Living Off Equity 2010

Its all a little bit old on this forum. Time to re-ignite.

I have PPR worth $1600M
$200K debt
$800K in availaible offset.

So presume 8% Capital Growth ( conservative even considering last 2 years)

Interest at 7% (again conservative)

Take 66% of the CG AND pay the ineterest- I can enjoy about $60K per annum.

PPR Equity still grows grows by $40K

Debt Grows by $85K compounding year on year but equit still outstrips.

Remember- I have offset account so I do not need to refinance for at least 5 years.


Would love some comment
Damo

 

Damo

It can work but it depends on your age and there has to be good reasons for doing so.

Also, 8% growth long term is not conservative it's optimistic.
Remember that inflation is low and is likely to stay low.

How long are you planning to do this for?
till retirement age?

Assuming that you're now employed, what are you going to do when you stop work?

 

I don't think you it's wise to make assumptions based on the last 2 years, nor do I think past performance of that last 10 will be indicative on the next 10.

If you a really serious about living off equity, then I'd highly recommend understanding, from a monetary economics perspective, as to what drives capital growth. In addition to this I would NEVER recommend anyone looking to retire have any debt.

My personally belief is that real capital growth over the next decade will essentially be none existent.

Once again over the long term 7% interest rates are not conservative, they are quite optimistic. And once again recent history shouldn't be your guide for the next 10 years.

I personally think that we are likely to head into an era of higher real interest rates.

The cost of living goes up each year though, so it's not just a case of equity growth outstripping debt cost, because if the cost of living inflation rate continues like it has over the last 10 - 20 years (ie the cost of living has gone up at a rate of about 5%pa) then you will find that your living cost requirement will quickly force you to eat into your equity.

I definitely agree here.

I'm not so sure about this one. I know the RBA says they will attempt to keep inflation between 2 - 3 percent, but if trouble ever hits Australia like it did the rest of the western world where we are forced to "quantitatively ease" also known as "printing money" then I'd say the notions of controlling inflation within such a low and tight bracket are extremely unlikely.

At the end of the day when it comes to planning for retirement I always just tell my mum to use this conservative and rough formula, take the annual income you'd like to live on and divide that by 2% - 3%. So if you'd want a income in today's dollars of $40,000, then divide $40,000 by 0.025 which equals $1.6M, which is how much equity you'd need to have a long and stable retirement.

Where do I get the figure, 2% - 3%, well this is the rate of productivity growth within the country, and is probably the best estimate of real growth rates because it excludes things like inflation, credit growth, population growth etc that are included in GDP growth figures. At the end of the day we as a nation and individuals only increase or standards of living if we produce more than we did last year.

Of course shares and property go up faster than 2 - 3%pa but this has a lot more to do with elements likes credit expansion and inflation than it does companies increasing productive capacities are rates greater that the national average.

That said everything above is just my opinion, I'm not a financial planner, and take it all with a grain of salt, and just use it as food for thought.

 

Damo,
We have some conservative members on this site which helps provide a view to be considered.
I work with both investors and seniors and I see what the results of the traditional conservative of never use debt (other than for their own home) and they retire on a pension and perhaps small saving but quickly gone due to longevity risk. It is a tough road to face.

I am not sure of how you have described the numbers but I would ask, why not simply refinance, set up a LOC facility and just draw down on that?
Use $60k a year, let the interest capitalise if you want, it is tax free money. As you said, generally equity will outstrip debt for many years. You keep your offset for a rainy day.

It depends on your end goals, longevity, leaving funds for beneficiaries etc but the concept of living a lifestyle now for your benefit rather than doing it hard just so you can leave money to someone to enjoy is a sound concept in my view. In essence it is reverse mortgage arranged by you without the restrictions and paperwork.

The real risk is the lender pulling back any unused LOC facility.
Greg

 

Thanks for your reply GregR,

Maybe I am missing something but.......

If I refinance, and keep my $800K for a rainy day as you suggest, then the new loan would have to pay out $1000K. So assuming 80% LVR (based on $1600K valuation), the bank would lend $1280K- leaving $280K to draw back on. However, without the offset, I would be paying interest on the full loan amount ($1000K plus any drawings against the $280K).

But perhaps I have confused myself........
Damo

 

Banks are making it extremly difficult to use LOE with stricter lending rules as of late

 

Damo,
I may have misunderstood what you have by the terminology used by the $800k in available offset and $200k debt

To me an offset account is essentially a savings account associated with a loan account, so the net balance of the loan account and savings (offset) a/c is used to calculate the interest on the loan.

Is your loan $1m, being a 62.5% LVR against your PPOR and you have $800k in offset so the net debt is $200k?

If this is the case, then your interest on your net debt of $200k is about $14k pa.
Why not draw down $60k from your offset/savings each year and let the interest compound if you want. You will get about 9 years before you reach the $1m loan limit and if your property grows at even 5% pa, it will be worth $2.5m and the loan now at an 40% LVR (up from the current 12.5%). The issue will be to refinance then rather than now depending on your income position.

It can work as a strategy but it depends on your age and what your goals are.
Greg

 

Thanks Greg,
You have summed it up.

This is exactly what I am poposing to do. I am proposing this as a short term plan (max 2-4 years) to allow me to contemplate a career change and add further investments to the portfolio.

As you said originally- essentially a reverse mortgage engineerd by me.

I wonder if the bank has any recourse to freeze or fix some of my offset at any stage in the future ?