The subject of LOE has been raised more than usual lately....
LOE is risky – this is because of the volatility of IP growth, eg Japan has experienced 50% fall is IP values over the last 15 years, after a significant bubble. However, LOE will work if the risks are reduced significantly – a lot depends on your SANF.
LOE is defined as a concept that entails borrowing ever-increasing amounts to live on secured against assets like IPs & shares. Another attribute of LOE is since you don’t have an income you don’t pay income tax.
A couple of the problems with using LOE are –
Another upside of using LOE is that it can be converted to a low risk strategy at any point in time e.g. if the banks stop lending money, or LVR gets to 80% after a period of no or –ve growth. Sell some assets and invest the profits in lower risk, higher yielding assets eg LPTs. The significant downsides of this are that it’s likely asset prices will be low when you need to sell; CGT will be payable and transaction costs will also eat into the gains....... and you’ll start paying income tax on the income produced. Timing will play a big part in optimally converting a proportion of growth assets into a low risk strategy whilst still incorporating LOE.
I use a combination of options 4,5,6&7. I have significant amounts of undrawn equity (therefore a low LVR), I diversify into shares & LPTs which are counter cyclical to IP, and I have enough +c/f for basic living if growth fails or the banks won’t lend. I pay small amounts of income tax, but compared to the asset growth & income it less than 4%. I have inthe past doen the odd reno.
Diversification
The diversification makes it likely that one of the asset classes is growing at any one time, so I can draw down based on the lower LVR. The stable +ve c/f ensures that I’ll have enough for food & bill regardless of any of the above worst case scenarios. I don’t consider that tenants will stop paying rent, all the blue chip companies stop paying dividends, and the banks stop lending money to be a worst case scenario – it’s likely there’ll be far more serious things to worry about than money if all of those occur at the same time.
Safer as Time Passes
As mentioned above, LOE gets safer as time passes. This is because the low volatility returns increase - ie income via rents & dividends rise faster than expenses - so portfolios become more c/f +ve. The high volatility returns (ie growth) will on average make the real difference to reducing risk, but unfortunately not in the short term (<10 yrs).
Additionally, with purchasing LPTs/quality shares you’ve got a margin lender to borrow from (or capitalise interest) if the banks won’t lend against IP.
Low risk LOE as an optimal early retirement strategy
LOE is risky – this is because of the volatility of IP growth, eg Japan has experienced 50% fall is IP values over the last 15 years, after a significant bubble. However, LOE will work if the risks are reduced significantly – a lot depends on your SANF.
LOE is defined as a concept that entails borrowing ever-increasing amounts to live on secured against assets like IPs & shares. Another attribute of LOE is since you don’t have an income you don’t pay income tax.
A couple of the problems with using LOE are –
- What if IP growth doesn’t happen?
- What if the banks won’t lend any more money for non-income producing investments ie living expenses?
- Pure LOE, relies solely on growth in IPs, with no risk mitigation – this is for the extremely wealthy & confident
- LOE with risks mitigated using a share-trading fund to produce income – this is not strictly LOE since it relies on income.
- Continually value-add/renovate to create equity, and draw down a small proportion of this equity to live on. This assumes you don’t currently want to retire - there are significant tax savings with this type of work.
- Have a huge amount of undrawn equity guaranteed to last 20+ years taking even after into account interest rate rises.
- Use LOE with different asset classes to reduce the volatility in growth.
- Have some c/f +ve income to cover living essentials, and use LOE for luxuries if/when growth occurs.
- Diversify into shares with a margin loan, receive the dividends, but capitalise some/all the interest using a margin loan.
- Have lots of c/f –ve growth IP, continue working to fund the shortfall, but borrow against IP for living expenses. This is similar to capitalising interest.
- Buy 7 houses over 7 years & draw down equity on each one successively after the 7th year - no risk mitigation.
Another upside of using LOE is that it can be converted to a low risk strategy at any point in time e.g. if the banks stop lending money, or LVR gets to 80% after a period of no or –ve growth. Sell some assets and invest the profits in lower risk, higher yielding assets eg LPTs. The significant downsides of this are that it’s likely asset prices will be low when you need to sell; CGT will be payable and transaction costs will also eat into the gains....... and you’ll start paying income tax on the income produced. Timing will play a big part in optimally converting a proportion of growth assets into a low risk strategy whilst still incorporating LOE.
I use a combination of options 4,5,6&7. I have significant amounts of undrawn equity (therefore a low LVR), I diversify into shares & LPTs which are counter cyclical to IP, and I have enough +c/f for basic living if growth fails or the banks won’t lend. I pay small amounts of income tax, but compared to the asset growth & income it less than 4%. I have inthe past doen the odd reno.
Diversification
The diversification makes it likely that one of the asset classes is growing at any one time, so I can draw down based on the lower LVR. The stable +ve c/f ensures that I’ll have enough for food & bill regardless of any of the above worst case scenarios. I don’t consider that tenants will stop paying rent, all the blue chip companies stop paying dividends, and the banks stop lending money to be a worst case scenario – it’s likely there’ll be far more serious things to worry about than money if all of those occur at the same time.
Safer as Time Passes
As mentioned above, LOE gets safer as time passes. This is because the low volatility returns increase - ie income via rents & dividends rise faster than expenses - so portfolios become more c/f +ve. The high volatility returns (ie growth) will on average make the real difference to reducing risk, but unfortunately not in the short term (<10 yrs).
Additionally, with purchasing LPTs/quality shares you’ve got a margin lender to borrow from (or capitalise interest) if the banks won’t lend against IP.
Low risk LOE as an optimal early retirement strategy
- The much publicised Pure LOE is v. risky with relatively small amounts of equity & high LVRs. Waiting until the LVRs are lower or equity is much higher will reduce risk, but takes an extra property cycle or two for this to happen.
- The traditional approach of waiting until rents provide enough +ve c/f is v. slow.