Investment leverage

Discussion in 'Share Investing Strategies, Theories & Education' started by Jumpingfool, 25th May, 2017.

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  1. Jumpingfool

    Jumpingfool New Member

    Joined:
    25th May, 2017
    Posts:
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    Location:
    NSW
    Hi, first time post so please be kind!

    My circumstances:

    - I am 35 and have an income of ~$200k
    - I own a PPOR in joint names with my wife worth ~$1.8m
    - $1.4m variable rate interest only mortgage on PPOR in joint names with my wife (currently @ 4.02%)
    - $1.3m cash sitting in a 100% offset arrangement against the mortgage

    The cash is new (a windfall as a result of a employee share scheme) so I'm trying to work out what options there are to put it to work.

    My current thinking is to pay out and close the current mortgage then use the PPOR as collateral to purchase cash flow positive assets using 100% (tax deductible) debt - possibly commercial property - and use the leverage to accelerate returns. So say purchase $5m worth of debt funded cash flow positive assets and then wait while the debt devalues with inflation over time and rental returns increase. The aim would be to generate a significant and stable passive income from the portfolio over time, eventually replacing my primary income.

    Where I'd appreciate advice:

    1) Does this sound like a reasonable investment strategy for my circumstances?

    2) What should I consider in terms of risk, other than the obvious risk of increasing interest rates, defaulting tenants, etc putting the positive cash flow at risk?

    3) Is there another asset class other than property where banks will facilitate this level of leverage where the asset can generate positive cashflow?

    4) Are there any holding structures that could be advantageous from a taxation perspective (eg. family trust or ltd company)?

    5) Any alternative strategies to consider that would achieve the same aim of generating significant and relatively stable passive income over time?

    Thanks in advance!
     
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  2. Hosko

    Hosko Well-Known Member

    Joined:
    21st Jun, 2015
    Posts:
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    Location:
    Victoria
    Hey Jumpingfool,
    Good on you for thinking about these sort of things rather than let mother nature take its course.
    What is the end game, are you content with $200k income, or more or less? (I don't need the answer just think about it)
    1) Yes
    2) Are your assets at risk in divorce, clients suing you, family illness longer term?
    3) Property offers great leverage for starting out. Can leverage into shares via equity in your home at similar levels.
    4) Don't know
    5) Pick a Bank/Blue Chip share currently yielding near 6%, chuck the $1.3mio at it and there is just shy of $100k per annum grossed up in dividends. Back of envelope calculations only but you get the drift

    And well done on being in this position so early in life!
     
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  3. Simon Hampel

    Simon Hampel Founder Staff Member

    Joined:
    3rd Jun, 2015
    Posts:
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    Location:
    Sydney
    Not quite.

    An effectively unencumbered PPOR will generally allow you to borrow up to 80% of the value for investment purposes (serviceability dependent), and you can then further leverage that to around 80-90% for investment purposes (APRA notwithstanding).

    So $1m value unencumbered gets you $800K loan, which @ 80% LVRs gives you $4m worth of additional leverage ($1m PPOR + $5m investment with $4.8m debt).

    The best you'd do using margin lending is a further 70% leverage on the 80% of equity drawn down - and that is going to put you at significant risk of margin calls if the market drops, so realistically you're looking at a much lower LVR. Let's say 60% LVR, gives you $2m margin loan for $3.3m of investments ($1m PPOR + $3.3m shares with $2.8m debt).

    That's quite a big difference in capital invested ($4.3m in PPOR + shares vs $6m with PPOR + IPs).

    Obviously, serviceability will determine how much can actually be borrowed - but these figures are still generally conservative (LVRs on real estate can be pushed quite a bit higher).
     
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  4. Simon Hampel

    Simon Hampel Founder Staff Member

    Joined:
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    Posts:
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    Location:
    Sydney
    In general I think it's a sound plan - however there are a couple of gotchas:

    1. banks have really tightened lending criteria based on APRA changes - will be difficult to go out and just get $5m worth of IPs.

    2. Sydney and Melbourne real estate markets are likely near their peaks. Now is not the time to buy in these locations. Brisbane and Adelaide still have potential. Perth is still in recovery mode - may be a while before that market is genuinely strong again.

    3. with this much capital available, I'd be looking at diversifying somewhat and perhaps looking to generate some cashflow using share based investments (LICs / ETFs primarily).

    If you're borrowing at 4%, you probably want to be earning 7%+ to ensure you're actually cashflow positive after all expenses. And interest rates WILL rise eventually - which may wipe out your cashflow.

    A property purchased just for cashflow will generally have less capital growth potential. If unexpected expenses / vacancies / interest rate rises / etc destroy your cashflow - all you've got is an expensive unperforming asset.

    I'd be looking at a mixture of growth and income assets to balance that risk.

    Your biggest risk in the short to medium term will be the ability to secure finance - APRA changes have made that really tough. Don't count on being able to borrow using IO loans - at least not without extra costs. It's no longer a given that you can simply refinance to another IO period once your initial period expires - and many cashflow postive investments will no longer be positive once you start paying P&I (although restricting borrowing levels to 80% will help here).

    No - property gets you the best leverage. The question is - can you actually get that level of leverage based on your ability to service those debts?

    I love leverage - but it does increase your risk significantly. Consider using some of those borrowed funds to invest in more cashflow focused investments such as quality LICs or high yielding ETFs.

    Owning in your own name is often the most tax effective if the portfolio is cashflow negative - but does have risks.

    Are you in a high risk profession? Are you likely to be sued? Are you ever likely to start your own business or become the director of a business? If yes to any of these, absolutely get the structure right first

    Either way - the challenge you'll face is that to buy via a trust, you'll need to get capital into the trust. That is typically by way of a loan - you borrow money against your PPOR, lend it to your trust, then have the trust reimburse you for your interest costs of the borrowed money.

    The problem here is that if you ever face bankruptcy, that loan (trust owes you money) is considered an asset and becomes a part of your estate which can be targeted by creditors.

    I think you're largely on the right track. It's the details which are going to cause you the most difficulty.
    1. where to buy
    2. what to buy
    3. how much to pay
    4. how much to borrow
    5. how long to hold
    6. will it grow
    7. will income grow
    8. will interest rates go up
    9. will you get sued or face bankruptcy
    10. how much income do you need
    11. what timeframes are you looking at
    My advice is to take your time and get good advice.

    Continue to ask lots of questions and do lots of reading!

    There's a lot of different paths you can choose - you're in the enviable position where you do have a lot of options available to you.[/QUOTE]
     
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  5. Jumpingfool

    Jumpingfool New Member

    Joined:
    25th May, 2017
    Posts:
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    Location:
    NSW
    Thanks everyone for the feedback, really appreciated.

    Sounds like I need to have a chat to my mortgage broker to find out how the recent APRA changes will impact my circumstances.

    Simon - is there a good source online where I can read up on LICs and ETFs?
     
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  6. twisted strategies

    twisted strategies Well-Known Member

    Joined:
    1st Jul, 2015
    Posts:
    1,461
    Location:
    QLD
    for LICs . member Austing's contributions/compilations are the best I have seen

    LIC Sector Research Reports

    for ETFs

    Cuffelinks.com.au is a good general place to start to get thinking on which flavours you need , but you really need to research each individual ETF ( INCLUDING the PDS ) very thoroughly even when they seem the same , those little differences can mean a lot .

    Bloomberg also runs several columns on ETFs

    please be VERY careful when using ETFs as collateral for margin loans ( despite the urgings for some sellers to do exactly that ) their $value drops in line with the relevant index ( by the minute ) so rushed selling could very distressing .