edit: apologies... post is not based on the presumption of a top in RE market... merely an end to the boom phase... there is a subtle difference. One indicates a downturn (long / short, extensive / minor), the other indicates prices can remain at current levels, or even possibly continue to climb (albeit slower)
Un-leveraged Residential Property - A DUD Investment?
- Thread starter JIT
- Start date
edit: apologies... post is not based on the presumption of a top in RE market... merely an end to the boom phase... there is a subtle difference. One indicates a downturn (long / short, extensive / minor), the other indicates prices can remain at current levels, or even possibly continue to climb (albeit slower)
I was just comparing and pondering the situation where you had $1MM cash invested in low-yield residential property versus $1MM cash invested in a high interest bank savings account.
The rough calculations I did suggest that after 10 years you would still be ahead from an income point of view with cash in the bank, assuming 3% pa rental growth, and about even assuming 6% pa rental growth.
The only difference of course being the capital growth/equity in the residential property. If you took leverage out of the picture, you wouldn't be able to access this equity/capital growth.
Hence, the only way of doing so would be to sell the property.
Therefore, if you take out the leverage, you're left with a dud...!
Bit like taking the b**lls out of a property bull
!
So...we know that residential property is primarily and best used for growth, and not income. If you're not going to use leverage when investing in residential property, you might even be better off putting your cash into a bank savings account, as you won't be using this asset to it's highest and most effective capacity.
And...at some point in time, for the investor that has already been investing in residential property, when they decide they have achieved 'enough' growth, and had 'enough' of this leverage business, they should start selling down these assets in the most tax effective manner possible.
I still haven't decided for myself how much is 'enough'.
Hmmm...I might also be making this all up as I go along, so don't pay too much attention to my ramblings here .
The rough calculations I did suggest that after 10 years you would still be ahead from an income point of view with cash in the bank, assuming 3% pa rental growth, and about even assuming 6% pa rental growth.
The only difference of course being the capital growth/equity in the residential property. If you took leverage out of the picture, you wouldn't be able to access this equity/capital growth.
Hence, the only way of doing so would be to sell the property.
Therefore, if you take out the leverage, you're left with a dud...!
Bit like taking the b**lls out of a property bull
!So...we know that residential property is primarily and best used for growth, and not income. If you're not going to use leverage when investing in residential property, you might even be better off putting your cash into a bank savings account, as you won't be using this asset to it's highest and most effective capacity.
And...at some point in time, for the investor that has already been investing in residential property, when they decide they have achieved 'enough' growth, and had 'enough' of this leverage business, they should start selling down these assets in the most tax effective manner possible.
I still haven't decided for myself how much is 'enough'.
Hmmm...I might also be making this all up as I go along, so don't pay too much attention to my ramblings here
.Who would really be in that situation? If I have $1m in net assets you can bet I also have a chunk of capital gains tax to pay if I sold, and I would know how to make better returns than a high-interest bank account, especially over the long term.
You can't take such a core thing out and expect to get realistic answers. It's like saying 'how do you guys like driving a manual car without ever shifting gears'? The reality is that I can and will switch gears. It seems pointless to think about something that is so far removed from reality?
Or are you having the same thoughts as my friend: that 'I would like ten million dollars' or whatever and can just live off the interest, ignoring the fact that those who build their wealth up to that sort of level would NEVER go 100% cash anyway? I mean, I've built up my wealth to a certain level with property, shares and leverage. What would possess me to suddenly cut all my leverage?
Alex
No not at all, just pondering the significance of leverage in this asset class.
I'm probably confusing people, and myself, but to put it another way, living off rental income is a very ineffective use of residential property...
Hi JIT,
I think you've hit the nail on the head now with this last comment.
IMHO - resi property is a growth tool. Before I get shouted down, yes I know you can:
1. Invest in +ve cash flow properties - but the cash on cash return is very low
2. Buy, reno and sell - but the transaction costs in RE are high and take most of the profits....and the risk/reward ratio is low into the bargain
3. Play property developer, but most I know would develop to keep....an exception might be a sub-division deal where you end up with a free block of land. Or get a DA approval and on-sell with a DA in place to say a builder.
4. Speculate on a rezoning - which may or may not come off - after a "hold" period
If you are looking for income then rent is a very poor use of resi property - its just the wrong tool for the job in MHO.
Cash income is generally better off sourced from either:
1. Personal exertion income
2. A business
3. The share market - combo of CG, dividends, option strategies etc
Just my 2c.
Aimy
I would have to say unleveraged residential property is a dud compared with say shares. To make it fair I'm talking buy and hold. Otherwise you can improve property as said in the above post, while you can also day trade. Somebody experienced in either can do very well.
Blue chip shares with fully franked dividends will give a higher return than blue chip property, and do not need maintenance, have troublesome tenants etc. Both blue chip shares and property are hedged for inflation.
IMHO the only thing that makes residential property better than shares is the capital gains through gearing. If it's unleveraged blue chip shares are the go.
Blue chip shares with fully franked dividends will give a higher return than blue chip property, and do not need maintenance, have troublesome tenants etc. Both blue chip shares and property are hedged for inflation.
IMHO the only thing that makes residential property better than shares is the capital gains through gearing. If it's unleveraged blue chip shares are the go.
ah - now I know what you are getting at. Capital gain is useless to your lifestyle - it's just a number on a page. At some point to make this number work for your lifestyle you have to sell up. Then you either spend it or put it into another investment vehicle with higher yields to enjoy your capital base.
or to put a real example around it. Imagine .......... I am 60 years old, I have an asset base of $1M in residential property investment but nothing else. I just had early retirement and want to safely enjoy my wealth for the next 15 years without digging into my capital. If I sell up and put it into a term deposit at 7.55% I can get $75K a year to live off without any risk for the rest of my life. If I leave it in property it might be $35K at the most. Or to put it another way YOY capital growth is no good if you are at a time in your life when you actually want the cash.
Yes.
And I do appreciate the alternatives of living off equity and gearing into shares off equity from property, but these are leveraged, inherently higher risk, and growth dependent strategies - and I just wanted to discuss un-leveraged property to illustrate my point in this thread.
And I also appreciate that there are CGT implications of selling property, but there are several ways to minimise this, especially when you involve the use of super, and that's why I said people should consider "selling down these assets in the most tax effective manner possible."
That is of course, when you've decided you've had 'enough' growth!
For starters I’m not sure I see the point of the thread ie. if you take out the leverage, if you don’t count capital gains etc. – well that’s not the reality, so what does it matter? How many people would actually own ANY property without needing to access some debt – I’d say the % figure of the population would be VERY low.
If you take out leverage and just look at the core asset return - history shows property has returned around 15%pa (from memory) – the same as the share market (from memory). (Yes I realize there are many people who think the world is going to end and REA cannot keep increasing.)
So there is the answer strictly speaking from a core asset position which I think is what the original question was. All the rest is variable and different – it’s not the properties fault if govt. make stamp duty high on purchase, and REA’s & CGT make selling costly etc. the core asset has historically returned 15%pa.
Yes, living off rents alone would not be a good return, but again that’s only part of the assets return, so again – not the assets fault, but the way you choose to use it in your personal situation.
PS This may be echoing others thoughts, I've only skimmed through.
If you take out leverage and just look at the core asset return - history shows property has returned around 15%pa (from memory) – the same as the share market (from memory). (Yes I realize there are many people who think the world is going to end and REA cannot keep increasing.)
So there is the answer strictly speaking from a core asset position which I think is what the original question was. All the rest is variable and different – it’s not the properties fault if govt. make stamp duty high on purchase, and REA’s & CGT make selling costly etc. the core asset has historically returned 15%pa.
Yes, living off rents alone would not be a good return, but again that’s only part of the assets return, so again – not the assets fault, but the way you choose to use it in your personal situation.
PS This may be echoing others thoughts, I've only skimmed through.
I reckon residential RE is a dud retirement vehicle, clear title or not, because the dividends are too low, the long complex threads on LOE show it is hard to access capital and you have tenants. Putting money in the bank is hopeless from a tax planning point of view.
But there are other options and it should not be too hard to find one for you. I'm enjoying the search.
But there are other options and it should not be too hard to find one for you. I'm enjoying the search.
I know they would.....but every strategy discussed involved "realising the under-performing assets", paying the necessary CGT and then re-investing the proceeds into a more "appropriate vehicle of our suggestion".
That advice, whichever way they suggested, necessitated the payment of ± 3 to 4MM in CGT and a whole bunch of upfront and trailing commissions.
If you were happy to do that....no problems. That hurdle for us was way too large to overcome and so we went down a different track.
LOE - despite the complications - was a far more attractive option, especially given that the capital base wasn't smashed by CGT. To get rid of the hassles altogether - PM's could be employed with strict instructions not to call us and deal with everything.
....anyway....
Thanks, that's a better way of putting it. Personally, I feel more so without the leverage, as you can't do the LOE + gear into shares thing.
What about something like this, so an effective CGT of just 7.5% on your IP's?
http://www.somersoft.com/forums/showthread.php?t=34595&highlight=CGT
Not everyone can do it of course, but Julia and MattR are both accountants and they thought it sounded legit...
What do you think, this thread didn't get much interest last time...
I know a few people who have been in that situation. In their cases it came from large share holdings that were bought out in a takeover, where they really had no option but to sell (because after the buy-out the stock was to be delisted). While this is sometimes done with share swaps, in this case it was a cash-only deal. And yes, there were some big CGT bills. Sometimes continuing to hold to avoid CGT is not a viable option.
So taking a slightly different tack on the question, if you did have $1m in cash parked in the bank right now, and were approaching or in retirement and thus looking for at least some income, would you consider investing it in residential real estate now?
The way I see it there is a dilemma. Without leverage the income stream from property is currently low, but there's no point leveraging while you still have cash to buy outright (unless you can find another income source that pays better than your mortage rate). And if you use it all to leverage real estate (eg. to buy $2m with 50% leverage), where will the income to sustain you come from? If you can get say 3% yield after expenses, then you'd be getting $60K a year, but the $1m loan at say 8% would be costing you $80K a year. OTOH, $1m unleveraged would be returning $30K, and $1m in the bank at 7% would be giving you $70K a year income, which if earned in a discretionary trust might keep the tax rate down a bit (eg. split between two retired non-earners at $35K each would involve a total tax of $9750 including Medicare, leaving a bit over $60K - probably more after deductions). Still a bit tight to live off and reinvest some to keep up with inflation, but at least you're eating for some time to come. And at some point in the not-too-distant future, some super might kick in to boost that.
Cheers,
GP
Nice question, my answer is no! - it's a DUD!
For me, the two most difficult questions underlying this are:
(1) How much growth and income is enough for you?
(2) At what point do you change from a predominantly growth orientated portfolio, to a more income orientated portfolio?
I haven't yet answered (1), but as for (2), I would think that it needs to be a gradual process that begins several years prior to your planned and estimated retirement time.
During which, some (not all) growth assets could be sold progressively and in the most tax-effective manner and in which income assets could be subsequently purchased.
In addition, any excess income generated by existing growth assets could gradually be used to fund the purchase of more income producing assets.
And further, any income from other sources (eg. JOB, business) could be gradually diverted towards purchasing more income producing assets rather than growth assets.
So the whole process towards retirement would require some foresight and planning, otherwise one could end up being in a position where they have accumulated a substantial amount of growth assets and now want to retire, but are left with, for instance, a high value portfolio with minimal or no leverage that is generating a very low yield - and this is most certainly a realistic scenario, as evidenced by many people who have posted here on SS in the past, and continue to do so now...
Here's a great article by a financial planner, Travis Morien, that I read this morning which made my thoughts on this thread (I knew I had a point to make here!) clearer:
http://travismorien.com/invest_FAQ/content/view/228/58/
Any thoughts/comments, do you guys follow what I've been saying?
Thanks.
ADD: And I appreciate that if you plan to LOE, then a different approach applies. I like the concept (used in 'moderation'), but would not yet be willing to hand-over my financial freedom to an ordinary bank valuer by using a pure LOE approach.
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Personally, the current goal is $100k per year. After that, I can kick the job and invest full time.
I still think you don't go from working / investing to full retirement. More likely, you slowly transition from capital to income, and then after a while you realise the income is enough for you to 'live'.
Alex
