5 Living Off Equity Strategies to Speed up Retirement

5 Living Off Equity Strategies to Speed up Retirement


Example for this thread
Tom has a $3,000,000 property portfolio generating 4% yield or $120,000 per year in rental income. The interest and expenses for this portfolio are currently $70,000 per year netting Tom $50k. But Tom needs approx $80,000 pa to live on. He is nearly there, but just $30,000 per annum short if his target. (all before tax)


Tom’s investment properties are worth approx $500,000 each and he has 6. His loans total about $1million or averaging about $166,666 each. Note that this is a great position to be in, but to get enough to live on Tom thinks he has 3 choices:

1. Pay down loans further. He needs approx. $30k more in income so he would need to pay the $1mil loan down to about $400,000. That is an extra $600k off them.

2. Sell 1 property and use the proceeds to pay CGT and pay down the remaining loans. But sale of a property and bringing forward tax means he has less capital working for him.

3. Wait for rents to increase. To get an extra $30k pa in rent across 5 properties would mean an extra $6k per property or an increase of $115 per week in rent across the 5 properties. It will take a while to happen.

But he has other options to quicken things up.


Strategy 1. Traditional Living off Equity (LOE)
The traditional LOE strategy involves borrowing to pay for living expenses. Tom has a good income so he could take out a $400,000 LOC and draw down $30k in the first year. The second year will see rents rise so he may need only $27,000 in income shortfall which he borrows. Interest will be approx. $1500. But the actual figures would be less as the LOC may be drawn weekly and this will reduce interest payable as money is only borrowed when needed. With a $400k this should last him 10 to 15 years. His $3million in properties should have doubled in value by then.


Strategy 2. Living off Rents
The strategy outlined in strategy 1 above is to borrow to pay for living expenses, but this is not so good because it results in loan interest not being deductible as living expenses are private in nature. Instead of doing it this way may be possible to use rents to pay for living expenses and to borrow to pay the interest on the loan. Interest on Interest is deductible if the underlying interest is deductible, but the ATO will possibly use Part IVA of ITAA36 to deny the deduction where the dominant purpose is to pay off the home loan sooner. See my thread Tax Tip 16: Capitalising Interest

In the situation of a person having their home loan fully paid off, no employment and a need to pay interest it is likely that the interest on a LOC used to pay the interest on other investment loans will be deductible. But Tax advice is needed if contemplating this.

Tom from above needs $30,000 extra for living expenses, so instead of borrowing to live he uses the rents and doesn’t pay the interest on one property which is rented for $500 per week (and a second property perhaps in part). Instead he borrows from a LOC to pay this interest. Interest on $30,000 would be about $1500 per year so he may save about $500 per year compounding after taking into account tax savings. This can stretch his LOCs to last longer and/or have a higher living standard.


Strategy 3: Don’t Pay down loans
Some people pay off the PPOR and then try to pay down the loans on their investment properties to make increase the income received from the investment properties. Paying down debt can be good, but not paying down can speed up retirement and can be more tax effective.

By taking out long term Interest Only loan periods excess cash can be stored in offset accounts on the investment properties (after the non-deductible debt is paid off). This would save the same amount of interest on the loans, but provide cash available for spending to supplement the cash flows of the properties.

Once Tom stops work he can then live on the cash flow from the properties and supplement this will cash from the offset accounts. The added benefit here is that everything Tom buys using cash from the offset account will be similar to borrowing to buy them as the interest on the loan will increase as offset money is withdrawn, but the interest will be deductible. See Tax Tip 82: Taking money from an offset account on an IP and Claiming Interest



Strategy 4: Eat into Capital
All of the above strategies involve leaving properties with substantial equity at death. Another option is to eat up capital so your heirs get little to nothing. This is ideal for those people that hate their children.

Tom could sell all his properties and incur large amounts of CGT or he could take his loans up to 80% or even 90% if his income is strong at the time of application and he could blow the lot before dying. CGT would only be payable when the properties are sold. This could be by the estate if the executor sells or by the children (or other heirs) when they sell. But any loans attached to that property would need to be considered carefully as loans are payable out of the property they are secured by. See Legal Tip 74: Loans Death and Inheritance


Strategy 5: Keeping instead of Selling
This strategy is really sub-strategy of the above strategies, but I should point out that some plan to sell one or more properties to either pay down the loans, keep money in the offset to supplement living expenses, or to just live on the proceeds. The problem with this is that once you sell a property you are giving up any future capital gains of that property and you are giving up the rental income which should keep rising with market forces (ie killing the goose that lays the golden eggs.

With the living off equity strategies above a person may be able to retire earlier and/or to keep a property that would otherwise need to be sold.


Some other strategies
Other strategies include selling one or more properties, paying tax, but then investing into direct shares or index funds. The benefits here are higher yields, franking credits (which are great in retirement when incomes are lower). The big benefit is that there are little ongoing costs involved. No land tax, no stamp duty on purchase and the ability to sell down a few shares here and there to supplement retirement income (you will find it hard to sell 10% of a property).

Selling and making a non deductible contribution into super is also worth considering. Any advice on super or shares in financial advice and you should seek a licenced financial planner to find out more.


Feel free to criticise my ideas and tear the strategies to pieces,

 

I realise these are example figures, but at 50k net, Tom really needs to play somewhere more profitable.

 

As another potential strategy to consider in the mix: Tom could take the $400k LOC and buy shares. The dividends would roughly equate to the loan interest payments (which I believe are also tax deductible as they are used to purchase an income producing asset).

The dividends however should grow year on year and this delta can snow ball into an income stream to augment the primary $50k.

He should probably try to get a much larger LOC though

 

Great strategies. If we were to change the person from Tom to Terry_w which strategy would he most likely pick and why?

Cheers,
Oracle.

 

Selling up and getting (est after CGT) $1.8M index fund shares @ 4.5% net dividend yield instead would make for a very relaxing $80Kpa retirement scenario right now. Stocks are even on sale ATM.

 

A combo. I would keep all loans IO if possible, save into the offset accounts and then set up the LOC so I could borrow to buy index funds, keep a buffer and use the cash in the offset to live on.

 

I have a client who is doing exactly this. She has sold a property in which the loan has been fully paid off and placed the money in a mixture of vanguard index funds. A property with low or no loan is not leveraged and in Sydney the yields are about 3% on top of this you have land tax and repairs and maintenance. You would be lucky to be getting a 2% yield. Capital growth may be slow for a while as well.

 

Yep, he should be able to buy shares that return more than the interest, even if he bought EPW shares and got a 9% return he could pay his interest with half put half in his pocket and also get any capital gain

 

I would suggest that Tom's strategy is flawed from day 1, if he's only got a yield of 4% on $3m of property, and that he's not quite ready to retire.....or that he learn to live on $50k.

Please also note that you say he's got six properties, then further along you say five.

 

Its called creative accounting.... much like DSE

 

Thanks Skater - I changed it to 6 because easier to divide into 3mil, but the same principles.

I think 4% is a common yield for most properties that people get for properties.

 

Can you please run that past me again I didn't get it the first time!

 

Lol. I meant the loans, was trying to get them to be an even figure $200k each rather than $166k, but I didn't go back and change it.

But this doesn't effect the outcome as the totals would be the same.

 

How easy is it to extend the IO period on 5-6 properties though in a post APRA world?

How long is he likely to be able to extend for? Probably not the length of a whole property cycle ?

 

As long as serviceability is met it should be possible. generally 5 years max, although 10 years is possible with some lenders. By this time the rents should have increased. Also when increasing the IO period he should extend the loan terms to 30 years again so that when IO does expire the PI repayments will be lower.

 

As easy as your serviceability allows, which for most people isn't easy at all for those kind of figures. Most lenders would only allow a 5 year extension of the I/O period. I suspect that in the future even that might be a stretch.

 

Or you can just refinance to another lender once the maximum period is reached to stay on IO

 

2mil equity & making net 50k per year? I think tom needs to move into an asset class with a better yield. Then retire?

 

That would mean CGT and possibly stamp duty. Worth considering perhaps. Don't forget that is after costs.

 

Terry, could you give us a breakdown of the 70k worth of costs please?