Where to from here?

Discussion in 'Investment Strategy' started by Harry Marcus, 27th Dec, 2019.

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  1. Harry Marcus

    Harry Marcus Well-Known Member

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    Hi All,

    Long time reader, seldom poster :)

    After a few years of inactivity, I'm considering actively moving towards a 'slow burn' property acquisition plan (perhaps 1 every 2 years?) with a focus on CG (vs. yield) and focusing on older walk-up / low-rise buildings in quality Sydney areas.

    As it stands today at mid-30s:
    • have a PPoR (valued approx 1.5M, debt approx 1M IO with over 80% of that offset with a cash account, so very little interest being paid)
    • An IP worth circa 500K (80% LVR IO, approximately -6K annual -ve geared).
    • Gross salary north of $300K, so OK to hold property negatively geared at this stage.
    • Serviceability wise, I can probably take on close to 1M incremental debt at this stage.
    I have some reluctance with my plan which is largely derived from:
    • Significant G/R in the last 5+ years in Syd and a pragmatic view of little CG for the foreseeable future
    • Aside from direct shares (~100K), I have no real exposure in the share market. I know logically I should probably diversify but significantly outside of my comfort zone and not sure where to even start (almost put some coin into Six Park but am yet to pull the trigger)
    • I guess like everyone, there is associated risk with the continuation of salary (or at a certain level) so keen to have manageable debt levels in order to sleep properly at night...
    Based on this, I'd be super curious to know if the experienced heads of Property Chat would think my 'slow burn' plan is ideal or whether I should be considering alternative thinking at this stage?

    Happy holidays....!
    Harry
     
  2. Jess Peletier

    Jess Peletier Mortgages, Finance & Property Strategy Aust Wide Business Member

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    Hi Harry and welcome :)

    What end result are you trying to achieve?

    It's hard to know what's right without knowing the end goal.

    Why Sydney over other cities/states?
     
  3. Harry Marcus

    Harry Marcus Well-Known Member

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    Hi Jess,

    Thanks for your reply.

    The golden question really. I guess it boils down to building a strong enough asset base to comfortably retire somewhere between 55-60 (17-20 years).

    This is essentially the core of it - there may be a need to upsize PPoR in the next 3-5 years but that's not entirely a priority as it stands today.

    I think it's comfort around accessibility and keeping close to what I know. Plus, I generally look for properties I can spruce up a little (to manufacture some CG off the get go) which is hard to do / coordinate from a distance.

    With that said, I'm not completely closed to exploring other states / cities.

    I hope that clarifies my position?

    Thanks Jess.
     
  4. The Y-man

    The Y-man Moderator Staff Member

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    Maybe check out the LIC threads (be prepared for a long read!) and REITs (search terms reit, "property trust")

    The Y-man
     
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  5. The Y-man

    The Y-man Moderator Staff Member

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    BTW congrats on getting to where you are. I don't think there is anything "wrong" with it.
    In many ways, each to their own.

    But the question I suspect you are really wanting to know is: how to convert the properties into income that supports your retirement.

    The Y-man
     
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  6. Jess Peletier

    Jess Peletier Mortgages, Finance & Property Strategy Aust Wide Business Member

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    Do you know how much you need for retirement?

    You can proceed without knowing, but it's kinda like trying to hit a target in the dark... ;)
     
  7. Harry Marcus

    Harry Marcus Well-Known Member

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    Thanks Y-man, I've started digging into REITs and no doubt, once I hit a wall I may come back with a question or two. Appreciate the nudge into that direction...
     
  8. Harry Marcus

    Harry Marcus Well-Known Member

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    Hi Jess,

    This is a difficult question to answer (I'd be surprised if anyone can clearly articulate this).

    Like most, I'd want to follow an optimal path that would maximise how much we have in retirement. Does quoting a specific number - let's say 200K p/a passive income at retirement vs. 300K p/a significantly alter a potential strategy to be implemented?

    I guess I struggle to articulate a particular target - how can this question be answered in a way that could help suggested long term investment strategies?
     
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  9. euro73

    euro73 Well-Known Member Business Member

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    All depends on what you want to achieve, but if you are after @200K income in @ 17-20 years, here is something to consider;

    1. PPOR - Sacrifice the 800K of funds in offset . Reduce your PPOR loan to 200K. This will immediately improve your borrowing capacity significantly

    2. Re-borrow 700K of the 800K you just sacrificed.... but this time for INV purposes so that the debt is deductible. Set it up as 5 x 140K sub accounts. So you'd have 6 sub accounts in total
    #1 would be the 200K P&I PPOR debt
    #2,3,4,5, and 6 would each be 140K, and would be used to fund 20% deposit + stamp duty + expenses for a 650K Dual Occ purchase. . Total debt against the PPOR would be 900K, which is less than you carry now, but 200K would be non deductible and 700K would be deductible.

    3. Borrow 520K x 5 for the purchase of 5 x Dual Occ's.


    You'd have 3 Million secured by the INV properties ( 2.6 for Dual Occ's and 400K for existing INV) + 900K secured by the PPOR , for 3.9 Million total debt . 3.7 of it would be INV debt and 200K would not.

    Set all loans to P&I ( including your existing INV property) and let them pay themselves off within 17-20 years . Even with zero growth ( which is unlikely) you would end up owning all the assets outright for a total asset base ( excluding the PPOR ) of 3.75 Million, but you'd have 11 x rental incomes. ( 10 from the 5 x dual occ's, and 1 from your existing INV property) The Dual Occ's are already producing over 40K of rental income. 5 of those is 200K , plus whatever your existing INV property produces. You'd only need 50-60% rental growth over 17-20 years for the rents to reach @ 350K . Allowing for your expenses to double from @ 6K to @ 12K per property over the same 17-20 year period, you'd have total expenses of @ 72K across your 6 INV properties. That would leave @ 278K as taxable income. But you'd still have at least 7 or 8K of depreciation on each of the 5 x Dual occ's , so that taxable income would reduce further to @ 238K .... tax on 238K is $80,197

    So if you are grossing 278K after expenses but before depreciation, and being taxed @80.2K ( based on 238K taxable) , that should leave you with a net income of @ 197.8K...pretty close to the 200K you want. Of course, considering that tax rates will fall as the 37% marginal tax rate is phased out, the tax paid on 238K will be less than $80.2K, so you'll net more than 200K in all likelihood:)

    Assumptions used.. Your borrowing capacity is adequate to do this. Loans are all set to P&I . Rental inflation is only 50-60% over 17 - 20 years . Expenses double in 17-20 years. No growth is assumed, although it's unlikely that would occur.


    OR - a different approach might be to take the same 3.9 Million total lending and chase blue chip growth instead ... If you are able to achieve say 5 Million in growth over 17-20 years, you could sell the properties, GROSS $5 Million profit, and then allowing for @ 1.125 Million in CGT, you'd be left with @ 3.875 Million. Reinvest it at 6% and you can get @ $232,500 Gross... You'd pay $77,497 in tax, for a NET income of $155,003. Or if you can reinvest the post CGT profits at 7% you'd generate $271,250 Gross, or $176,090.50 NET. Or if you can reinvest the post CGT profits at 8% you'd generate $310,000 Gross, or $197,403- which is a pretty similar kind of outcome to Dual occ's + 50%-60% rental inflation + zero growth...... except it requires 128.2% capital growth + 8% returns ... and we haven't accounted for the significant non deductible holding annual holding costs you'd incur with those kinds of low yielding blue chips when they go P&I and are costing you tens of thousands per year just to hold onto...none of which would be deductible. So it would be very likely to actually require significantly more than 128.2% capital growth just to match a zero growth strategy of debt reduction that the Dual Occ's would facilitate.... let alone to outperform it . You'd need closer to 150% growth...maybe more.

    Also consider that this comparison assumes the Dual Occ's achieve ZERO growth and only 50% rental inflation.... but if the Dual Occ's outperformed one or both of those two assumptions over 17-20 years, you'd need even more than 150% capital growth from the blue chips and even more than 8% returns on the post CGT profits just to match the outcomes they produce, and even more to outperform them. The reason is simple - the repayment of the debt in one approach versus the non repayment of the debt in the other. Proponents of growth always ignore the benefits and advantages of removal of the debt in their arguments- but the maths is the maths. Basically, a growth based approach is speculative and requires every kick to produce a goal, every play to be a spectacular winning play, and for holding costs to never be a problem , and the other , cash flow and debt reduction approach requires none of that. Just straight up dividend reinvestment - ie buy assets that produce a dividend and reinvest it for debt reduction. All they have to do to get achieve the goal you have outlined is to pay themselves off and deliver 50% rental appreciation over 17-20 years.

    Also consider that we also haven't accounted for the massive change to your borrowing capacity as the debt is repaid and the rents mature .... allowing you to add additional properties if you choose to, which can also be paid off very quickly , adding even more income, which allows even more purchases, faster debt reduction and more income, which allows even more purchases, faster debt reduction and more income, which allows even more...... Growth strategies produce equity but do not improve your borrowing capacity.

    Failure to pay down debt is why so few people get adequate retirement incomes from resi property , even after achieving significant growth. It's not a theory. It's a proven fact. We have 30 years of data proving it... 30 years of unbelievable growth has produced just how many wealthy, self funded retirees with 6 figure incomes? After all that easy credit and easy growth.... where are they all? Yes, many people have banked large lump sums from growth, but the reality is that unless you make millions - and I mean 4 or 5 Million of post CGT profits ( so 6 - 6.5 Million of Gross profits ) , you wont get to $200K net per annum.... That's why debt reduction is likely to be a superior strategy if a large income stream is your goal...

    Or you could buy commercial ...the yields there are better than anything in resi.

    Or you could buy old housing commission stock and flip them like @skater .... if you can do that 2-3 times a year and bank 300K per annum, over 17-20 years you can build up millions and live off that .... but in the end, if income is the prize, and because no one sells goggles that show the future, you can only look at what you want, do the maths about what you need to get there, look at what others have achieved for the past 30 years , and then decide what approach is likely to deliver you what you want.

    Separately - I'd also be looking into what you can do with super if I were you, to create an additional pool of income in a tax free environment .... at your level of salary you could potentially be using leverage + member contributions very effectively to build another 6 figure income stream . But of course, professional advice would be needed.
     
    Last edited: 30th Dec, 2019
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  10. The Y-man

    The Y-man Moderator Staff Member

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    Two variables - time to get to the "retirement income" and the amount of "retirement income".

    Kinda works like this (in my simple mind anyway):

    Let's say you have absolutely proven to yourself that you can survive on $30k pa (that's like no job, but keeping a roof over your head, keeping yourself clothed from vinnies/salvos/savers and eating basic healthy food without resorting to instant noodles and roadkill.... actually stuff it, take the road kill when you find it)

    For me, I believe I can reasonably expect to generate about 5%pa from my reits and shares dividends.

    So I need $600k of shares/reits to do this.

    (I haven't taken tax into account here, but at $30k income, it won't be a biggie).

    So now it comes down to how quickly can you get that $600k and how quickly you can learn how to drive the income.

    If you are earning $300k per year, and you can live on $30k pa (this would be a great test!!), you can stash away say $170k pa (coz tax will take $100k or so).

    So in 3.5 years, you should have enough stashed away to generate a minimum retirement income (survival minimum).

    Incidentally this exercise becomes much harder for those on even $100k, because it is going to take 15 years of living on "survival mode". That's why we go into other modes to "supercharge" the whole thing by leveraging into resi realestate, build up capital, sell it down the track so we can make up some time.

    In many ways, IMHO, for your case you could build that "saftey net" $30k pa (or whatever your figure is), and then if you are still working (after 3.5 years!) you can go splurge, or invest in other things be it houses, horses whatever AS LONG AS YOU PRESERVE the survival capital ($600k in my example). If you can build that working capital to $1.2m, you'll get $60k from it. Build it to $2.4m and you get $120k pa from it. Anything you don't spend, you can put back in to grow more.

    Again, for simplicity I am ignoring interest rate changes, inflation, invasion by a foreign nation, yadda yadda (figure that bridge out when we get there).

    Hope it all makes sense.

    The Y-man
     
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  11. Jess Peletier

    Jess Peletier Mortgages, Finance & Property Strategy Aust Wide Business Member

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    It's an interesting one - I think the path to $200k passive v $300k passive isn't that different...

    But $50k passive and $150k passive is very different.

    Do you know which your currently on track for?

    The problem is, most people don't... And they find out to late that they're closer to the former. :)

    It's not about having a really strict target, but more about being really clear where you want to be so you can be sure the actions you're taking are the right ones... And the right quantity at the right time.

    Because time is the biggest asset we have in wealth creation, so you don't want to leave things to late.
     
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  12. Mel Morgan

    Mel Morgan Sydney Property Manager Business Member

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    Since retirement is so far away, it may be hard to quantify exactly how much you need, but building a diversified portfolio of properties will give you options whether its selling down properties to fund retirement or living off the passive income.

    I would diversify not just in location over time, but also in type of property so that a portion would hopefully have CG over time whilst others are there for cashflow to allow for additional debt down the track.

    I also understanding wanting to buy some in Sydney so that you can get a head start with a reno/value-add, its something I've done in various degrees on my Sydney properties.
     
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  13. Sackie

    Sackie Well-known cafe bum of the East Premium Member

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    Imho the most realistic way to have massive ass CF after a period of investing is either though business and or building up a large amount of equity. Or commerical RE.


    I've said many times over the years, to have something like 300k passive income, your foundation ( aka mindset/daily habits) need to be super rock solid. So to does your level of commitment and somewhat obsession. Otherwise, imo, it just ain't gonna happen for most.
     
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  14. Harry Marcus

    Harry Marcus Well-Known Member

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    Hi Ultan,

    Thanks so much for the comprehensive response - that strategy certainly isn't one that has been in my consideration set at all. Once I've fully digested it I'm sure I'll have a number of follow up questions (a few have already come to mind).

    I am tempted by the flipping strategy, although ultimately with a relatively full on job (and a young little family) I'm not sure whether I practically have the time needed to pull it off.
     
  15. Harry Marcus

    Harry Marcus Well-Known Member

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    Thanks Y-man, that makes complete sense. We're on track to save approx $120K p.a, which should have us topping out the offset on the PPoR in just under 2 years. We'll no doubt continue to save as much as practically possible whilst earning at our prime.

    I've bookmarked some resources on REIT (as per your suggestion) which will make for some good reading while I'm on a long flight this weekend.
     
  16. craigc

    craigc Well-Known Member

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    Also consider your Super. I assume there is employer contributions going there and although it may not be directly controlled in your name, you are likely exposed to shares through your super fund.
    Well done on your position so far too!