cheap & virtually paying for themselves, so I drew down as much of the IP equity as I could & invested in quality, blue chip, dividend paying shares. These included 4banks, LPTs, PPT, QBE, ASX, WES, HIL, ALS, ORI, MBL, BHP, AFI, ARG. I also set up a margin loan & bought some more, but kept the LVR to a v. conservative 33%. My plan was to live on the dividends & capitalise the margin interest – a version of living on equity.

At that time shares were yielding around 7.5% (after franking). That generated enough income to pay the IP interest & quit the job (just).

The rough figures -
Draw down $1M equity from IPs – interest (5.95% fixed for 5 yrs!!) = $60K
Borrow $400K margin loan & buy shares – interest $0 – it's all capitalised (this is the LOE bit)
Dividends on $1.4M shares @7.5% - $105K
Nett income- $45K
NB The ATO considers that I pay the interest on the margin loan & borrow it again. So my taxable income is actually -ve.
As I need more than $45K income, I just draw it down from the margin loan.
I then had gross assets of $2.4M (+PPOR).
I was hoping the shares/IP would grow by their long term average 7%ish or $180K the first year, therefore covering the drawdowns for personal use & also the margin interest. Diversifying into shares & IP reduced the volatility.

I was still 30 something, so I knew if it all went wrong I could go back to my IT job. I've posted previously that I favour retiring as early as possible and 49% of SSers agree

Since 2003, share earnings/dividends have doubled & consequently shares prices have doubled.... and so more equity to available to buy more good value quality assets.

Since dividends increased by so much my LOE strategy really only lasted for a couple of years – I now have enough passive income from them. IP rents increased a little - $50pw or so doesn't go far though. The initial plan of using LOE did have some risk to it over the short term, but my backup was my willingness to return to work.

The future
My spreadsheet tells me that my equity with double every 5 years, simply through leverage & investing in balanced growth/income assets. Passive income will more than double. I never need do anything except draw down more equity when it becomes available & invest in IP or shares when they are good value. It's a completely passive and fairly conservative strategy. I hold $0 cash, although I have $Ms available at 1 days notice in my margin loan if I see a bargain.

My philosophy

  • I don't consider anything I've described above as risky or speculative.
  • I'll never buy speculative shares only quality ASX200 companies.
  • Margin LVR has always remained below 40% - I'm currently allowed a max of 72% - so it would take a >55% drop in the market before I got a margin call. I aim for 33% in the long term.
  • My IP loans are partly fixed, partly var. I can handle huge interest rate increases for more than just the short term.
  • I've diversified – IP & shares & LPTs are vaguely counter cyclical, so there's always likely to be some spare equity somewhere.
  • The diversified portfolio means reduced volatility – good for LOE, good for reducing risk.
  • I'm a big picture investor - I firmly believe in asset classes and the rising tide doing the work rather than me putting in the hard yards. I'm also fairly lazy – the 80/20 rule is good enough for me.
  • I don't invest in asset classes blindly, I only invest if they're good value.... IP was in 2001, ASX shares were in 2003, IP will be soon.
  • I concentrate on historical trends when deciding what to buy, I concentrate on forcasts when deciding when to buy.
  • I will never sell quality assets.

Things that haven't worked as well or at all

  • Share Options – wrong strategy at the wrong time
  • Speculative shares – it's gambling, not investing
  • Share trading – did my head in
  • IPOs – Rivkin said it best “if you can get an allocation, you don't want it”
  • Renos – there's easier ways of making money
  • IP fluff & flick – it’s a lot of effort for little return especially after txn costs
  • Selling quality assets - CGT
But I've learnt a lot & will return to some of them with more knowledge

Other things I stuffed up. Missed the Perth boom completely, missed the first couple of years of the resources boom. I don't feel bad about them though, as the equity was growing in other areas.

Have I been lucky ?
Yes - I've been lucky - that's what people tell me anyway. I've also been unlucky - see above. But I've tried stuff - some worked, some didn't.

Is this reproducable?
Yes. Buy good value IPs first. Wait for the rising tide. Draw down equity. Invest in the next good value asset class - it may be shares, china, resources. Convert the equity into c/f using LOE. The key is to create equity safely & fast using IP, then invest generated equity in c/f assets or LOE.

The bottom line
In 2001 I had a vague plan about creating wealth using IPs a la Somers. The wealth creation bit worked, but I realised it needed modifying to provide me with income for an early retirement. By incorporating LOE the direction changed. And in 2003 the economic cycle dictated that shares were the asset class of choice.

If in 2001 anyone had told me I'd be writing this story in 2007 I'd never have believed them. So to all the gunnas out there, I was once one of you, then I bought a really average IP at the asking price....

......and I apologise for the sensationalist title.

How did you get involved in property?

I started back in 2001 when a friend in Brissy was buying his first. His wife’s parents were big on IP and were keen to get their kids into it. So I kinda tagged along. Shortly after that I flew up from Sydney for a Geoff Doidge (now reno kings) 2 day seminar - learned all about depreciation, financing, finding bargains, legals, tricks to maximise deductions, etc. I bought 2 in Brisbane fairly quickly – one c/f neutral, the other c/f +ve both within 5km of CBD.

What is your property investment philosophy (CF, CG, renos, houses, flats, buy and hold, develop, flip, wrap, etc)?

Capital growth has always been most important, cashflow is also high on the list. Renos were up there too at one stage. The rest aren't passive enough for me - I see them as a business that requires ongoing input rather than as a pure investment. I prefer houses with land content to apartments. I need control.

I'm a value oriented investor - I prefer to buy quality when it's relatively cheap. As opposed to buying because prices are rising and consequently competing with owner-occupiers. My school reports invariably said could do better , must try harder, lazy. However, I'm of the opinion that 20% effort will achieve 80% of the results, and any effort in excess of the 20% is inefficient use of resources, so I'd rather put 20% effort into other investments and get 80% results there too.

What is your IP / property story so far?

I've ridden the property cycle up since early 2001, using solely borrowed funds with property that didn't cost me anything to hold. It was a v. low risk way of creating equity. Rents hardly rose for the first few years, so it was apparent that it would be a v. long wait until I got a significant passive income from them. At that point I decided to diversify my investments.

Is there a story of a really good IP that you would be prepared to share with us?

Probably the first one in Fairfield, Bris in 2001. It was on the market for $145K, I asked the agent what they would take for it (it was vacant) - she said probably $130K. Naive as I was then, I offered $130K which was accepted - the kitchen needed gutting, all the inside needed repainting, so I did it in a week, sleeping on the floor – total reno cost was about $6K. The agent that sold it to me said they had a tenant looking for a cheap place urgently, so he moved in with me. Although he didn't get charged rent till the following week when the kitchen was in! The same guy is still there, he's built a 6 foot fence with gates at the rear, sanded & polished the floors & done all other maintenance himself for the last 6 yrs. Rent was $195pw in 2001, now up to $260, and value is currently $360K. It was a really average property.

Is there a story of a really bad (or not so good) IP that you would be prepared to share with us?

Not really anything bad, although I've learnt good lessons. I bought one IP cheaply - more than 20% below an already reduced asking price & renoed it. It was hard to lease and just as hard to sell. It had v. steep back yard, no car space and was a 2 bedder in a predominantly 3/4 bedder suburb. It eventually sold, but made me realise that IP with poor unfixable attributes isn't usually worth the hassle.

What criteria do you use when selecting a property to purchase, and where would you buy now?

I look for IP with potential above simply renting out. One that fitted into this category is an ugly one but on a well located 1600m block, it had a v. poor layout and the development rules were due to change within a year. I was hoping that it would become subdividable as the council had been told to increase the land available for new development. But it was not to be this time, so I shuffled internal walls around & improved the layout, stripped off the ugly cladding to reveal the traditional weatherboard I'd noticed prior to purchase. It's good location with lots of space for parking meant that it was suitable for professional use - a doctor has been paying well above residential rents for it since.

Another category is reasonable quality that pays for itself. This usually ends up 4 out of 10 properties. I haven't found one of these for a while though.

High land content is essential. I never touch units, or apartments. I've never bought a whole block, but I'd like to.

I’ve looked at commercial and missed some bargains - one was a strip of 13 shops in a pleasant N.Bris village square zoned LMR, 2 blocks back from beach yielding 13.5%. I just couldn't stretch finances to get it. It would now be 13 shops, plus 26 apartments with sea views!

We know you invest in other asset classes, but what are your views on the “Economic Clock” and its value, or misconception in judging cycles?

I look at the big picture. I'm 50% certain that I can't predict the future on a short term basis, but in the longer term both shares and IPs tend to do well for a period of 3-4 years, followed by a flat period. And they are fairly countercyclical - that is when one is flat the other is booming and vice versa. So if I can identify the upswing phase in advance (or at least early), then I need only invest in the index or in average IPs and let the rising tide give me the capital appreciation. This gives the biggest equity increase as quickly as possible. Buying assets at the peak of their cycle will work, however it takes a lot longer to build equity.

The fact that there is an economic cycle itself isn't the indicator. Rather the cycle is a result of the reasons for each phase to begin eg rising interest rates, wages, unemployment, yields, PE ratios. If an asset class is good value relative to it's own historical value, and also relative to other asset classes, then investing there makes sense to me. Of course, all the other attributes of a good asset (location, yield, dev potential) are v. relevant, but only at the right time in the cycle.

There's no way of knowing when the upswing phase will start even though an asset class represents good value, But at that time in the cycle the cost of holding the asset is low or even c/f positive and eventually the hordes of investors will realise that it represents better value or lower risk than other asset classes and the upswing will begin.

Most people look at the recent past to judge if an asset is worth investing in, believing that the recent trend will be projected into the foreseeable future. I prefer to make sure it's supported by solid fundamentals rather than simply buying because everyone else is.

What legal structure do you use for your investing?

Original IPs in personal names (I knew no better back then), later ones in discretionary trust along with 99% of the shares.

What helped you see the ability to retire with property and shares?
And have shares always been part of your strategy?

The interest rate rise in November 2003 killed the property market for me. It was obvious that capital appreciation wasn't going to happen at the same rate as the previous few years. Rents hadn't risen much, so yields were particularly low. At that time the share market had been flat for 5 years, although earnings had been rising, so P/E ratios were relatively low indicating good value. An example of good value was buying bank shares yielding 7.5% (after franking) and borrowing (from the same bank) against IP at 6%. There was an immediate1.5% profit in exchange for taking the risk of them going down in price.

I've dabbled in shares over the years, with v. average results. However, it's fair to say they didn't play a part in my strategy until I could buy them at a discount when they paid for themselves.

At this stage my spreadsheet indicated that I had enough positive cash flow to pay for my bare minimum living essentials, and plenty of assets to borrow against to live on equity for the non-essentials. Diversifying between shares and IP reduced volatility making LOE less risky. My kids were still young, so I took the decision to spend time at home watching them grow up. As far as I could see, the worst case scenario was that I had a minimal income & no capital appreciation took place in either shares or IP, so I may have to return to work. Since then, IP hasn't appreciated much, but shares have. And more importantly, earnings and dividends have just about doubled since 2003, and rents have also increased. So my LOE plan didn't last long, it was superseded by purely passive income from IP & shares.

Can you give an example of your first few year’s transactions so we can see how you did it?

My PPOR was paid off, so it was the source of my initial equity. I bought the first 2 Brisbane IPs using that equity, so they were unencumbered. I renoed the first one. Then the following year bought IP closer to home. I renoed some, and sold some, the last sale being last year. As prices rose I drew down all available equity to invest in the share market as I thought it was good value. Without going into too much detail, the portfolio is roughly 1/3 property and 2/3 shares. In 2003 it was the other way around and in 3 years time I expect (& hope) it will be 20% shares & 80% IP.

If a budding property investor asked "what are the top 5 things I should do", you would say?

There's only one thing really. Just do it, you'll learn 100 times faster by experiencing it than reading books, or SS or seminars.

Don't be to concerned about finding the perfect property - either it doesn't exist, or it isn't for sale, or someone with experience will get to it first. Buying a really average IP will automatically put you in the top 1% of the population. And the 2nd one will be 10 times easier and you'll have a better idea of what to look out for to be above average.

The only minor caveat is the wrong finance can cause long term problems - an IP savvy mortgage broker should be able to help you avoid problems.

And if that same budding investor asked "what 5 things should I avoid", you would say?

Being independent is important. There are a lot more than 5 things out there who don't necessarily have your best interests at heart. I'd suggest do all your own research, find your own mortgage broker, and negotiate for yourself.

And in a slightly different vein - what would you suggest to the property investor who maybe has a portfolio of properties, but is at a loss as to how to proceed?

A pure buy and hold IP strategy a lá Jan and Ian Somers is very low risk and is virtually guaranteed to work, however it's v. slow and can suffer from serviceability problems. Many have lots of equity, but find it hard to convert that equity into cash flow. There are a few solutions –
l use Living On Equity
l convert some or all of the IPs into higher yielding assets (eg quality high yielding shares such as banks or LPTs), while retaining some growth.
l draw down available equity and invest in other asset classes such as commercial IP, LPTs or shares.
All these can be achieved while maintaining a core hold in IP. I was in a similar situation and I've done all of the above. I haven't sacrificed to much growth or paid to much CGT. It's all about finding the right balance between growth and income and accepting that the price for reducing risk is some tax.

How important is planning and having a varied portfolio, to being a successful investor?

It's important to have a goal and a rough plan of how to get there. But circumstances keep changing, yields, cycles, families, relationships, other asset classes. It's more important to adapt to the inevitable changes.

My spreadsheet is vital to my planning. It's motivating to be able to see a previously undreamed of net worth in 20-30 years time simply due to the effect of compounding and sticking to a rough long term plan.

Commercial property, shares and IP all have roughly the same returns in the long run, so my view is to invest in all of them. A diversified portfolio helps to smooth out gains, and lowers the risk of extended poor performance in any particular asset class.

Do you consider that there is any natural progression for an investor? (eg. From owning a few properties, to owning many, to being a developer)

Not really. It's a style thing. Pure IP investing is passive, developing is more of a business with a different set of risks. I think it's important to develop a style - my style is to buy good value with any extras that I can (eg dev potential, higher use) in the asset class that I believe is likely to grow the most in the medium term based on it's current attributes.

Do you have any thoughts on the CF vs CG debate or on the issue of metro vs regional, units vs houses?

Not especially. It depends on the circumstances. I prefer CG & CF - I don't see why I can't have both. Definitely freestanding houses over units – I'm a control freak. I prefer quality assets which means I tend to go metro rather than regional. In my limited experience my regional IPs have underperformed metro – it's tempting to sell up and invest in rising markets, but after a quick glace at my spreadsheet the urge goes away.

What do you prefer, fixed or floating interest rates and why?

Both - I fix either when it's cheap (like 2003) or when rates look like rising (like 2006). I always keep a couple of variable rate loans for flexibility. I alway maximise my cheap borrowings (ie borrow against IP & PPOR first), I've never had a LOC. I still have some loans that I fixed for 5 years in 2003 @ < 6%.

Finally, where do you see the market at the moment and do you think the current environment is making it harder for newer investors than when you started?

I said earlier that predicting (especially about the future) is hard. But here goes....
The last (East coast) boom ended in 2003, it's been mostly flat for the 4 years since, so real prices have actually fallen by 10%. There are currently pockets of good growth, but I feel this is mostly driven by owner occupiers on the back of low unemployment, rising rents, strong consumer confidence and a feeling of missing the boat again. I'd expect low growth at a little above inflation for a couple of years while rental yields rise to catch up, followed by a period of much better growth. But it depends on so many things - local share market performance, bond yields, employment, wage growth, IRs, oil, terrorism, the US, China, various left-field crises and many other unforeseeables. The share market will rise till at least early 2008, and maybe keep rising for a further couple of years – however, no-one can foresee what effects the chaos & emotion of the real world will bring.

It's not especially harder for new investors today, provided they are patient enough to wait for the most affordable time in the cycle, and are prepared to buy a less than perfect first PPOR. And try to avoid being conditioned to believe that success is having a newer car & plasma than the neighbours. I remember taking in a boarder in my first PPOR & eating lots of spaghetti.

For any comments or questions........