Reflections on a Broken Strategy

Back in 2009, I posted about a strategy that got me very excited about an early retirement.

Basically, it involved an acquisition phase, followed by an LVR equity draw-down phase. It all seemed so simple back then. The GFC had just hit, but the housing market stayed resilient and there was no suggestion of the 7% annual growth pattern subsiding. How wrong I was.

It's now 2011 and my properties have performed dismally. When I mean dismally, I mean DISMALLY. There had been virtually no rental increases on any of the properties and CG has, instead of the 7%, been on average 1-1.5% per year. DISMAL.

What else has caused a deviation from this 'plan' I hear you ask? It's only been two years after all, hasn't it?

The answer is cash flow. Without boring you with details, I have had to unload two properties; one, a money hungry beast with some maintenance issues the other just came along at EXACTLY the wrong time.

Rather than point the finger, I think it's basically a combination of a few factors, and probably the weird alignment of some planets, that has lead to this scenario.

So where to from here? Cash flow is now looking better thanks to the sales, but we are now looking for a PPOR, which will 'lock away' more cash flow. Will the market return to the 7% days, I honestly can't tell you, but what I can say is that in Queensland anyway, the $400,000 psychological price ceiling is still well and truly alive and wages just aren't going up fast enough. So, for an average investor like me, it's just not happening. I am looking to hold on to properties, but when rents are not going up, and prices are staying stagnant towards the bottom end of the market, it's not looking pretty.

Until next time...

I got a little bit excited this morning...

No, it wasn't that I had a dream of eating KFC, it was a realisation upon reading this forum post. Rixter quite rightly puts forward a good argument here. After I read it, I decided to do a little tinkering and I have come up with my own strategy. I'm going to call it the "5/7 Strategy". It all makes so much sense with numbers, I got a little bit excited with the prospect that I could retire in 5 years time. Anyway, let's see it I can explain the 5/7 as clearly as possible:

In a nutshell, the 5/7 Strategy will allow you to retire in 5 years, by owning 7 investment properties.

This strategy assumes that the 7% annual growth that has historically continued, keeps going...there is little to suggest it wont.

In Year 1, you buy two houses, valued at a measly @200,000 each.

In Year 2, you buy one more.

Year 3, one more.

Year 4, one more.

Year 5, two more.

I would assume it would be vital to not cross-collateralise, as you will be drawing down on each properties' individual equity.

Year 6 - first year of semi-retirement

So by Year 5, you have accumulated 7 properties. The first property would now be worth $300,000 and you draw down the equity in this property to the maximum 80% LVR (loan to value ratio). So this gives you $40,000 for the year. You perhaps will need to continue to work part time to really sustain a higher standard of living, but you could easily live on this. This will provide you with approximately $770/week. Admittedly, this is not a huge amount, but you don't have to lift a single finger, or pay any tax on this amount. It's the equivalent of a $57,000 annual wage, before tax.

Year 7

It's now time to draw down on IP2 - Another $40,000 for the year.

Year 8-12

You continue to draw down 80% LVR on all of your acquisitions with 40K in your pocket every year.

Year 13: Jackpot!

By now, you have owned your first purchase for 12 years and, by following historical data, it will have doubled in value and it's now worth $400,000. This will mean you can now draw down the remaining $120,000 of your 80%LVR and this is the equivalent of a $171,000 pre tax wage.

That's it! It's really quite simple, well, definitely sounds very simple and it seems reasonable. Here is a little catch. If you can do this with $250,000 properties, EVERY YEAR you could draw down $96,000 and it would mean that by Year 13, you would draw down $104,000 tax free as well! Imagine that! Yes, you will have to repay the mortgages, but you have rental income coming in helping and you MAY need to work. At a minimum, imagine the extra cash coming in, tax free!

I think I may be able to do this...I'm getting a bit excited though and I'm sure there will be something that I missed and will mean this dream will crash. BUT, I'm optimistic. So here is where things get interesting (for me at least).

I have just purchased a $255,000 house, I also have another that was purchased for $390,000 and one for $151,000. I'm about to purchase another for $195,000. So I am possibly ALREADY in Year 2 of this plan. Furthermore, I have a block of land that has at least $100,000 in equity. The only issue for me, is that they are cross collateralised, but I'm sure my trusty broker and I can change that. SO, I have to acquire three more, one next year, one after that and one after that. THEN, I can possibly retire, or at least, a scenario that allows me to have some choices in my life. Like how much KFC I want to eat.