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Most people are investing in property in order to build wealth and secure a comfortable retirement. The problem is, many of them jump in before thinking about a way out.
Blogger: Cam McLellan, CEO, Open Wealth Creation
Many property ‘advisors’ promote the need for people to become lavishly wealthy. The really corny ones show pictures of themselves lying on the bonnet of a Ferrari or at the helm of a luxury yacht. In reality they’re only appealing to around 1 per cent of the population.
Most people simply want security in life. They want to pay off their own home and have enough to live a comfortable retirement and if possible pass something on to the kids.
For the majority of the population I’ve outlined the four major exit strategies. The first giving the ability to pay off your own home in a third of the time it would otherwise take if you were to use earned income.
Here are the four main exit strategies:
1. Sell to pay off your debt. There are some pros and cons to this strategy. Many people feel the need to be debt free and their only financial goal is to pay off the family home.
From time to time you will hear people toss around the saying ‘work smarter, not harder’. But the majority of people don’t do this. Instead, they work hard to pay off the family home with income they earn from a job. And that is a big waste of time.
I realise most people have been conditioned to think this way by their parents and society as a whole. But that doesn’t make it a viable strategy. I’ll give you an example that shows why paying off the family home over 25 or 30 years with earned income is a bad strategy.
Let’s say you only ever buy three properties in your life.
Two well-chosen investment properties bought at $500,000 each and the family home also bought for $500,000.
Investment property value - $1,000,000
Family home value - $500,000
Total property value $1,500,000
For simplicity’s sake we’ll assume the total loan amount is also $1,500,000.
Remember tax breaks and rental income will help you fund most of the loan repayments.
As we know, well-chosen property will double in value about every 7 to 10 years. That being the case, all you need to do to become debt free is to hold the investment properties through one full growth cycle and then sell them.
This means your two investment properties will increase in value from $1,000,000 to $2,000,000. If you were to sell the two investment properties at this point for $2,000,000 you would incur capital gains tax of 25% on the profit from the sales (25% rather than 50% as these properties will have been held for a period longer than 12 months). The remaining amount available to reduce debt after tax will be $1,750,000.
You can now pay back the $1,500,000 debt on the investment properties and your own home, leaving you with $250,000 to play with. I’m sure you’ll think of something to do with the extra money.
This is a simple example of what you can do, though it’s not the strategy I recommend. Remember, if the rent is covering the repayments on your portfolio, then what you have is good debt. It’s worth examining whether your desire to reduce debt is due to societies deep-seated belief that all debt is bad.
2. Move one of your loans to principal and interest, or keep it as interest only but start paying off the principal from your excess cash flow. Once you pay the debt on this property, focus your increased cash flow on your remaining total debt.
Your interest repayments have been reduced because you’ve already paid off one house. This means you can pay off your next house in an even shorter timeframe.
This is called the domino effect.
As each loan or house is paid off, cash flow improves and subsequent loans are paid off at a faster rate until you are debt free. This is a reasonable strategy to use while you are still working and it means you can have a stress-free retirement with a solid income. To truly become debt free or to fast track your wealth building, you may need to use the selling exit strategy in conjunction with the domino effect.
3. Neither of the above two strategies are my preferred options however. My choice is to make interest-only payments and live off the equity gains and increases in rental yield.
This is relatively simple process. Once I’d achieved an increase in my portfolios value, I had my portfolio re-valued. I then created a line of credit with the banks. This now allows me to use these funds to live off. This is an ideal situation, as long as your portfolio grows in value faster than your living expenses.
Most people want to know how they can eventually own their properties outright. But ask yourself this. If your portfolio is supporting your loan repayments and providing you with an adequate income, why do you need to pay them all off?
You could simply have your portfolio at a positive or neutral cash flow position and leave it to increase in value. Meanwhile you live off the equity gains. If the value of your portfolio increases on average at a faster rate than your yearly expenses, this may be a satisfactory strategy for you.
4. Hand it over to your kids, if they are smart enough to handle it. You can use this strategy in conjunction with the others I’ve mentioned. Simply transfer control of a portfolio that’s held in trust by appointing a new company director. The actual asset never changes hands so no tax is incurred. You are simply signing across control of the asset’s holding entity.
As with any exit strategy, the right ownership structure is very important.
Remember, your portfolio will be equity rich and positive in cash flow by the time you make an exit. An exit strategy is all about minimising tax and maximising returns.
• Always begin with the end in mind.
• Sell to pay off your debt.
• The domino effect.
• Live off the equity gains and rental yield.
• Give your portfolio away.
About Cam McLellan
Cam McLellan is a successful property investor, businessman and father and the CEO of Open Wealth Creation. In addition to amassing a substantial commercial and residential property portfolio, Cameron has built a group of companies listed in five BRW fast growth lists.
Cam and his wife Felicity built their first portfolio of seven properties when he worked in a call centre and she worked as a recruitment consultant. Cam’s base salary in those days was just $22,000!
While Cam is an accomplished entrepreneur with a track record of success across a number of different industries, his true passion is property. He founded Open Wealth Creation to advise, coach and guide people through the property investment process. Cam and his team help clients with everything from arranging finance and choosing property to finding tenants and portfolio management.