How to live off equity
September 26, 2016
At the end of the year as we get closer to Christmas, I always find people start thinking about how great it would be if they didn’t have to go back to work. This brings them to thinking about how much they will need for each year of retirement and how to go about accessing their equity.
When people start building their property portfolio it is all about buying and holding and many can’t visualise an exit strategy when the time comes to retire.
In the early days we thought we’d buy 10, sell five, pay off our debt and own five outright. This is a nice little dream for people who can’t handle debt but it’s not necessarily the best solution. There is a much better way to access equity. For me it was a light bulb moment when we realised we didn’t have to do anything but wait, to access our equity and it changed my life.
Let’s say you purchase five properties for $500,000 each, so your portfolio is worth $2,500,000. If you wait for 10 years, this should have grown in value to about $5,000,000. If you had a loan-to-value ratio (LVR) of about 80 per cent, or $2,000,000, you would need to wait until your portfolio had grown by about $3,000,000 to have a difference between your value and required LVR level.
At this stage you would be able to create an equity loan or line of credit. After you put aside the money required to hold the properties, you should have $2,000,000 in equity to fund your lifestyle. Now if you want $100,000 a year, that’s 20 years of living! The great thing is, if you’re chewing into this money for 10 years and it goes down to $1,000,000, your portfolio will have doubled in value again to $10,000,000.
So when you go to your bank, 10 years down the track and you’ve lost a bit of hair and gone a bit grey, you can say, “Hey look, the property’s now worth $5,000,000 and I owe you $3,000,000 – can I have $1,000,000 to take it to 80 per cent?”
They’re going ask how you are going to support your loan and you’ll be able to, through rental growth. If your properties are bringing in about $450 a week now, by then they might be bringing in $800 or $1000. When my business partner Al bought his first property about 16 years ago his tenants were paying $100 a week, these days his tenants pay $400 per week.
This isn’t an exceptional property but Al is $15,000 a year in positive territory and is still getting growth. Now if Al has five of these, he is $50,000 ahead and this reduces the amount he has to draw out. At the moment property is rising by 8.34 per cent each year, so if your portfolio is valued at $5,000,000, you’re making $400,000 a year.
A lot of people ask about the right time to start drawing out equity. I like to play it very safe and have a huge amount of equity. If for some reason a property takes 12 or 13 years to double in value, you still have a buffer if you wait. So investing is all about having a buffer and not putting things to the wire.