Discussion in 'Investing Strategies' started by Jayar, 22nd Jan, 2006.
Living on Equity Part 3 is now available under 'Education'.
15 pages....ENJOY !
This is a good example of a quality article/series that makes InvestEd membership worthwhile.
Just finished reading Bryce Courtnay's Whitethorn, must I must admit I love this stuff too!
If one was starting from scratch using this theory to create wealth....
the idea is to start and continue buying investment properties (using the rental reality formula) until you reach your serviceability limit, use a cashbond to improve serviceability (from drawing down equity), then use excess equity to buy into the Share market, using a 60% margin loan and another IP?
I've read these documents many times already and followed all the forum posts on here and Somersoft but there's one thing thats still not quite clear to me...
The examples seem to show the investor using borrowed money (ie. LOC) all the way thru the process to cover the interest payments. I.e. your effectively using your equity not only for deposits but also to help cover the interest costs.... Am I getting this right? I have no problem with doing this, just want to know if thats what the actual strategy is or if I'm reading it wrong.
Any responses on the last question???
Steve can give you a definitive answer, but I think the ideal would be that you:
1) redraw equity from properties
2) invest that into high yielding shares/funds (eg Navrainvest)
2a) probably get a margin loan to gear the share/fund investment up a bit
3) the improved income from the share investment not only covers the interest on the margin loan and property LOC but funds the deposit and most/all of the interest costs on new borrowings and the increased income is what helps you get over the bank's servicability issues...
To a large extent it will probably depend on the yield you are getting from your properties plus how strong your personal (ie job) cashflow is. Certainly amounts held in the LOC as a BUFFER could be used to help you through periods of cashflow squeeze, but I don't think that's an ideal approach until you're truly at that stage where the portfolio growth far exceeds your total cashflow needs...
But Steve can give you a definitive response...assuming he's finally taken off the grass skirt !
Was wondering this myself the other day...
So, my "income" from my share investment that is over and above the costs of that investment (LOC plus Margin Loan) can be counted as income when applying for a loan? I don't think I'm at my servicability limits yet, but am looking to buy an IP soon that is above my pre-approval limit achieved via my mortgage broker. I thought I might have to sell off some of my shares to use as deposit and thereby reduce my LVR and increase my servicability. If I can hold that portfolio and just count the income in my servicability equation then I'd be better off.
I haven't had to cross the bridge either, but I understand from Steve that once you have say 2 quarters distribution statements some of the banks will count some of that income towards servicability...
On page 12 of the LOE 3 article steve has used the funds from a LOC to cover interest expenses as part of the strategy to build up to truly living off equity.
The funds in the LOC are called the "buffer" which I originally thought would only be used in circumstances where you were out of work for a while or interest rates went up for a while or whatever, but I suppose there is nothing wrong with using it to cover interest for any period where there would be a shortfall.
Use of the distribution from the fund as income for servicibility seems to depend on the financial institution. Westpac were happy to view it as income after a couple of quarters whereas Adelaide Bank seem to want 2 years worth before accepting it as income.
You can always go low-doc...
Another variable to consider is what percentage of the distribution the lending institution actually allows. I think last time I queried Westpac, although they would take into account Distributions from two Quarters, they would only allow 50% of the Distribution.
Is that 2 years of the fund's returns or at least 2 years of returns of you owning the investment?
Would seem stupid if it were the latter.
One example I was given was that some lenders want to see the distributions on two years of tax returns! Westpac at least here sounds better with two quarters.
not sure your question here got answered with the detour into the behaviour of banks! Steve gives the LOC as one option on page 12, which can be used as a buffer like you say. Steve may clarify this, but consider the LOC as a way of converting the equity created in property into cashflow, preferrably via investment in well performing shares (direct or fund), but also as a buffer to cover the interest on an IP, if necessary.
If equity grows faster than the interest and other costs (after rental income, tax returns, etc) you end up with a surplus. For example, if equity is growing by $50k/yr and the negative geared shortfall (in the wash) is only $10k, then extending an LOC to cover the cashflow shortfall isn't going to be a big problem - just not sure the banks see it that way!
If the portfolio is big enough, LOE (... with some conversion via shares/fund distributions ...) becomes possible. By moving the LOC $ into shares and living off the share/fund income $ distributed (after tax), the tax deductability of the original LOC remains - well that's my understanding anyway.
I have seen another approach were this is done purely on the growing equity in property. You extend the LOC to cover both interest and living expenses, but in that scenario the LOC converted to living expenses wouldn't be tax deductible. The beauty of Steve's approach is in linking property and shares together, not selling down your properties, and living off the share/fund distributions ... or reinvesting them
Hope this makes sense, Dave
Thanks Dave, that was exactly what I was after.... the other slightly off-topic posts are also most interesting. Thx.
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